The Individual Alternative Minimum Tax: Historical Data and Projections : Updated June 2008

The Individual Alternative Minimum Tax: Historical Data and ProjectionsGreg Leiserson, Jeff Rohaly

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.

The text below is an excerpt from the complete document. Read the full report in PDF format.

Congress enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least some tax. The AMT now threatens to grow from a footnote in the tax code to a major component affecting tens of millions of taxpayers. Although most lower- and middle-income taxpayers will remain unaffected by it, policymakers need to deal with the explosive growth of the AMT from an obscure tax affecting only 20,000 filers in 1970 to one affecting more than 33 million–a third of all taxpayers–by 2010. This document provides updated estimates of AMT participation, revenue, and distribution.

Congress originally enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax each year. Due to design flaws, however, the current alternative minimum tax (AMT) threatens to grow from a footnote in the tax code to a major component affecting tens of millions of taxpayers every year. One reason for the projected expansion of the AMT is that–unlike the regular income tax system–the AMT brackets and exemption are not indexed for inflation. In addition, since they reduce regular income taxes without a corresponding permanent fix to the AMT, the 2001-06 tax cuts exacerbate the AMT problem. Absent a change in law, more than 33 million taxpayers will be subject to the AMT by 2010. If Congress allows the tax cuts to expire at the end of 2010, the number of AMT taxpayers will fall dramatically in 2011, but will then trend back upward over time. By 2018, about 43 million taxpayers will be subject to the AMT under current law; that number will swell to almost 57 million if the tax cuts are extended. Although most lower- and middle-income taxpayers will remain unaffected by the tax, policymakers will need to deal with the explosive growth of the AMT from an obscure tax affecting only 20,000 filers in 1970 to one affecting more than a third of all taxpayers by 2010.

The Tax Policy Center (TPC) has written extensively about the AMT. This paper updates Rohaly and Leiserson (2006) with the TPC’s latest estimates of AMT participation, revenue, and the distribution of AMT liability. It starts with a brief overview of how the AMT works.

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The Individual Alternative Minimum Tax : Testimony before the U.S. Senate Committee on Finance

The Individual Alternative Minimum TaxLeonard E. Burman

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.

The text below is Burman's oral testimony.
Read the full written testimony in PDF format.
Read Burman's response to follow-up questions from Senators Baucus and Grassley in PDF format.

The AMT threatens to grow from a footnote in the tax code to a major scourge affecting tens of millions of taxpayers every year. The practice in recent years has been to patch the AMT every year or two on a temporary basis so that not too many people are affected. The latest patch expired at the end of 2006. This testimony outlines how the AMT works, whom it affects, why it demands attention, and why financing AMT repeal or reform is important. Burman lays out a number of fiscally responsible options to fix or eliminate the AMT and discusses their effects on the distribution of tax burdens, the number of AMT taxpayers, and marginal tax rates.

Chairman Baucus, Ranking Member Grassley, Members of the Committee: Thank you for inviting me to share my views on the individual alternative minimum tax.

A few years ago, my colleagues and I wrote a paper titled "The AMT: Out of Control." It's really out of control now. If Congress doesn't act, virtually everyone in this room, along with 23 million Americans will owe AMT next April.

A lot of the AMT's victims will be solidly middle class, not the millionaires who were its originally intended target. In my testimony, I show that a family with four kids under age 17, earning $75,000, with no itemized deductions will see their tax double in 2007 because of the AMT. Their tax planning mistake (in AMT world) was having four kids.

Last night, I checked the IRS website to see whether this family would have enough tax withheld to pay the AMT. No. Assuming one parent earns all the income, the IRS advises him or her to claim 11 exemptions on the W-4 form employers use to set withholding, and promises that the family will get a $25 refund at the end of the year. Actually, under current law, that family would be underwithheld by almost $2,000. Talk about a rude shock at tax time.

The smart money says that Congress will patch the AMT for another year or two to make sure that my hypothetical family won't be affected. The latest patch expired at the end of 2006. This stopgap approach leads to endless confusion though. How much estimated tax and withholding should I pay? What is my tax bracket? Would I benefit from the tax credit for hybrid vehicles if I bought one?

