The Alternative Minimum Tax

Aimed at the "Rich," It Now Hits Middle Class Families

Jon Kyl, May 29, 2005

Earlier this week a Senate subcommittee I chair held a hearing on a law that provides a classic example of what happens when politicians try to narrowly target the "wealthy" for tax revenue.

Most Americans have probably not yet heard of the Alternative Minimum Tax (AMT), but if we don’t succeed in repealing it, they will soon. Enacted in 1969 with the ostensible goal of preventing very wealthy individuals from using legitimate deductions and credits to eliminate their tax liability, it is a parallel tax system that it does not allow many traditional deductions and exemptions, such as those for state and local taxes paid or for spouses and minor children.

Those most likely to be affected are those from high-tax states supporting families, and many don’t even find out that they have an AMT liability until they are penalized by the IRS for not paying it. In effect, the law today requires millions of people to calculate their tax liability twice - once under the regular system, and again under a completely separate AMT system - and pay whichever is greater.

Set aside the downright cruelty of forcing anyone to do their taxes twice. The bigger problem with the AMT is that, like most attempts to "soak the rich," it has ended up hitting middle-income taxpayers the hardest, particularly families with children. Because it is not indexed for inflation, the AMT’s parameters define more and more taxpayers as "wealthy" every year.

How many? When the AMT was born it affected a few hundred individuals at most. By 2003, that number had grown to more than 20,000 people in Arizona alone, and it’s expected to grow to 1.6 million in 2006 - the latter an increase of 7900 percent in just three years. Nationwide, the numbers are equally alarming: next year the AMT’s victims are projected to hit 21 million, and 30 million by 2010, according to the Treasury Department.

Surely, one thinks, these people can’t all be extraordinarily wealthy. And, of course, they’re not. In fact, in 2002 nearly two-thirds of those paying the AMT had adjusted gross incomes between $50,000 and $200,000. By 2010, over 80 percent will fall into this bracket. The average additional tax owed in 2004 (that is, on top of their regular tax liability) was $6,000.

At the hearing of the Subcommittee on Taxation and IRS Oversight of the Senate Finance Committee, we heard testimony that the AMT does more than penalize families. It also hurts economic growth.

When Congress and President Bush cut income tax rates for all Americans to help pull the economy out of recession, the cuts were specifically designed to encourage work, savings, and investment. The theory, endorsed by many distinguished economists including the 2004 Nobel Prize winner in economics, is that when someone’s last dollar earned is taxed at a relatively low rate - meaning that the tax penalty for working extra isn’t too great - people tend to work harder and be more productive. Conversely, when a worker’s last dollar earned is taxed at a relatively high rate, that person is much less likely to put in the extra effort. This reduces productivity and creates a drag on the entire economy.

When Congress cuts tax rates to encourage greater productivity, it reduces taxpayers’ regular tax liability, relative to the exemptions and deductions they can claim legitimately. But this reduced rate increasingly triggers the AMT for middle-income taxpayers, who are then stripped of the benefits of the tax cuts. In effect, the AMT takes away a significant part of the pro-growth incentive that was supposed to encourage people to work harder, save more, and invest more.

Or, in simpler terms, one hand giveth and the other taketh away. Which is what usually happens when Washington starts trying to soak the rich. But that doesn’t make it fair, much less good tax policy. And that’s why I’ve introduced legislation to repeal the AMT.

Senator Jon Kyl, a Republican, represents Arizona in the U.S. Senate. He serves on the Senate Judiciary Committee, the Finance Committee, and the Energy and Natural Resources Committee.