How Did We Leave Behind A Whopping Middle-class Tax Hike?

January 25th, 2009 at 9:44 pm | 34 Comments |

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Throughout the frustrating 2008 Presidential campaign, many conservatives wondered:  How did our party allow Barack Obama to outflank us on middle class tax relief?

Here’s an even more painful question: How could the GOP, after 8 years in the White House, leave a whopping tax increase for millions of middle-class taxpayers?

America needed a tax cut in 2001–and the Bush administration delivered one.  It delivered again in 2003.  But our tax cuts left the possibility of sharp future tax increases for the middle class.  And it’s no surprise that the middle class did not rally to defend them.

What if we had done things differently? What if rather than waiting for “fundamental” tax reform–which never came–we had made the choice after 2003 to make it a priority to reform or repeal the Alternative Minimum Tax, the tax that falls hardest on the middle class?

The AMT was originally designed in 1969 as a legislative response to a famous list of 155 people who, despite having incomes over $1 million in today’s dollars, nevertheless managed to avoid Federal income tax liability.  But time and inflation has eroded this vision.  It has snared, or threatens to snare, millions of taxpayers in the middle class and above. With its complex and arcane rules about what qualifies as exempt for AMT purposes, no wonder Sandra Block of USA Today called it “the AMT zone, a parallel tax universe that’s much scarier than anything you used to watch on black-and-white TV.”

Had there been no 2006 AMT “patch,” over 75 percent of filers with incomes of between $100,000 and $200,000 (for instance, a married couple each earning $60,000) would have been subject to the AMT.  The Treasury Department estimated that for 2006, the AMT would have kicked in at $67,890. And because the AMT eliminates personal exemptions, it hurts families with children in particular.

Because of this direct threat to the middle class, every year Congress has enacted a “patch” essentially keeping the AMT rules the same as the previous year.  Otherwise, as many as 26 million more taxpayers would be caught in the AMT trap this year.  (The cost in lost revenue of this year’s fix will be about $70 billion.)  Even worse, when Congress delays passage of the fix, the IRS must delay the start of the filing season.  This happened last year, and the returns of 13.5 million taxpayers were affected.  (Because state and local tax payments are not deductible under the AMT, the over 10,000,000 returns that include Schedule A could not be processed until the IRS knew what the rules would be.)

So the political back and forth each year over a law that everyone knows will eventually be passed means inconvenience and delays for all.

The 2003 tax cuts lowered marginal rates for many filers, reduced the marriage penalty, lowered capital gains tax rates, capped taxation of dividend income, and helped small business-owners.  On the whole, it was a good package.  But with up to 35 million Americans subject to the AMT by 2011 and up to 45 million by 2014 if we keep the current income tax rates, would we have been better off simply repealing the AMT?

First, a clarification.  It’s true that the 2001 and 2003 tax cuts themselves are principally responsible for the vast increase in the number of filers subject to the AMT.  Lowering tax rates for everyone makes more people subject to the AMT, because it is not indexed for inflation.  And one may make a clever – perhaps too clever – argument that the AMT sword of Damocles hanging over Congress forces a “tax cut” every year.  Opponents of AMT reform such as the Center for Budget and Policy Priorities claim that the idea of a one-year repeal “masks” the true cost of AMT reform, because the “costs” of AMT repeal continue over time (in other words, the taxpayers who pay regular income tax at a lower rate will continue to do so).

But beware, then, of politicians saying that you won’t need to worry about the AMT when the Bush tax cuts expire – precisely so, because your income tax rates will have gone up, automatically, without a vote in Congress.

Treasury has estimated that by 2013 it would be more expensive to repeal the AMT than to eliminate the income tax.  But this analysis assumes that the Bush tax cuts will be made permanent rather than expiring – which no one now expects.

If we assume that the Bush tax cuts will expire in 2010 – as President Obama has repeatedly promised – some might argue this weakens the case for AMT repeal.   Quite the contrary.  Because the number of taxpayers potentially affected by the AMT would dramatically decline (as a result of people being pushed back into higher income tax brackets), the political pressure for AMT fixes will correspondingly decline.  But that doesn’t reduce the injustice inherent in the AMT capturing middle-class taxpayers who were never intended to be snared in its provisions.

