By Peronet Despeignes

(FORTUNE Magazine) – WHEN PRESIDENT BUSH TALKED ABOUT tax reform last year, many Americans were hoping he'd tackle the new scourge of the middle class: the alternative minimum tax (AMT). The tax, whose origins date to 1969, was designed to ensure high-income taxpayers don't avoid taxes by claiming excessive deductions, credits, and exemptions. However, every year it ensnares more and more members of the ordinary middle class. But there are signs that an AMT fix may not be a top priority for the GOP. One theory as to why? Kerry-supporting states--especially New York and California--are hardest hit, due to their higher incomes and bigger write-offs for things like local taxes, mortgages, and charitable deductions. "Look who's affected by the AMT. It's all those people in blue states," says Steve Moore, recently head of the Club for Growth. "Have [California Senator] Barbara Boxer and [New York Senator] Hillary Clinton deal with this situation."

Congress has applied temporary Band-Aids to the problem for years, and the official line from the White House is that a comprehensive and permanent AMT fix is still on its to-do list. But the U.S. Treasury Department said recently that a study it promised last year will be preempted by the work of a new tax- reform panel tasked with considering a wide variety of changes to the tax code. The panel had its first meeting in mid-February but doesn't report back until midyear at the earliest, and it's not clear whether or when the administration would act on its recommendations. Plus there were no cost estimates for an AMT fix in the President's recently released fiscal 2006 budget proposal.

The AMT works by imposing a flat 26% tax rate on the first $175,000 of income and 28% after that. By law, taxpayers pay either their regular taxes or the AMT--whichever is higher. But because it is not adjusted for inflation, the tax has already ensnared more than one million taxpayers and could hit a total of 30 million taxpayers by 2010. With a war, Social Security overhaul, already enacted tax cuts Bush would like to make permanent, and a mounting deficit, the administration has plenty of good political reasons to put the AMT on the back burner. A permanent fix could cost the federal government $600 billion to $1 trillion in forgone revenue over the next decade.

But the red/blue divide can't be overlooked. According to Urban Institute tax expert Len Burman, the 11 states that already have the greatest percentages of taxpayers paying the AMT are blue states, topped by New York, New Jersey, California, and Massachusetts. When Washington, D.C.--bluest of the blue in the last election--is included, it ranks second. Grover Norquist, head of the influential anti-tax advocacy group Americans for Tax Reform, has privately said Bush's message to blue states should be "Drop dead." Asked by FORTUNE to elaborate, he noted that the AMT currently just doesn't rank very high on his list of priorities. As Norquist puts it: "The Senators expressing the most angst about it are Democrats who routinely vote against our tax cuts, so my position is, when they whine to us our response should be, 'We want to help you. What are you ready to give us in return?' "

Over time, however, the red/blue divide will get blurrier. According to the Congressional Budget Office, as early as 2010 the AMT will hit 95% of all families with an adjusted gross income of $100,000 to $200,000; they don't all live in blue states. And everything being equal, the bigger the taxpaying family, the more exemptions claimed, and the higher the AMT risk, "which kind of works against a lot of red states," Norquist admits.

It's not clear whether the White House's message to blue states will truly be "Drop dead" or whether the AMT will be used as leverage for broader reform. But Scott Hodge, head of the free-market-leaning Tax Foundation, notes a recent conversation he had with a senior Treasury official he refused to identify in print. Hodge had joked about how the AMT was, for now, a blue-state issue. "This official said nothing," says Hodge. "He just smiled." -- Peronet Despeignes