The Public Policy

A Tale of Two Taxes

Washington was spared a fight on alternative minimum tax extension -- but the death tax debate is bound to prove much more explosive.

By 3.26.09

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For Washington's tax writers, it is the best of times and the worst of times. On one hand, the alternative minimum tax, which has created political angst for years running, has already been "patched" for another year. On the other, a looming debate over the estate tax could be even more politically charged. Examining these two taxes -- with important similarities but a fundamental difference -- yields great insight into the dynamics of U.S. tax policy.

Perennially "patched" to negate its unintended ensnaring of middle-income earners, the AMT has become the tax world's Sisyphean task. Its sizable cost -- and whether it should be offset -- make it the stone Congress laboriously rolls up the Hill each year…only to see it roll down the next.  This has made it a "lights out" legislative issue -- done at year's end with other tax items attached. Until this year. The economic stimulus' size and urgency allowed the AMT to pass rapidly and unoffset through Congress.

But those thinking Washington will be spared a tax fight, can think again. Looking deeper into the tax code, one finds an even more politically explosive tax provision lurks.

Labeled the "death tax" by foes, the estate tax has more facets than the Hope diamond. Reduced in the 2001 tax cuts, it goes on a whip-sawing roller coaster ride over the next three years. In 2009, it assesses a 45% rate on estates over $3.5 million, disappears completely in 2010, and then reverts to its pre-2001 level of 55% for estates over $1 million in 2011. 

Political liability and fiscal opportunity arise from this wild ride compelling legislators to it. Politically, it will be extremely difficult to have the tax disappear for one year and then sky-rocket back to pre-2001 heights. For opponents, this would be akin to Moses leading his people into the Promised Land…and then seeking to lead them out a year later! Fiscally, this on-off-on scenario opens the door to "budget baseline arbitrage" -- anything less than 2010's full repeal will yield "savings" relative to budget estimates -- a fiscal windfall worth billions.

This tale of two taxes has some intriguing similarities. 

First, both are expensive. When the Congressional Budget Office estimated the 10-year cost of maintaining just the 2007 AMT fix (then the most recent), it was $646 billion. CBO estimated permanently eliminating the estate tax would cost $668 billion over the same period. Second, both affect a small percentage of respective filers. Separate 2005 CBO studies showed just 1 percent of income tax filers were subject to the AMT in 2000 and "…fewer than 2 percent of all estates have had to pay estate taxes." 

The two are also exemplars of unintended consequences. The AMT was designed to ensure no wealthy individuals escaped tax liability. With its exemption and rate brackets unadjusted for inflation, it captures increasing numbers of middle class taxpayers. The estate tax was implicitly a temporary measure -- enacted in 1916 to compensate wartime tariff shortfall. The Kaiser may be long gone, but the revenue raiser remains.

Both even have their defenders. For purists, the AMT is a comparatively flat, low, and broad system many reformers seek. For those anxious of wealth's concentration, if not its redistribution, the estate tax works against large legacies. 

Yet there is a fundamental public perception difference between the two. 
The AMT is largely unknown to its potential victims. Its annual "patching" mutes its impact on taxpayers. It is hard to demonstrate the non-calamity of a non-event. Most potential victims are neither fearful, nor grateful. 

The estate tax is just the opposite. It is viscerally known and universally reviled -- even by those who may never face it!  It strikes not only at estates, but at the American dream: the Jeffersonian ideal of the small farmer and business person seeing their life's work wrested from their family's hands. It smacks of unfairness -- resources having passed through the tax thresher repeatedly over a lifetime being gleaned again when the Grim Reaper visits. Death and taxes may be inevitable, but most believe that taxes at death should not be.

The result seems counterintuitive: while the estate tax may reach far fewer, it may be even more politically potent than the AMT. The AMT's impact is concentrated -- particularly in areas with high state and local taxes because these are not exempt from it as they are under the regular income tax. The estate tax's impact is dispersed all across the country, particularly in the country -- i.e., on farms. This gives opponents a broad swath in which to seek Congressional support.

The estate tax assures Washington will not miss its annual contentious tax fight. Both taxes also underscore an important reality behind taxes in America. The AMT shows, it is difficult enough to raise taxes in general. And the estate tax demonstrates, the more real the tax becomes to the public, the more it offends their sense of fairness and the more adamant their opposition to it. 

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About the Author

J.T. Young served in the Department of Treasury and the Office of Management and Budget from 2001 to 2004 and as a Congressional staff member from 1987 to 2000.