Bush’s Secret Tax Hike

Everyone knows the AMT is incredibly unfair. So why won’t the president and Congress fix it?

This tax season is shaping up as a banner one for the federal government. The strong stock markets have produced a gusher of capital gains taxes. Corporations are continuing to reap massive profits, and so they’re paying more in corporate income taxes. Lehman Brothers economist Drew Matus told Barron’s that he expects “a 17 percent jump in tax receipts this season (not including regular withholding), and just a 5 percent increase in refunds.” The upshot: Tax-season payments could be $59 billion higher than last year.

Should these projections materialize, Republicans will trumpet them as a validation of the supply-side tax-cutting mania. Just reduce taxes on capital and high-earning individuals, and tax revenues will magically leaven. But in fact, the rising revenues may prove exactly the opposite, Democratic point: If you raise taxes on people who make a lot of money, you’ll end up with more tax revenues. In addition to windfalls from capital gains and corporate taxes, Matus noted that rising receipts attributable to the Alternative Minimum Tax are filling Washington’s coffers. “My suspicion is the AMT has captured a large amount of the tax cut for upper-income earners,” he told Barron’s. In other words, tax receipts are up in part because many of the rich are paying higher taxes.

The AMT is rapidly becoming an ATM for the government. In the past I’ve argued that the AMT, which effectively eliminates deductions people take for property taxes and state and local taxes, functions as a stealth tax on well-off people living in Democratic-leaning states. But because the AMT isn’t indexed for inflation, and because Congress has failed to fix it, even in a piecemeal fashion, the AMT is set to become a broader tax on pretty much anybody who makes more than $100,000 and who has children—in other words, a good chunk of the national Republican base.

In the spring, the political class tends to get exercised about the AMT. Last year, when about 3 million people paid the tax, there was a flurry of activity. The Senate finance committee held a hearing that promised to blow the lid off the stealth tax. Generally, Congress has kept the AMT under control by enacting so-called patches—temporary increases in the amount of earnings exempt from the AMT. At the hearing last spring, Robert Carroll, deputy assistant secretary at Treasury, testified that the AMT was set to spread rapidly. It is designed to ensnare the prosperous middle—people whose income places them in the 25 percent tax bracket. (The AMT imposes a tax ranging from 26 percent to 28 percent on income.) Even with the patches, about 3.8 million taxpayers, including 13 percent of those with incomes between $100,000 and $200,000, would pay the AMT for tax year 2005, Carroll said. But for tax year 2006, if the patches expired, the number would rise to a whopping 20.5 million. “When taxpayers file their tax returns in the spring of 2007 for tax year 2006, over 75 percent of taxpayers” in the $100,000 to $200,000 income bracket will owe the AMT. Looking ahead, as the Congressional Budget Office noted back in 2004, “some 95 percent of married taxpayers with AGI [adjusted gross income] between $100,000 and $200,000 will owe AMT in 2010.” This prospect was so troubling that in July, President Bush’s tax reform advisory panel concluded that the AMT should be abolished entirely.

So, what happened in the months since? Essentially, nothing. With the Bush presidency in meltdown, the tax-reform panel’s recommendations—which included eliminating popular deductions—were buried. And comprehensive reform was never in the cards because the long-term numbers are so large. The AMT accounted for about $18 billion in revenue in 2005, according to Carroll of Treasury. But it will provide increasingly large sums of cash in the coming year: $210 billion by 2015. Eliminating the tax increases imposed by the AMT would require the government either to raise other taxes, or to run much larger budget deficits. In other words, the administration needs the AMT to make the Office of Management and Budget’s unrealistic budget projections look good.

Bush asked Congress for the patch to be extended—basically to take the exemptions that existed in 2005 and add them on for another year, at a cost of about $30 billion. But Congress hasn’t dealt with the short-term patch for the same reason it hasn’t dealt with immigration, or passed a budget—the Republican-controlled House and Senate can’t legislate, and the White House can’t provide any leadership. Last week, Congress abandoned efforts to move a bill that would extend capital gains and dividend tax cuts and provide AMT protection.

If higher-than-expected tax receipts materialize this spring—thus improving the short-term fiscal picture—Bush and Treasury Secretary John Snow will surely crow about the success of their tax cuts. In fact, it’s the opposite. The effective tax increases imposed by the AMT have helped add revenues. More broadly, the growth of the AMT—and the unwillingness or inability to do anything about its spread—should lead people to think more carefully about Bush’s legacy. Most of his signature achievements from the first term—the Iraq war, the Medicare prescription drug plan, No Child Left Behind—are already seen as problematic. At this point, tax cuts are pretty much all he has left. And now it’s clear that those cuts are turning into tax hikes for a huge number of upper middle-class Americans—but not, of course, for the superrich who are such key Bush supporters.

There’s sure to be a lot of discussion in the next two years about the wisdom of extending the temporary income-tax reductions beyond 2010. The Republicans argue that letting a temporary tax cut expire as designed amounts to a tax increase. Maybe so. But with every passing year, as more and more people pay the AMT, and as the revenues it provides account for a larger chunk of total revenues, the Bush tax cuts are being unwound. We don’t have to wait until after Bush leaves office for the tax cuts on the well-off to expire. Thanks to the AMT, they already have.