How the AMT might doom Bush's tax cuts

NEW YORK (Money Magazine) -- A House Ways and Means subcommittee held hearings on the fixing the alternative minimum tax this afternoon.

Check out the chart to the right, which is based on data from the Joint Committee on Taxation. The blue line is how many people will be snagged by the AMT under current law. The red line is how many people will have to pay it if the 2001 rate reductions are renewed. (They are set to "sunset" in 2011.)

Extending the tax cuts will dramatically increase the number of people who will have to deal with two separate tax systems, even as fewer and fewer people enjoy the benefits of the cuts. That's because without those tax cuts, more people would have a high enough tax under the regular system that they wouldn't be moved into the AMT.

One thing to be clear about: This chart does not mean that the Bush tax cuts will actually raise the taxes of those who end up on the AMT.

As Alan Viard of the American Enterprise Institute explains in his Ways and Means testimony today:

Suppose that, without [the recent tax laws], a hypothetical taxpayer would have a $100 tax liability under regular tax rules and a $90 tax liability under AMT rules. The taxpayer would then be on the regular income tax and would have a $100 tax liability.

Suppose that those laws reduce the taxpayer's liability under regular tax rules to $85 while leaving his or her liability under AMT rules unchanged at $90. Because liability under the AMT rules is now higher than the liability under the regular tax rules, the taxpayer moves onto the AMT and has a $90 tax liability.

Although these laws cause the taxpayer to move onto the AMT, they do not raise his or her tax liability, relative to prior law. On the contrary, the laws reduce the taxpayer's liability from $100 to $90. Moving onto the AMT merely reduces the size of the tax cut, which would have been $15 without the AMT, to $10. In colloquial terms, the AMT "takes back" one-third of this taxpayer's tax cut.

Even so, the AMT clearly erodes the constituency for extending the tax cuts. Not to mention driving people crazy.

AMT: Keep it or kill it, you'll pay for it