Government has its own ATM

By KYOKO OISHI and RICHARD SOUSA

HOOVER INSTITUTION

In the midst of the Vietnam War, when 550,000 military personnel were deployed there, members of Congress noted another issue that was generating more constituent mail than the war. A 1969 Treasury Department report stated that 155 individuals with adjusted gross incomes of more than $200,000 paid no federal income tax in 1966. The average American was outraged and wrote to Washington about it.

Congress responded quickly, enacting an “additional tax for tax preferences” — the precursor to today’s alternative minimum tax (AMT). This legislation created a minimum tax provision in the IRS code that was intended to prevent high-income earners from using tax breaks to escape all federal income taxes.

Meant to snare the rich, the AMT’s effects were immediate. In 1969, the year before the law went into effect, 300 people who earned more than $200,000 owed zero federal income tax. In 1970, only 111 people avoided paying federal income tax, a substantial decline in hard numbers.

The AMT remains effective today, ensuring that few high-income earners avoid paying income taxes. In 2004, 177 returns with adjusted gross incomes above $1 million (approximately what $200,000 in 1969 is worth in today’s dollars) did not owe any taxes, only 0.1 percent of those in that high-income category. It has gotten difficult to avoid paying federal income tax.

The AMT legislation, however, did not index for inflation. Bracket creep (individuals moving to higher tax brackets because of inflation, not because of increases in real income) was essentially eliminated from the tax code in the 1980s, but bracket creep is alive and well today in the AMT.

In 1970, 19,000 people paid the AMT equivalent. By 2005, this number had risen to more than 4 million. By either measure, more than 150 times as many people paid the AMT in 2005 as did in 1970.

Although originally targeted at the very wealthy, the AMT has increasingly shifted toward those in the middle-class and upper-middle-class income brackets. In 2005 (the last year for which detailed data are available), one in 12 people subject to the AMT had adjusted gross incomes of less than $100,000. In total, 45 percent of those paying the AMT had adjusted gross incomes of less than $200,000 — not the destitute but certainly not the super rich Congress was focused on in 1969. Little did those who wrote to Congress in 1969 know that their letters would lead to legislation that could easily end up ensnaring them.

Distorting geographic effects

There are also distorting geographic effects. The AMT works primarily by limiting the extent to which deductions may be taken — notably mortgage interest, property taxes and state income taxes. Hence, the AMT disproportionately affects those from the East Coast and California, where housing prices (and mortgage interest payments) and state and local taxes are higher.

Sound public policy must be transparent, sensible, widely known and generally approved of. The AMT is none of these. It is expected that the AMT will snare 25 million taxpayers this year. In most cases, those unsuspecting taxpayers have little previous knowledge of this tax and most certainly would disapprove of this parallel tax system that is imposing an unexpected burden of $6,800 per payer, not including compliance costs.

Currently, the chairman of the U.S. House Ways and Means Committee, Charlie Rangel, is attempting to pass a temporary patch to the AMT that would shield the 25 million people for the 2007 tax year. Rangel is also looking at longer-term overhauls that may repeal this tax, but they are not expected to move through Congress until next year. With the Nov. 1 deadline looming by which the IRS must modify the 2007 tax forms, Congress needs to act swiftly and decisively.

The patch is a step in the right direction of returning the AMT to its original intent: making sure the wealthy pay their taxes, rather than serving as an ATM machine for the government.

X Richard Sousa is senior associate director and a research fellow at the Hoover Institution at Stanford University. Kyoko Oishi edits the institution’s “Facts on Policy” Web site. Distributed by McClatchy-Tribune Information Services.