Alternative Minimum Tax, deducting state/local taxes, exemptions for children

As in previous years I was unable to understand my accountant’s explanation of why I was paying Alternative Minimum Tax (AMT). If other people are as confused as I am that means that Americans generally have no idea what their income tax bracket might be, i.e., they won’t know until the end of the year how much of a pay raise they would be able to spend.

With a little digging, e.g., this CNBC article, it seems that “The taxpayers now most likely to be liable for AMT payment are people with big families who live in high-tax states.” It seems that with regular taxes the government provides tax benefits for having children and tax deductions of amounts paid in state and local taxes. Then with AMT those benefits are taken away.

I’m wondering why any of this makes sense. Can it truly be efficient to have a country where most of the people who pay significant amounts of tax don’t have any idea what their tax rate is? And if the government needs more money, why are children and state/local taxes deductible?

Let’s consider local taxes. Suppose that you live in a low-tax/low-service town. The town won’t take ownership of streets within developments. You and your neighbors will have to get together to pay for snow plowing of the common street. That won’t be deductible. If the town taxes you, however, and pays the same snow plowing contractor the same amount of money, now the expense is deductible. People who pay more in state/local taxes get more government services, presumably, than people who live in low-tax areas. If people are getting services for their money from their state and local government why do they also need to get money back from the federal government (i.e., from the rest of us)?

How about children? In the old days the federal government didn’t do much for kids so maybe it made sense to provide extra money through the tax system. But now the federal government is involved in funding local schools, in subsidizing student loans, and in providing free or subsidized health insurance for children (the Department of Education was created only in 1979 and now has a budget of more than $70 billion per year; the CHIP program was created in 1997). Is the additional tax subsidy justified? Also, there are people who are earning substantial profits from children who nonetheless may claim these kids as “dependents”. For example, see this posting that refers to Cameron Kennedy’s lawsuit against Peter Orszag where she is trying to get $300,000 per year in tax-free child support to supplement her $350,000 per year salary. If Kennedy can keep the kids with her for 51 percent of the nights of the year, the IRS will give her a reduced tax rate on her $350,000 per year McKinsey consultant income. If we assume that she spends $100,000 per year on the two kids in private school tuition, gold-plated iPhone cases, etc., that means the average American taxpayer will subsidize Kennedy for having a $200,000 per year tax-free revenue source in her house. That’s roughly equivalent to the after-tax yield on $15 million of IBM stock. So we’ve set up a system where, for the sake of fairness, we would have to allow childless Americans to claim a $10-15 million stock portfolio as a “dependent”.

Consider a person who has had the misfortune to be born with an unlovable personality and physical appearance. This person is single, childless, and lonely. In addition, this person will be living in a lonely West Texas town or an isolated hamlet in New Hampshire (i.e., low tax jurisdictions) with very spartan public services.  This unfortunate soul will pay federal taxes to support the Department of Education, the Department of HHS, and other agencies that provide free services to more fortunate Americans who enjoy the company of their children on a daily basis. Mr. Lonely Heart will also have to pay additional federal taxes to make up for the money that families with children did not pay because they were deducting state and local taxes in high-tax, high-service locations.

As a parent in a high-tax state I personally am one of the beneficiaries of these subsidies, but I can’t understand why a single childless person in a small West Texas town is paying for our family’s use of the new nearly $100 million Cambridge Public Library. If we ran out of money for whatever reason, the government would step in and give us free housing, free health care, food stamps, and, always, a free education for our kids plus subsidized student loans for college and/or subsidized tuition at state-run colleges. If we haven’t run out of money then why do the existing government subsidies to our kids need to be supplemented with tax subsidies? (In Cambridge, regardless of family income, a child will be able to enjoy the library system, the $27,000 per pupil school system (does not include capital costs so probably $35,000 to $40,000 per year in actual spending), and a 50 percent subsidy of the costs of attending the University of Massachusetts.)

What would it look like if we eliminated the AMT, deductions for state/local taxes, and exemptions for children?

