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Yes, Virginia, there really is a 45% marginal tax bracket 
17th-Jan-2004 05:08 pm
and it's not for super-rich assholes, either.

First off, we'll need my

Capsule summary of the Alternative Minimum Tax

Imagine an alternate universe (coexisting on the same dimensional plane as our own, blah blah blah....). It's a universe that, at first glance, looks warm and familiar. Many of the same physical laws apply. The sun shines, trees grow, fish swim, Planck's constant is roughly the same, etc...

Upon closer examination one begins to notice subtle differences (Spock has a beard; there's an Empire instead of a Federation; Lister and Rimmer are female; Dog instead of Cat; and so on...). Eventually, one comes to understand the vague but corrosive sense of wrongness and unnecessary evil that permeates all aspects of life there.

As you might expect, this new universe has its own version of the US federal income tax.

Now, to be fair, some people already regard the ordinary income tax we all know and love as being somewhat evil already, but one can still think of this as a kind of mundane and, perhaps, even necessary evil (... we'll leave this whole debate topic aside, for now...).

In the new universe, the tax code seems at first glance like it might actually be nicer (True Evil seems to have a knack for this). There's this utterly huge exemption and if you do manage to get above that, there are only two marginal brackets, a 26% bracket that goes up to $175K and a 28% bracket for everything beyond that. It's Steve Forbes' wet dream, really.

But then you discover the various layers of complete irrationality that lurk beneath:

  1. There is no standard deduction. If you don't itemize, you're just screwed.
  2. The exemption phases out at an oddly low level (at least as compared with the size of the exemption).
  3. You cannot use any of the EZ forms. In general, most of the simplified rules for common situations do not have any analogues in this code (e.g., if you want to claim a credit for foreign taxes paid, there is no choice but to wade through the full horror of Form 1116, twice)
  4. State and local taxes are not deductible. (Why do this? Because we can.)
  5. The floor on medical expense deductions is 10% AGI instead of 7.5%.
  6. Home equity loan interest is not deductible.
  7. State and local "private activity" bonds are taxable. (Why? Why not?)
  8. The special breaks for incentive stock options (ISOs) do not apply. (OK, whatever...)
  9. ...
and, I almost forgot (well okay, I didn't actually forget, but it's important to set this apart for closer examination), last, but not least:
  1. Neither the exemption,
    nor the tax brackets,
    nor the level at which the exemption phases out
    are indexed for inflation.
See, in the alternate universe, the 1986 Tax Reform never happened.

Likewise for all of the other rationalizations that, over the past 45 years since this Alternative Minimum Tax was first introduced, have been attempting (with admittedly varying degrees of success) to make the ordinary tax code easier to deal with --- at least for ordinary folks who aren't doing really complicated things to make their money in the first place.

None of that ever happened. And Bobby Ewing is still alive there, too.

In short, if I didn't know better, I'd say the AMT Code is a tax code that is explicitly designed to make people hate the tax code --- and by this I mean a level of hatred well beyond what the ordinary tax code might engender.

Back to the real world

So here's the actual rule:  You fill out your 1040 stuff and calculate the ordinary tax in the usual way. Then you hop into the dimensional gateway, skip over to the Alternate universe, and calculate what your tax would be there. If it turns out that the Alternate Federal Government wants more money, then SURPRISE! you go back to the real universe, fill out form 8251, bend over, and pay the difference on top of your ordinary tax.

So really, we have the worst of both worlds. This is, of course, by design. The reason this didn't originally bother most people in 1968 when this all went in is that, back then, the exemption amount, $45,000, was an ungodly amount of money --- multiply by something like 7 to get the amount in today's dollars --- and the various marginal brackets were all much higher then, too. There have been a couple of one-time increases to the exemption, but they never really addressed what the 70s inflation did to us. Today's exemption of $56000 is thus a rather middle class amount and one can easily imagine it being poverty line in the not-too-distant future.

And the various other AMT bracket boundaries are likewise shrinking in real terms.

If I really, really didn't know better, I'd say that the true reason GWBush and Friends are concentrating their efforts on reducing the top brackets in the ordinary tax code rather than reforming/eliminating the AMT is not so much that

  • the former provides a much bigger windfall for "the base" (i.e., his big campaign donors, who tend to be so far up in the income stratosphere that AMT is irrelevant --- once you get above $400K/year, your 35% ordinary marginal rate quickly overwhelms whatever the AMT might be doing to you at 28%), whereas the AMT is really essentially a middle/upper-middle class tax.
but rather that
  • once the coming inflation (that is pretty much guaranteed by the monster deficits this crew has been running) really kicks in, you're going to start seeing millions of middle class folks getting seriously hit by the AMT, and they're probably going to be way too angry to care about making the distinction between AMT and ordinary tax. Meaning we get total Prop-13-style tax rage/revolt, but this time on a national level, which could well be enough to destroy whatever fiscal foundation the federal government has left.
Which of course just happens to fit in with Grover Norquist's agenda of being able to "drown the Federal government in a bathtub".

Coincidence? I wonder.

And now for the vaguely worked example.

Let's say you have a relatively low salary income (say $40K filing jointly), but you have this monster long-term capital gain ($100-150K is enough to get you into The Zone, e.g., you sell a house and can't use the exclusion for whatever reason, or it's someplace where the exclusion isn't enough,...).

In the normal universe, you pay your 15% on the capital gain and the taxes on your salary are pretty much as before. You might get some portion of your $6K exemption whittled away --- roughly 5 cents on every dollar that your adjusted gross goes over $210K --- but it won't be the end of the world.

In the Alternate universe, you start losing your AMT exemption the moment your adjusted gross hits $150K and it's at a rate of 25 cents for every additional dollar you earn. Meaning each new dollar in salary translates to $1.25 worth of AMT income, to be taxed at 26%, which comes out to 32.5 cents.

But that's not all. Because your're still down in the 15% ordinary marginal bracket, the rest of that bracket is being filled up by long-term capital gains to be taxed at 5% rather than the usual 15%; every additional bit of income pushes a corresponding amount of capital gains back into being taxed at the regular 15% rate. And the AMT works the same way. Meaning that when you have an extra $1.25 of AMT income, that pushes $1.25 of your gain back into the 15%-long-term-capital-gain taxation zone. Meaning you're paying ANOTHER 10% of that $1.25, or 12.5 cents.

Add the two together and the net effect is that for every additional dollar of salary income, you're paying 45 cents in additional AMT --- i.e., a forty-five percent marginal bracket.

Fun, eh?

(Deleted comment)
24th-Jan-2004 07:30 pm (UTC) - I am SO not going back to RvL
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