Honesty Is the Best (Tax) Policy

February 26, 2009

Finally, we see some honesty on the AMT patch. Today Obama released his fiscal year 2010 budget. We would like to note that he has included an AMT patch in the baseline budget estimates through 2019, at a cost of $576 billion over 10 years. On the surface this may not sound remarkable, but it is a significant break from the last administration. Here is why:

The alternative minimum tax (AMT) was created in 1969 to keep high income earners from using various deductions, exemptions and credits (“tax preferences”) to dramatically reduce their tax liability. When the AMT was created the exemption levels were not indexed for inflation and inflation gradually eroded their value, so that now millions of taxpayers are required to pay the AMT, instead of the roughly 150 that were originally targeted.

Since the passage of the Bush tax cuts starting in 2001, at the urging of the Bush administration Congress has routinely passed an AMT “patch” which increases the exemption amount to keep more moderate-income taxpayers from being hit by a tax increase from the AMT. Had they not passed a patch every year, the Bush tax cuts would have become less valuable because the cuts would have pushed people into AMT, negating some of the savings they otherwise would have received. The Bush administration knew that in the absence of a patch many people would see a tax increase and so the patch became a regular part of the administration’s tax policy and an assumed piece of standard legislation.

However the Bush administration never actually included the cost of future patches in their budget projections. That is, they always assumed that the budget would include the extra tax revenue that would result in the absence of a patch even though everyone knew that there would be a patch and this revenue would never actually be collected. The administration was often accused of using “accounting gimmicks” by not including the full cost of their tax policies in order to reduce projected future budget deficits.

But by assuming that Congress will continue to patch the AMT and not including the extra revenue in his budget baseline, Obama has been honest and at least admitted to the true cost of the AMT patch: over half a trillion dollars over the next ten years. And honesty is always welcome in the budget process.

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