Alternative Minimum Monster

Taxes targeting the rich eventually end up hitting the average guy. For example. when the modern federal income tax became law in 1913, Congress intended to only tap the wealthiest Americans. Rates ranged from 1 percent to 7 percent, and well over 90 percent of the population was exempt from filing.

Of course, today, income tax rates range from 10 percent to nearly 40 percent, and the income tax takes from all but the poorest workers.

Get ready for round two. There’s a new kind of income tax, originally designed to hit the rich, that’s now coming after nearly everyone.

Back in 1969, the American public was outraged at reports that 155 filers with over $200,000 in income legally paid no taxes. The Vietnam War was reaching a peak, and Congress wanted to go after these super-rich, who were using tax loopholes to avoid paying income taxes.

Of course, the right solution would have been to simplify the tax code, eliminating the exemptions that these 155 taxpayers were exploiting. Tragically, though Congress instead created a parallel tax system, the Alternative Minimum Tax, or AMT.

The AMT is a kind of shadow tax system, with its own rates and special deductions. It’s designed to be less generous than the main income tax. Higher income filers must compute their taxes under both systems—the regular income tax and the AMT—and pay whichever tax is higher.

So, why should you care about the AMT? Just like the income tax, the AMT is rapidly moving downstream into the middle class, as greedy politicians seek more and more spending cash. While the AMT originally targeted filers with unusual business deductions, in practice today it is gouging taxpayers with deductions for children, second mortgages, capital gains, high state and local taxes, and incentive stock options. Today, tax advisors recommend that any family with a gross income above $75,000 and write-offs for personal exemptions, taxes and home-equity loan interest also complete the AMT form. Over 4.4 million taxpayers did so in 1997.

In 2002, a household with $75,000 in income, particularly for families with kids, is not the super-wealthy that Congress originally targeted. Indeed, the AMT is rapidly applying to larger and less wealthy swaths of America. While only 19,000 people owed the AMT in 1970, 1.3 million were paying it in 2000, according to the IRS. In 2010, it will affect 17 million taxpayers, and according to the IRS, 60% of these filers will earn less than $100,000.

(If you’re interested in how the AMT might impact you personally, check out the TurboTax A.M.T. Evaluator)

Worse, it’s difficult to predict when the AMT will apply. There’s a huge compliance cost– it’s necessary to do AMT calculations even if you don’t end up paying the AMT. In fact, millions of taxpayers have to file the AMT but don’t end up owing any AMT tax, which is a massive waste of time and money filling. No wonder W. Val Oveson, the former national taxpayer advocate at the I.R.S., describes the A.M.T. as “absolutely, asininely stupid,” and most tax organizations have called for repeal of the AMT on individuals.

The reason the AMT is expanding so rapidly is that its rates and exemptions aren’t indexed to inflation. Thanks to inflation and economic growth, income levels that would have been spectacular thirty years ago are rapidly becoming middle class. For example, someone earning $100,000 in 1969, when the AMT was created, would be the equivalent to someone earning $490,000 today. Families earning $100,000 today aren’t super-rich, but the AMT law is stuck in 1969 and still thinks they are.

For the regular income tax system, Ronald Reagan fixed this inflation “bracket creep” problem twenty years ago by automatically indexing the system to inflation. But there’s been no leadership on fixing the AMT. President Bush should step forward and attack the AMT, in part because the AMT threatens to undermine his own income tax cuts. Bush cut regular income tax rates, but left the shadow AMT rates the same. The result is that more people will be forced to pay the AMT, since it is the higher of the two. A Treasury Department study estimates that those affected families will lose about two-thirds — or $88 billion — of their Bush tax cuts in 2010 because they’ll be forced to pay the AMT.

The political problem here is that repealing the AMT will “cost” the government more each year as the AMT brings in more cash. The Treasury Department estimates that the 10-year cost of repeal now stands at $619 billion — and is rising. So, as more Americans get hit by the AMT, it actually will be harder to repeal because spend-crazy Congress won’t be able to live without the money the AMT squeezes from taxpayers.

Is your blood boiling yet? There is one last, exasperating thing about the AMT. Remember that the tax was adopted because of public outrage at 155 taxpayers with incomes above $200,000 who paid no taxes? In fact, according to the Joint Economic Committee, in 1998 3,572 filers with incomes over $200,000 paid no income taxes – that’s a far high number than before the AMT was created to solve the problem.

The AMT is a complete failure, a drain on the U.S. economy, and a threat to America’s middle class families. It should be immediately repealed.