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Monday, October 31, 2005

The AMT is A-OK

Taxes, taxes, taxes. In some way, shape or form, it seems that any conversation regarding government will eventually fall upon the dreaded subject. Some pay, others do not, but when it comes down to it, taxes seem to be both the success and demise of many individuals come April 15. However, with the current structure of progressive taxation, it would seem that this system of vertical equity, seems all too unequal, not to mention inefficient.

Under our current system of progressive taxation certain individuals of society pay little to no tax, and other individuals pay as much as 40% of thier annual income. True, certain tax breaks and deductions give these "high payers" slight movement within the tax bracket, but the current system still remains inefficient.

Short of adopting a proportional tax rate structure, it would seem that all attempts for efficency and equity have fallen short of their goal. However, the Alternative Minimum Tax seems to be closest shot at the bullseye on the proportional tax rate target.

The alternative minimum tax, established in 1969 in attempt to "ensure that high-income individuals, corporations, trusts and estates pay at least some minimum amount of tax, regardless of deductions, credits or exemptions." In short, it makes it so individuals have to pay their fair share of tax. Now it Washington could only figure out what that fair share was in real terms. The alternative minimum tax is successful implementation of one small step towards the proportional tax rate structure. The AMT requires that at least a minimum, is required and that no one can avoid paying tax. This tax is expected to bring in almost $1.2 trillion over the next ten years. Now if only this tax were assessed accross tax brackets evenly, we would be inching our way toward the proportional system. But alas, President Bush is attempting to rid the nation of the AMT. The tax reform commission is working as I write to repeal the tax. But they seem to have noticed one small problem with the repeal; making up the difference in the budget.

I for one suggest that we keep the AMT, after all, what would more efficiency hurt?

I don't think you make it clear why you think the AMT increases efficiency.

In contrast, I think the AMT is likely to increase the inefficiency of the federal income tax over time. The reason? The marginal tax rate is the key. The income tax is an inefficient tax because it causes changes in labor market choices at the margin. Roughly, the higher the MTR, the greater the incentive effects with respect to efficienct choices.

While recent tax law changes have reduced marginal tax rates, there have been no changes in the AMT. Tax rates under the AMT have not been reduced. Further, the AMT is not indexed for inflation. Therefore, over time, even constant real incomes, will be growing incomes in monetary terms. Since the AMT is not indexed for inflation, over time more and more people will become subject to the AMT over time. For these people, they will see an increase in their MTR, and this increased marginal tax rate implies greater inefficiency, not less.
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