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  • Contrarian Tax Policy

    Posted by Mitch Townsend on May 6th, 2004 (All posts by )

    At the risk of inciting a riot, let me propose that the alternative minimum tax may not be the worst idea since the designated hitter rule. Bear with me a little while before you start looking for something to throw.

    The alternative minimum tax is widely unpopular for good reason. It obliterates itemized deductions, including state taxes and mortgage interest not directly related to the purchase or construction of one’s home. It comes as a surprise to the unwary individual taxpayer. Originally intended to keep rich people with clever accountants from escaping income tax, it applies at income levels that hardly qualify for tycoon status ($40,250 for single filers, $58,000 for married couples). The capital gains rate has been temporarily lowered to 15%, but will revert to 20% unless new legislation is enacted. So what is there to like about the AMT?

    There are actually a couple of things to like about this tax. First, it is almost perfectly flat. The rate is 26% up to $112,500 for single filers, $150,000 for married couples. Above that, the rate increases, but only to 28%. Depreciation schedules are either straight-line or at least not as accelerated as the MACRS tables used for regular income tax. This brings the cost of tangible assets closer to the way they are presented for financial purposes. Elimination of the state tax exemption keeps the effect of state taxes inside each state’s borders.

    The hidden beauty of the alternative minimum tax is that it is almost free of the effects of using tax law for social engineering. There is no income redistribution effect. Most of the rewards and penalties for economic behavior are removed, leaving it an essentially neutral revenue-raising device. It is nearly everything Jack Kemp or Steve Forbes could have asked for. If no legislative remedy is applied, it will slowly become the most common tax regime. Rather than abolishing this tax, perhaps we should consider abolishing all the others.

     

    19 Responses to “Contrarian Tax Policy”

    1. Jonathan Says:

      Interesting idea. What makes me nervous about it is the thought that if we adopted such a scheme we might end up with the AMT as a base, with other taxes added over time as usually happens.

    2. Richard A. Heddleson Says:

      If I had a flat rate on income I had actually earned and received cash for, it might be of interest. But being taxed on paper gains and having to pay in cash I have not received seems no great bargain.

    3. Michael Hiteshew Says:

      Hmmmmm. While I’m generally against social engineering via tax policy – it rubs my independent libertarian instincts the wrong way – I’m not an idealogue. I think we always need to look at the practical aspects of policy.

      The mortagage tax deduction comes to mind immediately. I think it can be argued that home ownership stabilizes society. That’s a good thing. In addition, it’s the most profitable (and practical) investment most people will ever make. Does it make sense to reward people, financially, for buying a home? Looked at another way, does it make sense to penalize those who don’t? It’s a tough call. My ideals say no. But the practical benefits are enormous. For everyone.

      Isn’t home ownership the basis upon which America was built? To become a land owner, a stakeholder? That the ‘wretched refuse’ could rise above their roots and buy into the middle class. That, and the freedom to practice reliigion without govenment interference drove American immigration and social development for our first 200-250 years.

      How much economic activity in this country is driven by homeowners? How many businesses are financed with homes as colatteral?

    4. in-cog-nito Says:

      Hey a tax guy! (in my former life I was a tax accountant…)

      Jonathan makes a good point – a flat AMT for everyone would be the second ideal behind utopian zero tax, but government will inevitably raise that minimum.

    5. Mitch Says:

      Michael — I’m oversimplifying here, but the mortgage interest deduction is allowed under AMT if it is used to “build, buy, or improve your house.” So the primary purpose of encouraging capital formation is preserved.

      Richard — Agreed in principle, but I still believe there should be a capital gains tax for publicly traded securities. If one company pays out its profits to its shareholders and the other keeps them, why should the shareholders in each company be treated differently?

      And here’s a really scary notion: the law provides for the ability to levy a tax on “all income, from whatever source derived.” In theory, there is no reason Congress could not decide that your unrealized gains are income. Does that seem far-fetched? Remember that the tax code already makes you pay on unrealized gains on some derivatives (sec. 1256, etc.).

