I once had a career as a federal tax professional. I was initially hired for a project that refigured taxes for people that had failed to take known deductions. It felt good to be generating refunds for people.
Eventually I worked up the ladder and went to tax auditor school. I learned to read the Internal Revenue Code, which is the compilation of actual tax laws that Congress has passed and the President has signed. If you pop open your handy-dandy IRC for some light reading, you will quickly realize that few legislators could possibly have actually read through the arcane language they put into place.
Not surprisingly, tax professionals (and even judges) can’t read it very well either. And ingenious taxpayers are forever coming up with ways to apply the code that nobody ever thought of before. So the Department of the Treasury issues Treasury Regulations, which include advisories from the IRS, rulings by the Commissioner of Internal Revenue, rulings by lesser authorities, and rulings by tax courts. While the IRC itself comprises thousands of pages, the Regs are roughly four times as thick.
Again, it should surprise no one that even the addition of this multi-tome set fails to adequately clarify matters. Often it serves to murkify. But thankfully the private sector has come to the aid of both taxpayers and tax officials swimming in a seemingly boundless sea of laws and regulations by offering a variety of guides aimed at the professional level. These voluminous guides dissect each minute subsection of the code, cross reference pertinent Regs and court cases, and gingerly explain how issues are applied in real life. I supply no link to these because they are available only by spending considerable money.
During my tenure as a tax professional, our federal politicians succeeded in “simplifying” the tax code so much that it doubled its required shelf space. The regs and guides, of course, did the same. That is why I’m always skeptical when I hear a politician talking about tax simplification.
Utah Policy’s LaVarr Webb is fond of saying that Congress is only capable of two things: nothing and overreacting. Nowhere is this better exemplified than in the tax code. It is a collection of 94 years of overreactions and failure to act where action should have been undertaken.
Politicians regularly gripe about the complexity of filing a tax return. Some give lip service to the idea that taxes should be simplified to the point that they could be filed on a postcard. But they cannot bring themselves to go this route. Why not? For two reasons, which are actually two variations of the same reason: 1) Tax law is frequently used to pay political favors, and 2) tax law is often employed as a tool of social engineering.
Let’s look at an example of the latter, which is also an excellent case study of Congress’ two default behaviors of both overreacting and doing nothing — just at different times. It started in 1969 when Congress overreacted to the news that 21 tycoons had escaped paying taxes by applying legal loopholes. In its fury, the Democratically controlled Congress imposed the Alternative Minimum Tax, which was designed to make sure that rich people that get out of paying regular income tax will still pay some taxes. President Nixon signed it as part of that year’s tax act.
Over minority objections, the AMT was not indexed for inflation. So over the years, the tax began to apply to increasing numbers of taxpayers. In 1993, Congress exacerbated the problem by raising the AMT rate from 24% to a combined 26%/28% rate. The upshot is that for the 2006 tax year, 3 million taxpayers had to pay AMT. But this number was only that small because of temporary measures included in the Bush tax cuts that are set to expire. In this case, Congress didn’t do nothing, but it failed to go far enough to reign in this unruly tax. While Congress now sits around doing nothing about the problem, the tax is set to impact 23 million taxpayers in the 2007 tax year.
So a tax that was meant to apply only to a small handful of Warren Buffett types will soon apply to 20% of the taxpaying public. If you’re sitting there thinking that at least you’re out of the woods, consider the fact that some people earning only $75,000 will be paying this tax when they file their taxes next year. You might find yourself among that number. Oddly enough, some of the tycoons for whom this tax was custom built have managed to find legal ways to avoid paying it. Go figure.
Why is Congress doing nothing about this? The simple answer is that they are addicted to spending. It is estimated that scrapping the tax would “cost” the government billions next year and $1 trillion over a decade. (Never mind what it will cost taxpayers if the tax isn’t scrapped.) These numbers ignore the revenue increases that would occur via regular income tax if the AMT were not collected, because Congress mandates that it live in a universe that ignores reality.
Why is Congress likely to at least make some attempt to do something about the AMT? Many of the taxpayers that will be paying the AMT for the first time come from states with the highest state tax rates. You see, state taxes that are deductible for regular income taxes are not deductible for purposes of the AMT. And unsurprisingly, congressional delegations from states with the highest tax rates consist overwhelmingly of Democrats, some of them quite powerful. Think California, New York, New Jersey, and Michigan, among others.
The Wall Street Journal editors note in this editorial that the “easiest exit from this box canyon would be for Democrats to cut the AMT rate back to its pre-Clinton levels….” But the most common schemes being floated around ply the old class warfare waters of sticking it to the rich. Um, you might note that sticking it to the rich was the entire goal of the AMT, and that this didn’t work out so well over the long haul. It’s a bad idea to try to fix the problem simply by creating another similar one.
The other night I spent half an hour running through Form 6251 to figure my retired (decidedly not rich) parents’ AMT. It only took half an hour because, as a former tax professional, I know how to do these things quickly. Fortunately they didn’t owe any AMT — for 2006. I don’t know what will happen to them in 2007. I wouldn’t be surprised if this 1969 get-the-rich scheme ends up getting my faltering parents in their twilight years instead.