South-Western College Publishing - Economics  
America's Hidden Tax
Subject The Alternative Minimum Tax
Topic Taxes Spending and Deficits
Key Words

Income Taxes, Tax Reform, and Alternative Minimum Tax

News Story

In 1969, Congress added a complex and baffling tax to the U.S. tax code. Its intent was to prevent the super rich from using tax deductions to avoid paying their fair share of income taxes. Over time, this seemingly desirable tax has come to affect millions of American families, including moderate-income and middle class families.

When April 15 arrived in 2005, the alternative minimum tax required 2.9 million families to pay an average of about $6,000 more than they would have paid under regular tax schedules. The tax works by blocking people from using most of the big deductions that reduce their taxable income under normal rules of the tax code. Take, for example, a married couple making $100,000 a year in combined income. The couple must first compute their tax obligation under the regular tax code, then calculate their total taxes due again using the rules of the alternative minimum tax--where they must strip out all of their personal exemptions and most itemized deductions, such as those for home office use, state and local taxes, medical expenses, and interest on home equity loans. Then the couple must apply a flat rate of 26 percent to their gross income calculations. For couples earning more than $175,00, the flat rate is 28 percent. The taxpayer is required to pay the higher of the two calculations--either the one computed from the A.T.M. or the one calculated under traditional methods and schedules.

As nominal incomes rise and A.T.M. calculations are not adjusted for inflation, more and more American are being caught up in the A.T.M. and are thus required to pay higher taxes than under the traditional code. Analysts predict that if the current law remains unchanged, an additional $33.9 billion will be wrung from 18 million American households in 2006. In 2010, this figure will rise to $100 billion, and by 2015 an additional $200 billion will be required from households complying with the alternative minimum tax under what amounts to a form of bracket creep.

President Bush has ordered a bipartisan advisory panel to come up with recommendations on tax reform by the end of July 2005. Mr. Bush has promised to fix the alternative minimum tax as part of the reform; however, he has also given instructions that any recommendations regarding the A.T.M. must be "revenue neutral." "My understanding is that any reform in the A.M.T. that loses money would have to be made up with offsetting revenue," said Elizabeth Barrett, a tax panel member and professor of law at the University of Southern California.

Questions
1.

Discuss the difference between nominal income and real income.

2. How would adjusting the A.T.M. calculations for inflation affect the amount of tax revenue collected?
3. Discuss the concept of "revenue neutral" as it pertains to reform of the tax code. Given President Bush's tax policies in the past, how do you think any offsetting revenue would be raised?
Source Edmund Andrews, "A Tax Increase That Bush Didn't Mention," New York Times Online, April 10, 2005.

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