A Right and Wrong Way to Kill the AMT

By Allan Sloan
Tuesday, November 8, 2005

There are shelves all over Washington groaning under the weight of blue-ribbon committee reports that made a big initial splash, then sank into obscurity. Many people predict just that fate for the report that emerged last week from President Bush's tax advisory panel -- but I doubt it.

Sure, Bush's current political weakness limits his ability to shove unpopular measures through Congress, but he's right about the need to fix the tax code. Otherwise the accursed alternative minimum tax will spread like a financial flu.

The hideously complex AMT was added to the tax code in 1969 to stop a few rich people from avoiding taxes entirely. But this year, it will afflict 3.6 million families, according to the Tax Policy Center, a joint venture of the Urban Institute and Brookings Institution. Next year, 18.9 million. In 2010, 30.9 million. That's not a handful of tax dodgers; it's the masses. The commission's report will set the agenda for dealing with this plague. As you'll recall, the proposals call for eliminating the AMT, cutting taxes on income from investments and making up for lost tax revenue by shrinking or eliminating deductions for home-mortgage interest and state and local taxes.

This has been portrayed in political terms, as low-tax, low-housing-cost red states benefiting at the expense of high-tax, high-housing-cost blue states. But if you crunch the numbers in the commission report, you see this isn't about blue and red. It's about wealth. And that's the topic we'll deal with today, rather than trying to parse the entire proposal and decide what's good and bad about it. The wealth aspect is really quite simple. Families with plenty of investments would do great under these proposals, but families whose major asset is their home -- which is most families, I think -- would be hurt.

The reason is right out of Economics 101: If you decrease the cost of owning something, you make it more valuable. If you increase the cost, you make it less valuable.

Investments would become more valuable because they'd get even better tax treatment than they do now, which would reduce the costs associated with them. By contrast, reducing the mortgage-interest tax break for most people and eliminating the deduction for property taxes would make owning a home more expensive. That would decrease home values -- or at the very least, keep them below where they'd otherwise be.

If you own a lot of investments as well as a house, the increased value of your investments would more than offset any decline in your house value. But if your major asset is your home, the decline in its value would be offset by . . . nothing. The have-a-lots make out a lot better than everyone else.

The problem here isn't the commission members -- it's the instructions that Bush gave them. (You can find the report and Bush's executive order creating the commission at http://www.taxreformpanel.gov .) Bush didn't ask the panel to design the best possible tax plan. He pre-determined the outcome by ordering that investments and businesses be treated more favorably and that the "reformed" tax system produce the same revenue the current system produces.

Keeping tax revenue the same while giving tax breaks to corporations and families with lots of investments requires extracting extra taxes from everyone else. I'd predicted the commission would do this by proposing a national sales tax or value-added tax, which it carefully considered (see Chapters 8 and 9). Instead, it recommended reducing existing tax breaks.

My favorite example of how the commission favors people with capital at the expense of those without are the proposed "Save at Work" accounts that would replace 401(k)s and such under the "Growth and Investment" plan. Workers now contribute pretax dollars to 401(k)s, but the commission proposes they use after-tax dollars (box 7.2, p.160).

That's great for people who already have plenty of money, but makes it much harder for people trying to bootstrap their way to a comfortable retirement. The solution? We ought to do what the commission proposes and kill the AMT -- but take another stab at fixing the tax code. Let's flash back to 1986, when Congress gave us true tax reform by eliminating popular deductions like sales tax (which Congress has since restored) and credit card interest. Dividends, which now get special treatment, were taxed the same as wages.

People shared pain -- and shared gain, too. Despite all the grumbling at the time, the 1986 reforms were fair both to people with plenty of capital and to people trying to amass it. Make a proposal like that today, and you'd have a report that would leap off the shelves, not be buried on them.

Sloan is Newsweek's Wall Street editor. His e-mail issloan@panix.com.

© 2005 The Washington Post Company