Tax Reform and the AMT

The brand-new White House budget proposal for 2006 contains some interesting details. One of them is this: the White House is not requesting, or planning for, any reform of the AMT system in this budget. As such, it may represent a backhanded way of effectively repealing the Bush tax cuts. And yes, I’m actually taking my tongue out of my cheek for this post. (C.v. the previous post.)

The exemptions for the AMT are currently scheduled to shrink dramatically at the end of 2005, which means that starting next year millions more middle class taxpayers will be paying their taxes according to the AMT calculation rather than according to the traditional tax calculation. After four years fully one-third of all taxpayers, and virtually all families and individuals who earn over $75,000 per year, will pay taxes according to the AMT system of tax rates and exemptions – which were unchanged by the Bush tax cuts.

This phenomenon is exactly what accounts for the forecasted rise in personal income taxes as a percentage of GDP over the next 5 years according to the CBO, as illustrated in this chart:

(Note: the rest of the rise in personal income taxes as a % of GDP comes from the expiration of the 2001 and 2003 tax cuts, and from bracket creep.)

Yet despite the sharp rise in income taxes that many middle-class taxpayers will face over the next few years, Bush’s budget proposes no changes to the AMT. It does propose an overall tax reform of some sort, which would presumably include altering or abolishing the AMT. However, Bush’s budget also explicitly says that his Advisory Panel on Federal Tax Reform is to “focus on revenue-neutral reforms” (Analytical Perspectives, p. 281). If true, this suggests that the White House is planning on letting the sharply higher tax rates that the AMT will effectively impose on upper-middle income taxpayers during the period 2006-10 remain in effect.

It’s hard for me to believe that the Bush White House will actually let such an increase in tax collections actually happen, so I’m not sure where this leaves us – other than with a strong suspicion that any fundamental tax reform that Bush proposes will be anything but revenue-neutral.