Bush’s Secret Tax on Democrats

How the Alternative Minimum Tax has become a Republican weapon.

Illustration by Robert Neubecker

President Bush and the Republican Congress, who believe fervently in cutting taxes for the rich, are quietly presiding over a most remarkable kind of tax increase for high-income Americans.

The Alternative Minimum Tax is becoming a miserable annual tradition for a growing group of prosperous taxpayers. (If you’ve just received a nervous phone message from your accountant—that’s probably what she’s calling about.) The AMT traces its origins to a minimum tax enacted in 1970 when Americans were scandalized to learn that some 155 high-earning taxpayers owed no income taxes in 1966. The AMT was originally designed so that people who had a lot of income but loads of deductions—through the standard exemption, the ability to write off property taxes and state income taxes—couldn’t reduce their taxable income to next to nothing. Historically, it applied to a tiny minority of taxpayers. But with every passing year, more and more citizens are ushered behind the velvet ropes. This congressional backgrounder suggests that 1.8 million Americans paid it in 2001. Newsweek’snearly infallible Allan Sloan wrote earlier this month that “about 2.3 million returns for 2003 got nipped by the AMT.” The numbers are set to rise exponentially in the next several years. A two-income couple in New Jersey—he’s an accountant, she’s a public school teacher—with combined income of $230,000, three kids, and annual property taxes of $15,000, could easily fall into paying the AMT. Even government bureaucrats get nailed. Last year, IRS Taxpayer Advocate Nina Olson paid the AMT.

While Republicans are patting themselves on the back for reducing marginal taxes, they’ve been oddly silent about how the AMT excludes millions of Americans—and relatively well-off ones at that—from the benefits of the tax cuts. Here’s a theory: Could it be because those most likely to fall prey to the AMT live in states that Bush-Cheney ‘04 has already written off?

A variety of factors influence whether you get trapped by the AMT. But two of the most important ones are high property taxes (which tend frequently, thought not always, to correlate with high housing prices) and high state and local income taxes. (The high nonfederal taxes increase your deductions, pulling you toward the AMT.) So if you live in a no-income-tax state like Florida, Texas, or Wyoming, or in a state where housing prices and property taxes are very low, like, say, Mississippi or anywhere in the Great Plains, you’re less likely to be AMTed. (These helpful charts from the Tax Foundation list state income-tax rates and state and local tax burdens.) Income from options incentives can also help land you in AMT territory.

The AMT seems designed to snare people who earn between $200,000 and $500,000; who work in fields like finance and technology; and who live in places where property taxes and state and local income taxes are high, like New York, New Jersey, Connecticut, Massachusetts, California, and Oregon—states that are resolutely Democratic.

There’s an element of personal-injury journalism to all the moaning about the AMT because a lot of business and finance writers who denounce it have to pay it. But the scribes are the canaries in the coal mine. Because the AMT isn’t indexed for inflation, and because state income and property taxes tend to rise as people’s incomes rise, more and more taxpayers will be pushed into AMT territory with every passing year.

As Bill Gale and Leonard Burman of the Brookings Institution warn in this piece:

By 2010, the AMT will affect 33 million taxpayers—about one-third of all tax returns—up from 1 million in 1999. This would make the AMT almost as common as the mortgage interest deduction is today. The AMT will be the de facto tax system for households with income between $100,000 and $500,000, 93 percent of whom will face the tax. It will encroach dramatically on the middle class, affecting 37 percent of households with income between $50,000 and $75,000 and 73 percent of households with income between $75,000 and $100,000 (compared to less than 3 percent for each group in 2002).  

Even as the tax experts are penning op-eds accusing John Kerry of wanting to raise taxes on high-earners, most have been inexcusably silent of late on the AMT. (Amity Shlaes, where are you now that we really need you?)

Republicans don’t want to fix the AMT because fixing the AMT would require undoing their beloved tax cuts. Without the billions generated by millions of taxpayers getting slammed by the AMT, the marginal rate cuts would be impossible to sustain for the next several years, let alone make permanent. Without the AMT, the deficit picture would look far worse than it does. This paper by Daniel Feenberg and James Poterba of the National Bureau of Economic Research projects $480 billion in AMT revenues between 2003 and 2010, with the AMT providing $125 billion in 2010. Gale and Burman estimate that repealing the AMT could cost the treasury $1.1 trillion through 2014, assuming the tax cuts are extended. The kicker: “By 2008, it would cost more to repeal the AMT than to zero out the regular income tax.”

So what’s the problem? After all, tax revenues have to come from somewhere, so why not AMT payers? Economists point out that the AMT has become a nonsensical tax, totally disconnected to its intended purpose. As taxpayer advocate Nina Olson pointed out in her Dec. 2003 report, the AMT now functions “randomly, no longer with any logical basis in sound tax administration.” The AMT no longer serves to trap wealthy tax avoiders as it was designed to do. Instead, because it isn’t indexed, it punishes people who were never intended to be its targets.

The administration, out to lunch on so many aspects of economic policy, is either oblivious or willfully ignoring the AMT problem. A few bills were introduced last year to deal with aspects of the AMT tangle, but there’s been no sign of progress. It’s hard not to conclude that there are some pretty crude political calculations behind the inaction. Most of the victims of the AMT live in places where Bush and many Republicans can’t compete. Besides, with Bushenfreude still rampant, Republicans know that offering high-income, coast-dwelling liberals tax relief won’t help the GOP in November.