Farewell AMT, Hello Surtax?

October 26, 2007

In a strange political twist, Ways and Means Chairman Charlie Rangel has virtually ignored the “middle class” in the massive new tax plan he has put before the nation. In the context of a presidential campaign with candidates of both parties gushing promises of tax cuts and spending programs for the “middle class,” it’s almost refreshing to consider a plan that’s all about the poor and rich.

Here’s a Fiscal Fact that gives a broad outline of Rangel’s plans for individual taxation in the context of the expiring Bush tax cuts. Here’s a comment that some people have been too eager to call the plan a tax hike.

A proposal to cut the corporate tax rate and make up the revenue with other business taxes is a major part of the Rangel plan, which prompted us to compare his proposed rate cut to what other major trading nations have been doing. Here we commented on how the concept of progressive taxation does not apply to corporate taxation.

In the area of individual income tax, the centerpiece of Rangel’s proposal for high-income people is repealing the Alternative Minimum Tax in exchange for a big new “surtax” on wages, dividends, Social Security, capital gains, interest, and other income—all the components of Adjusted Gross Income.

In his formal proposal, the new tax kicks in on singles who make $150,000 or more and on couples who make $200,000 or more. This is the same income range that makes most of the AMT payments, so at first it seems like an even swap: replacing one tax on high incomes with another. But there is an important, economically damaging feature of the new surtax that the AMT, for all its faults, does not suffer from: unusually high marginal tax rates.

The AMT identifies for extra taxation only those high earners (and some middle-income) who by coincidence or clever tax planning receive multiple deductions, credits and exemptions. These are people we would expect to find paying in the 28%, 33% or 35% income tax brackets but who have managed to whittle down their taxes to such a low percentage that the AMT kicks in. The rates applied by the AMT, either 26% or 28%, are moderate so that even AMT payers (who undoubtedly feel cheated that their multiple deductions were repossessed) do not end up paying tax at an exorbitant rate. We’ve given “typical family” examples of how the AMT works in this AMT primer published last May, and we’ve explained how the AMT could be repealed or greatly curtailed without damagingly high new tax rates in this revenue-neutral proposal.

The Rangel surtax does not ferret out cleverly low-paying, high-income filers. Instead, it rewards tax avoidance. Tax-exempt municipal bonds, though derided by economists as an unfair giveaway to people in the top tax bracket, will be all the more valuable. Other tax-avoidance vehicles will also thrive in the absence of the AMT and the presence of the new surtax.


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