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A Little-Known Map of Tax Policy

Thursday, March 15, 2007

Geography and the literal political landscape are helping shape the response to the Alternative Minimum Tax.

Much has been written lately about the looming crisis in the tax code known as the Alternative Minimum Tax (AMT). The AMT was initially designed to limit the extent to which other provisions of the tax code could reduce the tax liability of the wealthiest filers. But today, this tax threatens to impact a broad-cross section of filers if not reformed or repealed.

Fixing the AMT is a central goal of the new Democratic leadership in Congress.  The House Ways and Means Committee held their first hearing on the subject last week. A temporary patch to reduce the magnitude of the tax expired at the end of last year, and without action by Congress this year the number of households hit by this bizarre tax will balloon from about 3 million to about 23 million and keep expanding every year after that. The cost of a hold harmless policy for 2007 is nearly $50 billion.

Why do AMT receipts tend to increase in areas close to cold salt water?

The key to the fight is geography and disparate political representation across the country. The six states whose populations are most affected by the AMT are New Jersey, New York, Connecticut, California, Maryland, and Massachusetts. These states are disproportionately represented by Democrats. Collectively, these six states hold 118 of the 435 House seats, and 71 percent of those seats are held by Democrats, while in Congress as a whole, Democrats hold only 54 percent of all seats. Furthermore, those states are home to many in the new Congressional leadership. House Speaker Pelosi is from California. Ways and Means Committee Chairman Rangel is from New York. Majority Leader Hoyer is from Maryland. Congressman Neal, who chairs the Ways and Means Subcommittee charged with exploring solutions to the AMT, is from Massachusetts.

Chart 1

Meanwhile, in the south central region of the United States, where Republican congressmen outnumber Democrats 44 to 30, the percent of taxpayers affected by the AMT in 2004 range from 0.7 percent (Mississippi) to 1.4 percent (Kentucky). In the eight states that form that region, 13 of the 16 senators are Republicans.

Why do AMT receipts tend to increase in areas close to cold salt water? The biggest single factor that contributes to a taxpayer being hit with the AMT is his or her state’s own fiscal policy. Because taxpayers are allowed to deduct from their taxable income the amount they paid in state income taxes, the more your state collects from you, the lower your ordinary federal tax liability. But if your ordinary tax liability gets “too low” the AMT kicks in, and the AMT does not permit you to deduct state income taxes. Which states are most impacted by the AMT? You guessed it: states with high state income tax burdens. Of course, in a tax system as complex as the AMT, there are other factors at play as well. Strange as it sounds, having many children greatly increases your chances of being hit with the AMT, and your income level certainly isn’t irrelevant either—so far it has been a problem concentrated among those with low to mid six-figure incomes.

If Democrats want a fair solution to the complex and burdensome AMT problem while adhering to their desire not to make the deficit worse, the simple change would be to prevent any taxpayers from deducting their state taxes from their ordinary federal income tax returns. Such a change would knock out the major reason for the AMT’s growth, and would at the same time eliminate the federal tax subsidy that encourages big state governments.  If Democrats prefer not to pursue a tax solution aimed at resolving the AMT by addressing their own constituents’ tax woes directly, their other option will be to burden the Republican-leaning South, mountain states, plain states, and Midwest. The politics of geography is up for a test this year.

Chart 2

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