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A Punitive Parallel World

March 07, 2004

President Bush went on the offensive again Wednesday about the need for further tax cuts. "The voters," he announced to campaign donors at Los Angeles' Shrine Auditorium, "will have a very clear choice this year between keeping the tax relief that is moving this country forward, or putting the burden of higher taxes back on the American people."

But what if those very tax reductions make middle-class families owe more by shoving them into the poorly understood but punitive Alternative Minimum Tax system? Families with several children or who have relatively high state and local taxes (as in California) may see their tax relief wiped out because such credits are disallowed under the AMT.

Say a family with six children that makes $90,000 a year takes the standard deduction for 2003 -- $9,500 for a married couple -- and personal exemptions totaling $24,400 for each person in the family, plus the special $1,000 per child tax credit. It has a tax liability of $1,715. Not so under the AMT. The AMT doesn't include exemptions for children, and the family's tax liability increases by 35%. The child tax credit softens the blow somewhat, but the family still owes $605 more than it would under the regular income tax -- and in coming years, families will owe far more because the AMT is on track to increase rapidly unless Congress reforms it.

This is only one of the unintended consequences of a parallel tax system that IRS National Taxpayer Advocate Nina E. Olsen warned Congress about in January, saying it is "a time bomb on a short fuse." Congress approved the tax in 1969 after public outrage arose over 155 millionaires who, because of deductions and shelters, weren't paying any income taxes. But the AMT has morphed into a complicated stealth tax that hits millions of middle-class families every year. Unless Congress reforms the AMT, an estimated 37% of households earning between $50,000 and $75,000 and 73% making $75,000 to $100,000 will be paying it by 2010, adding from hundreds to thousands of dollars to their taxes.

Taxpayers who have any chance of being covered by AMT are supposed to calculate what they owe on the standard 1040 form, then rerun the figures -- minus standard deductions and certain exemptions -- on the dreaded IRS form 6251.

What's worse is that the truly wealthy have more options and can easily avoid much of the alternative tax. For one thing, the AMT has no curbs on the most basic tax shelters for protecting capital gains.

Bush is proposing a one-year remedy in his 2005 budget by temporarily extending provisions that shield millions in the middle class from the alternative tax. However, he's loath to propose a permanent cure because that would make tax cuts for the wealthy even more unaffordable, swelling the deficit by more hundreds of billions.

Firefighters and nurses shouldn't be paying for tax cuts for the wealthy. The AMT needs radical surgery, not a Band-Aid.

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