A $1.2 Trillion Tax

Last January, I had an occasion to talk with retired U.S. Senator John Breaux, shortly after President Bush had appointed him to a bipartisan commission on federal tax reform. Knowing that Breaux had a warm rapport with Bush, I asked the former Senator what Bush wanted the new commission to accomplish.

Almost before the question had left my mouth, Breaux responded: “That’s real simple. He wants us to recommend how to fix the AMT without bankrupting the federal government.”

The “AMT” is the Alternative Minimum Tax. If you haven’t encountered this malevolent portion of the tax code yet, read up on it, because it will be coming your way soon. Congress enacted the AMT in the 1960s, because some of the wealthiest taxpayers were able to pile on enough deductions and credits to avoid paying any federal income tax. The AMT worked very efficiently, and even the very rich began paying some level of income tax. Unfortunately, there was a poison pill in the AMT legislation that is now haunting middle-income taxpayers, as well.

Congress did not index the AMT for inflation when it passed the legislation. For a certain period of time, that caused few problems for the vast majority of taxpayers. But now, 40 years later, taxpayers with incomes that seem very middle-class are being forced to pay federal income taxes at a much higher level. A $90,000 family income in 1965 was a huge amount of money. Today, it doesn’t buy nearly as much, but it is treated almost the same as it was decades ago under the provisions of the AMT.

Consider a working family consisting of a factory worker and a teacher. They have four children, and each has almost 20 years on the job. With hard-earned overtime for the husband, and perhaps a summer job for the wife included, their family income is approaching $100,000 a year. They have managed to save money over the years and have an investment portfolio to go along with their regular retirement plans. The kids are reaching college age, and the couple cashes in some of their stock to begin paying for college tuition and costs. They also take out a second mortgage to help with the college costs. This family can’t be considered among the “super rich” by any means, but they are prime candidates for paying the AMT.

Things like personal exemptions (this hypothetical family has six), capital gains (the stock sales), and a second mortgage interest deduction (if it isn’t for home improvements) can result in families meeting the threshold requirements of the AMT. Miscellaneous deductions, medical expense deductions and various tax credits can also help move middle-class families into AMT territory.

Congress is in a quandary. It would take $1.2 trillion to replace the AMT – a huge amount of money, even in Washington. Yet if something isn’t done to rein it in, this insidious tax that is fueled by inflation will continue to swallow up the resources of more American families every year. Those families are not going to be delighted to pay this exorbitant and often unforeseen tax. The AMT is expected to affect four million families this year, 21 million next year and 51 million during the decade. Solutions will revolve around either cutting spending or shifting taxes. That is why President Bush wants the bipartisan commission to suggest a way out of this tricky political dilemma.

Considering Congress’s proven inability to reduce federal spending, look for tax increases under the guise of “tax reform” to be the solution in Washington to the AMT problem.