During the Bush Administration, voices were raised in support of full AMT repeal.  Nina Olson, the Taxpayer Advocate at the IRS, endorsed repeal in 2003, stating “The AMT is extremely and unnecessarily complex and results in inconsistent and unintended impact on taxpayers… [T]he AMT is bad policy, and its repeal would simplify the Internal Revenue Code, provide more uniform treatment for all taxpayers, and eliminate the oddity of dual tax systems.”  Nancy Killefer, whom President Obama has named the Federal government’s first Chief Performance Officer, endorsed Olson’s views in 2004 in her capacity as Chair of the IRS Oversight Board.

And a bipartisan group of Senators (Grassley, Baucus, Wyden, and Kyl) endorsed repeal in their “Individual Alternative Minimum Tax Repeal Act of 2005.”  They freely admitted that their bill would cost the Treasury $611 billion in lost revenue by 2015 or $900 billion if the 2001 and 2003 tax cuts were made permanent.  Yet they addressed the issue squarely and fairly, not wanting to leave middle-class families at the mercy of Congress every year.

But the Bush Administration’s consistent position was that AMT repeal could only be addressed in the context of broader, “fundamental” tax reform.  After the Republicans lost Congress, that day would never come.   So the Administration’s position was tantamount to pushing AMT repeal off the agenda, leaving the country with what the Treasury Department described as “two parallel tax systems – even for the many millions who do the calculations but ultimately have no AMT liability.”

It’s no answer to respond that by limiting deductions, the AMT acts as a pressure valve to encourage high-tax states to lower their tax rates.  There’s simply no evidence that this has happened.  New York, New Jersey, California, and other high-tax states will make their own decisions regardless of what happens with the Federal AMT.

The Republican Congress was right to pass full AMT repeal in 1999, and Bill Clinton was wrong to veto it.  For many taxpayers, the AMT is a nightmare that threatens their family budgets.  Tax evasion is illegal; tax avoidance is legal but distorts economic incentives.  Tax planning, on the other hand, is what everyone should do.  But that’s exactly what the AMT prevents; with the AMT, for millions of families, it’s virtually impossible to know in advance what one’s tax liability will be.

It’s hard to escape the conclusion, therefore, that the Bush Administration missed a trick by not advocating full AMT repeal in 2003 or later.  Sadly, we cannot always assume that we will win elections.  Without the AMT, we would have had a fairer, cleaner, and more equitable tax system that does not discriminate against families with children or those who happen to live in high tax states.

Honest liberals oppose repeal because the AMT is “an important source of revenue for the Federal government.”  Fine – let’s have that debate, which will become an honest debate on the proper size of government.

So long as the AMT exists in its current form, simple inflation and every tax cut will force more and more people into the AMT, absent a never-ending series of “fixes.”  So these tax cuts won’t really be tax cuts at all.  The middle class faces the prospect of higher tax rates in 2010 when the Bush tax cuts expire or getting hit by the AMT.

Instead, Congress needs to face reality: If it wants to raise income taxes, then it should do so squarely and not rely on the unfair and inequitable AMT.

Recent Posts by John S. Gardner



34 Comments so far ↓

  • senorlechero

    Mr. Gardner….I love your keen perception that “honest liberals oppose repeal…”. And of course any who claim they are for “middle class tax cuts” are dishonest. Clinton promised MCTCs in two elections, and really never delivered. I don’t expect OBAMA to deliver, and I dont think democrats do either. If Obama had run an honest campaign he might have lost, and we couldn’t have that now could we.

  • senorlechero

    OOPs, I forgot to say Thank You for the great post.

  • Chekote

    How did Obama outflank the GOP on taxes? He had $600 million to spend on running endless commercials stating over and over again “tax cut for 95% of the people”. Le’t not underestimate the impact of the unlimited funds Obama had.

  • rk

    AMT should be a poster child for failed liberal programs. In fact we should have a formal laundry list of failed liberal programs.

    The Left has done substantial damage to the country (like CRA). R’s don’t have much time left to tell their story.

    I suspect the Left will be happy to get rid of AMT now since it impact their voters more (NY, CA, etc). As usual they will look like heros.

    We need to play ahead of the curve, not behind it.

  • greg_barton

    Hi, I’m an evil Liberal.

    I want to pay taxes. I happily paid taxes throughout the Bush years, even though I detested some of the policies.

