Leonard E. Burman, William G. Gale, Matthew Hall, Mohammed Adeel Saleem The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.
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By now, the problems with the individual Alternative Minimum Tax (AMT) are well known. Originally intended to ensure that high-income people pay at least some tax, the tax is now on track to ensnare 33 million households by 2010—or about one-third of households—in a web of pointless complexity and higher taxes by the end of the decade1. The AMT increasingly afflicts middle-income taxpayers, especially those with children or who live in high-tax states. Under current law, 97 percent of married taxpayers with two or more children and incomes of $75,000 to $100,000 will be affected by the AMT by 2010.
The President's Budget, released on February 2, 2004, admits that there is a problem with the AMT, but proposes only a small and temporary fix—extending through 2005 an existing temporary fix that currently expires at the end of 2004. This not only fails to resolve the problem, it also substantially reduces the apparent budgetary cost of the President's main proposals to make the 2001 and 2003 tax cuts permanent (because taxpayers on the AMT will get less benefits from the rate reductions).
Taxpayers owe AMT only if their taxable income—augmented to include certain "preference items" such as personal exemptions and state and local taxes—exceeds the AMT exemption, which is currently $58,000 for married couples and $40,250 for singles and heads of households. Under current law, those thresholds are scheduled to fall to $45,000 and $33,750 respectively at the end of 2004, which would cause the number of AMT taxpayers to skyrocket. The new budget would delay that day of reckoning by one year—the temporarily higher exemptions would be extended through 2005. In addition, taxpayers will be able to use their personal credits, such as the education and child and dependent care tax credits, to reduce their AMT liability as well as their regular income tax liability.
The consequence of these provisions is that the projected number of AMT taxpayers in 2005 will decline from the current estimate of about 13 million to under 4 million. But, in 2006, after the temporary fix expires, the number jumps back up to almost 21 million. Moreover, because the budget proposes to make permanent the income tax cuts enacted in 2001 and 2003, the number of AMT taxpayers will continue to grow after 2010. We project that, by 2014, over 44 million taxpayers will be affected by the AMT. (See Figure 1.)
Table 1 shows that, without the temporary fix, the AMT would be seriously encroaching on the middle class in 2005. About 27 percent of tax filers with incomes between $75,000 and $100,000 (in $2002) would be on the AMT in 2005 without a fix. More than half of those with incomes between $100,000 and $200,000, and more than 80 percent of those with incomes between $200,000 and $500,000, would be affected by the tax. (The participation rate falls at higher income levels, suggesting how far the AMT has strayed from its original purpose.) But, if the higher exemptions are retained, less than 10 percent of tax filers with incomes between $100,000 and $200,000, and only about 1 percent of those with income between $75,000 and $100,000, will be subject to the tax in 2005. The table also shows that the temporary fix will also reduce the onerous marriage and child penalties inherent in the AMT—married families and those with kids will still be disproportionately affected by the tax, but the number of such families would be sharply curtailed.
Table 2 shows who would benefit from the AMT provisions in the budget. More than threequarters of the benefits would accrue to those with incomes over $100,000, although only a tiny fraction of the cut goes to those with incomes over $1 million. Similarly, the average tax cut for people with incomes between $200,000 and $500,000 is almost $2,100, because so many of those families are slated to owe AMT in 2005 under current law. Tax filers with incomes between $100,000 and $200,000 would get an average tax cut of $869. The tax cut amounts to almost 1 percent of income for those with incomes between $200,000 and $500,000, and about 0.7 percent for those with incomes between $100,000 and $200,000. The tax cut is smaller, but still significant for those with incomes between $50,000 and $100,000. For most other taxpayers, the tax cut is negligible.
The tables show that the proposal would provide meaningful relief to taxpayers in 2005, but it does nothing to address the problem when it becomes most acute. Indeed, extending the 2001 and 2003 tax cuts makes the AMT problem much larger and more expensive to correct. The President has asked the Treasury Department to study ways to solve the AMT problem. Unfortunately, the large tax cuts enacted by this Administration will make coming up with the resources needed to address the AMT problem an even more difficult challenge than it would otherwise be.
Notes
1. For a detailed discussion of the AMT problem and options for reform see Leonard E. Burman, William G. Gale, and Jeffrey Rohaly, "The AMT: Projections and Problems," Tax Notes, July 7, 2003. http://www.taxpolicycenter.org/publications/template.cfm?PubID=1000505
Note: This report is available in its entirety (including all figures and tables) in the Portable Document Format (PDF).
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