President’s Weekly Radio Address: Congress Should Patch AMT Quickly

Today, President Bush used his weekly radio address to call on Congress to pass an AMT patch immediately so as to limit any possible problems for the 2008 tax filing season. Here’s text from the President’s address:

To deal with this problem, Congress has in recent years passed temporary legislation that prevented most middle-class taxpayers from having to pay the AMT. But this year, Congress has yet to pass this legislation. A failure to do so would mean that 25 million Americans would be subject to the AMT — more than six times the number that faced the tax last year. If you are one of those 25 million, you would have to send an average of $2,000 more to the IRS next year. This is a huge tax increase that Americans do not expect and do not deserve.

The longer Congress waits to fix this problem, the worse it will get. Last month, Treasury Secretary Paulson wrote a letter to members of Congress warning that delaying action on legislation to fix the AMT could create confusion for millions of taxpayers and delay the delivery of about $75 billion worth of tax refund checks. Congress has ignored Secretary Paulson’s warnings — and we are now beginning to see the consequences. On Friday, the tax forms for 2007 had to be sent to the government printer. And because of Congress’s refusal to act, the IRS will be forced to send out tens of millions of tax forms that will almost certainly end up being wrong — wasting your money, delaying refunds, and making it even more complicated to figure out your taxes.

It is clear that Congress’s failure to adjust the AMT for inflation was a mistake. Unfortunately, Congress seems determined to compound this original mistake by making another one. Last week, the House passed a bill that provides relief from the AMT — but raises other taxes. Congress should not use legislation that millions of Americans are counting on to protect them from higher taxes in one area as an excuse to raise taxes in other areas. I will veto any bill that raises taxes as a condition of fixing the AMT. Members of Congress must put political theater behind them, fix the AMT, and protect America’s middle class from an unfair tax hike.

President Bush is right that something should be done sooner rather than later if AMT is going to be patched. The costs of delaying action on AMT in terms of taxpayer compliance and IRS administration will offset to some degree the added interest that the government would have to pay on the debt it used to finance the patch should PAYGO be violated. Under a 5 percent interest rate, a $55 billion patch for AMT in 2007 would cost the government about $2.75 billion in interest payments. However, it would be interesting to determine how much the government has gained, if anything, from delaying action on AMT because some taxpayers may be withholding in 2007 based upon current law. Thereby, even if a patch was passed, the government would have profited via the free loan it received from the taxpayer. This would also offset any added interest cost the government would incur in the future from deficit-financing an AMT patch.

Also, if taxpayers’ employers have been withholding based upon an assumption of no patch, then assuming no rational expectations as politicians appear to be doing when they say this tax hike is “unexpected,” the degree of unexpectedness may be limited. However, if taxpayers have rational expectations (an average, they are right), the harm done to the taxpayer would be a function of the variance of the difference between expectations and what policy outcome actually occurs.

In terms of economic inefficiency, the harm of unstable tax policy has already been done because rational economic agents would have made their work/investment decisions in 2007 based upon some projection of what the marginal tax rates they estimated they would be paying. Fortunately, the harm done by this is not as great as one may expect due to the fact that those who are set to be hit by AMT this year under a no-patch scenario are in marginal tax rate brackets that are fairly close to the AMT rates. In terms of retroactive changes, there is little economic loss or gain in the short-run from such policies. However, such changes can make taxpayers change their future expectations of government policy.

One final note: it is somewhat inconsistent for the president to call allowing the AMT to expire a tax hike given his budget. That’s because in his future deficit numbers he cites every year that come from his budget, he assumes no AMT patch for future years (beyond current tax year). For example, when the administration claims that the budget deficit will be cut in half within the next five years, that figure assumes no AMT patches for future years. In other words, by the president’s own definition, he is assuming “tax increases” will take place to reach his deficit-reduction goal, which are tax increases he will favor eliminating every year when the time comes. Unfortunately, President Bush is not the first politician to engage in the act of assuming the same dollar pays for two different things.