Urban Institute
WASHINGTON, D.C., September 18, 2002—The descendant of a 1969 tax designed to prevent 155 wealthy people from escaping federal tax liability will affect 36 million, mostly middle-class taxpayers by 2010, say researchers from the nonpartisan Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution.
Today's alternative minimum tax (AMT), like the original minimum tax of three decades ago, is focused on a small minority of high-income households. But the AMT is about to explode from a "class" tax to a "mass" tax involving 1 in 3 taxpayers, according to a new Tax Policy Center report, "The Individual AMT: Problems and Potential Solutions," written by Leonard Burman, William Gale, Jeffrey Rohaly, and Benjamin Harris.
The researchers project the number of AMT taxpayers skyrocketing to 36 million in eight years, almost 14 times as many as in 2001, because the AMT is not indexed for inflation and last year's tax cuts significantly reduced the regular income tax without making long-term cuts to the AMT. In addition to explaining the origins and effects of the looming crisis, the report and its companion policy brief, "The AMT: Out of Control," describe the AMT and explore options for fiscally responsible reform.
"Right now the AMT is an obscure, complex sideshow to the income tax," notes the Urban Institute's Leonard Burman, the tax center's co-director. "But it is no exaggeration to say it is on the verge of dominating our income tax system and will create major problems for the economy."
"We wouldn't be so concerned with the steep growth in the AMT if it were fair, efficient, and simple, but increasingly the tax fails all of those tests," says co-director William Gale of the Brookings Institution. "As a result, the AMT problem must be addressed. But doing so will be expensive; by 2008, getting rid of the AMT is going to cost more than repealing the regular income tax."
The Alternative Will Become the Standard
In 2002, 1.4 percent of filers earning between $50,000 and $75,000 and 3 percent with incomes between $75,000 and $100,000 will face the AMT. By 2010, the figures jump to 43 and 79 percent, respectively. The AMT will become the de facto tax system for 95 percent of filers with incomes between $100,000 and $500,000.
The AMT's role as a backstop to the progressivity of the income tax will erode as the AMT becomes more burdensome to the middle class and the 2001 tax cuts increasingly benefit higher-income taxpayers. Filers with incomes under $100,000 will account for 53 percent of AMT taxpayers in 2010, up from 24 percent in 2002. Those 2010 filers will account for 24 percent of AMT revenues, compared with 8 percent in 2002. Only 9 percent of AMT revenues in 2010 will come from taxpayers with incomes above $500,000, compared with 33 percent in 2002. This group will account for 30 percent of income tax revenues in 2002 and 26 percent in 2010.
Ironically, while the 2001 tax bill magnified the AMT's impact, the AMT will undermine the tax cuts. By 2010, the AMT will reclaim 36 percent of the overall income tax reduction enacted in 2001, including more than 70 percent of the cut targeted to taxpayers with incomes between $100,000 and $500,000.
And because it does not allow parents to claim exemptions for their children and disallows deductions for state taxes, the AMT will hammer families with children and those who live in high-tax states. In 2010, 6 million taxpayers will be on the AMT simply because they have children. More than 8 million will be AMT taxpayers because of state or local tax deductions.
Called by the Internal Revenue Service one of the most difficult tax law areas to comply with and administer, the AMT—because its rules on the timing of income recognition and deductions differ from regular income tax rules—forces many taxpayers to keep two separate sets of books, yet most people who must fill out the AMT forms end up owing no additional tax. The complex rules do reduce the number of high-income filers paying no income tax, but that end could be advanced by less burdensome measures.
Looking at Options
The researchers analyzed a spectrum of potential reforms, from outright repeal of the AMT to revenue-neutral adjustments. Despite the growing share of middle-class filers paying some AMT, they point out, repeal would be regressive and expensive. More than three-quarters of the benefits would accrue to taxpayers with incomes over $100,000 and about $800 billion would be added to the public debt over the next decade.
One way to partially offset the revenue and distributional impact of AMT reform, the Tax Policy Center researchers suggest, would be to freeze last year's tax cuts at 2002 levels, which would raise revenue and ensure that the most regressive features of the cuts are removed. Full AMT repeal under this scenario would still cost about $285 billion. An alternative to freezing the income and estate tax cuts would be to pursue some kind of revenue-neutral reform of the AMT alone, such as refocusing it on upper-income households without sacrificing tax revenue.
"The Individual AMT: Problems and Potential Solutions," by Leonard Burman, William Gale, Jeffrey Rohaly, and Benjamin Harris, is available online. "The AMT: Out of Control" can be also accessed on the Web.
The Urban-Brookings Tax Policy Center The Tax Policy Center, a joint venture of the Urban Institute and the Brookings Institution, provides independent, timely, and accessible analysis of current and emerging tax issues. TPC research may be found at www.taxpolicycenter.org. The site includes a Tax Facts section with detailed information on federal, state, and foreign taxes.
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