On Fixing the Alternative Minimum Tax

When people vote for candidates, they are not just voting for an individual, they are voting for a party. I don’t just mean in terms of control of the White House or Congress, but in a philosophical sense.

The two parties have very different philosophies on various issues, and when one votes for a candidate of a particular party, one essentially is voting for that philosophy, regardless of the views of the individual candidate. No matter what that candidate may say or believe personally, over time they eventually are forced to conform to their party’s philosophy if elected.

On tax policy, it is pretty clear what the two major parties think. Democrats believe that the tax system should be used aggressively and systematically to equalize incomes. Those at the top must be brought down by high tax rates, and those at the bottom should be lifted up by tax subsidies, such as the Earned Income Tax Credit.

Republicans, on the other hand, generally believe that the tax system exists mainly to raise the revenue needed to fund necessary government services and should not be used to implement social policy. In principle, Republicans believe that we should have a tax system that interferes as little as possible with economic and social decision-making.

Obviously, both parties fall far short of their own ideals. Nevertheless, one can
assume that tax policy will tend toward each party’s philosophy if they are given the power to make policy. Therefore, it is worth looking at specific tax policies to see how the two parties differ, as an indication of how they might act on a broad range of issues. A good example is the Alternative Minimum Tax (AMT).

The AMT grew out of testimony by Treasury Secretary Joseph W. Barr, who was secretary for about two months at the very end of Lyndon Johnson’s Administration. Just days before Richard Nixon took office in January 1969, Barr used to his position to publicize the fact that 155 wealthy taxpayers had avoided paying any federal income taxes in 1967 because of legal tax avoidance techniques. This was considered a scandal that demanded legislative action.

In the Tax Reform Act of 1969, which Nixon stupidly signed into law, the AMT was first imposed. The idea was that if people were too aggressive in using tax deductions, credits and exclusions, they should be punished, even if everything they did was perfectly within the law.

In 1986, largely at the behest of Democrats, the AMT was broadened into the form it is now. Taxpayers calculate their taxes under the ordinary income tax and again under the AMT, and pay whichever yields the higher tax.

Under the AMT, many deductions that are legal under the ordinary income tax are disallowed. One of the most important is the deduction for state and local taxes. As a consequence, the AMT tends to heavily hit people who live in high tax states like New York. Indeed, some analysts have taken to calling the AMT the “Blue-State Tax,” since most of the states hit hardest by the AMT are those where the Democratic Party is strongest–i.e., those that voted for Al Gore in 2000.

The real problem with the AMT is that its income thresholds are not indexed to inflation or real income growth. As a consequence, many of those who were considered rich in 1986 are simply middle class today. This illustrates an important point about tax policy: Laws designed to soak the rich eventually end up hitting the middle class.

Since the middle class earns the vast bulk of the nation’s income, any tax that significantly affects this segment of society is going to raise a lot of revenue. And so it is with the AMT. According to the Treasury Department, by 2013 the AMT will raise more revenue than the regular income tax.

On May 5, the House of Representatives voted 333 to 89 to protect 9 million middle-income taxpayers from paying the AMT next year. Three to four million of the “wealthy” would still pay the tax. Even though this fix would apply for just one year, 89 Democrats still voted against it. Further proof that each party really does have a different philosophy.