Tax Proposals: Solve this One (Case Study)

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This morning I was talking with a friend who falls firmly into the upper middle classes that most of the posters here want to save from strangling taxes. And, well, despite how much they make, I know they are not capable of living extravagantly (in my eyes) or wastefully. They are capable of living generously and securely.

End summary, they fall in a group that I think most people will agree should feel rewarded for their hard work, and not strangled.

But there is not a single proposal out there that would make things better for them.

The husband is a doctor, owning his own practice, so squeeze medicare and you cut his income (which has, apparently, already been going down steadily for 10 years). My friend HATES the Ryan plan.

The couple is firmly with the AMT (alternative minimum tax), so cutting the top regular tax rate does absolutely nothing for them, and raising it doesn't hurt them, either: they don't PAY regular tax, they pay AMT. But, they still are bothered by Obama calling them "wealthy" because while their income may mean a really good life in the mid west, it does not out here in CA. Their home is probably 1700 square feet with a postage stamp yard. That doesn't seem "rich," does it? All tax types combined she figures they paid over 50%, which is that psychological line it is best not to cross.

The wealthy clients happy to pay more tax tend to be in the over a million range. For those in the 250,000 - 800,000 range, it is more complicated. In this area they aren't living that big. But a plan like Obama's probably can't raise enough money if it doesn't hit below $1,000,000.

So what actually helps them? Or do you figure they shouldn't get the break?

I would suggest getting rid of the AMT to start, since that hits this bracket hardest and it is a really bitter pill to swallow for those who pay it. But an offset is needed, because spending cuts aren't going to balance the budget.

Then adjust the top rate more slowly, perhaps starting at $500,000 instead of $250,000. Take it up to 40% at over $1,000,000.

My friend says end the #@!*(&! wars because she is tired of paying for them. Same thing, actually, I'm hearing from many rich clients. After that, she is interested in a flat tax not just rate, but no personal deductions of any sort (no home mortgage, no charitable, no taxes, NONE of it) but I'm not convinced that gets her closer: after all, the AMT IS a more flat tax, and that is what bit her. Still, perception obviously matters.

What are your ideas?

I think you're mistaking the positions of a lot of the posters here. First, I think many posters here are perfectly willing to strangle the upper middle class. Second, those who oppose increasing taxes don't necessarily think we should be "making things better" for any subgroup - rather, the main thing is that we shouldn't be making things worse, as Obama's proposal does.

For example, one of the main reasons I like the Ryan plan is specifically because it does not cut the overall tax burden. It flattens rates but removes deductions to achieve an overall revenue neutral result. The reason it's good is not because it makes people pay less taxes; it's good because it allows people to work harder and earn more and incidentally pay more taxes, not less, due to that additional income.


I suspect he doesn't understand what would actually happen to medicare under the Ryan plan. Ask him whether he gets more per procedure or per visit from medicare patients or from private health insurance patients. I bet it's the latter. And the Ryan plan converts medicare patients to private health insurance patients, which will allow him to charge normal rates, rather than depressed medicare rates.

Also I would note that the Ryan plan still increases the medicare budget every year. It will slow the spending primarily by hitting newly developed highly expensive procedures. Unless that's what your friend's husband makes his money on, it won't actually hurt him.


If they are paying AMT, that means they are sheltering a large proportion of their income with deductions. There are a variety of ways to do this, but the most frequent is to have a large mortgage on a very expensive home. Their home might be such a home if it's in one of the best parts of San Francisco, or they might be taking advantage of other deductions, but if they're paying AMT, they are escaping a lot of taxes by having a lot of deductions.

I am quite skeptical that they paid over 50% on their AGI, which is the relevant figure, if they are paying AMT. Did you do their taxes? Can you vouch for that figure? Can you provide a realistic example of someone paying AMT who is paying more than 50% of their AGI in taxes? I suppose it might be possible depending on what California state taxes are like, but ... it would be very hard in Massachusetts. Or are you saying it's just a 50% marginal rate?

And that does kind of illustrate the problem with the idea that you can raise tax revenue by raising the regular tax rates. More people will do like your friend has done, find more deductions, and pay the lower AMT rates instead. Of course, they'll be unhappy that they have to do that, because they'll be spending money on what special interests like the housing industry want them to spend it on, rather than on what they want - but the government won't get more taxes out of that unhappiness.


People on AMT are already dodging much of their taxes. If anything, we should keep the AMT and get rid of the regular income tax.


But even you said that won't be enough.


I've been arguing for years that Obama's escalation of Afghanistan is an expensive mistake. Intervention in Libya is stupid too. However, I have to admit that while it would save a little money, it's not where the big money is going.


Closer to what? Closer to having a few more bucks? Or closer to being happy? They aren't the same thing, you know.

Money isn't happiness. The problem with the existing tax system is more with its burdens on happiness rather than on money. Specifically, the current tax system makes decisions for us by essentially forcing us to spend money on the things that are deductible, rather than giving us the freedom to spend money on whatever we want to spend the money on; by forcing us to waste time figuring out the complex tax impacts of everything, rather than freeing us to spend our time working on the things we want to work on.