Is it safe to ignore the AMT, as the IRS does in its withholding calculator? Is the IRS prescient or just clueless like the rest of us? Why should 23 million Americans have to guess about their tax situation?

Some people say that the AMT isn't such a bad tax system so we should just let it take over. Actually, the AMT is a terrible tax system. The AMT exemption, which you deduct from income to calculate AMT, phases out at a 25-percent rate. This boosts the effective tax rates in the phaseout range by a quarter, so instead of the advertised 26 and 28 percent rates, many AMT taxpayers face effective rates of 32.5 and 35 percent. The highest rates don't apply to the highest-income people, which is why the AMT hits almost everyone with incomes between $200,000 and $500,000, but not so many millionaires.

What's more, unlike the regular income tax, the AMT is not indexed for inflation so people's average tax bills can increase every year, even if their incomes don't grow at all in real terms. And the AMT hammers married couples and especially families with kids. In 2007, married couples will be 15 times as likely as singles to owe AMT.

Some claim that software and paid preparers make AMT complexity no big deal, but there are at least three problems with this argument. First, as the AMT consumes the middle class, it will hit more and more people who do their taxes by hand, or try. Second, even with software, it's complex—as I explain in my written testimony. Third, you might want people to understand how the tax system affects them. With the AMT, the tax system becomes an inscrutable black box.

Some argue that the AMT is a "blue state" tax—only one party's problem. Although it is true that, historically, taxpayers in relatively high-income, high-tax coastal states were more likely to owe AMT than those in the interior, the AMT is going to hit people in all states hard if it isn't fixed. And, even back in 2004, lots of red states had AMT hot spots—zip codes where 10 percent or more of the residents owed the tax.

The AMT hits middle and upper income families with kids—soccer moms. It's in all of your interests to do something about it.

What to do about it?

Some members of this committee have suggested that the solution would be to repeal the AMT and not worry about the $800 billion in revenues that would be forgone. Those members argue that the AMT would tax people who were never its intended target and thus AMT revenues should never have been counted on. The real baseline, they assert, should assume no AMT.

Those members might have—but didn't—raise that argument in 2001 when large projected AMT revenues greased the skids for the ensuing tax cuts. In fact, the AMT masked much of the cost of the tax cuts since people who pay it do not get the full income tax rate reductions. Eliminating the AMT after it has helped finance the largest tax cuts in history amounts to a major bait and switch if the lost revenue isn't offset.

Fortunately, there are many options to reform or repeal the AMT that would not increase the deficit. My favorite option, and probably one shared by everyone on this panel, would be to eliminate the AMT as part of fundamental tax reform. But given political reality, the best alternative may be a simple surtax of 4 percent of adjusted gross income (AGI) over $200,000 for joint returns and $100,000 for others, which would raise enough to offset the revenue lost from repealing the AMT.

The surtax would be simple and progressive. The vast majority of AMT-paying taxpayers would pay lower taxes. Only the richest 1 percent would pay higher taxes on average. And they would lose far less than they gained from the 2001-2006 tax cuts. Moreover, most of the taxpayers who lost a large share of their tax cut due to the AMT would now receive the full benefit.

Some critics have complained that the surtax would raise effective tax rates and discourage work and saving. But since the current AMT has even bigger implicit surtaxes built into it, most affected taxpayers would face lower rates under the alternative.

Many other fiscally responsible options are outlined in my written testimony.

I understand that fixing the AMT isn't easy. If it were, it would have been done a long time ago. I applaud the Committee for taking the first steps toward what I hope will be a permanent solution.

The text above is Burman's oral testimony.
Read the full written testimony in PDF format.
Read Burman's response to follow-up questions from Senators Baucus and Grassley in PDF format.

The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.

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Top Individual Income Tax Rates: How Does the U.S. Compare?

Jim Nunns

Discussions of the effect of taxes on international competitiveness usually focus on corporate income tax rates, but individual income tax rates may also affect a country’s (or state’s) ability to compete for workers.

