Oct. 26 (Bloomberg) -- The alternative minimum tax is an abomination that should be abolished.

So-called carried interest, the gimmick that allows managers of hedge funds and private equity firms to treat what is really earned income as lightly taxed capital gains, is grossly unfair to other taxpayers. So is a provision that lets such managers defer tax on income they park offshore.

Getting rid of all of these provisions and using the revenue raised by killing the latter two to offset part of that lost by abolishing the AMT is a great idea.

Representative Charles Rangel, the New York Democrat who heads the House Ways and Means Committee, yesterday proposed doing just that. The remarkable thing is that the first step in that direction might become law -- at least for the current tax year. And it should.

Year after year, both Republicans and Democrats have approved temporary increases in the income threshold above which taxpayers become subject to the AMT. These ``patches'' have been adopted because no one has wanted to let the AMT hit the additional 21 million taxpayers -- some with incomes as low as $50,000 a year -- who otherwise would have to pay it.

In the past, the annual patch has been made without finding any way to offset the lost revenue, estimated at $50 billion for 2007. Now, with Democrats controlling Congress, there is a so- called pay-as-you-go rule that requires that revenue lost due to a tax cut must be matched by either some other tax increase or spending cuts.

Actually, the rule isn't quite as tough as it seems. The $50 billion is a one-time revenue loss since the patch applies only to 2007. The revenue gain from permanently eliminating the provisions affecting fund managers can be counted for a number of years.

Pass Both Parts

That is no more implausible than a lot of other congressional budget accounting rules. And since both parts of Rangel's proposal make so much sense, it should to be passed.

A key reason that may happen is that there is a deadline regarding the patch.

Treasury Secretary Henry Paulson said in an Oct. 23 letter to some members of the House and Senate tax committees that unless the AMT patch is passed by Nov. 7, tax forms and Internal Revenue Service computers can't be updated by the time taxpayers start filing returns early next year. That would delay taxpayer refunds next year, he said.

Without the patch, those 21 million households would see their AMT tax increase by an average of $2,000, Paulson said.

Republicans are as eager as Democrats to limit the impact of the AMT. However, they generally are going to oppose raising anyone's taxes. Instead, they likely will push to waive the pay- as-you-go rule.

The Stealth Tax

Rangel's proposal for this year is just a small part of a sweeping plan, the foundation of the broader plan is permanent repeal of the AMT, which is so badly flawed there's no way to fix it. Left untouched, the AMT eventually would begin even to limit use of the standard deduction claimed by a large majority of taxpayers.

The AMT hasn't been repealed because it raises so much revenue, and because it's a sort of stealth parallel tax system and not well understood. For instance, while President George W. Bush brags about the large cuts in income tax rates enacted since he took office, the reality is that those lower rates also have made millions of additional taxpayers subject to the AMT for the first time.

Longer term, Rangel would replace the lost AMT revenue with a 4 percentage point surcharge on whatever marginal rate a taxpayer is paying when his adjusted gross income, or AGI, is above $200,000. The surcharge would rise to 4.6 percentage points when AGI is above $500,000.

The current 15 percent top marginal rate on capital gains and dividends would also be subject to the surcharges.

Those changes in tax rates, Rangel explained first to the Ways and Means Committee on Oct. 23 and later to reporters, would raise about $832 billion over 10 years, more than enough to cover the AMT repeal.

Time for Honesty

Even with the surcharge and the higher capital gains rates, most taxpayers with AGI's between $200,000 and $500,000 would pay less than they would under the AMT, he said.

There are a host of other provisions in Rangel's plan covering corporations, professional partnerships, mergers and acquisitions, and individual provisions such as the child tax credit, the earned income-tax credit and the standard deduction. All these latter individual provisions would lower taxes modestly.

Rangel said the overall plan, which he doesn't plan to bring up for a committee vote this year, is intended to be revenue neutral.

House Minority Leader John Boehner of Ohio issued a statement yesterday denouncing the proposal, saying it would raise taxes by $1.3 trillion over 10 years.

Well, some taxes are going to have to go up to get rid of the AMT, because neither Republicans nor Democrats have any stomach for cutting spending to offset the revenue loss.

For years everyone's budget projections have been phony because, with the single year patches, the full amount of AMT revenue is counted for future years even though everyone knows it won't be collected.

It's time for a little honesty.

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: October 26, 2007 00:04 EDT