6 Comments

  1. Joseph Reagle

    April 19, 2014 @ 2:41 pm

    1

    TurboTax Maker Linked to ‘Grassroots’ Campaign Against Free, Simple Tax Filing

    http://www.propublica.org/article/turbotax-maker-linked-to-grassroots-campaign-against-free-simple-tax-filing

  2. jay c

    April 19, 2014 @ 5:28 pm

    2

    Does MA have personal property tax? Virginia used to. One strategy to avoid deductions for personal property tax is to have only worthless personal property. My dad owned a 1978 Dodge Aspen in the 1980s. The personal property tax was basically zero. The thing was so bad by the early 90s that he could drive it into NE DC to collect the rent and not bother to lock the doors and nobody would touch it.

    is it likely the AMT will be scrapped at some point? Highly unlikely. If the AMT were scrapped, the progressive tax rates would probably rise. It would be a benefit for people hit by the AMT but ultra-high net worth people would see higher taxes. These people tend to have a lot of influence on american politics. I think reform of the child exemptions are even less likely to pass.

    Seriously, why not move to NH? Every engineer who works in the Boston area that I know lives in NH, even one that works in Norwood.

  3. J. Peterson

    April 19, 2014 @ 6:52 pm

    3

    Phil, why are you paying taxes at all?

    You probably have enough resources to higher a lobbyist. Have them draft the “Helicopter Educators Relief Act”, then pay off^H^H^H^H^H^H^H make a campaign contribution to the right congressman and they’ll tuck it into the next farm bill or defense appropriation. Depending on how HERA is drafted, the feds could be issuing you refunds for the rest of your life.

    [NPR's planet money discovered that lobbyists were by far the best investment a company can make]

  4. guest

    April 20, 2014 @ 1:39 am

    4

    There really isn’t a lot of benefit to having children in a high-income family. Exemption per child is $3,900, so maximum benefit is $1,544. And Kennedy’s $300,000 income is not really tax-free since it is Orszag’s after-tax money: child support is not deductible. Eliminating these exemptions will only hurt poor people.

    Deducting state taxes (or mortgage interest, or real estate taxes), on the other hand, only benefits well-off; in a way, AMT actually works as designed, by not letting people get away with reducing their taxable income too much. Eliminating these deductions is a great idea.

    I have to point out the irony that it only took 7 paragraphs to get from not understanding AMT to suggesting its elimination.

  5. David Krider

    April 21, 2014 @ 1:31 pm

    5

    All of this just makes me want a flat tax even more. There’s been a lot of argument about it being hard to determine what the level would wind up being to produce an “income-neutral” switchover, but it seems to be an easy calculation to my eyes. We’ll never get one, of course, because the tax code exists to influence how the populace spends and invests its money, and how politicians get paid, as J. Peterson pointed out.

  6. Walter Mitty

    April 22, 2014 @ 7:03 am

    6

    The AMT only makes sense if you view it as a political response to a political outcry. From about 1915 to 1965, the Congress enact tax preferences, one after another, that had the effect of softening the steep progressive nature of the tax brackets. It also had the effect of making the tax system incomprehensible to, and therefore suspicious to the vast majority of Americans in the middle, who feel that their tax burden is way too high.

    As David Krider comments, a flat tax could be made revenue neutral. In addition, it could be made approximately as “fair” as the present system by simply taking tax load data and applying linear regression. Once you have the data in hand, this can be done in less than an hour with a good spreadsheet program.

    What you get if you do regression is a “flat tax”, but one that does not go through the origin (zero income, zero taxes). Instead, it’s like a straight line with a universal credit attached to it. The universal credit raises two question however. Should it be a function of family size? And should there be a negative income tax for people at the very low end? There are good answers to both questions.

    About twenty years ago, (after the Clinton tax hike), I did exactly this, but for incomes in the $20K to $100K range. The result was amazingly close to the then actual tax load. But when I presented it, the liberals compared me to Attila the Hun, while the conservatives compared me to Karl Marx.

    So there you have it. If you want a tax code that raises about the same revenue and distributes the load about the same and is simple and is linear, you can do it. But don’t expect people to like it.

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