December 30, 2011
Buffett enjoyed the low effective tax rate not because of any illegal evasion, but because of legitimate mechanisms in the tax code.
This revelation led to calls for tax reform to ensure that the super-rich pay an equal or greater tax rate than the middle class.
If such tax reforms ever materialize, it wouldn’t be the first time that public outrage was caused by disclosures of the rich getting off easy with taxes.
In 1968, it was revealed that 155 individuals with incomes exceeding $200,000 (about $1.3 million today) paid no income taxes the previous year.
Under strong public pressure, Congress passed the Tax Reform Act of 1969, and it was signed into law by President Richard M. Nixon on December 30, 1969.
The main provision designed to remedy this issue was Section 56, which created the “Minimum Tax for Tax Preferences,” or as it has become known today, the Alternative Minimum Tax (AMT).
However, the minimum tax created by the 1969 Act operated a little differently than the AMT we know today.
Most notably, 1969’s minimum tax was not an “alternative tax;” it was an additional tax.
Whereas the current AMT system is an alternative to regular income tax liability (the taxpayer is to pay whichever tax liability is greater), the 1969 minimum tax was imposed in addition to all other taxes under the tax code.
This change occurred in 1982 with the passage of the Tax Equity and Fiscal Responsibility Act, which also modified several other aspects of the 1969’s minimum act.
For instance, originally, the minimum tax was equal to 10% of the sum of “tax preferences” in excess of $30,000.
Tax preferences were defined by the Act as any number of specified different tax deductions that primarily pertained to capital gains (i.e. “excess investment interest,” “stock options” and “investment expenses”).
Although tax preferences are still a part of the calculation of AMT today (they’re now called “tax preference items”), they represent a much smaller part of the equation (it would require too much space to discuss the entire AMT calculation, so you’ll have to just take my word for it).
One piece of the 1969 Act that wasn’t updated in 1982 is arguably one of AMT’s biggest flaws: there are no adjustments for inflation accounted for.
This means that as incomes have steadily increased in the past 42 years, more and more taxpayers find themselves subject to the AMT (and thus are paying more in taxes).
When originally enacted, the minimum tax was only intended to target those 155 individuals (and others like them) who, despite their high incomes, had escaped paying income taxes altogether.
As of 2011, according to the non-partisan Tax Policy Center, 4.2 million taxpayers paid AMT.
It should be noted, though, that this marked increase in recent years is an effect primarily of the 2001 tax cuts (commonly called the “Bush tax cuts”), since they decreased marginal tax rates for all income tax brackets without making similar changes to AMT rates.*
Ironically, this impact was primarily felt by the middle class, away from whom the minimum tax was originally designed to shift the tax burden.
Unfortunately, despite the massive increase AMT’s effect in the future, there will likely be little public push for reform, mainly because AMT has been mostly kept obscure by easy tax preparations offered by TurboTax and H&R Block.
However, the fact that President Obama tried to add an inflation index to the AMT calculations in his fiscal year 2011 budget proposal (which didn’t pass) indicates that the issue isn’t off of all politicians’ minds.
Thus, it is entirely possible that any future tax reform efforts (such as ones prompted by Buffett’s comments) may include an AMT inflation index.
If such becomes reality, the minimum tax may actually resume its originally intended purpose of shifting the tax burden away from the middle class.