Bill Clinton's AMT bomb

Bill Clinton's
AMT bomb
Alternative minimum tax 'will explode in the pocketbooks of 23 million taxpayers'

As tax season nears, Democrats in Congress are discovering they have an urgent political bomb to defuse--the alternative minimum tax. The AMT already hits four million Americans, and without new legislation this year it will explode in the pocketbooks of 23 million taxpayers come April 15, 2008.

What's amazing is that many Democrats and reporters are trying to blame this looming tax increase on the 2001-2003 tax cuts. See if you can follow their argument: Taxpayers are obliged to pay the higher of their tax bill under either the regular IRS code or the AMT. And because the tax cuts reduced the regular income tax of the average family by $2,000 a year, more middle-class families are being bounced to the AMT system. Ergo, it's all President Bush's fault.

This logic requires overlooking that a taxpayer's bill under the AMT is still lower than it would have been without the tax cuts. But never mind: The political game here is to use the AMT as an excuse to justify repealing the Bush tax cuts.

In reality, the AMT is one more liberal monster that was created in the name of soaking the rich but has now come back to swallow the middle class. Democrats created the AMT in 1969, amid a political frenzy to capture a mere 21 millionaires who had paid nothing. And the politician most responsible for the AMT's relentless expansion in recent years is none other than William Jefferson Clinton.

Remember the 1993 tax hike that was supposed to fall only on the rich? In addition to raising gas taxes and Medicare payroll taxes and income tax rates, the Democratic Congress that year also raised the AMT: from a 24% flat rate to a dual tax rate of 26% on AMT income up to $175,000 and 28% on AMT income above that amount.

It's true that the 1993 bill slightly increased the AMT's family income exemption, but Democrats refused to index those exemptions for inflation. So the combination of the higher rates and the failure to index for inflation has caught more and more middle-class taxpayers in the AMT's maw. From 1992 to 2002, this Clinton stealth tax hike increased sixfold the number of filers paying the AMT, to nearly two million from 300,000.

A Joint Tax Committee (JTC) analysis requested last year by Senator Charles Grassley of Iowa shows that about 11 million more Americans will have to pay the AMT next year thanks to the higher post-1993 AMT rates. The House Ways and Means Committee calculates that if you live in a high-tax state (such as California or New York) and have two or more kids, you're very likely to be hit with the AMT this year even if your income is as low as $75,000.

All of which means that if Democrats really want to spare Joe Lunchbucket from the AMT, the cleanest solution is to repeal the Clinton AMT rate hikes. The nearby chart, prepared by the American Shareholders Association based on Joint Tax data, compares the number of filers who will be hit by the AMT under current law and what would happen if the AMT rate was moved back to the pre-Clinton 24% and the exemption was indexed for inflation at the 2005 level of $40,250 ($58,000 for a joint return). Going back to the pre-Clinton rates would leave only about 2.6 million tax filers subject to an AMT penalty next year instead of 23 million under current law.

The estimated "cost" of this fix to the Treasury over 10 years would be some $632 billion, which is money Democrats in Congress would prefer to spend. But as Senator Grassley notes: "This tax was never meant to tax the middle class, so why should we count it as a revenue loss when we make sure they don't have to pay it?"

There's a larger policy lesson to keep in mind as the debate unfolds over both the AMT and the looming expiration of the Bush tax cuts in 2010: Beware politicians who say they only want to tax the rich. Sooner or later their tax schemes will soak the middle class because that's where the real money is. Regarding the AMT, Democrats are now saying they'll be glad to provide AMT relief for the middle class but they'll have to raise taxes on CEOs and other high-income Americans to do it. Where have we heard that one before?