Fixing the AMT by Raising Tax RatesC. Eugene Steuerle The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
©2007 C. Eugene Steuerle. Reprinted with Permission.
House Ways and Means Select Revenue Measures Subcommittee Chair Richard E. Neal, D-Mass., recently told reporters that fixing the alternative minimum tax was likely to involve increases in statutory tax rates rather than cutting back on preferences in the tax code. He said the former was "probably more realistic." Or is it? Raising rates at first seems easier than dealing with preferences that people want to keep. However, the simple fact is that real reform involves winners and losers. The only way to avoid that problem is to keep the status quo. But the status quo isn't tenable either: Taxpayers are increasingly dissatisfied with an AMT that continually raises their tax burdens, and in fairly arbitrary ways.
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House Ways and Means Select Revenue Measures Subcommittee Chair Richard E. Neal, D-Mass., recently told reporters that fixing the alternative minimum tax was likely to involve increases in statutory tax rates rather than cutting back on preferences in the tax code. He said the former was "probably more realistic."
Or is it? Raising rates at first seems easier than dealing with preferences that people want to keep. However, the simple fact is that real reform involves winners and losers. The only way to avoid that problem is to keep the status quo. But the status quo isn't tenable either: Taxpayers are increasingly dissatisfied with an AMT that continually raises their tax burdens, and in fairly arbitrary ways.
So what to do? Let's start with the economics. Relative to increasing tax rates, broadening the tax base and limiting preferences is almost always the superior choice: It not only promotes economic growth but it is fairer to all taxpayers. Because both preferences and higher rates cause distortions, combining the two is particularly bad. Moreover, higher statutory tax rates increase the value of all other deductions and exclusions that aren't even part of the discussion. For instance, suppose one increases tax rates so that state and local tax deductions can be used more widely. Then the value of fringe benefits and nontaxable perks on the job also increase, and people can be expected to demand and take more of them.
There's another side to the equation, however. It's one thing to try to limit preferences. It's another to be sneaky about it, which is essentially the way that the AMT works. If the AMT really did target only preferences that should be limited anyway, it might not be that bad. However, several "preferences" in the AMT aren't really preferences at all, such as the dependent exemption for children and legitimate employee business expenses. To top matters off, some taxpayers face higher rather than lower tax rates in the AMT when they earn additional income.
From an economic perspective, therefore, the best solution would be to limit preferences as much as possible in the tax code, and then keep rates as low as possible along the way. A traditional large-scale reform would go well beyond the AMT, defining the tax base as best as possible, and, once that base was established, picking the rate schedule that would raise the desired level of revenue. If some remnant of the AMT must be kept as a second-best solution, the preferences that are kept should be ones that are least justifiable as part of the regular tax. Reform in the latter case would concentrate first on removing from the AMT those items that least belong there. For that group only, a case can be made for taxing people directly through statutory tax rates rather than by arbitrary restrictions in those deductions.
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