Americans Have Met the Tax Enemy, and He Is Us

April 12 (Bloomberg) — Congress left some 20 million taxpayers in the lurch when it went off on Easter break without agreeing on the budget.

Unless the lawmakers get their act together later, those taxpayers will find themselves in a punishing parallel tax regime known as the Alternative Minimum Tax.

Dentists, salesmen and other middle-income earners will find themselves confronting an effective marginal tax rate of as much as 35 percent. This is happening even though American politicians from both parties are constitutionally incapable of advocating a tax increase for the average American.

The AMT story is an object lesson in the perversity of using the tax code to get one group for the benefit of another. Back in the winter of 1968-69, Lyndon Johnson, the departing president, appointed a man named Joseph Barr as Treasury secretary to serve until President-elect Richard Nixon chose his own man.

Barr had only 28 days, and he was desperate to make his mark. He went before Congress bearing news of an outrage. There were 155 rich Americans out there, people with annual incomes exceeding $200,000, who had found so many tax loopholes that they were paying no tax at all. Twenty-one of these "extreme cases" even had incomes of more than $1 million. Lower earners were being wronged. Congress duly addressed the outrage by creating a separate minimum tax system to trap plutocrats.

Tax Revenge

Two things stand out about this event. The first was that lawmakers didn't simply close all the loopholes and lower all the rates, the obvious solution. Instead they chose the fun of the AMT regime.

The second was that the federal budget was in surplus when they did this. The AMT in its original form was not about revenues. It was about revenge.

Barr faded into the private sector, but not his legacy. More and more Americans became subject to the AMT. The technical reasons for this were complex. Congress didn't index the AMT to inflation, for example, as commentators so often point out.

But there was a second factor at work: Americans were moving up, not only from middle levels to higher ones, but also from poverty into homeownership. The AMT was hitting these strivers too.

In a report released today, the Tax Foundation, a Washington-based policy research group, notes that more and more Americans are finding themselves experiencing "real bracket creep" as they move up the tax schedule — in other words, a tax on success.

Stopgap Measures

In recent years, lawmakers have created various stopgaps to limit the AMT pain, but haven't done away with the system. The current statutory rates for the AMT are 26 percent and 28 percent, and the amount that is exempt fades out. That's what brings the effective marginal rate to 35 percent.

For citizens of high-cost states such as New York or California, the AMT is a special danger. That is because those states also tend to have high property taxes, which normally are deductible from federal income taxes. While mortgage interest doesn't trigger the AMT, property-tax deductions may.

President Bush's tax cuts for their part have had the perverse effect of rerouting some citizens into the AMT by reducing their tax liability. Or, to put the story in political terms: under Republicans, people who have trouble paying for college will sometimes find themselves paying tax rates they associate with the Democratic Party. Over in Blogland, the new line is that this is not about the middle punishing the rich but about the Red States punishing the Blue states, and enjoying it, too.

Revenue Machine

But the AMT phenomenon has little to do with the corruption of specific political parties, and lots to do with the corruption of the political process in general. Recently the Congressional Budget Office predicted that the AMT will bring the Internal Revenue Service an additional $51 billion in 2007 if Congress doesn't change the law.

William Gale, an economist at the Brookings Institution, has pointed out that the AMT is such a revenue engine that by 2010 it will bring in more money than the traditional income tax. From having nothing to do with federal deficits, Barr's symbolic gesture has become crucial to narrowing them. From having nothing to do with middle earners, the AMT is becoming a regular guy's rite of passage.

Class Goes Mass

Nor is the AMT the first class tax to become a mass tax. When they created the original income tax almost a century ago, lawmakers swore the top rate would stay low and that the tax was for the rich. Someone suggested putting a ceiling on rates, but everyone else in Washington decided that was crazy because the top rate couldn't go higher than the initial rate of 7 percent.

The conclusion is simple: beware of officials who talk about getting the rich on behalf of low or middle earners. In the end, that person is just setting in motion a process that punishes those it would help.

Barr died about a decade ago, but you have to wonder what he would have thought upon hearing that his own tax device was hurting the "tens of millions of families" he talked about with such concern. The truth about America is that it is unwise to talk about social classes here, especially when it comes to taxes. As the AMT demonstrates, we have met the enemy, and he is us.

(Amity Shlaes is a Bloomberg News columnist. The opinions expressed are her own.)

© Copyright 2006 Bloomberg

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