What's Worse, the AMT or a Recession?

Now this would hurt. If the politicians in Washington do nothing, 23 million Americans will get hit by the alternative minimum tax next year, up from 4 million this year. A temporary fix to the AMT will cost some $45 billion to $50 billion. Repealing the AMT, according to the Congressional Budget Office, would cost more than $600 billion over 10 years. Now under new pay-as-you-go rules in Congress, any fixes or repeals will have to be paid for through higher taxes or budget cuts. One payment possibility suggested by some on the left is to repeal the Bush 2001 and 2003 tax cuts, under the logic that many taxpayers will get caught by the AMT because the Bush tax cuts lowered their tax bill. (The biggest problem, though, is that the AMT is not indexed for inflation.)

According to the static economic models of the CBO, repealing the Bush tax cuts would bring in hundreds of billions in new tax receipts every year with scant effect on economic growth. But, you might ask, wouldn't the accompanying huge tax increase dramatically slow the economy, thus hurting tax collections to some degree? Not if you look at the CBO numbers, which show the economy barely slowing after the tax cuts expire in 2010.

But is that how the real-world economy would actually react? Not according to a study by Goldman Sachs. Using the highly regarded Washington University Macro Model, Goldman ran a simulation that assumed all the Bush tax cuts expired in 2010. According to the WUMM model, the economy fell 3 percentage points below what it would have been otherwise–even assuming massive Federal Reserve rate cuts.

"Absent a tailwind to growth from some other source," the analysis concludes, "this would almost surely mark the onset of a recession."

Now the Keynesian model does show that eventually the additional revenue would help balance the budget, leading to stronger longer-term growth, a conclusion some pro-growth economists would disagree with. But you can get to a balanced budget without raising taxes. For instance, freezing federal nonentitlement spending at 2007 levels–a radical move, to be sure–would mean $1.3 trillion less spending over the next decade. That would be more than enough to pay for repealing the AMT. (And remember, if Uncle Sam had merely matched spending with revenue since 2000, spending would still be up a healthy 30 percent.)

But you wouldn't need $1.3 trillion. Nor, in all likelihood, would you need $600 billion, since the CBO's analysis assumes that the massive AMT tax increases–if nothing is done–would have no ill effect on economic growth or government tax revenues. If they did–and that is likely–then repealing the AMT wouldn't be so costly. How will Democrats in Congress, the ones really pushing for AMT reform since it hits Dem voters in "blue" states like California and New York, eventually pay for AMT relief? My sources on Capitol Hill are betting that in the end, they'll have to circumvent the pay-as-you-go cap and just add AMT relief to the budget deficit.

Carnival of the Capitalists

One of my favorite websites is Carnival of the Capitalists, a weekly roundup of some of the smartest economic and business blogs on the Web. Great, great stuff with tremendous variety and supersavvy analysis. Even better, Carnival of the Capitalists is today relaunching its primary website. As a minicelebration, every day this week, I am going to answer a question from one of the CotC's group of brainy bloggers. Here is today's from Anita Campbell of Small Business Trends:

Small business is a hot segment right now, and in recent elections we've seen campaigners go out of their way to show that they are the friend of entrepreneurs and that they support the small-business market. Do you anticipate that the candidates for the 2008 presidential election will heavily court the small-business vote, and have any of them already started doing so?

Absolutely, Anita, though each party would have a different take on things. I think both Republicans and Democrats view healthcare as an issue to attract small-business owners and sole proprietors. Democrats will be offering government-directed universal healthcare. Most of the 2008 Dem candidates already have concocted at least some prototype of a plan. From Republicans, what the candidates will very likely be offering is something more along the lines of President Bush's recent proposal to offer a large tax deduction to make it easier for people to buy their own health insurance and not depend on their employers. What is interesting about Bush's plan is that it seems to recognize that more and more Americans are "free agents" responsible for their own healthcare coverage. That is a real megatrend. Another big issue in the 2008 election will be the Bush tax cuts, set to expire at the end of 2010. If they do expire, that could mean higher taxes for the many entrepreneurs and small-business people who file a Schedule C along with a 1040.