    It’s my patriotic duty to pay taxes.

    And yes, I easily make enough to be hit by the AMT.

    That being said, would I like them to be lower? Sure. But at the moment there’s things to do, and then a whole lot of national debt to pay off. It can’t be done without money, folks.

    Anyway, I’m glad this site exists. Despite the fact that I’ve never voted for a Republican in my life, I want the opposition to be real, and intelligent. Intelligent dissent only makes things better. The best years of governing I’ve seen is when there was a strong Republican majority in the house and a Democratic executive. Great things were done when conservatives forced Democrats to be fiscally responsible. It’s sad that that became impossible when a Republican was in the white house. I expected more from ya’ll then.

  • suey

    During the Bush years the only people to benefit were the top 1% his “Base”. The middle class were told that the money would “trickle down” on them like some benevolent rain of cash. How did that work out for you? For most it meant a big drop in earnings. And you wonder why the Conservatives lost, you managed to build a huge deficit by spending like a man with a printing pres in the garage. You started a war that is costing billions. You refused to apply restrictions on banks and speculators (Phil Gramm anyone). Then you asked us to trust you that you could sort the mess out. Guess what the “Deciders” did not agree. The voters spoke and found you wanting. Now in opposition you bring forth the same failed policy as the answer to the crisis. Get some new ideas if you want the voters to ever trust you again.

  • Chekote

    suey

    Glass-Steagall was repealed during Clinton.

  • Chekote

    Greg Barton. You can pay more taxes than you owe right now. This is a moral issue for me. I should keep what I have honestly, ethically earned. It is my money. You know, private property.

  • suey

    30,000 jobs lost today and that is only the ones announced on TV. DOH! I must be wrong there was I thinking that Bush had been in charge for the past 8 years and a GOP congress for 6 of them, guess Clinton has been in power all the time. When are you conservatives actually going to accept your part in this disaster? Yes Clinton did some dumb things but Bush/GOP wee the prime movers. I notice that you do not debate my points just more pointy fingers at Clinton.

  • Chekote

    suey. I was not taking a shot at Clinton. I just stated a fact. The Glass Steagall was repealed under Clinton. I don’t like what Bush did domestically. He was a Democrat lite. So I will accept that part of the disaster. I also blame the GOP for squandering their turn at the helm by enganging in the same old politics of buying votes via federal spending.

  • suey

    Well good for you, an honest Conservative. Whodda thunk it! I congratulate you.

  • senorlechero

    Greg Barton….Great Post.

  • MSheridan

    Chekote, the repeal of Gl-Steagall was a bipartisan disaster and Clinton absolutely suld have vetoed it and it is fair to ld him to account for not doing so. wever, Gramm-Leach-Bliley was not a Democratic measure. Its eponymous sponsors were all Republicans and when it first came up for a Senate vote, it was ped on a party line vote with the minority of Democrats then serving voting 44 against. It was only when the use and Senate versions of the bill (both ped with Republican majorities) could not be reconciled and a revised version of the bill came back to the Senate that it got any Democratic votes. I think that was a moral and political failure for the Democrats, but trying to place primary blame for the repeal on Clinton is pretty gutless when the impetus for the bill was very clearly Republican.

  • MSheridan

    I’m not sure why the 1st few letters of several words were deleted from my post below. I pasted it in from my notes and it looked fine before I hit “Add Comment.”

  • sinz54

    During the 2008 presidential campaign, many conservatives pleaded with McCain to propose a big middle-cl tax cut. So in the presidential debates, Obama was able to get away with his claim that “Our plan cuts taxes for 95% of working families,” while McCain kept obsessing about earmarks, his favorite bby rse.

  • Chekote

    MSheridan. Furthering the notion that the GOP is for big business, while the Dems are for the little man is very damaging. The reality that votes like the Gl Steagall are not so much dictated by ideology as they are dictated by campaign contributions. There is a disconnect between the people’s will and what government does. The majority of the people opposed TARP. Yet it was approved. The majority of the people opposed the auto industry bailout. Decisions are being driven by interests group more than the people’s will. That’s the problem. Sitting here and saying Dem bad, all bad. Or GOP bad, all bad is useless.