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Individual Taxpayers and Federal Tax Reform : Testimony before the United States Senate Committee on Finance

Individual Taxpayers and Federal Tax ReformWilliam G. Gale

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.

In the next few years, several factors will push tax issues to the forefront of policy discussions. First, under current law, almost all of the Bush Administration's tax cuts will expire at the end of 2010. A second factor is the rapid growth in the alternative minimum tax (AMT), which will increase the inequity and complexity of the tax system. A third issue is the expected increase in government spending over the next several decades. Despite these pressures on the system, tax changes are not inevitable, and achieving meaningful reform—that is, with substantial design improvements—will require strong political leadership. Gale's testimony focuses on some overarching principles that should guide tax reform efforts.

The text below is an excerpt from the complete document.
Read the full written testimony in PDF format.

Chairman Baucus, Ranking Member Grassley, and other members of the Committee:
Thank you for inviting me to testify at this hearing on individual taxpayers and tax reform. The tax system needs to be simpler, more equitable, more conducive to prosperity, and sustainable. My remarks focus on some overarching principles that should guide reform efforts. There is no clean line between individual taxes and business taxes. In particular, individuals–not businesses–bear the burden of taxes imposed on businesses.
The key item in any tax reform is to broaden the tax base. The goal should be to tax all income once, tax it only once, at the full, income tax rate. Broadening the base taxes different types of activities at the same rate, and thus "levels the playing field," and reduces the extent to which taxes distort economic behavior;allows for lower rates in order to raise a given level of revenue, or allows an increase in the revenue level, if needed; lower overall rates, in turn, further reduce the extent to which taxes distort economic behavior; andmakes taxes simpler.After base broadening, special attention should be given to the form of any surviving tax preferences. Deductions are regressive and are only justified if there is a true reduction in ability to pay, a condition that is rarely met among existing tax preferences. Converting the deductions to flat, refundable credits would in most cases be preferable on revenue, distributional, incentive, and efficiency grounds.It is time to eliminate the AMT, but only if the revenue is replaced and the loopholes that would be created are closed.A revenue system that is not adequate to finance government spending will be unstable and unsustainable.The importance of simplifying the system can not be overstated. Taxpayers are overwhelmed by complexity, real and imagined, in the tax code. Oddly, although the need to simplify the tax system is the one goal everyone accepts in tax discussions, every year the system becomes more complex. If simplification is not the primary goal of reform, tax changes will likely make the tax system more complicated.

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The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.

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The Individual Alternative Minimum Tax: Historical Data and Projections, Updated October 2009

The Individual Alternative Minimum Tax: Historical Data and Projections, Updated October 2009Katherine Lim, Jeff Rohaly

The text below is an excerpt from the complete document. Read the full report in PDF format.

The alternative minimum tax (AMT), which originally targeted high-income taxpayers, requires annual legislation to prevent it from affecting millions of middle-income individuals each year. There are two primary reasons for the AMT's broadening impact; its parameters are not indexed for inflation and the 2001-2006 tax cuts reduced regular tax liability without changing AMT liability. In 2009, four million taxpayers will pay $33.5 billion in AMT, but without congressional action that number will rise to 27 million owing $102 billion in 2010. This paper describes the AMT and provides TPC's latest estimates of AMT coverage, revenue, and distribution.

Congress originally enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax each year. Due to design flaws, however, the current alternative minimum tax (AMT) requires annual congressional action to prevent it from affecting tens of millions of taxpayers each year. One reason for the expansion of the AMT is that-unlike the regular income tax system-the AMT brackets and exemption are not indexed for inflation. In addition, the tax cuts passed during the Bush administration exacerbate the AMT problem because they reduce regular income taxes without a corresponding permanent reduction in the AMT. Absent another temporary fix or other change in law, the tax cuts and lack of indexation will combine to push more than 27 million taxpayers onto the AMT in 2010. If Congress extends the Bush tax cuts, that number would swell to almost 52 million by 2020. Alternatively, if Congress allows all of the tax cuts to expire-which is highly unlikely-the number of AMT taxpayers would fall dramatically in 2011, but then trend back upward over time to hit more than 37 million taxpayers by 2020. Regardless of how Congress deals with the coming expiration of the Bush tax cuts, policymakers will also need to address the explosive growth of the AMT from an obscure tax affecting only 20,000 filers in 1970 to one that could affect nearly a third of all taxpayers in 2010.

