TCS Daily

How the GOP Lost the AMT Debate

By James K. Glassman - December 24, 2001 12:00 AM

Editors Note: A version of this article first appeared in the Wall Street Journal.

With talks over a stimulus plan over for now, the one certainty is that this tax debate has been a disaster for Republicans. The House passed a bill originally designed as a compromise that would be quickly enacted, one that pleased few conservatives and reached for Democratic votes. In exchange Republicans got effective Democratic spin and predictable conservative grumbling. Painful as it may be, it is important to dissect the episode, because a replay next year would give the House back to the Democrats.

A feature of the discourse has been the wide disdain for an idea launched by House Republicans to repeal the Alternative Minimum Tax on corporations. The most damning complaint from Democrats is that repeal would refund AMT payments all the way back to 1986. A typical partisan attack came from Paul Krugman, in the New York Times, who called the bill "lurid," with "huge retroactive tax cuts for big corporations." Sen. Barbara Boxer (D., Calif.) called "this kind of political profiteering" by House Republicans "downright shameful."

It is difficult to find a news story on the Republican plan that does not refer to AMT repeal as a retroactive tax cut. In fact, it is nothing of the kind. But the damage has been done, and the administration has made no attempt to defend an eminently sensible repeal.

How did it go so wrong? The AMT was designed by Democrats in the late 1960s, dismayed that some corporations were paying little or nothing in taxes because of healthy deductions. Think of the current law as a fine that is assessed if a firm is identified as a tax evader. The way the AMT works is that the penalty is assessed if a corporation`s deductions are "too large" relative to income. But if a corporation`s taxes rise enough that it no longer falls under the penalty system, then the "fine" that it paid in the past gets refunded. A corporation that has paid AMT in the past has credit carry forwards.

How do firms end up on the AMT? Perversely, recession is a leading cause. Suppose a firm was especially optimistic about sales at the start of the year and purchased a lot of new equipment. But assume that the firm made a poor forecast, and the economy, in fact, plunged into recession, because of which income was lower than expected. Yet the deductions for the equipment spending were planned well ahead of time. Deductions, therefore, end up "excessive" relative to income -- not because deductions were unusually high, but rather, because income was unusually low. In the last recession, the AMT hit about half of all corporations.

In other words, the AMT tax penalty is poorly timed. Under the law, firms lose the benefits of many of their normal deductions, and the marginal tax on investments rises sharply when AMT kicks in. Despite the partisan rhetoric, no economist has ever made the case that the AMT is a sensible policy, and none ever will.

But AMT repeal raises transition issues. Corporations have $25 billion worth of credits for past AMT fines, and they expect to claim these when profits rise and they get off the AMT. But if the AMT is repealed, what befalls those credits? Clearly, the answer depends on whether the firms would have gone off the AMT and received the money anyway. If they would, then wiping credits off the books is simply government seizure of property.

House Republicans, in a bill passed on Oct. 24, decided to refund the credits immediately. Why the immediate refund? Since few firms stay on the AMT for long periods, these corporations were going to reclaim credits anyway. An immediate refund simplifies tax matters greatly, at little cost. Besides, the 10-year cost of such a move is negligible.

In no sense was the tax cut retroactive. For example, repealing the AMT and issuing legitimate refunds is not the equivalent of cutting the corporate tax rate to 20% effective Jan. 1, 1998, and letting companies claim the difference between the new rate and what they paid for the preceding four years. The AMT credits existed already, and would have been claimed anyway.

So how did this issue turn into such a public relations disaster for Republicans? One big reason is that the administration never bothered to explain the issue to the press and the public.

Republican House members have told us that Democrats and a senior representative from the Treasury had given the outlines of their package, including AMT repeal, a thumbs-up in negotiations before passage. However, shortly after the bill was made final, Treasury Secretary Paul O`Neill began questioning it in public, starting with his now infamous quote denigrating the bill as "show business."

At the same time a "high-ranking Bush administration official" described the cut as retroactive to columnist Robert Novak, who quoted the official as saying, "I frankly cannot understand the rationale for this." The Novak column in the Washington Post was the first reference to a retroactive cut turned up by our news search -- and it came from a Republican! Smelling blood, Democrats reneged on their deal to support the House bill and began singing "retroactive cut" in unison. Their economist mascot, Mr. Krugman, took up the chorus.

House leaders are furious at the administration`s duplicity, and the error may have a significant impact on the administration`s future ability to formulate economic policy. When negotiations began to devise a compromise stimulus bill, House Republicans requested that no administration officials be present. Who can blame them? The Treasury publicly criticized a bill that it was instrumental in helping to draw up.

Normally, Treasury staffers are important players in the tax debate, preparing memos that clear up confusion on complicated tax issues. In this sorry case, the confusion appears to have begun at Treasury, and there are no signs of an end. Many senior administration officials still have not been briefed about the rationale for the AMT repeal.

On purpose, or merely through bumbling, an important piece of tax policy was sabotaged within the Bush administration itself. If the root cause of this debacle is not identified and fixed, Republicans will have little chance of advancing their agenda next year.

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