CONGRESS ENACTED the Alternative Minimum Tax, or AMT, in 1969 to target 155 people who earned more than $200,000 in 1967 (more than $1.2 million today) and paid no taxes. Over the past 40 years, this tax has expanded so that unless Congress acts, next year the AMT will hit about 25 million American taxpayers and more than one in five of Massachusetts's taxpayers. The AMT is terrible tax policy, both because it targets the wrong deductions and because its unpredictability gives lawmakers too much ability to misrepresent the future.
Without reform, more than one-third of taxpayers earning between $75,000 and $100,000 a year, and more than 70 percent of taxpayers earning between $100,000 and $200,000 a year, will pay some AMT in 2007. The AMT hits middle-income taxpayers by eliminating the deduction for state and local income taxes and the standard deduction that increases with family size. While the original AMT went after the ornate tax shelters of the uber-rich, today's AMT goes after the automatic deductions of the middle class. Does this make sense?
Certainly, there is a good case for not eliminating these deductions. Schools are the big budget item for most local governments, and we all benefit when towns invest in children. Education makes children more successful, and when they become skilled adults, they improve the productivity of everyone around them. Thomas Jefferson argued that education makes people better citizens, and there is plenty of data that now backs him up. By eliminating the deductibility of local taxes, the AMT pushes citizens to oppose spending on education.
The Welfare Reform Act of 1996 shifted the burden of supporting poorer Americans onto state governments. I have always been skeptical about localizing responsibility for welfare, because when localities raise taxes to care for the poor, then businesses and the rich just run away. The federal government should fight the tendency of the rich to flee the poor, but when the AMT eliminates the deductibility of state taxes, it just increases the incentive for the prosperous to move to low-tax, low-service states.
I am also unenthusiastic about eliminating tax preferences for larger families. Most people seem to think that giving tax relief to bigger families is a matter of simple fairness. As an economist, I lack standing to make proclamations about fairness, but there is another reason to subsidize larger families. When parents decide to have kids, they are creating a massive benefit for their children. As much as parents may love their children, they are unlikely to reap all the benefits those children will offer during their lives. Economists often think that it makes sense to subsidize behavior that generates big "external" benefits for others: parenting seems like a particularly natural example of such behavior.
These arguments are open to debate, but if, as a society, we didn't want the tax code to subsidize public schools or larger families, then we should eliminate these deductions entirely, not just for the people hit by the AMT. I could get enthusiastic about tax reform that reduced the agony of tax preparation, but while the AMT may be flat, it is far from simple. The AMT just adds to the system's complexity by layering on more rules.
The AMT is even worse for Washington than it is for taxpayers. Because the AMT is not indexed for inflation, it requires constant tinkering. Since this tinkering is not automatic, the AMT gives lawmakers leeway to make rosy projections about future revenues by assuming that the AMT will remain in full force. Politicians are untroubled by the fact that such projections contradict the historical record of Congress regularly reducing the AMT to makes it less onerous. These rosy revenue projections can then be used to understate the long-run consequences of tax cuts. It was, in fact, the AMT that made the fiscal consequences of the Bush tax cuts less transparent.
The AMT's one virtue is that it does raise money, but even this virtue is actually a vice. This country needs root-and-branch tax reform that will make the tax code simpler and more efficient. By raising tax dollars, through the dubious means of eliminating deductions for state and local taxes and larger families, the AMT makes it easier for politicians to avoid the harder and more important task of real tax reform.
Edward L. Glaeser, a professor of economics at Harvard University, is director of the Rappaport Institute for Greater Boston.