"Stealth Tax Increase" Eating Into 2006 Income Of Nearly 19 Million Households....

The New York Times
With Tax Break Expired, Middle Class Faces a Greater Burden for 2006
By DAVID CAY JOHNSTON

As millions of Americans rush to meet the Monday deadline for reporting how much tax they owe on last year's income, a stealth tax increase has begun eating into the 2006 income of nearly 19 million households.

Unless Congress takes action, one in four families with children — up from one in 22 last year — will owe up to $3,640 in additional federal income tax come next April.

Few of them realize that their taxes have increased, because Congress has not voted to raise taxes. Instead, Congress let a tax break expire. That break limited the alternative minimum tax, which takes back part of the tax cuts sponsored by President Bush.

Mr. Bush has asked Congress to temporarily restore the tax break, known as the A.M.T. patch. He has also asked Congress to extend another break that lowered the tax rate on most investment income to 15 percent.

Leading Republicans and Democrats agree that there is simply not enough money to do both. Congress was unable to reach an agreement on tax breaks before adjourning for vacation earlier this month.

The expiration of the A.M.T. patch and the tax break for investment income almost balance each other out this year, according to the Tax Policy Center, a nonprofit organization whose computer model of the tax system has been deemed reasonable and reliable by the Bush administration. The impact will be felt primarily among taxpayers of two different income levels.

The A.M.T. will cost Americans who earn $50,000 to $200,000 nearly $13 billion more next April. That is about how much people who earn more than $1 million will save because of the break on investment income like dividends and capital gains. Both figures were provided by the Tax Policy Center, which is a joint project of the Brookings Institution and the Urban Institute.

Taking action on either measure will require more government borrowing, adding to the federal budget deficit, which is projected to reach $423 billion this year.

The question of how to deal with the alternative minimum tax is central to the negotiations between the House and the Senate over a $70 billion package of tax cuts. Republicans had hoped to reach an agreement before the Easter recess and reap some political benefit at tax time. But one of the sticking points was the A.M.T. patch.

House negotiators proposed extending the tax break, but Senator Charles E. Grassley, an Iowa Republican and chairman of the Finance Committee, pushed for a more generous plan that would also expand it and give more relief to middle-class taxpayers. Negotiations are expected to resume when Congress returns later this month, and Republicans say they are determined to reach a deal in this election year.

Those favoring an extension of the investment tax break, including House Republican leaders, say it encourages investment and leads to more jobs. Two recent studies by the Congressional Research Service, which examines issues for Congress, have raised the possibility of unintended and perverse effects, such as reducing savings and creating more jobs offshore.

Proponents of lower tax rates on investment income also warn that ending the break will hurt stock prices. A number of economists have cast doubt on this assertion.

Representative Dave Camp, a Michigan Republican who was chosen by his party to advocate for extending the investment tax break, pointed out that it affected more people than the increase in the alternative minimum tax. About 30 million taxpayers get dividends, while nearly 19 million are expected to pay the A.M.T. on 2006 income.

But many of the dividend checks are quite small. The investment tax savings in 2006 will be heavily concentrated on about 234,000 households, generally headed by someone 50 or older, with an average income of $2.6 million, more than most Americans earn in a lifetime. By comparison, most of the increase in the alternative tax is being paid by about 12 million families with children.

Leonard Burman, a co-director of the Tax Policy Center, said he had not noticed the similarity in the amount that the middle class will pay and that the rich will save until The New York Times sent him a comparison of the separate estimates produced by the center.

Mr. Burman said the comparison "puts in context claims made by some that this is a tug of war between" what Mr. Bush has dubbed the haves and the have-mores.

He added that once Americans realized their taxes had increased, he expected more pressure on Congress to restore the A.M.T. patch.

Tom Minnery, vice president of public policy for Focus on the Family, a politically influential Christian ministry based in Colorado Springs, said his organization was just beginning to study the effective taxes on families.

"This is a new one on the horizon, and I am very concerned about it," Mr. Minnery said of the A.M.T. increase, adding that "any policy that punishes the nuclear family is foolish."

The tax break that expired at the end of 2005 limited the alternative minimum tax to 3.6 million taxpayers, of which 2.1 million were families with children.

This year 18.9 million taxpayers are facing the alternative levy, with 11.8 million representing families with children. Without Congressional action, those affected will pay $26.6 billion more in federal income taxes for this year. Almost the same amount, $24.1 billion, will be saved by all investors, the Tax Policy Center estimated. Actual savings for investors are likely to be higher if recent stock market growth continues.

The alternative tax was originally adopted in 1969 to ensure that people who earned the equivalent of more than $1 million in today's dollars did not live tax free. It has not been fully adjusted for inflation and was not integrated into the Bush tax cuts. In addition, Congress in 1986 made basic changes in what kind of deductions are counted in determining whether one has to pay the alternative levy, causing it to become a tax on the middle class.

In the beginning it took away exotic breaks to high-income taxpayers who paid little or no tax. Now it denies people exemptions for themselves and their children and deductions for state income taxes and local property taxes.

Just one-tenth of 1 percent of the increased alternative tax is being paid this year by those making $1 million or more, the Tax Policy Center estimates, even though this is the only group affected by the original version of the levy.

Carl Hulse contributed reporting for this article.