March 4, 2007
The Alternative Minimum Tax Posted by John Steele Gordon at 03:35 PM EST In 1969, in the last, dying days of the Lyndon Johnson administration, the secretary of the treasury, Joseph W. Barr, who has the distinction of having had the shortest of all tenures as secretary of the treasury, less than one month, testified to a Congressional committee. He stated that 155 very high-income families had managed to pay no federal income taxes in 1966 (the last year for which information was then available), thanks to various perfectly lawful means. For instance, the interest on state and city municipal bonds was not taxable, so if one invested only in such bonds, no income tax would be due, even if the interest income was in the millions. The story, not surprisingly, was big news, and well it should have been, with millions of citizens with average incomes paying income taxes and a few with very high incomes not, thanks to accounting technicalities. This had happened before. In 1934, for instance, J. P. Morgan, Jr., had spent several months cruising on one of the world’s largest yachts, Corsair, but still paid no income taxes thanks to the deductibility of capital losses against regular income. Morgan had simply sold stock at depression prices that had been bought in the booming twenties at high prices, and then bought it back, thus establishing a capital loss while maintaining his position in the stock. This too, had caused an uproar, and Congress amended the tax code making only a very small part of capital losses deductible against ordinary income. The rest could be deducted only against capital gains. The result of the 1969 revelations was a new provision in the tax code that required the rich to pay a minimum tax regardless of whatever legal deductions they had. To ensure they did, certain potential deductions effectively available only to the rich, such as accelerated depreciation, reserves for losses, and mineral depreciation allowances, were limited or not allowed at all in certain circumstances. But in 1986, as part of the great tax reform of that year, the minimum-tax provisions were changed fundamentally. Many of the limitations on the rich-guy investment deductions were removed, and limitations on such ordinary-guy deductions as mortgage interest, state and local taxes, and even union dues were imposed on those with high incomes. Since the point at which these limitations would kick in was set very high, little money was raised—only $1.7 billion the first year—and almost exclusively from the rich. But the drafters of the legislation made one serious mistake. They did not index for inflation or for rising real incomes. These caused more and more people to become subject to the alternative minimum tax, as it was now called, and have to pay more taxes. In later years, other changes in the two tax systems—the regular tax system and the alternative minimum tax—including the Bush tax cuts, brought still more people under the AMT. This year it is estimated that 23.4 million taxpayers, more than one in four, will have to pay under a system intended to catch the rich. By definition, far fewer than 25 percent of the population can be “rich.” Still worse, the very people who are supposed to be targeted are not being caught. Most people having to calculate their taxes under AMT are in the $75,000–$500,000 income range. In other words, the upper middle class. Meanwhile, more and more upper-income families are paying very low taxes. In 2003, the last year for which we have data, 41,000 families earning more than $200,000 paid less than 10 percent of their incomes in federal taxes. And remember those 155 rich families that got off scot free in 1966? In 2003, 2,824 rich families paid no taxes at all. It is highly unlikely that anything beyond a few patches will be done about this until a new administration is in place in 2009, as the next presidential election is already, alas, in full swing. But nothing could make clearer the utter moral, financial, political, and economic bankruptcy of the federal tax code. I would hope that liberals, moderates, and conservatives of good will (and that’s the overwhelming majority of each group, as otherwise democracy couldn’t work) would agree that something fundamental needs to be done, and the sooner the better for all of us. We, and the American economy, have suffered under the tyranny of the federal tax code long enough. I would propose that as a starting point we might agree that any new tax code (the old one, I think, is quite beyond repair) should conform to these basic principles: 1) Everyone ought to pay taxes that are proportional to their incomes. 2) The richer should pay a greater proportion of their incomes than the less rich. 3) The amount of tax owed should be clear, easy, and inexpensive to calculate, and paid in a way that least inconveniences the taxpayer. 4) Taxes should distort the underlying economy as little as possible. The current system (not, of course, that there is anything even remotely systematic about it) flings down and dances upon each of these common-sense principles, which are straight out of Adam Smith. I’ll have more to say about this in a future post.
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