The problem with the AMT isn't that it's flat, but that it means that not only are we forced to spend all that time on figuring out how to spend money in tax deductible ways, it adds yet another rule. Now instead of maximizing deductions, we have to hit one specific amount of deductions. That just increases the frustration even further.

I think her proposal will get her closer to happiness. They may end up paying more in taxes, but that will be made up for by being able to spend the money they keep on the things they want to spend it on, rather than worrying about what the government wants them to spend it on.


I agree with your friend. Flat tax, no deductions, no credits. I personally would pay more in taxes under that system, but I would be happier because the money we kept we could spend on the things we wanted to spend it on, rather than having to spend it on things the government wants us to spend it on.

The reason I support the Ryan plan is because it's the closest proposal to your friend's plan that's being offered. It's not quite flat; it's not quite no deductions; it's closer than anything else on offer.

You miss understand the AMT. Almost every single California family earning in the $200,000 to $800,000 range (rough estimate; I dont' have the statistical cut offs) pays AMT with the ONLY adjustment being the deduction for taxes (state and property). They aren't trying to shelter anything; they are just paying exactly what they are supposed to.

The AMT was designed to do exactly as you say, but as the regular tax rate went down, things changed. Pretty easy math, if regular tax is 50% and AMT is 25%, as it was back in the 80's, hardly anyone will pay AMT. But now regular tax is 35% and AMT 29%, all it takes to trip is a high state tax rate. AMT is THE issue for upper middle class taxpayers in California.

FYI, a large mortgage will NOT result in AMT.

I don't do my friend's taxes, but I would assume they've added social security, state income, and property taxes to get to 50%. Regardless, perception can be more important than reality.

OK, I thought you were talking about people EXACTLY like them when you discussed tax incentives and the effect of rates. But you aren't?

By my calculations, someone with $200,000 in income would need over $50,000 in deductions for their regular income tax to fall below the AMT level. In Massachusetts, that someone would have about $10,000 in state income tax and typically $5,000 in property tax on an $800,000 home. They'd need a lot more than just those deductions to cover the gap between $15,000 and $50,000.

Are taxes in California really three times as high as in Taxachusetts? If so, I'd say your friend's problem isn't AMT, it's excessive state and property taxes. Or, if you think my calculations are wrong, feel free to provide specific numbers of your own - but not just assertions, please, actual numbers and arithmetic.


You might want to go back and reread my discussions of those subjects, keeping in mind the difference between marginal tax rates - the rate paid on a dollar of additional income - and average tax rates - the total tax divided by total income. The incentive to work harder or to work less is based on the marginal tax rate, not on the average tax rate. I was talking about people like them, but I'm fine with average tax rates staying the same or even increasing slightly, as would happen from elimination of deductions, provided marginal tax rates can be kept where they are or even lowered.

Again, I am talking about lowering the marginal tax rate, not lowering the average rate. A flat tax with no deductions and no credits, as your friend suggests, would be perfect.

Last edited by psychohist on 02 May 2011, 3:07 pm, edited 1 time in total.

Have your friend examine THE FAIR TAX being proposed. It's what we should have in the USA, but it won't pass joined to other major reform as it's a big proposal by itself.

In short...NO INCOME TAX AND NO IRS.

We go to a national sales tax. Consumption and productivity is rewarded. No exemptions. Government has a vested interest in growing the economy and the huge waste in dealing with a cumbersome tax code is eliminated.

I think you nailed it with the AMT. Back in college in 2005 my tax teacher talked about how AMT is swooping lower and lower and that it was never meant to be a private citizen tax. As for balancing the budget though, we need to figure out a way to stoke the fires for business without leading to a whole bunch of regulation and bust. Taxes are okay but for better or worse we're in a global labor market and thus we'll feel the effects that much faster these days if we overdue it and they all start reincoporating to other nations.

CA state taxes ARE that high. I find MA state taxes to be outrageous on someone grossin 100k, but CA moves past MA when you get to higher incomes.

If I can find the time, I'll run up an example. But call any random CPA in CA ask what the odds are of a 300K client paying AMT, and he'll tell you exactly what I have.

5k in state taxes on 100k in income is "outrageous"? Honestly, with most recent administrations, the Massachusetts state government has done an excellent job in providing services given the tax rate. There have been years when I've paid the voluntary higher rate, I've felt the state government was doing such a good job.

Granted out of state returns benefit from Massachusetts government services only indirectly, so they may not realize what they're getting for their money.

100k of GROSS income. For federal, after deductions, taxable income is likely to be 60K. Compared to the FIT calc, the MA tax comes out relatively high compared to other states.

Of course 100k of gross income (AGI). Federal taxable income is a joke.

That's the whole problem with federal taxes - how much you pay depends more on how much time and effort you spend on increasing your deductions than on how much money you actually make.