The Democrats have continuously claimed that they are looking out for America’s middle class by keeping the tax rates the same for them while seeking to raise rates on the top 2% who need to “pay their fair share”. The spotlight has been on this point of contention in the fiscal cliff negotiations, thereby serving to deflect attention away from the one policy that 1) is already the mechanism for ensuring that the wealthiest pay more and 2) will raise rates on the middle class for certain if the fiscal cliff has not been resolved. What is it? The AMT.
The Alternative Minimum Tax (AMT) currently serves virtually no useful purpose, other than the raising of an ever-increasing amount of tax revenue. The AMT was instituted in its present form when the prior “add on” Minimum Tax was transformed into the AMT in the early 1980’s. Its stated purpose was to require that all taxpayers paid at least a “fair share of tax”. Yet it has become very clear in recent years that this AMT tax revenue is not coming from just the taxpayers who were the intended targets of this tax – and 28 million additional taxpayers will now be impacted if the method by which it is calculated is not fixed by the end of the year.
The AMT was developed to identify“loophole” type deductions, also known as “preferences”. There would then be an alternative calculation using lower tax rates applied against this taxable income as increased by the preferences. Whichever of the taxes is higher is the one the taxpayer must pay.
However the AMT was seriously flawed from the outset. Instead of focusing on these loophole type preferences (which would have limited the tax to a very small number of tax law abusers), the law that was passed included items that were not loopholes at all. A convoluted formula is used to calculate and compare the differences between income and deductions in order to determine who falls under the guidelines. Interestingly, a very substantial majority of all current AMT paid by taxpayers results from the following factors: 1) treating state and local taxes as a preference; 2) treating miscellaneous deductions as a preference; 3) allowing lower exemptions than the regular tax.
These factors have flaws. For instance, state and local taxes are hardly a loophole because taxes exacted by state and local governments are hardly “voluntarily” paid by taxpayers in an attempt to avoid paying federal taxes. Likewise, “Miscellaneous Deductions” is the category of deductions that consists primarily of expenses incurred to earn income. It often includes unreimbursed employee expenses, investment expenses, etc. This is the most basic and important deduction necessary to have a truly fair income tax system and should not be considered a loophole. Furthermore, the exemption available under the AMT is a fixed dollar amount which, unlike exemptions and standard deductions under the regular tax system, is not indexed for inflation; it is also phased out entirely over certain income levels.
The indexing brings us back around to the problem at hand. Each year, Congress has to approve an annual “patch” which raises the threshold for inflation in order to raise the exemption limits of the tax — so that less wealthy taxpayers won’t be subject to the AMT. During AMT discussions, Congress likes to posture and point to the patch as some major revenue loss (had the AMT been applied to those families) as an excuse to raise to raise taxes in order to offset this “potential missing tax revenue”. It’s all song-and-dance really. Congress always approves the patch; the yearly patching process itself, however, is poor government. We are learning this lesson the hard way as a quiet showdown is unfolding during negotiations.
The AMT presents a dire situation with the fiscal cliff right now. If the patch isn’t approved by the end of December 31, the AMT will reset and taxes will go up for millions. If we go off the fiscal cliff, the Democrats will be directly complicit in a massive tax increase on millions of middle-income taxpayers’ families – the opposite of what they have been claiming in their bid to raise taxes on the most wealthy.
How could this occur – unless the Democrats really do prefer to let the patch lapse…and hope they can pin the discussion failures on the Republicans. After all, if more citizens pay the AMT, more revenue is raised for the rapacious government. Is it all part of a grander scheme, perhaps? What we do know for certain is this: the Democrats have shown that their narrative of protecting the middle class is a lie and empty rhetoric. They would risk sacrificing the tax rates of 28 million taxpayers for the sake of ideology and the job creators (the top 2%).