The Alternative Minimum Tax was born in 1969, in a fit of populist indignation over the use of tax breaks by rich people and corporations to wipe out their tax liabilities. Rather than prune the tax breaks, Congress created a parallel tax code to make sure no one paid too little. Many taxpayers thus have to compute their tax liability under both the regular and the alternative code, and pay whichever is the higher.
In the alternative tax code, tax brackets are not indexed for inflation or wage growth. Since more and more people are rich by the dollar standards of 1969, more people pay the tax. Bush’s tax cuts have lowered many people’s regular tax liability to the point where they, too, must pay the AMT. Unless Congress and the president act, 23 million people will pay the AMT this year.
Both parties have objections to the AMT. Because the AMT does not include a deduction for state and local taxes, it is hitting more and more residents of high-tax, which is usually to say blue, states. This feature of the AMT is one of its merits: A deduction for state and local taxes amounts to a subsidy by low-tax states to high-tax ones, and thus encourages states to keep taxes higher than they should. But the increasing pain the AMT is inflicting on blue America is the reason many Democrats want to reform or repeal the tax. Republicans, meanwhile, dislike, or ought to dislike, the way the AMT punishes large families and investment, its raising of marginal tax rates, and the deadweight loss to the economy of making people fill out two tax forms.
Until now, Washington has passed temporary “patches” that minimize the damage from the AMT each year. Now Charles Rangel, the chairman of the House Ways and Means Committee, is proposing to abolish the AMT for individuals. He is also proposing to cut corporate tax rates. That’s the good news.
The bad news is that he has chosen the most economically damaging way possible to compensate for these tax cuts. His plan assumes that most of Bush’s tax cuts will expire and that taxes on capital gains, dividends, estates, and high earners will therefore go up. Then Rangel adds on still more taxes. People making more than $200,000 (or maybe more than $150,000 — the precise number has not been determined) would pay an additional 4 percent tax; people making more than $500,000 would pay 4.6 percent. The top marginal tax rate would thus go from 35 percent to 44.2 percent. It is an anti-growth plan that ought to be stopped.
Conservatives in the House, led by Rep. Paul Ryan, share Rangel’s interest in abolishing the AMT as part of a larger tax reform, but their reform looks very different. They would create a new, reformed tax system with lower rates and less complexity. Taxpayers would be able to choose between filing under their new system or under the old tax code, but the AMT would be eliminated. They do not want to find a way for the government to recoup the revenues it is forgoing by getting rid of the AMT, since they do not believe it was entitled to that money in the first place.
Representative Ryan’s plan is admirably pro-growth, but we confess to some concerns about his version of reform. The current system overtaxes investments in children, but tries to make up for this problem by offering a $1,000 tax credit per child. Under the conservatives’ plan, this paltry amount would shrink still further. The marginal tax benefit per child would be reduced to $350. In this important respect, the plan goes in the wrong direction. We hope that Ryan and his colleagues revisit this question before proceeding further.
Given the tax-hiking predilections of this Congress, the best outcome over the next year would be another temporary patch, with no tax increases to balance it. If Congress tries to take up AMT reform, conservatives should insist that the AMT be made less hostile to savings and to children. In the longer run, they should follow Rangel’s lead and make the repeal of the AMT part of a larger reform of the entire tax code. But that larger reform should, unlike his, favor growth, and unlike the current supply-side plan, help families too.