      Jonathan, In-cog-nito — I’m shocked and disappointed at your lack of trust in our government. Considering the changes in the tax rates from 1913 through the present, though, I can see where you’re coming from. Any tax can be raised if there are not enough obstacles put in the way. Maybe we should think more about designing those obstacles. Giving the government more money just lets them stray from their time-honored functions of maintaining a reliable currency, administering justice, maintaining the roads and bridges, and keeping the barbarians on the other side of the river (formerly the Danube; now, I guess, the Jordan).

    6. Scott Says:

      Heresy! Off with his head.

    7. Ken Says:

      “The mortagage tax deduction comes to mind immediately. I think it can be argued that home ownership stabilizes society. That’s a good thing.”

      Stability, like most things, is good in moderation. Enough stability to prevent violence and allow long-term investment to take place is good. More stability than that is not necessarily better.

      “In addition, it’s the most profitable (and practical) investment most people will ever make. Does it make sense to reward people, financially, for buying a home?”

      Seems to me that if the investment is indeed profitable, then people are already rewarded for buying homes. Do we really need more reward than that?

      “Looked at another way, does it make sense to penalize those who don’t? It’s a tough call. My ideals say no. But the practical benefits are enormous. For everyone.”

      The practical drawbacks are also considerable. Rooting people in their communities has costs as well as drawbacks – if fewer people have the flexibility to move easily, then adjustments in regional labor markets happen much more slowly – some areas end up lacking workers for longer than necessary, while others have too many workers looking for jobs for longer than necessary.

      “That, and the freedom to practice reliigion without govenment interference drove American immigration and social development for our first 200-250 years.”

      You really think buying homes and practicing religion freely are the only things that have been attracting foreigners and enabling our prosperity? And if you think that immigrants and natives indeed count the buying of a home as one of the most important features of life in America, surely you don’t expect them to need a tax incentive to actually do so.

    8. In-Cog-Nito Says:

      “Giving the government more money just lets them stray from their time-honored functions of maintaining a reliable currency, administering justice, maintaining the roads and bridges, and keeping the barbarians on the other side of the river (formerly the Danube; now, I guess, the Jordan).”

      Absolutely, give me my money, justice, roads, keep the barbarians out, and I’m a happy camper. Everything else is more or less pork.

      For shits and giggles, if I remember correctly, some tax form or other I read a while ago had a section that read something along the lines of: if you would like to help reduce the federal debt, please send checks to…

    9. Richard A. Heddleson Says:

      Mitch,

      I’m not sure what your comment regarding capital gains versus dividends referred to. I was speaking to the point you make later about being taxed on unrealized gains. It’s wrong and it exists today not just on derivatives as you point out.

      I’d favor eliminating all corporate tases and forcing companies to pay out earnigns to shareholders as do REITs. If companies had to go to the market to build capital instead of having a captive source of funds a lot of today’s management abuses would come to a screeching halt.

      Actually, I favor repeal of the 16th amendment.
      the prohibition on direct taxes was a good idea in 1787 and it still is. It has lead to the uncontrolled government we have today. The only Progressive era amandment that was any good was the franchise for women. One down, two to go.

      Michael,

      As long as we have this corrupt tax system and mortgage interest is deductible to loandlords, it should be deductible to homeowners as well.

    10. Michael Hiteshew Says:

      Seems to me that if the investment is indeed profitable, then people are already rewarded for buying homes. Do we really need more reward than that?

      It’s the tax deduction that makes buying a home affordable to poor slobs like me. I agree, a flat, no-dedections tax system is more idealogically pure. It will also result in fewer home owners. Interesting trade.

      The practical drawbacks are also considerable. Rooting people in their communities has costs as well as drawbacks…

      I thought about that, believe it or not. That’s why it was a tough call for me. I could see costs and benefits in both directions. I actually sat, staring at the screen, thinking about alternative scenarios. I came down, eventually, on the side of keeping the deduction. Purely a subjective call on my part, I know. The fact that I’m on the receiving end of that deduction certainly influences me. But I also believe it allows the average Joe and Jane to build capital in a way that’s almost unparalled by any other investment. That also has many secondary benefits, as discussed above.

      Aren’t we really discussing how pure we like our capitalism? I’d say it’s akin to how rare we like our steak, except peoples lives hang in the balance of our subjective opinions.

