Friday, June 17, 2005

Mea culpa, subject to the Nuremberg defense

A reporter was asking me today why we have such a terrible problem with the alternative minimum tax (AMT), which is on the verge of being bigger rather than the regular tax, leaving most people (at least in a few years) in the position of having to deal with both systems. "Why" meaning, not how is it a problem, or even how as a technical matter did it become a problem (which is a consequence of the failure to index its exemption amount for inflation), but why was it permitted to become such a problem?

Once the system, with its unindexed exemption amount, was in place, no one had a short term political interest in fixing it. The Clinton Administration pursued other priorities. The George W. Bush Administration has affirmatively relied on it for Iraq war-style budgeting deception, since the rise of the AMT greatly lowered the revenue estimates for the 2001 and 2003 tax cuts without people realizing that the (relatively) low estimates relied upon widespread denial of the tax cuts via the AMT. So there is a politically satisfying (from a cynical standpoint) story of negligence rising to malignance as the problem approached and nothing was done.

But I'm convinced that a sheer element of accident played a role as well. Now for the mea culpa and the Nuremberg defense. I was on the Congressional staff that worked on designing the AMT during the 1986 tax reform process. Needless to say, my colleagues and I were only following orders. We certainly knew about indexing, which had recently been introduced for regular tax purposes. So I was wondering recently why we didn't index the AMT exemption amount. I don't remember for sure, but here is what I think. We probably were not allowed to index it within the five-year window for which revenue estimates were being done, since this would have required more money to be raised from rich people or business in some other, presumably more visible and politically painful, way. So why didn't we try to get it indexed to inflation beginning after the 5-year period? That would probably have been easy to do. The answer, I think, is that no one thought of it or realized it would be necessary. We weren't used to enacting such deferred changes. And presumably we figured Congress would get around to fixing the problem long before it became serious.

Suppose the AMT exemption had been indexed to inflation, beginning, say, in 1992. It's possible that politicians would have eliminated the indexing to pay for something else, putting us back where we now stand. But this is far from certain. Had we gotten to 2001 with indexing, it certainly would have been harder for the Bush Administration to eliminate indexing as a way of disguising the size of the tax cuts than to simply rely on the AMT in place. So accident was probably very important.

This is hardly unique to recent tax policy. In the same conversation with the reporter, it occurred to me that the 1986 tax reform probably wouldn't have happened if there hadn't been a Treasury Secretary in 1984 (Donald Regan) who happened to be willing to let the staff design an ambitious tax reform plan. Suppose James Baker, who took over Treasury the next year and helped pass tax reform, had already been there in 1984. It's hard to believe that he would have let the staff develop such a plan. Yet Reagan Administration personnel decisions may not have reflected any intention regarding the encouragement of tax reform by having Regan rather than Baker there in 1984. This was simply a by-product of other forces determining the personnel decisions.

Likewise, I've been told that it is to some degree an accident of personnel in place that led the current Administration to be as honest as it has been about the fact that private accounts are not a free-lunch solution to the Social Security financing gap. Karl Rove may have permitted the senior economic staff in place to commit the Administration to a non-free-lunch stance out of post-election hubris that he wishes he could take back, but he would not even have faced the issue had free-lunchers from the first term senior economic staff (and I don't mean Glenn Hubbard or Paul O'Neill) still been there.

47 comments:

josh narins said...

That's pretty cool, as I wrote a paper once on the Reagan era tax cuts.

I got an A-.

10 pages, the gist of which was that the supply side cut was supposed to have increased private investment, but which, at least until the effect of the 1986 hike, did not increase PI rates.

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