The alternative minimum tax scheme

Posted: Apr 26, 2002 12:00 AM
On Jan. 17, 1969, Democrat Lyndon Johnson's last Treasury Secretary, Joseph Barr, testified before the Joint Economic Committee on the growth of tax expenditures. In passing, he noted that 155 Americans with incomes above $200,000 in 1967 paid no federal income taxes that year. Twenty-one of them had incomes above $1 million. The respective income thresholds would be $1.1 million and $5.3 million in today's dollars. The important point Barr made was that what these people did was perfectly legal. They weren't scofflaws or tax evaders. They simply took advantage of provisions that allowed them to reduce their taxable income by arranging their affairs appropriately. Predictably, there was outrage at very rich people legally paying no taxes. Under political pressure, Republican Richard Nixon signed the Tax Reform Act of 1969 to address this problem. Among the features of this legislation were an increase in the capital gains tax and institution of a minimum tax, designed to ensure that all wealthy persons paid some income taxes, no matter how many deductions, exclusions and exemptions they might have. This initial effort to tax the rich did not work very well. Within a few years, Congress had to pass further legislation to restrict tax loopholes it missed in 1969. Another Republican president, Gerald Ford, signed it into law. Among the provisions of the Tax Reform Act of 1976 was one requiring the Treasury Department to produce regular data on the number of rich people -- defined as those earning more than $200,000 per year -- that paid no income taxes. In 1977, it found 60 Americans falling into this category. Despite the existence of a minimum tax, the number of wealthy Americans legally avoiding all income taxes rose sharply. By 1986, 659 of them managed to do so. This led Congress to toughen the minimum tax significantly. Now called the Alternative Minimum Tax (AMT), it required millions of Americans to calculate their taxes two ways: first the normal way and again without many so-called tax preferences, such as the personal exemption and deduction for state and local taxes. The threshold for the AMT was relatively high at $40,000 for couples, and the rate was a flat 20 percent. After calculating one's taxes both ways, people paid whichever was higher. In 1987, 609,000 Americans filed AMT forms, and it raised $6.7 billion. But only 140,000 actually owed AMT, and the net revenue raised was just $1.7 billion. Despite the new, tougher minimum tax, the number of Americans paying no income taxes rose. In 1987, it climbed to 857 and has continued to rise more or less continuously since. In 1998, the latest year available, 1,467 Americans with incomes above $200,000 paid no federal income taxes. This was principally due to business losses and receipt of tax-exempt interest on municipal bonds. It should be noted that Treasury taxes business income up to 40 percent, so it is hardly unfair for it to share the losses, too. Also, those buying municipal bonds pay a large implicit tax by getting lower interest rates. Lately, municipal bonds have been paying about 5.14 percent, versus 6.7 percent on corporate bonds. This means that municipal bond buyers are actually paying a tax of 23 percent, which accrues to local governments in the form of lower borrowing costs. The problem is that because the AMT threshold has not grown as fast as incomes, more and more people now have to pay it. Although the threshold increased to $45,000 in 1990, it should be closer to $65,000 just to keep pace with inflation. To also compensate for real income growth, it would have to rise to $76,000. Furthermore, many of the preferences that are lost in the AMT calculation have risen. The personal exemption has grown from $1,080 in 1986 to $3,000 today. State and local taxes have also gone up. Yet the AMT continues to treat higher taxes paid to state and local governments as some kind of tax loophole, punishing those who live in high-tax states like New York. The result is that the number of those paying AMT is rising rapidly. By 2011, the number will reach 16.4 million, according to the Joint Committee on Taxation, unless legislative action is taken. Moreover, more than half of all AMT revenue will come from taxpayers with incomes below $200,000. In short, the AMT is becoming a tax on the middle class, rather than the rich. Indeed, this is the history of all tax-the-rich schemes. The rich figure out how to get around them and the middle class can't, with the result that the latter ends up paying taxes designed for the former. That is why it is in the interest of the middle class to support reductions in tax rates on the wealthy. Though they may not benefit immediately, it puts a cap on what they and their children ultimately can pay.