How U.S. Income Tax Cuts Are Really Tax Increases

Oct. 4 (Bloomberg) -- While purring about middle-class tax breaks, U.S. lawmakers who backed them ignored how the cuts would further accelerate state and local tax increases.

The $146 billion "Working Families Tax Relief Act of 2004" -- passed by Congress on Sept. 23 -- will actually increase the total tax burden for most households.

The tax savings will hold up like papier-mache when you consider how other taxes shred the federal breaks. The alternative minimum tax as well as state and local levies will continue to balloon as the new law vacuums money from the coffers of local schools, agencies and state governments.

"The decline in federal revenue sharing causes a greater burden on middle-class homeowners," said Richard Roll, head of the American Homeowners Association, a national consumer membership organization. "The federal tax cuts have a concealed effect. It's a detriment."

The tax relief act extends the child tax credits to 2009, the marriage penalty breaks until 2008 and the 10 percent tax bracket through 2010.

What families may save on slightly lower federal tax bills, though, will be offset by higher state and local taxes.

'Unfunded Mandates'

While Congress has passed legislation to bolster national security and education ("No Child Left Behind Act") and to fund Iraq and Afghanistan reconstruction, it has shortchanged state and local governments with "unfunded mandates," which are laws passed by Congress without adequate funding given to states to implement them.

The federal government's spending binge and tax-cut shortfalls shifted some $33 billion in bills to deficit-ridden state and local agencies in fiscal year 2005. These expenses are passed on to you through higher sales, excise, small-business and property taxes, according to the National Conference of State Legislatures, an association that represents state lawmakers. As a result, state taxes alone rose by $18 billion from 2000 to 2003.

Combining the effects of record home appreciation with federal-revenue shortfalls, local tax authorities have increased property-tax bills as much as 56 percent during the last four years in some areas.

In a survey of 12 metropolitan areas that included New York, Los Angeles, Boston and Chicago, property taxes increased 23 percent from 2000 to 2004, according to Runzheimer International, an international management-consulting firm that specializes in living costs.

The AMT

In the meantime, average monthly household income has dropped in real terms, declining from $4,607 in 1999 to $4,385 in 2003 (adjusted to 2003 dollars), according to a study by the Harvard Joint Center for Housing Studies. That means fewer dollars are available for rising tax bills.

In addition to failing to relieve state and local agencies of their growing burden, Congress also dodged the tax tiger -- the Alternative Minimum Tax.

Potentially biting as many as 40 million taxpayers by 2014, the AMT was introduced in 1969 to ensure that the ultra-wealthy paid federal tax by taking away deductions if they reached a certain level. Now the tax increasingly affects mostly middle- income families in states with high local and state taxes.

In 2004, those subject to the AMT paid an extra $6,000 (on average) in federal taxes over what they would normally pay, according to the Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, two social-research organizations.

AMT's Impact

The easing of the marriage penalty in the current tax law, which lowers effective tax rates for dual-income married couples, also can be a wash. The alternative tax affects middle-class married couples with children the most.

"Virtually all (94 percent) of married couples with two or more children and adjusted gross income between $75,000 and $100,000 will be on the AMT by 2010," the center's update on the AMT stated recently.

What stings most about the AMT is that if you are subject to it, you can't deduct state and property taxes, which have risen as fewer federal dollars have reached your community. The alternative tax can even be partially triggered by high state and local taxes.

Instead of reforming the way the alternative tax is calculated by indexing it to inflation, two weeks ago Congress punted and extended one-year AMT exemptions, which don't even come close to fixing the long-term problem.

AMT Fix Put Off

"Half of New York City was paying AMT this year -- even with the exemptions," said Martin Nissenbaum, national director of personal tax policy for Ernst & Young LLP, the New York-based accounting firm. "If you weren't in AMT last year, you can do traditional planning."

Cutting ordinary federal income tax rates also worsened the AMT problem.

"Extending the 2001 and 2003 tax cuts makes the AMT problem much larger and more expensive to fix," the Tax Center concluded earlier this year.

Clint Stretch, director of tax policy for Deloitte & Touche LLP, said the new tax law's enactment offers little incentive for Congress to reform the alternative tax, which nails taxpayers hardest in expensive states like New York, California and New Jersey.

"There's no (national) political mandate to fix the AMT," Stretch said. "It comes down to a regional fight now."

Appealing Your Taxes

While there's little you can do to avoid the alternative tax, it's possible to reduce your property taxes.

There's a three-part process to see if you're paying too much in real-estate taxes.

-- First, review your assessment notice. This is what your local assessor says your property is worth, which may be inaccurate. If you spot mistakes, tell your local assessor. You may be able to get a reduction through a letter.

-- Since as much as 60 percent of real-estate tax bills may have errors, you need to check if your property description (square footage, number of bedrooms and bathrooms) is correct. You could be overcharged based on those factors.

-- Also compare your property value to similar houses with equal square footage and amenities in your area. Sometimes neighbors will even let you see their tax bills. If you are paying more than your fair share, file an appeal with your taxation authority.

Ultimately, lawmakers did a disservice in extending tax breaks by using borrowed money and exacerbating long-term fiscal woes. Don't let the cat get your tongue when you confront them about your additional tax burden. Some genuine growling is in order.

To contact the writer of this column:
John F. Wasik in Chicago at [email protected].