Tax Relief for the Common Man
By: A. B. Jacobs
On May 28, 2003, amidst considerable acclaim, President George W. Bush signed the Jobs and Growth Tax Relief Reconciliation Act of 2003. Most prominent among its numerous provisions was the lowering of tax rates, particularly on dividends and capital gains. In the accompanying hoopla, that promised $330 billion in tax cuts to an overtaxed nation, no factor seemed more heavily emphasized than the spur to American investment anticipated by lowering the maximum long-term capital gains rate from 20 to 15 percent. In general, this provision of the act received approval, with many financial pundits soon acknowledging the increased business activity surely to accrue. However, as is so often the case, the devil is firmly ensconced in the details-and this case is no exception.
What is the detail in which the devil is buried? It is a provision of the tax code known as Alternative Minimum Tax (AMT), created in 1969 to prevent the wealthiest taxpayers from employing various devices-deductions, credits, and the like-so to completely avoid taxation. The concept gained its initial impetus in January of that year when President Lyndon Johnson's outgoing Secretary of the Treasury, Joseph Barr, charged in a speech before the Joint Economic Committee of Congress that hundreds of persons with incomes exceeding $100,000 paid no income taxes in 1966-67. He then urged that laws be written to insure " . . . the rich pay their fair share of the burden." The almost immediate result was the passage of the 225-page Tax Reform Act of 1969-at that time the most sweeping and complex revision of the Internal Revenue Code ever enacted-which included such provisions as limiting accelerated depreciation and depletion allowances, repeal of the Investment Tax Credit, and restrictions on other tax shelter items. Although in reality the wealthiest of taxpayers easily sidestepped the intended effects, the new statutes began to take their toll on the nation's middle-income earners. Succeeding legislation, most notably the Tax Reform Act of 1972, championed by Senator George McGovern, that year's Democratic presidential nominee; the Tax Policy Review Act engineered by Congressman Wilbur Mills, then-chairman of the powerful House Ways and Means Committee; and the grotesquely-contrived Tax Reform Act of 1976, all dipped more deeply into the pockets of the American middle class. Since then, with each succeeding revision of the law, the AMT functions so to penalize the ordinary citizen with a levy ostensibly designed for the plutocracy.
This bring us to the here and now. Let's peek in a little more closely at how the widely heralded 15 percent long-term capital rate, that took effect May 6, 2003, actually works out for many of us. I'll pick as our example Carrie, a hard-working and unmarried real estate saleswoman. Her 2003 net income from sales commissions amounted to $100,000, generated largely through dint of 12-hour-working-days, plus a fortuitous gain of $200,000 from the sale of a vacant lot she owned for fifteen years. Bear with me as I perform a quick tax computation. In a world unencumbered by complexity, the tax tables indicate the tax on $100,000 to be $20,569. Add to that an additional $30,000, representing the advertised 15 percent tax rate on capital gains, and you see that Carrie's beneficence to the federal government calculates out at $50,569-no small sum, to be sure.
Let's now look at the Alternative Minimum Tax, and the question: might Uncle Sam possibly want more? It's time for a revelation. Although the authors of the tax law acquiesced in setting the long term capital gains rate at 15 percent for AMT purposes, they mickey moused the AMT exemption rules in a way that the gain can boost ordinary income into a higher bracket. The result in this case is that Carrie will pay out an additional $5,431-the practical effect: an increased capital gains rate.
So much for this particular law; let me now state my conviction. The example I've just given is replicable in one way or another with every section of the tax laws. The fact is that meaningful tax reduction for the citizen is largely an illusion. Although the politicians must regularly genuflect to the concept of tax relief, the reality is that the percentage of Americans' income taken by government has been rising unabatedly since implementation of the 16th Amendment to the Constitution in 1913. I'm sorry to report that there is no sign that anything is going to change.
Though you may detect a trace of pessimism, I'll try to conclude on a happy note. As an aside, recognize what Carrie's actual income taxes are. This hard working lady will fork over an additional $13,688 in FICA taxes-yes, it's a tax in every sense of the word. And if she pays California taxes, as do I, you can add in another $25,099, for a total outlay of $94,787 . . which helps to explain why she may need to work until she is an octogenarian. As I said, this ends on a happy note-for the tax collector, that is.
Al Jacobs has been a professional investor for nearly four decades. His business experience ranges from real estate, mortgage, and securities investment to appraisal, civil engineering, and the operation of a private trust company. In addition to managing his investments on a day-to-day basis, he is a featured financial columnist for both online and print publications. He is the author of Nobody's Fool: A Skeptic's Guide to Prosperity. You may subscribe to his financial Newsletter, "On the Money Trail," at no cost or obligation, by visiting http://www.onthemoneytrail.com/.