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The Economics of an AMT Patch

2 min readBy: Gerald Prante

Although it is likely that Congress will pass an AMT patch today and send it to President Bush for signature, it is still an interesting question to ask what the economic ramifications would be if the patch wasn’t passed versus its passing.

The main downside to a patch from an economic efficiency perspective is that a patch for 2007 taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. law would not change economic behavior (for the better) for 2007 as it has already been done. Because of this, there is little, if any, Laffer curve effect from the patch either, meaning the static revenue score will be the same as the dynamic score. Here are some of the other economic ramifications of a patch for 2007 tax law:

(1) Keynesian View — Short-run economic boost from the patch when tax refundA tax refund is a reimbursement to taxpayers who have overpaid their taxes, often due to having employers withhold too much from paychecks. The U.S. Treasury estimates that nearly three-fourths of taxpayers are over-withheld, resulting in a tax refund for millions. Overpaying taxes can be viewed as an interest-free loan to the government. On the other hand, approximately one-fifth of taxpayers underwithhold; this can occur if a person works multiple jobs and does not appropriately adjust their W-4 to account for additional income, or if spousal income is not appropriately accounted for on W-4s. checks are sent out versus people having to write huge checks to the IRS this spring. Could have significant effects given higher probability of a recessionA recession is a significant and sustained decline in the economy. Typically, a recession lasts longer than six months, but recovery from a recession can take a few years. next year than the past five years.

(2) Optimal Tax Theory View — No patch for 2007 may lower people’s expectations of a patch being passed for 2008, thereby increasing their expected marginal tax rates for 2008, and thereby reducing economic efficiency. This is very similar to the economic effects of a windfall profits taxA windfall profits tax is a one-time surtax levied on a company or industry when economic conditions result in large and unexpected profits. Inheritance taxes and taxes levied on lottery winnings can also be considered windfall taxes on individual profits. on past profits, which would have no harmful economic effect (in terms of reduced future investment) if there was somehow a guarantee that no such tax would be passed in the future.

(3) Deficit-Hawk View — The deficit-financing of the AMT patch will have to be paid somehow, whether in the form of higher taxes or lower spending in the future.

(4) Public choice view — To the extent that a deficit-financed AMT patch is able to “starve the beast” and prevent excessive future growth in government spending beyond social welfare maximizing levels, it can enhance social welfare, exceeding the harm done in #3.

From an economist’s perspective, one must also look at the opportunity cost of a $50 billion patch for AMT in 2007. In other words, what else could we have done with that $50 billion and is it better than a 2007 patch for AMT? In my opinion, the answer is yes. I can think of about 10 tax cuts that would likely be better than patching AMT from an economic efficiency perspective and my own normative view of what is good tax policy, including what is fair. However, fairness is in the eye of the beholder. And most politicians see the AMT as putting an unfair burden on AMT taxpayers, despite the fact that these are the same people that often benefit from the myriad of deductions and exemptions that are in the tax code to begin with, while those outside of AMT that don’t benefit from such provisions pay even more than these AMT payers, as explained for some typical families here.