Reclassifying the “Middle Class” in the AMT Debate

April 27, 2007

Democrats in Congress are once again focused on the issue of the alternative minimum tax and its projected growth over the next few years. The latest proposal put forth is highlighted below courtesy of the Baltimore Sun:

House Democrats are looking to unravel many of President Bush’s tax cuts for wealthy people to pay for protecting middle-class families from a hidden tax increase.

They also plan to provide modest tax relief to the working poor and married couples in legislation being fashioned by Rep. Charles B. Rangel, the New York Democrat who is chairman of the House Ways and Means Committee.

Rangel’s plan represents the Democrats’ first major tax salvo since they won control of Congress and comes after years of criticizing Bush’s tax cuts as giveaways to the rich. A House vote on it is possible as early as June.

The measure, still in its early phases, would protect married couples making $250,000 or less each year from paying the alternative minimum tax, or AMT.

Without action, 20 million mostly unsuspecting taxpayers — on top of 4 million paying it now — could end up paying AMT surcharges averaging about $2,000 next filing season.

There’s considerable irony in the new Democratic proposal for AMT reform. They’re offering a tax cut to everyone who makes up to $500,000. But when the Bush tax cuts were passed that gave these taxpayers significant tax cuts (much bigger than their current AMT liability), Democrats cried foul, calling the tax cut packages “giveaways to the rich.”

The truth is that most of the AMT payments have been made by people making between $200,000 and $500,000. They will love this new tax relief, but in truth, their extra AMT payments have been small compared to the tax cuts they received in 2001 and 2003. (In fact, some are only in AMT today because the Bush tax cuts significantly lowered their ordinary tax bills.)

Are they suddenly “middle class” and therefore deserving of the public’s sympathy? They didn’t use to be, but now they have been conveniently reclassified. (Note: $250,000 in AGI would put a tax return in the top 5 percent of tax returns.)

Unfortunately, tax policy (especially on this issue) has suffered too much demagoguery and half-truths from both sides of the aisle. (Note: Democrats aren’t alone in currently pursuing bad tax policy.) Ideally, the focus of tax policy in Congress should not be on AMT alone or how to pay for AMT relief. Instead, members of Congress should look at more fundamental tax reforms that include, among other improvements, eliminating the AMT system.

It is true that those on the political left and right disagree on the degree of progressivity that a tax system should have. But that should be the last question asked in tax policy. Experts in tax policy on both sides of the aisle agree that given some revenue constraint and desired level of progressivity (whatever it is), the tax code should be written in a way that maximizes economic efficiency. Unfortunately, we are not close to an efficient tax system.

But even setting aside the issue of fundamental tax reform, if Democrats want to use this as an opportunity to roll back those portions of the Bush tax cuts that they oppose and make the tax code more progressive in the process, some ways are better than others to accomplish that goal. For example, cutting marginal tax rates on lower-income individuals and/or expanding EITC (policies that have positive marginal incentives) are better tax policies than expanding the child tax credit or increasing the standard deduction, which have little, if any, economic benefits.

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