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Taxing the Sick Is Sick

Posted on January 9, 2009 by David Cay Johnston
Document originally published in Tax Notes
on January 5, 2009.

"Change we need."


-- Obama campaign slogan

President-elect Barack Obama calls his transition Web site http://change.gov a symbol of his promise to bring real change to Washington. Changing Washington is a daunting task, but he can start with a quick and easy victory by calling in his inaugural address for repeal of the most reprehensible tax law in America.

The provision raises income taxes on sick and injured people who fall under the alternative minimum tax. While most Americans can deduct medical expenses that exceed 7.5 percent of their adjusted gross income, under the AMT that threshold is raised to 10 percent under section 56(b)(1)(B).

Winning repeal should be a quick, slam-dunk victory for the new president. Presented as a single-measure bill, repeal should sail through both houses with unanimous votes. Can you imagine anyone defending a law that raises taxes on the sick and injured? And if someone does, isn't that just the kind of fight the Obama White House would relish?

More importantly, demanding this repeal would provide an opportunity for Obama to further his cause by opening eyes to how callous Washington has become to the needs of ordinary Americans. The corporate rich, and their lobbyists and campaign donation bundlers, surround lawmakers. That distorts their view, making the problems of these politically connected supplicants loom large while those of most Americans look distant.

Lawmakers in both parties denounced the provision when I examined it 10 years ago in a Sunday New York Times article headlined "Funny, They Don't Look Like Fat Cats." (Jan. 10, 1999, available at http://query.nytimes.com/gst/fullpage.html?res=9800EEDA1E3EF933A25752C0A96F958260&sec=&spon=&pagewanted=all).

The human faces of this situation are David and Margaret Klaassen of Marquette, Kansas. They were hit with the AMT because they had 13 children, and one of them, Aaron, ran up big medical bills fighting leukemia.

The Klaassens are a frugal family. When you have 15 mouths to feed, you learn how to stretch every dollar, a struggle whose constancy I know well as the father of eight. The Klaassens got by on less than $90,000 a year in the 1990s by producing some of their own food and squeezing every nickel.

David is a lawyer and Margaret is his secretary. One way they scrimped was by picking up blank tax forms, available for free at most post offices. David filled them out in pencil, and Margaret used a typewriter to make final versions.

They got hit with an audit notice -- and a demand for penalties and interest. The Klaassens went to Tax Court, where they lost, although Judge Robert N. Armen Jr. expressed sympathy with their plight. (See Klaassen v. Commissioner, T.C. Memo 1998-241, Doc 98-21429 or 98 TNT 128-55 .) Ultimately the penalties were abated, but the rest of the bill stuck.

Over the years the AMT has cost the Klaassens a small fortune relative to their taxable income. Only in 2007 did the tax not apply, David Klaassen said.

         AMT Doubles Klaasen Family Income Tax Bill Over a Decade
 ---------------------------------------------------------------------
                                     
Personal      Itemized
 Year          AGI      Exemptions   Exemptions    Deductions

 ---------------------------------------------------------------------


 1997        89,751.07      14         37,100        14,733.52
 1998        67,695         15         40,500        10,131
 1999        94,081         15         41,250        20,114
 2000        86,537         15         42,000        28,885
 2001        97,068         15         43,500        13,562
 2002       121,133         14         42,000        20,711
 2003       110,355         14         42,700        15,361
 2004       105,092         14         43,400        19,157
 2005       120,377.00      13         41,600        15,994
 2006       137,813         12         39,600        20,682
 Total    1,029,902.07                413,650       179,330.52


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Tax Before                   AMT as Percent of
 Year    AMT              AMT         Ordinary Income Tax

 ---------------------------------------------------------------------


 1997      5,689         2,994              34.5%
 1998          0         1,596             100%
 1999          0         3,887             100%
 2000          0         2,346             100%
 2001      2,349         4,019              63.1%
 2002      5,371         5,710              51.5%
 2003      2,391         3,746              61%
 2004      3,932         3,068              43.8%
 2005      3,574         4,041              53.1%
 2006      8,896         3,135              26.1%
 Total    32,202        34,542              51.8%
 ---------------------------------------------------------------------


 
Source: David & Margaret Klaassen tax returns

Five years ago the House Ways and Means Committee asked David Klaassen to testify -- provided he paid his own way. Because of a health problem, he did not appear, but asking him to pay his own way shows how much our lawmakers favor those with the resources to work Capitol Hill. This makes it hard for lawmakers to hear the voices of those without such means.

