"AMT Deficit" Goes On-Budget
Change has profound implications
By Kaye A. Thomas
Posted February 23, 2009
Honesty is the best policy.
The Obama administration is poised to make a stunning change in budget policy. The change will add over $1 trillion to the projected federal debt — and that's good. It puts an end to a charade that has persisted in past administrations, both Democratic and Republican. The "AMT deficit" is going to go on-budget.
Stitch and bitch
The alternative minimum tax, or AMT, is built around the notion that high-income individuals should pay at least some minimum amount of tax even if they qualify for tax benefits that would otherwise allow them to pay less. It works by recalculating your tax according to a different, or alternative, set of rules that take away many benefits you can claim under the regular income tax. You have to pay AMT when the number produced by this alternative calculation is higher than your regular income tax.
The regular income tax is indexed for inflation, but the AMT isn't. That means the annual inflation adjustments reduce your regular income tax but not the amount calculated under the AMT rules, potentially increasing both the number of people paying AMT and the amount of AMT paid by those people. To prevent this from happening, Congress has had to pass a law each year called the AMT patch, adjusting in an important number called the AMT exemption amount for inflation.
It would be one thing if this special law made a permanent increase in the AMT exemption amount. Congress would still have to pass an AMT patch each year, but the effect on the budget would be relatively small. For many years, however, Congress has left the "permanent" level of the AMT exemption amount unchanged. That means the budget impact of the AMT patch grows each year. A few years ago, the budget impact of fixing the AMT for a single year was about $30 billion. The most recent patch, included in the 2009 recovery act, weighed in at $70 billion.
As the budget impact became larger, the AMT patch became a political football. Democrats have tried to couple this patch with loophole closers that would offset the budget impact, but Republicans have used the threat of a filibuster in the Senate to block those provisions. The acrimonious debates have sometimes gone down to the wire at the end of the year, delaying actions needed to get the tax filing season started.
An honest budget — and a permanent fix?
The budget impact exists only because projections are based on the assumption that Congress will not patch the AMT. The last budget produced by George W. Bush, for example, assumed that Congress would allow the AMT exemption amount to revert in 2009 to levels set in 1993, eliminating all the inflation adjustments that had been made in the interim and sharply increasing the tax burden of tens of millions of taxpayers. No one truly believed that would happen, so $70 billion of the budget projection was fictional. Yet the money was there in the official budget, and that left the next President, and the next Congress, to grapple with that number, and even bigger numbers in subsequent years.
Now President Obama proposes to take the fictional AMT revenue out of the budget projections. His budget will be built on the assumption that Congress will continue to protect taxpayers from an inflation-related increase in AMT. This may seem like an obvious move, but it was previously unthinkable because people at both ends of Pennsylvania Avenue have had a vested interest in creating unrealistically rosy budget projections, and the number here is almost unbelievably huge: a permanent fix to this problem has a ten-year budget impact of over $1 trillion.
Obama's choice is a major step toward honesty in the federal budget process, and it's coupled with others. For the first time, ongoing costs of the wars in Iraq and Afghanistan will be included in the budget, as will an amount designated for dealing with natural disasters. The budget will be a much more realistic reflection of our nation's finances.
The change has other implications, though. Once the budget acknowledges that the government isn't going to collect the inflation-induced AMT revenue, Congress won't have to grapple with the difference between the budget projection for AMT and the amount the government truly intends to collect because there won't be any difference. The need to handle this problem in a piecemeal fashion, with all the attendant political posturing, will be gone. In a stroke of the pen, the obstacle that has stood in the way of a permanent fix for the AMT will be removed.
Tax reform
There's more. It seems likely that at some time in the next several years a major reform of the income tax will move onto the national agenda. The last stab at this occurred with a commission set up by George W. Bush. Their proposal didn't go anywhere, but one aspect of it was particularly significant. The commission decided to compare its reform proposal with a "baseline" that included this fictional AMT revenue.
Why is this important? The baseline is used to determine whether the reform package unfairly shifts the tax burden onto any particular group of taxpayers. By adopting a baseline that included this AMT revenue, the commission in effect said that since these people are already going to be paying this higher tax, it's okay to adopt a tax reform proposal that hits them with the same amount of higher tax. As a result, the tax reform proposal would have vastly increased the tax burden on the upper middle class taxpayers who pay the bulk of the AMT, while reducing the burden on truly wealthy taxpayers who, ironically, mostly escape this tax. If and when we return to the subject of tax reform, Obama's choice to eliminate fictional AMT revenue from the budget will forestall this shift in how we share the burden of taxation.
