Earlier this week, the National Commission on Fiscal Responsibility and Reform released a draft version of its proposals on how to take control of our nation's deficit challenges, including suggestions for comprehensive tax reform. The good news in the proposal is that it includes a repeal of the highly unpopular Alternative Minimum Tax (AMT). The "bad" news is that the proposal also includes a repeal of many popular tax credits and deductions as well. But the reality is that we can't really have one, without the other.
The draft proposal set forth by the Fiscal Commission - or actually, a 50-slide PowerPoint presentation - includes two different versions of tax reform. The first, entitled the Zero Plan (beginning on slide 23), repeals the AMT entirely. It also unwinds all of the so-called tax expenditures - the numerous deductions and credits that are provided under the tax code to support or incentivize various behaviors - at a total tax savings of $1.1 trillion. Accompanying this simplification in deductions, tax rates are also dramatically simplified (and reduced), down to three tax brackets: 8%, 14%, and 23%. No more AMT, and virtually no more deductions at all; just add up your income, apply the three progressive tax brackets, and send the U.S. Treasury whatever you owe. Talk about a simpler tax season!
Admittedly, the Commission seems quite cognizant that so dramatic a change probably will not get traction, so they also provide "Option 2" - a reform package modeled after the Bipartisan Tax Fairness and Simplification Act of 2010 which was proposed earlier this year by Senators Ron Wyden (D-Ore.) and Judd Gregg (R-N.H.). Under the Wyden-Gregg proposal (beginning on slide 26), AMT would be repealed and the tax brackets would be reduced again to just three: 15%, 25%, and 35%. The standard deduction would increased to $30,000 for married couples ($15,000 for individuals), reducing the need for many to itemize deductions at all. In exchange, though, many itemized deductions would be reduced or eliminated entirely; no more deductions for state and local taxes paid or miscellaneous itemized deductions; mortgage deductions would apply only to the primary residence, up to $500,000 of mortgage indebtedness; charitable deductions would receive a 2% of AGI floor; and the income tax exclusion for employer-provided healthcare would be capped at a value comparable to what Federal employees receive in benefits.
So why does everything that includes AMT repeal have to take a whack at all of our most popular tax deductions as well? Simply put, because all of these tax expenditures are incredibly expensive for the Federal government to provide, and it needs the money not only because of today's deficits, but because AMT repeal itself is also spectacularly expensive. Accordingly to estimates just a few years ago from the Tax Policy Center, AMT repeal would cost nearly $1 trillion over the 10 year period from 2008 to 2018; and that's if the 2001 tax cuts actually expire as scheduled. If we wish to repeal the AMT while extending the current tax brackets, the price tag rises over $1.8 trillion. Remember, we pay the higher of either our tax liability under the AMT system, or under the regular tax system, which means the more we cut our regular tax bill, the more the AMT looms.
Accordingly, the numbers make it clear that AMT repeal just isn't possible unless it is accompanied by one of two options: raise all the regular tax rates and eliminate the deductions far enough that people aren't subject to the AMT (simply because they're paying more under the regular system); or reform the whole system to the point where tax revenues can be managed and redistributed without using the AMT as an anchor point in the first place. Given the spectacular unpopularity that would entail line-by-line changes to tax rates and deductions under option #1, we should realistically expect that option #2 - comprehensive tax reform - is going to be the path out of the AMT quagmire.
But the bottom line is that we cannot have our cake and eat it too. Although the AMT is sometimes not bad news from a tax planning perspective, the reality is that the AMT now provides a baseline amount of tax revenue for the Federal government. In order to eliminate the AMT from our tax system, the government must still address its revenue needs in some manner, through higher tax rates, fewer tax expenditures, or a comprehensive reform package that indirectly accomplishes some combination of the two. Unfortunately, there are no easy solutions here.
So what do you think? Is AMT repeal appealing, even at the "cost" of tax reform that also eliminates many popular deductions and credits? Does the Federal government need to find a way to manage the tax system while still retaining all of these credits and deductions, or would you prefer the proposals with a "simpler" system with lower rates but tax expenditures along with it?