Had he testified -- or were Congress to fly him in to testify now -- Klaassen could ask a simple question:

"What kind of policy taxes you for spending money to save your child's life?"

Bringing along Aaron to testify would help illustrate the issue, creating a human symbol of the official disregard for the people who give Congress its power.

Aaron got through his childhood leukemia, the last signs of which were detected 18 years ago. He is now, fittingly, a fiscal analyst for the Kansas state government in Topeka. (Nine children remain on the parents' tax returns, a number that time will steadily shrink.)

At the time the Klaassens' story was told, politicians in both parties denounced the medical deduction rules under the AMT. The late Sen. William V. Roth Jr., the Delaware Republican who staged the infamous hearings into supposed abuses of taxpayers by the Internal Revenue Service, said that what happened to the Klaassens "simply isn't fair." Sen. Richard G. Lugar, R-Ind., called for repeal of the provisions. Lawrence H. Summers, now a top economic policy adviser to Obama, who was then the Treasury secretary, told me the Clinton administration was "very concerned that the AMT has a growing impact on middle-class families, including by diluting the child credit, education credits, and other crucial tax benefits."

"We hope to address this issue in the president's budget," he said, but added a qualifier: "Subject to budget constraints, we look forward to working with Congress on this important issue."

Despite the rhetoric, nothing happened. Here was a law that not one politician has spoken in favor of, and yet it continues on the books. Its existence screams of official Washington's disregard for the American people who are not part of the Beltway policy and political apparatus.

The provision is part of the 1986 Tax Relief Act. It was used to provide a scintilla of extra revenue so that the computer models of the old and new tax systems would show that they were revenue neutral. The total tax take was to be unchanged, with the burden just distributed differently. But with all the focus on big issues like the top tax rate, corporate taxes, and dubious tax shelters, no one paid attention to this levy on the sick and injured.

While raising taxes on the sick and injured is disgusting, what makes the law reprehensible is what President Bush persuaded Congress to do -- with bipartisan support -- in 2001. Under his Economic Growth and Tax Relief Reconciliation Act, the extra revenue raised by taxing the sick and injured is used to finance tax cuts for others, notably the richest among us, under the details of the plan that skewed its benefits in favor of those at the top.

The 2001 law provided $1.8 trillion in tax cuts over 10 years and then proposed to take back about $550 billion of it through increased AMT revenues, including the added levy on the sick and injured. Not all that AMT revenue has come in because Congress has each year put a patch on the law so that the numbers affected did not balloon to a third of all taxpayers. But the underlying mechanism remains -- the extra levy on the sick and injured helps finance tax cuts for those at the top.

The amount of money raised by increasing taxes on the Klaassens and others with big medical bills is a drop in the proverbial bucket. The Tax Policy Center estimates it at around $200 million for 2007, about two-hundredths of 1 percent of federal individual income tax revenues. (For the Tax Policy Center report, see Doc 2008- 25536 or 2008 TNT 235-21.)

Why would repealing this tax code provision be simple, easy, and quick? No lobby favors it, as best I can tell, nor does any policy shop. Who would fight to retain it?

So why does this unjust law remain if no one favors it? Because the past two presidents failed to act, failed to simply ask that the law be repealed. It remained because, to Clinton -- for all his rhetoric about the people and the dispossessed -- it was not worth the bother, and to George W. Bush the extra levy was a source, however small, of help for his plan to cut taxes paid by the haves and have-mores.

A new president who wants to show he means business about change, that he is a man of action and not just promises, can show just that -- and he can do so with no political risk. Change comes from leadership. All Obama has to do is explain what this odious law does and then declare that "it is wrong to burden the sick and injured with extra taxes" and that Congress should repeal it before April 15.

Your thoughts? E-mail me at JohnstonsTake@tax.org.



David Cay Johnston is a former tax reporter with The New York Times. He is also the author of two books about taxes: Free Lunch and Perfectly Legal.