Finding a Long-Term Fix for the Alternative Minimum Tax

While it has been an annual occurence to fix the Alternative Minimum Tax (AMT) as suggested in this November 9th, 2010 CNN Money article written by Jeanne Sahadi, Congress needs to work on finding a permanent solution.  AMT is a tax law that was specifically targeted to affluent individuals in order to ensure that they paid an extra tax in addition to their regular taxes.  Its intent was to make sure that rich individuals would pay their fair share in taxes, especially when they are able to qualify for various tax deductions that limit their tax liability.  This issue is becoming a problem because income thresholds were never adjusted for inflation.

There is bipartisan support for adjusting AMT, but eliminating or adjusting it will create more pressure on the deficit.  Even though Democrats and Republicans want to make changes to it, they cannot reach an agreement on finding alternative revenue sources or government spending cuts to finance the change.  With an economic recovery still tenuous, both parties will be reluctant to raise taxes in any form.  It will also be difficult to find significant cuts in government spending since that would probably involve restraining entitlement spending or impacting national security.

If their interest is in maximizing economic growth, then they will want to look at instituting taxes based on consumption.  One popular initiative that has not received much traction in Congress is instituting a national sales tax.  This tax would create incentives to save, rather than spend.  Therefore, there is the potential to boost loanable funds for financial institutions and that could lead to more investment and job creation.  The main problem with this proposal is that low income and middle income households would bear larger share of the tax burden, particularly if food is not exempted.  When looking at proportion of income, it is much easier for affluent households to cut down on household spending than other families.

Another option is to focus more on equality and less on efficiency.  When looking at income tax rates to other countries, raising marginal income tax rates on high-income individuals could be done.  This would be applying the ability-to-pay principle where people who can most afford the tax should pay more.  The downside to this strategy is the concern that this might lead your most productive individuals to not invest as much.  That could hamper future economic growth.

With a divided Congress, it will be difficult to find a compromise in replacing this unpopular tax.  This is an issue that has gone unresolved for a number of years, so it will not be surprising if another stopgap solution will emerge.  If that is the case, then we will have to wait another year before finding a permanent fix.