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Obama AMT-Buffett Rule Combination Pits Well-Off Against Ultra-Rich

We've heard a lot of talk about the one percent and the 99 percent. With the release of his proposed budget for fiscal 2013, President Obama has opened a new front in the class war. He's pitting yuppies against the overclass, the struggling well-off against the very rich.

This declaration of class warfare can be found on page 39 of the section on cutting waste and reducing the deficit. President Obama's deficit-cutting proposals rest in part on making life more expensive for the very rich. He wants to let the Bush-era marginal tax cuts for those making $250,000 or more (about 3 percent of American households) expire, and limit the amount of deductions they can take. He proposes to end the loophole through which "carried interest" —the money private equity magnates are paid for managing other people's money — is taxed at a low, long-term capital gains rate. And he's proposing to codify what's come to be known as the Buffett Rule, the notion that "those making over X million $ should pay no less than 30 percent of their income in taxes." That's a proposal that would really impact the tiniest minority of American households. As Jonathan Karl of ABC News notes, "There were 236,883 taxpayers who earned more than $1 million in 2009. That's less than two-tenths of one percent of all filers."

The funds raised from soaking the ultra-rich won't all be used for deficit reduction. No, a good chunk of the money raised will be used to help keep the merely rich a little more dry. As the budget message notes, Obama is "proposing that the Buffett rule should replace the Alternative Minimum Tax, which now burdens middle-class Americans rather than stopping the richest Americans from paying too little as was originally intended." In other words, Obama is proposing to stick it to a few hundred thousand extremely rich people for the sake of making life somewhat easier for tens of millions of people who may make $100,000 or more.

A bit of background is in order. (Here's a good primer from SmartMoney) The Alternative Minimum Tax was created in the 1970s to try to prevent really rich people from taking massive deductions to avoid paying taxes. The thinking was relatively simple: Above a certain amount, people should pay a 28 percent marginal rate on income, regardless of the amount or number of deductions they've taken. So taxpayers must calculate how much they owe under the regular tax regime, and then calculate how much they owe under the AMT scenario, which limits the ability to deduct items like state, local and property taxes from taxable income. They have to pay whichever is higher.

Over time, as frequently happens, the tax aimed squarely at plutocrats caught up more and more people. The AMT wasn't indexed for inflation, and didn't account for rising tax rates and levels. As time went on, people who lived in certain areas — high-income districts in states with income taxes -- and who have high property values and property taxes have come to expect that they'll get hit by the AMT. Since many of the AMT hot zones are on the coasts -- places like New Jersey, New York, Connecticut, Massachusetts, California — the AMT may be considered a tax on yuppies or, as I dubbed several years ago, a Tax on Democrats. Those screams you hear while driving through Fairfield County, Connecticut, in early April are thousands of members of the top five percent confronting the AMT yet again.

The AMT, which ensures that people pay a 28 percent rate on marginal income above $175,000, falls heavily on people who are wealthy by any standard — i.e. they earn a multiple of the national and state and even local median income. But these folks don't feel by wealthy because they've chosen to live in zip codes where housing prices are high and lots of other rich people live. The AMT thus contributes to one of the big ironies in American politics. It's been a great mystery to many on the political right that so many people who live in high income areas aren't more enthusiastic about voting for candidates that aim to preserve the Bush-era tax levels. (President Obama won a majority of the votes in 2008 in Greenwich, Connecticut.) Attitudes toward social policy have a lot to do with it. But the reality is that many people who live in high-income areas and who derive their income predominantly from wages never really felt the full benefit of the Bush tax cuts thanks to the AMT.

With each passing year, more and more people fall into this category. (Here's some background data from Tax Policy Center.) But because their income tends to come more from wages than from lightly taxed capital gains or dividends, the merely rich are more likely to get sucker-punched by the AMT than the very rich. As the Tax Policy Center notes, "In 2011, 42 percent of tax filers with cash income greater than $1 million were affected by the AMT, compared with nearly 52 percent of those with cash income between $200,000 and $500,000."

Almost every year, Congress passes a "patch" that prevents the AMT from ensnaring vastly more people. Had Congress not acted, as the Tax Policy Center points out, in 2012, "45 percent of all tax filers with cash income between $75,000 and $100,000 will pay the AMT, up from 0.4 percent in 2011, when the temporary AMT fix or 'patch' is in place."

For politicians, the AMT has become a double-edged sword. With each passing year, it gets more annoying to constituents and more expensive to fix. On the other hand, with each passing year the AMT brings in more revenues, which means it would be difficult to replace. So it's not surprising that the AMT hasn't been permanently "fixed."

So, here's the deal Obama is proposing in this budget: Better and simpler tax treatment for millions of people in exchange for ensuring that a few hundred thousand others aren't able to use their resources and ingenuity to avoid paying a significant chunk of their annual earnings in taxes. It sounds like a winner.

What could go wrong? Well, this budget proposal, like every other presidential budget proposal in recent memory, has been pronounced dead upon its arrival in Congress. What's more, this is precisely how the AMT got started in the first place. Note that Obama isn't proposing indexing the AMT to inflation. Twenty years from now, there will likely be many more people making $1 million than there are today, and they'll begin to argue that they, too, are simply middle-class.

What do you think? Do you favor swapping the Buffett Rule for the AMT fix? Give us your thoughts in the comment section below.

Daniel Gross is economics editor at Yahoo! Finance.

Follow him on Twitter @grossdm; email him at grossdaniel11@yahoo.com.