Commentaries

Posted: Nov 12, 2007 | Author: Pamela Villarreal

Fixing the AMT: Could a Flatter Tax System Be in the Works?

Over the past two weeks, Congress has introduced a couple of proposals designed to "fix" the Alternative Minimum Tax (AMT) that may hit an additional 23 million taxpayers this year.  What are the alternatives being proposed?

The Rangel Proposal:   Charles Rangel (D-NY) introduced a bill that would permanently repeal the AMT.  Rangel's proposal would also increase the child tax credit, increase the standard deduction for joint filers and reduce the corporate tax rate.

But it would also:

• Replace the AMT with a surtax of 4 percent for singles earning $150,000 or more and couples earning upwards of $200,000 to $500,000, and a 4.6 percent surtax for couples earning $500,000 or more.
• Raise capital gain taxes from the current 15 percent to 19.6 percent.
• Tax the capital gains of fund managers at regular income tax rates, instead of current capital gains rates.

In other words, somebody would have to pay for AMT relief, according to Rangel, and the "wealthy" are the ones to do it (for further consequences associated with a surtax, see Michael Schuyler's NCPA Brief Analysis #599, "The Surtax:  Worse Than the Alternative Minimum Tax.")

The Ryan Proposal:  But an alternative proposal put forth by House Rep. Paul Ryan (R-Wis), the Taxpayer Choice Act, would permanently repeal the AMT and replace it with a simpler system of tax rates.  Ryan's proposal would:

• Provide an alternative Simplified tax system: 10 percent on taxable income up to $100,000 for joint filers and $50,000 for single filers, and 25 percent on taxable income above these amounts.
• Eliminate several itemized deductions and credits and replace them with a a standard deduction of $25,000 for joint filers and $12,500 for single filers.
• Including the personal exemption, a family of four would be exempt from taxes on the first $39,000 of income.

This proposal would not eliminate the current tax regime.  It would instead allow taxpayers to choose between the current rates or the simplified tax system.  But the choice would be permanent, with only one allowable switch during a taxpayer's lifetime, or in the event of a change in status, such as divorce.

Are We Moving Toward a Flatter Tax System?  David Henderson of the Hoover Institution notes that the AMT contains elements of a flat tax, such as fewer deductions and only two marginal tax rates (for more on Henderson's analysis, see NCPA Brief Analysis #588, "How to Fix the Alternative Minimum Tax").  But it could be further modified by further reducing exemptions and limiting deductions, and reducing the tax rates.

Ryan's proposal is a start toward a flatter tax that Henderson describes, but allowing taxpayers to switch their choice of tax regimes only once in their lifetime could be problematic.  After all, tax forms are complicated; if an unsuspecting and confused individual accidentally misses line 55 or some other on Form 1040, he should not be penalized for a lifetime through higher taxes.

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