  • sinz54

    If you think the repeal of Gl-Steagall was a disaster, the Commodity Futures Modernization Act (CFMA), ped by Congress in 2000, was a far bigger disaster. That law, co-sponsored by a number of Republicans, gutted the SEC’s ability to regulate credit default swaps. Overindulgence in tse derivatives led directly to last summer’s financial crisis, and the collapse of big firms like AIG. Additionally, the CFMA exempted energy futures trading from the same regulatory requirements as other stock trades. In stepped Enron to take advantage of that loople–and we all know w that turned out. The CFMA is my poster child for what happens when deregulation goes way too far.

  • fact based

    w could this have happened…

    gee it couldnt possibly have anything to do with the trickle down philosophy of the repubs that only cares about getting big tax cuts to the very wealthiest

    that couldnt possibly be the reason could it

    oh and also if they repealed the amt they would have to come up with something to make up the revenue or see the deficit forecasts go throught the roof even with the scam of keeping the costs of the iraq war off budget

  • MSheridan

    I see what is happening here with the mangled comments. The site has installed a particularly stupid software censor that is excising offensive syllables out of perfectly innocent words. Please fix soon.

  • dragonlady

    IRT to some other posts, no one has been able to make a convincing argument to me that the repeal of Gl-Stegall was a disaster. The banks that have diversified under G-L-B Act (see Bank of America, Wells Fargo, and Goldman Sachs also asked the Feds if they can diversify from investment to commercial services) are doing much better in this downturn than the pure investment banks (Lehman Brothers, Bear Sterns) or primarily commerical banks (Washington Mutual, IndyMac). The current crisis was caused by government telling banks to loan $ to people w could not afford mes (see Community Reinvestment Act amendments in the mid-90s; this act also allowed risky mortgages to become securitized), creating a moral hazard by encouraging Fannie/Freddie to buy up more subprime loans, and the failure of the SEC to regulate exotic credit instruments. I believe the regulation vs deregulation mantra as the panacea to all this is too simplistic.

  • suey

    Funny h-ow often h and o come together!

  • dragonlady

    Great article, btw. Definitely suld repeal the AMT. I would also like to see discussion on payroll taxes. GOPers, why can’t we explain to the voters the difference between tax cuts and tax credits? This is w Obama is outflanking us on tax cuts.

  • suey

    dragonlady. Driving interest rates down to unrealistic levels unsupported by common sense in order to drive the bubble even faster, could that be an aspect?

  • suey

    Dragonlady Obama is outflanking you on tax cuts because you insist on giving the rich all the benefits of lower taxes and ignoring the middle cl. That is a dumb policy politically because there are many more middle cl than rich people, but hey carry on, and at the same time alienate Hispanics and African Americans while you are at it. Great way to a majority.

  • suey

    Dragonlady Obama is outflanking you on tax cuts because you insist on giving the rich all the benefits of lower taxes and ignoring the middle cl. That is a dumb policy politically because there are many more middle cl than rich people, but hey carry on, and at the same time alienate Hispanics and African Americans while you are at it. Great way to a majority.

  • outwest

    Great analysis. The only people to come out ahead one way or the other with our arcane tax system are the accountants! Re: sinz54 comment on CDS: the intent of the CFMA legislation was to establish the legality of swaps, namely interest rate swaps and foreign currency swaps, (CDS were not around at that time) and to define these instruments as not futures. These instruments could have been regulated as banking products but they were not. And, even if they had been covered by CFMA doesn’t mean they would have been regulated properly. The regulators had sufficient regulatory autrity to prevent (or at least lessen the impact) of the financial crisis. What was lacking was enforcement of existing regulations and supervisory will and political pressure to make everyone living in the U.S. a me owner through agressive using goals established by HUD and carried out by Fannie and Freddie.

