Do we really need a second AMT?

The famous Yogi Berra quote, “It’s déjà vu all over again”, is certainly appropriate for the wasted effort President Obama and the press is placing on the tax returns of a very few people. Since one of those few Americans is a presidential candidate (Mitt Romney), we will continue to hear about it, if for no other reason than because it makes good populist politics.

The so-called Buffet Rule is nothing more than a reworking of the existing Alternative Minimum Tax (AMT).  Similarly, the justification for passing any Buffet Rule is the same as what was used for initially passing the AMT. That justification is contained in the “General Explanation of the Tax Reform Act of 1969”, prepared by the Staff of the Joint Committee on Internal Revenue Taxation. On pages 104 and 105 of such report, Congress explained the reason for the new AMT as follows:

“G. Minimum Tax

Under prior law, many individuals and corporations did not pay tax on a substantial portion of their economic income as a result of the receipt of various kinds of tax-favored income or special deductions. …

The prior treatment imposed no limit on the amount of income which an individual or corporation could exclude from tax as the result of various tax preferences. As a result, there were large variations in the tax burdens placed on individuals or corporations with similar economic incomes, depending upon the size of their preference income. In general, those individual or corporate taxpayers who received the bulk of their income from personal services or manufacturing were taxed at relatively higher tax rates than others. On the other hand, individuals or corporations which received the bulk of their income from such sources as capital gains or were in a position to benefit from net lease arrangements, from accelerated depreciation on real estate, from percentage depletion, or from other tax-preferred activities tended to pay relatively low rates of tax. In fact, many individuals with high incomes who could benefit from these provisions paid lower effective rates of tax than many individuals with modest incomes. In extreme cases, individuals enjoyed large economic incomes without paying any tax at all. This was true for example in the case of 154 returns in 1966 with adjusted gross incomes of $200,000 a year (apart from those with income exclusions which do not show on the returns filed). Similarly, a number of large corporations paid either no tax at all or taxes which represented very low effective rates.”

That’s right. The Alternative Minimum Tax, which currently ensnares millions of middle class tax filers each year, was initially created by some do-gooders who were trying to tax 154 taxpayers. Those 154 taxpayers used legitimate tax deductions that some other do-gooders previously thought would support economic activities that the economy needed.

The so-called Buffet Rule will affect two relatively small groups who are important to our economy.

First, there are those who receive lots of dividends from publicly traded companies that have already been taxed on their corporate income. President Obama thinks it is a good idea to increase the double taxation that already exists for these shareholders of C-Corporations (usually large corporate employers) who pay dividends. This will move capital formation to smaller businesses that are able to use conduit taxation applicable to a Subchapter S corporation or partnership. Hurting large corporations in favor of small corporations will not really accomplish anything useful.

Second, there are those who have large amounts of one-time income for investing in growing businesses that compensated their investors by increasing the underlying value of the business (instead of paying current cash dividends). These investors financed the creation and growth of companies such as Google, Apple, and (in its early years) Microsoft, as well as practically every small business in America. Theses business owners take a lifetime of work and investing, and eventually convert their labors in a one-time sale of their company. More often than not, this is done in connection with their retirement. Discouraging these folks from creating economic value is not a good idea for our economy.

A third group of taxpayers should face additional tax.  Income of investment managers called “carried interests” are actually not substantively different than other service income, and should be taxed as ordinary income.  Currently, such income can be structured in a way that it is taxed at favorable capital gains rates.  This desireable fix does not require anything more complicated than legislating carried interest income be ordinary (not capital gains) income.  We do not need a whole new AMT regimen to address this item.

Like the implementation of the original AMT, most successful people will not be affected by the so-called Buffet Rule. The marginal tax rate for income over $1 million is already well over 30%. Sure, there are some exceptions (I describe them above), but they are only highly-publicized exceptions.

The additional taxes will not solve the budget mess the country faces. The vast majority of wealthy are already paying a greater amount of income taxes than this proposal proposes. The additional taxes will get lost in rounding when compared to the enormous issues that the President is ignoring or aggravating. Although the additional taxes (which will be paid by those described above) are a bad idea, the President’s rhetoric regarding protecting the rich will cause too much other damage. Consequently, my advice for the Republicans (who certainly have not asked for my advice) is to yawn at the President’s insignificant additional tax. Implementing the President’s ideas will hopefully allow the administration and Congress to address the much more serious issues that need to be addressed.

The additional taxes proposed by President Obama are indeed class warfare, directed to a very few Americans who are successful and are creating opportunities for the rest of us. The additional taxes will be paid by a limited number of people (most of whom are retirees or just entering retirement) who have genuinely been successful, and thereby earned the envy of others who have not been nearly as successful when playing by the same rules. Don’t let the examples of Messrs. Buffet and Romney convince you otherwise.  Like the AMT, the Buffet Rule will initially be directed to a only a few people who are lawfully applying the Internal Revenue Code in exactly the way that the initial authors of those provisions intended.

But let’s be clear. Each time the tax code is tweaked for some do-gooder’s purpose, there are unintended consequences. Like its close cousin (the AMT), the Buffet Rule will get morphed into something that will not have the desired effect, but will end up instead affecting other things. If the President really wants to make things fair (instead of primarily punishing success of too few people to even matter), a simpler and much flatter-rate tax would (i) increase tax compliance, (ii) save enormous wasted efforts implementing a too-complex tax code, and (iii) have fewer unintended consequences.

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