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The Individual Alternative Minimum Tax (AMT): 12 Facts and Projections

The Individual Alternative Minimum Tax (AMT): 12 Facts and ProjectionsLeonard E. Burman, Julianna Koch, Greg Leiserson, Jeff Rohaly

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.

The text below is an excerpt from the complete document. Read the full paper in PDF format.

Congress originally enacted a minimum tax in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax. Under today's alternative minimum tax (AMT), middle- and upper-income taxpayers must add a number of "preference items" to their taxable income, subtract a special AMT exemption, and calculate their tax according to the AMT rules. If the tax under those rules turns out to be higher than their regular income tax, taxpayers pay the difference as AMT. Unless Congress acts, 26.8 million taxpayers will be affected by the AMT in 2008.

1. The AMT is exploding. Unless Congress acts, 26.8 million taxpayers will be affected by the AMT in 2008. In 2007, only 4.1 million taxpayers owed the tax because of the temporary AMT "patch," which has now expired. By comparison, in 1970, just 20,000 taxpayers were affected by the AMT. If the 2001-2006 tax cuts expire as scheduled at the end of 2010, 43 million taxpayers (almost two-fifths) will be hit by the AMT in 2018. If the tax cuts are extended, the number jumps to 57 million taxpayers (more than half) (tables T08-0094 and T08-0095).

2. The AMT is encroaching on the middle class. Although the AMT is highly progressive, the distribution of AMT liability will shift toward tax units with lower incomes. In 2007, tax units with $500,000 or more in income paid 50 percent of the tax; by 2010, they will pay only 18 percent. About 78 percent of households with incomes between $100,000 and $200,000 and 46 percent of those with incomes between $75,000 and $100,000 will pay the AMT by 2010 (compared with 3.6 percent and 0.6 percent in 2007) (tables T08-0096 and T08-0098).

3. The average AMT liability in 2007 was $6,577. Barring legislative action, the average is projected to decline this year to $3,264 as millions of middle-class families-that tend to owe a smaller amount of the tax-join the ranks of AMT taxpayers (table T08-0097).

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The Individual AMT: Problems and Potential Solutions

The Individual AMT: Problems and Potential SolutionsLeonard E. Burman, William G. Gale, Jeff Rohaly, Benjamin H. Harris

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.

TPC Discussion Paper No. 5

The Urban-Brookings Tax Policy Center

The Tax Policy Center (TPC) aims to clarify and analyze the nation's tax policy choices by providing timely and accessible facts, analyses, and commentary to policymakers, journalists, citizens and researchers. TPC's nationally recognized experts in tax, budget and social policy carry out an integrated program of research and communication on four overarching issues: fair, simple and efficient taxation; long-term implications of tax policy choices; social policy in the tax code; and state tax issues.

A joint venture of the Urban Institute and the Brookings Institution, support for the TPC comes from a generous consortium of funders, including the Ford Foundation, the Annie E. Casey Foundation, the Charles Stewart Mott Foundation, and the George Gund Foundation.

Views expressed do not necessarily reflect those of the Urban Institute, the Brookings Institution, their boards of trustees, or their funders.

I. INTRODUCTION
II. THE INDIVIDUAL AMT: AN OVERVIEW
Current Rules
Evolution of Minimum Tax Rules
III. PROJECTIONS OF AMT PARTICIPATION AND REVENUES
IV. ECONOMIC ISSUES
Potential Justifications
Equity
Efficiency
Complexity
V. POLICY OPTIONS
Reform Options
A Constant-Revenue, Distributionally-Neutral AMT and Income Tax Change
Changes in the AMT and EGTRRA: Revenue effects
Revenue-Neutral AMT Reform
VI. CONCLUSION
VII. APPENDIX: MODEL AND METHODOLOGY
VIII. REFERENCES

In January 1969, Treasury Secretary Joseph W. Barr reported to Congress that 155 individual taxpayers with incomes above $200,000 paid no federal income tax on their 1967 tax returns.1 The news created a political firestorm. Members of Congress received more constituent letters in 1969 regarding the 155 taxpayers than concerning the Vietnam War (Graetz 1999). Later that year, the Tax Reform Act of 1969 created a minimum tax designed to ensure that individuals with high incomes did not take what was deemed undue advantage of tax laws to reduce or eliminate their federal income tax liability.

