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Muddy
Waters: The AMT and the U.S. Tax Code
MARCH
2007 - Few aspects of our nation’s muddled tax code
exemplify the snowball effect of complexity better than the
alternative minimum tax (AMT). The AMT—which is owed
when tax computed using AMT rules exceeds the regular tax—was
introduced by the Tax Reform Act of 1969 to ensure that high-income
individuals could not use deductions and exemptions to completely
eliminate their tax liability. Today, however, the AMT ensnares
not just high-income taxpayers paying little or no tax, but
many more people than its creators probably ever intended.
Indeed, one of the most critical issues facing our nation
today is the increasing burden being placed on the middle
class by the AMT.
Consider
that only 20,000 people paid the AMT in 1970, according
to the IRS. That number has grown dramatically to about
three million taxpayers in 2005, and if the tax code doesn’t
change, as many as 33 million taxpayers may pay additional
taxes under the AMT by 2010. Imagine 33 million people having
to calculate their tax twice to meet their civic responsibility.
Once should be enough!
Why
are so many taxpayers now affected by the AMT? The two main
reasons are rate creep and inflation. The AMT was created
when the maximum regular tax was at 50%, two and one-half
times the 20% AMT rate. Countless rate changes later, the
current maximum regular rate of 35% is only a quarter higher
than the 28% AMT rate, which itself is an indirect legacy
of the Tax Reform Act of 1986. Furthermore, since the mid-1980s
the regular income tax components have generally been indexed,
or automatically adjusted, for inflation—but not the
AMT. Over 20 years, these changes, largely enacted for different
tax- policy reasons, have made a huge impact on how the
regular tax and the AMT affect a given taxpayer. The difference
between the regular tax and the AMT is further exaggerated
because tax reductions, such as the child tax credit, often
reduce the regular tax but do not impact the AMT. For all
these reasons, each year more and more taxpayers find that
their AMT computation exceeds their regular tax.
So
why doesn’t Congress just eliminate the AMT? According
to a Congressional Budget Office report, simply scrapping
the AMT would prove extremely costly. The AMT currently
rakes in about $18 billion annually; eliminating it would
shrink projected government revenues by at least $600 billion
over the next 10 years. Making changes on a temporary or
piecemeal basis has delayed the larger political battle
over how to deal with such a large projected revenue shortfall.
Achieving
a Workable Solution
In
May 2005, the NYSSCPA proposed the Simple Exact Transparent
(SET) Tax, a greatly simplified income tax system, devoid
of unnecessary complexity, including the AMT. Under the
SET Tax, Congress would select a politically acceptable,
economically appropriate single tax rate for both individuals
and businesses, and then use only straightforward exclusions
of its choosing to accomplish additional public-policy goals,
such as eliminating the income tax for the poor and reducing
the effective rate of tax on the middle class. An individual’s
tax would be calculated using this simple, easy-to-understand
formula:
(Income
– Subtractions/Congressionally defined exclusions)
x Rate = Tax
Because
the SET Tax uses a single tax rate, it can, on the surface,
be confused with so-called “flat tax” proposals.
But unlike the various flat tax proposals, the SET Tax adheres
to the current tax code’s tradition of tax progressivity:
higher tax rates for higher incomes. Essentially, the SET
Tax would continue to give Congress the flexibility to use
the tax code to accomplish policy goals, but it would do
so more transparently, through an easier to understand and
administer code.
Under
the SET Tax, income would be measured using existing, familiar
principles and rules: generally the cash basis for individuals
and small businesses, and the accrual method for larger
businesses. Current law definitions would be very helpful
in this area, and would be retained. Exclusions in the SET
Tax system could include all of today’s deductions,
exemptions, exclusions, credits (reengineered into exclusions),
and other mechanisms that reduce an individual’s or
a corporation’s gross income to determine the taxable
income. Exclusions could be used not only to achieve progressivity
but also to encourage economic behavior such as saving for
retirement, encouraging domestic manufacturing, exploring
for oil, or developing alternate energy sources. They could
also accomplish social-policy goals such as encouraging
homeownership and charitable giving.
In
terms of progressivity, a lump-sum exclusion could eliminate
or greatly reduce the income tax for people who can least
afford it in a way that would be easy to find and easy to
understand. More-complex exclusions for the highest-income
individuals would require a little more work to calculate
and understand. That’s called progressive complexity,
and it addresses the needs of our complex economy and policy
goals. The burden of progressive complexity falls on those
who should be capable of dealing with it. The work to claim
tax exclusions that would reduce someone’s tax (and
their related required disclosure of complex behavior) makes
the SET Tax easier to administer, and easier for the government
to detect tax-evaders. In addition, a tax code based on
the SET Tax system could be designed to generate a tax liability
equivalent to each taxpayer’s current obligation,
but the amount would be easier to understand and calculate.
A
Nation Ready for Change
The
midterm elections last November revealed an American public
that is eager and ready for change. Tax policy would be
a great place to start, and the SET Tax proposal gives the
nation a viable solution that is equitable and transparent.
It also obviates the need for an AMT (both corporate and
individual) and provides an elegant, revenue-neutral solution
to replace the lost revenues. The full version of the SET
Tax proposal can be found on the NYSSCPA website at www.nysscpa.org/pdfs/set.pdf.
Louis Grumet
Publisher, The CPA Journal
Executive Director, NYSSCPA
lgrumet@nysscpa.org
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