Middle classes pay for get-the-rich folly

In the late 1960s Wilbur Mills, the mighty chairman of the House ways and means committee, held show hearings to expose all the ways the rich got away with paying fewer taxes.

The problem, it was said, was that progressivity was not working properly. America, to be sure, had a structure of graduated rates, but somehow the wealthy were not paying those rates. Instead, mysteriously, a number of loopholes had worked their way into the tax code. Often, these loopholes were being used in ways their authors had never intended. The system had become too complex, over-engineered. And the loopholes were so numerous that some of the wealthy wound up paying a lower rate of tax than some of the middle class.

Joseph Barr, the Treasury Secretary, was also intent on exposing the evil rich. As Julian Zelizer recalls in his book Taxing America, a biography of Mr Mills, Mr Barr published a list of shame showing that 155 wealthy American families paid no income tax at all, even though they earned $200,000 or more.

So the Nixon administration and Congress came up with a solution. They would get the rich by making a complex system even more complex. They did this first of all by taking numerous steps to strengthen the progressive rate structure. They also created an alternative tax regime, a sort of fiscal penalty box, to punish rich guys who claimed "too many exemptions" or "too many preferences" by sending them there. In that regime, many of the usual loopholes would not be allowed. Thus the Alternative Minimum Tax was born.

The programme's authors were sure that their gizmo was watertight, that this time they had finally managed to trap the errant rich guys. And trapping the rich guys was their paramount goal. Although today Washington's budgeteers report that killing the AMT would cost hundreds of billions of dollars, it was not originally a revenue-getting exercise. In other words, the plan was pure behaviouralism.

Fast forward to today. Just as in the old days, we have a get-the-rich progressive rate structure. Just as in the old days, people are screaming that the rich are not paying enough taxes. And just as in the old days, government's special devices are not working as advertised.

Indeed, the star failure turns out to be the AMT. The scholarly journal Tax Notes reports that the National Association of Enrolled Agents, a group of tax professionals which negotiates with the Internal Revenue Service on behalf of taxpayers, has honoured the AMT with the label "Tax Headache of the Year".

The charges against the AMT are numerous. Rather than precision-bombing the rich, as was originally intended, the AMT is hitting many of the middle class. It is hurting families, who may not claim "too many children" for fear of being sent to the penalty box.

It is also murdering the high-technology crowd. That is because this group often takes advantage of their companies' incentive stock options, or ISOs. And when workers exercise those options, the difference between the fair market value on the day of exercise and the strike price is often taxable under the AMT regime. In other words, because of the AMT and the market correction, these folks pay taxes on income they never had in the bank.

Still, once again Congress is treating the matter in the old fashion and holding hearings. They are ignoring what should by now be clear: the real problem is progressivity, which inevitably generates loopholes. Lawmakers have instead come up with a wonderful set of mini-solutions for the AMT's failures, all very technical and reminiscent of the late 1960s' efforts. Indexing the AMT, they say, would help the middle class escape the ugly levy. Rejigging the AMT preference list would also do much to make the AMT fairer.

Zoe Lofgren, a California Democrat, has proposed special narrow legislation to target the dread ISO problem. "My constituents are a lot more interested in this bill than they are in marginal tax relief for people in the top 1 per cent bracket," she says.

If this is so, those constituents deserve their AMT punishment, and more. For if the AMT fable reveals anything, it is that "getting the rich" nearly always backfires. We have met the rich, and they are us.

© Copyright 2001 Financial Times

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