Why the AMT Is No Flat Tax
BusinessWeek's Feb. 16 Cover Story on the alternative minimum tax, "The Stealth Tax", generated lots of reader response. Many readers, such as John Gaylord of Houston, wondered whether the dreaded AMT is anything like the flat tax -- that simple, one-rate, file-on-a-postcard tax return that economists have been dreaming about for decades.
It's a good question. And on its face, the AMT does look like the flat tax. The AMT has only two rates -- 26% and 28% -- and it effectively eliminates many deductions, as any simplified tax system would. Indeed, many conservative economists do see the AMT as a big step in the direction of a flat tax.
NO RHYME OR REASON.
But the resemblance is only skin deep. In fact, the AMT is about as far from a true flat tax as you could imagine. If the AMT is tax reform, Paris Hilton is a pig farmer. Here's why:
A key benefit of the flat tax is its simplicity. By dumping deductions, it makes filling out a return easy and can make the tax code fairer. Under most reforms, you figure your gross income, subtract whatever you save and invest, take an exclusion to ease the burden on the working poor, and multiply by whatever tax rate the law requires.
The AMT doesn't work that way at all. For starters, you need to do your regular income tax return, then do it all again under the AMT. Nothing simple about that. Then there's the matter of deductions. In a true flat tax, you would lose them all, including such untouchables as mortgage interest and charitable contributions. Dumping those deductions is what would allow Washington to drive down rates and still generate enough tax revenue to operate the government.
The AMT is much more arbitrary. You lose some deductions, but get to keep others with no economic rhyme or reason for what you keep and what you lose. No logic exists for protecting the mortgage interest deduction under the AMT, or for letting you exclude some municipal-bond interest, but making you pay tax on income from other state and local bonds. These choices are the inevitable result of tax politics. But they're horrible tax policy.
Finally, consider investment income. Under most versions of tax reform, you pay no tax on investment income until you stop saving the money and start spending it. At the same time, you lose all interest deductions. The AMT, however, still taxes investment income and, in fact, effectively taxes dividends and capital gains at higher rates than under the regular tax. And you lose the deductions for some, but not all, of your interest costs.
And about those rates. Sure, the AMT only has two. And that sounds better than the six the tax code has today. But rate structure is the least important element of tax reform. The real key is what happens to deductions, which influence what economists call the tax base. It's those decisions about deductions that really drive the bus. The broader the tax base -- that is, the more income that's subject to tax -- the lower the rates.
Reformers don't care much if the code has one, or two, or four rates. They just want the broadest tax base possible. Besides, under the AMT, many taxpayers end up paying higher effective rates than they would under the regular tax. And the whole idea of tax reform is to get your rates down.
So no, the AMT isn't a flat tax. Indeed, in many ways, it's anti-reform. But those that see a link between the AMT and tax reform do have one thing right: The alternative minimum tax is so hideous that it might make us all want to rebuild the income tax system.
By Howard Gleckman in Washington
Edited by Patricia O'Connell