  • dragonlady

    Suey, on the interest rate thing, I’d consider that as a possible cause if you can point me to a rational economic argument for it, but low interest rates were in large part due to an enoromous amount of Asian assets coming into the US economy (see how much US debt China has bought up). The Fed has some control over short term rates, but less over long term ones: http://www.usnews.com/articles/business/economy/2007/09/22/is-alan-greenspan-to-blame-for-the-housing-crisis.html. So I think it’s more complicated than saying: The Fed did it. It surely did not help though, when the gov’t pushed banks to loosen mortgage underwriting standards: http://www.nypost.com/seven/02052008/postopinion/opedcolumnists/the_real_scandal_243911.htm?page=0

  • MSheridan

    dragonlady, defending the repeal of Gla-ss Steagall is unhelpful for three reasons. First, your statement that “The current crisis was caused by government telling banks to loan $ to people wh-o could not afford h-omes” is factually incorrect. The % of loans made because of redlining practices (about 3%) was tiny compared to the massive inflation in the number of loans made. Really. Second, until the crash finally happened, a financial institution was literally losing money (in the short term, anyway) if it didn’t invest in those “securitized” loans. Yes, some few saw the dangers and avoided them as risky, but the short-term thinking on Wall Street didn’t encourage the long view necessary. Third, if the Republican Party defends what is now widely (even among conservatives) seen as a failure of policy, it will drive away the voters it needs to attract. Better to say it was a mistake that’s been learned from and move on.

  • dragonlady

    MSheridan, so you want me to declare repeal G-S a mistake w/o giving me any evidence? I don’t know where you got your redlining statistic, but when the govt pushes banks to lend, lend, lend, I’d imagine those redlines would start disappering. Your 2nd statement is in a way correct that the gov’t encouraged banks to increase their loans they were making, and boy, did those subprimes skyrocket: “There is evidence that the Federal government leaned on the mortgage industry, including Fannie Mae and Freddie Mac (the GSE), to lower lending standards.Also, the U.S. Department of Housing and Urban Development’s (HUD) mortgage policies fueled the trend towards issuing risky loans. In 1995, the GSE began receiving government incentive payments for purchasing mortgage backed securities which included loans to low income borrowers. Thus began the involvement of the GSE with the subprime market.” Read the rest of it and weep: http://en.wikipedia.org/wiki/Subprime_mortgage_crisis. Sure Wall St made bucks, and those who were deceptive should be punished, but should the govt be telling banks to make dubious loans all in an effort to attract a political constituency? How does it help those who are feeling the pinch? Thankfully, the market is going back to sane lending practices by requiring income verification, a certain percentage down, etc., before the govt pushed the idea that everyone should be a home owner.

  • MSheridan

    dragonlady, here’s some evidence from the same wiki article you cited: [quote]
    “Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk of default could be originated almost at will, with the risk shifted from the mortgage issuer to investors at large. Securitization meant that issuers could repeatedly relend a given sum, greatly increasing their fee income. Since issuers no longer carried any default risk, they had every incentive to lower their underwriting standards to increase their loan volume and total profit.

    The traditional mortgage model involved a bank originating a loan to the borrower/homeowner and retaining the credit (default) risk. With the advent of securitization, the traditional model has given way to the “originate to distribute” model, in which the credit risk is transferred (distributed) to investors through MBS and CDOs. Securitization created a secondary market for mortgages, and meant that those issuing mortgages were no longer required to hold them to maturity.” [end quote] What the above means is that there was absolutely no need to PUSH lending institutions into making unsafe loans. The market practically dragged them in.

  • dragonlady

    MSheridan, yes, I think securitization of these loans definintely changed the trad’l model but you really don’t think the gov’t had anything to do with pushing the securitization of loans? The govt authorized this in an amendment of CRA in ’95 because banks were trying to figure out how to get these loans off their books once HUD pushed them to make dubious loans.

  • MSheridan

    dragonlady, I think our politics differ sufficiently that an online message board discussion is unlikely to bring total agreement between us as to how this all started. However, as I said in my first post on this thread, this was a bipartisan disaster. Although Gramm-Leach-Bliley may have been initiated by Republicans, the majority of the Democrats in the Senate and House did eventually sign on to it and thus are every bit as much to blame (perhaps even more so, given that they compromised their political principles in so doing). Really and truly, I think what’s important here and now is the takeaway lesson from all this, which is that a certain amount of regulation is necessary. To defend the repeal of Gla.ss-Steagall is to say that deregulation cannot be taken too far. I don’t believe that’s a winning (or correct) formula for Republicans.

  • dragonlady

    MSheridian, yes, I agree both parties are culpable but probably in a different way than you do. Just so we’re clear, I don’t believe regulation or deregulation is an end in itself. I want the markets to function properly. Let’s fix the current mess and get on with it.

  • MSheridan

    There we’re in agreement. I just wish I was sure I knew how the mess could best be fixed.