      (It’s tough to blog with a strong bloody mary in you. It’s even tougher when part of your attention is on the Orioles game on TV downstairs. Hope I didn’t do too badly.)

    11. David Mercer Says:

      So long as we’re on the subject of taxes…what the HELL is up with requiring ADVANCE quarterly payments of estimated tax for self-employment income?

      I have no freakin clue how much I’ll bill each month, let alone quarter. If my choices included being able to pay monthly, after I get my money, and know how much of it I’ve made, I’d, well, let’s say be much more likely to pay on time and leave it at that.

      As it stands, you get nasty penalties if you don’t pay quarterly, UNLESS you pay all of it on time in one giant lump sum on April 15.

      Which is all well and good if you’re doing well, but what about us poor sobs who are at or below the poverty line and self-employed?

      Flat, regressive, progressinve, whatever, quarterly in advance or annual lump sums aren’t realistic for those of us who are barely making it self-employed. Which is part of why at age 33 I’m returning to the (compared to independant solo consulting) warm womb of academia.

    12. TM Lutas Says:

      I think that a large part of what makes AMT so horrible is not the tax itself, it is its alternativeness. The AMT increases the calculation burden for those who do things manually, causing more and more people to shift over to software or a professional accountant, something that is nice for those industries but hardly a valid social engineering goal even by most liberals’ lax standards. If it were the only regime, it would drastically reduce complexity, a social good, and reconfigure a good chunk of the economy to something more productive.

    13. Richard A. Heddleson Says:

      I doubt that the elimination of tax deductibility would result in a substantial reduction in the rate of home ownership except at a very small margin. This may have been true before 1970, but not now. It would result in smaller houses and lots with an increased urbanization of the population.

      Houses are really very liquid investments in most markets and I do not see mortgage deductibility anchoring people in locations. People tend to get rooted in their house due to preferential property tax treatment like California’s proposition 13 and other lax assessment processes in other locales. People tend to get rooted in communities because of the value of the human networks they develop. Replacing these networks with newly established ones is time consuming, financially and emotionally expensive and deleterious to the development of children. That is why people prefer to stay in a community even if they can trade up in house value. It is only when these networks are destroyed that people become eager to leave a location. This was the perceived threat that drove the white flight of the 70’s as much as racism.

      The deduction for landlords and owner residents should go. They subsidize overinvestment in real estate and, dare I say it, sprawl.

      TM,

      I can’t believe you do your taxes by hand as your post implies. I quit five years ago when I was doing workshhets and subsidiary calculations all over the place for this and that new condition that had been added to the tax code as a means of increasing tax revenue without changing tax rates. The complexity of the tax code that makes turbotax profitable is one of its greatest injustices. People should be able to calculate their taxes by hand in less than 3 hours. Anything else is additional tax in time as well as money.

    14. Bart Says:

      As an expatriate (temporary), I take exception to your positive inclination towards the AMT. I paid significantly more taxes in Italy last year than I would have paid had I been living in the U.S. Nevertheless, I get nailed by the AMT every year; essentially, my income is double-taxed. There may be some potential in the AMT, but it requires serious engineering before it could ever approximate a “fair” tax. The AMT must go.

    15. dontno Says:

      What if one loses 50000 in the last market crash, then in 2003 makes 50000 cap gains. Would he have to pay AMT? Or can the loss offset the gain without triggering AMT?

    16. Richard A. Heddleson Says:

      dontno

      Same tax year? If so, they wash no AMT issue. If not, you probably need to hire a tax attorney to work it out and defend you after the IRS disagrees.

    17. dontno Says:

      Richard:

      My tax preparer still has my return (filed extension) but last I heard I would owe due to AMT. If this is the last word, I’ll have someone else look at it. It didn’t seem fair to me. Thanks for your reply.

    18. Richard A. Heddleson Says:

      Trust you’re tax preparer more than me, but this is the most astonishing AMT result I’ve heard of yet. Same year, eh? Do you understand why?

    19. dontno Says:

      Richard:
      The loss was in 2001, the gain was in 2003. If a loss can be carrid forward I don’t see what difference it would make. The difference to my taxes is $1500. Think I’ll call monday and see what she found out.