Analysts are still poring through the details of the recently passed tax bill, and it will be some weeks before all its provisions have been thoroughly digested. However, there are a two items getting a lot of attention that are worth commenting upon now.
Alternative Minimum Tax. The AMT is like a parallel tax system. You calculate your taxes under the normal tax system and again under the AMT. Whichever one yields a higher tax, that's the one you pay.
The big problem with the AMT, aside from the fact that it is utterly unjustified and should not exist, is that its exemption levels are not indexed for inflation. The basic AMT exemption level is $33,750 for individuals and $45,000 for couples, levels unchanged since 1993.
As a consequence, the higher incomes go, the more people get pushed above the AMT threshold. Furthermore, any tax cuts that cause one's normal tax liability to fall can trigger an AMT liability.
For some years, many tax analysts have been calling for abolition of the AMT or at least indexing its threshold amounts to prevent a sharp rise in the number of people affected by it. The AMT, like so many provisions of the Tax Code, was originally to impact only the "rich." Now, of course, due to inflation and real growth in the economy, the "rich" are almost everyone considered middle class.
Bill Clinton refused to consider reform of the AMT; indeed, he increased it. As a result, the number of taxpayers who will be forced to pay the AMT would have risen from 1.5 million this year to 17.5 million in 2010, absent any change in law. However, ironically, the just-passed tax cut will actually INCREASE the number of people affected by the AMT in 2010 to 35.5 million.
The reason is that because of the tax cut, more taxpayers will have a lower tax liability in the future. Hence, their normal tax will be less than that under the AMT, thereby triggering an AMT liability.
Congress was aware of this problem when it enacted the tax cut. To help alleviate the added tax burden, it increased the AMT exemption level by $2,000 for singles and $4,000 for couples. Basically, this keeps the number of people affected by the AMT from rising through 2004.
Very interestingly, though, the higher AMT exemption sunsets in 2004. The result is that unless further action is taken, the number of taxpayers affected by the AMT will jump from 5.3 million in 2004 to 13 million in 2005. No Congress or White House, regardless of party control, is going to allow that to happen. Therefore, there will have to be another AMT "fix" before the end of 2005.
In effect, Republicans have built a "time bomb" into the tax bill that guarantees at least one more big tax bill before the entire tax cut expires in 2010. (In order to get around wacky budget rules, all tax cuts in the current legislation end on December 31, 2010. Therefore, there will be a massive tax increase on January 1, 2011 unless further legislation is passed.)
Thus, even if Democrats retake the White House and control of both houses of Congress in 2004, they will not be able to avoid passing additional tax cuts, if only to prevent de facto tax increases from occurring. This will create opportunities for tax cutters in coming years regardless of what happens in future elections.
Tax rebate. Congress was faced with a situation in which it had a pot of money it could use for tax cuts in fiscal year 2001 and couldn't really use for any other purpose. It was too late in the year to spend on pork barrel projects because the fiscal year ends on Sept. 30. Rather than "waste" the money by just paying down the debt more than planned, a tax rebate was just about the only option left.
I liken the situation to someone getting a gift certificate for Christmas that expires on January 31. This person does not have the option of saving the money and can only spend it. Moreover, they must spend it quickly or lose it altogether.
The rebate idea appealed to members of both parties. To Democrats, it looks like a give-away spending program, which they like. To Republicans, it looks like a tax cut, which they like. So as the checks go out in the mail starting in late July, both sides will be happy.
The rebate checks amount to 5 percent of the first $6,000 of taxable income for singles and $12,000 for couples. Thus the maximum checks will be $300 for the former and $600 for the latter. This means that ONLY those with a positive tax liability will benefit -- a rare exception to the recent custom that tax "cuts" must also benefit those who pay no taxes.
Proponents of the rebate believe that people will take these checks and immediately spend them. This will stimulate consumption, which is two-thirds of GDP, and give the economy a boost. However, the experience of the 1975 tax rebate is that people will save almost all of it, thus giving no boost to aggregate spending. People have long shown a tendency to save windfalls and keep their spending relatively constant.
Moreover, the design of this particular rebate means it will probably not have much stimulative impact. The first check won't go out for two months and then go out in batches of 11 million per week. This means that any possible stimulus won't be injected into the economy for three to four months, by which time it may no longer be needed.
Also, those most likely to spend a windfall are those who probably pay no taxes because their incomes are so low. But these people are excluded from the rebate. This makes it even more likely that almost all the rebate will be saved. Since government saving, in the form of the surplus, will decline by exactly the same amount, there will not even be any increase in total national saving.
The rebate is nothing but a gimmick to let people see some of the tax cut quickly and as political insurance for politicians in case the economic slowdown drags on. They can always point to the rebate checks as tangible evidence that they are doing something about it.
Chart data: Taxpayers Affected by the Alternative Minimum Tax (millions)
Year ---- Previous Law ---- New Law
2001 ---- 1.5 ----1.4
2002 ---- 3.5 ----2.7
2003 ---- 4.3 ----3.3
2004 ---- 5.6 ----5.3
2005 ---- 7.1 ----13.0
2006 ---- 8.7 ----19.6
2007 ---- 10.5 ----23.9
2008 ---- 12.8 ----29.1
2009 ---- 14.9 ----32.1
2010 ---- 17.5 ---- 35.5
Source: Joint Committee on Taxation