Although the original minimum tax and its successor, the individual alternative minimum tax (AMT), have historically had limited scope and applied only to a small minority of high-income households, the AMT is now on the verge of switching from a "class tax" to a "mass tax." In 2001, for example, fewer than 2 percent of taxpayers paid AMT. These taxpayers had substantial incomes, accounting for 7 percent of all adjusted gross income (AGI). Nevertheless, the tax accounted for just 1 percent of income tax revenue. Under current law, by 2010 the AMT will affect one-third of all taxpayers, who account for 55 percent of all AGI, and raise 10 percent of income tax revenues. The AMT will encroach significantly on the middle-class, affecting a majority of taxpayers with AGI between $50,000 and $100,000. It will become the de facto tax system for taxpayers with AGI between $100,000 and $500,000, 95 percent of whom will pay AMT. Among married couples with two or more children and income between $75,000 and $500,000, the AMT participation rate will approach 100 percent. Indeed, by 2008, it would cost less in lost revenue to repeal the regular income tax than to repeal the AMT.

These projected increases raise a host of issues because the AMT is notoriously complex, its effects on efficiency and equity are questionable, and its underlying purpose is controversial. The purpose of this paper is to provide information on the AMT, its economic effects, and potential reform options.

Section I describes the calculation of AMT liability and the historical evolution of minimum taxes. The AMT tax base is essentially the sum of regular taxable income plus a variety of factors that are not included in the regular tax base, less the AMT exemption. The base is taxed at flatter rates than under the regular tax. AMT liability is the difference, if positive, between a taxpayer's overall liability under the AMT and a measure of tax liability based on the regular income tax.

The history of AMT reforms suggests that legislators intend for the tax to address broad issues of vertical and horizontal equity as well as the desire that every high-income person pay at least some income tax. Most major tax reforms since 1980 have involved AMT changes that broadly conform to the changes introduced in the regular tax. Two notable exceptions—the 1981 tax cuts, which indexed the regular income tax for inflation without indexing the AMT, and the 2001 tax cut, which slashed ordinary income taxes while leaving AMT rates and brackets unchanged (but for a temporary fix through 2004)—are the main culprits behind the predicted explosion of AMT coverage and liability. In section II, we use a new tax policy simulation model developed at the Urban-Brookings Tax Policy Center to document the projected AMT expansions noted above and relate the expansions to the lack of indexing for inflation and the 2001 tax cut.

Section III analyzes economic issues related to the AMT. Although tax policy trade-offs and constraints imposed by budgets, political factors, and public opinion might rationalize the existence of some form of minimum tax, the existing AMT is difficult to justify formally. In equity terms, the AMT is more progressive than the regular tax, but AMT progressivity will decline markedly over the next decade, as more middle-class households fall prey to the AMT. The number of high-income people who pay no income tax has been roughly constant over time, but would have increased if not for the AMT.

The efficiency effects of the AMT are complicated. Observers typically characterize the AMT as having a broader base and lower marginal tax rates than the regular income tax. We show, however, that as of 2010, the opposite characterization will generally hold. For the vast majority of AMT taxpayers, the AMT will apply to less income and will be assessed at higher marginal tax rates than the regular tax. Interactions between the regular tax and the AMT have ambiguous effects on efficiency.

The AMT is complex. Rules regarding the timing of recognition of income and deductions require taxpayers to keep separate books for the regular tax and the AMT. The revenue gains of these rules are largely offset by another complicated set of rules that allow future tax credits for the tax benefits lost through the first set of rules. Thus, these two sets of rules are doubly complex and raise little revenue. The rules do, though, serve a recognizable policy goal: they reduce the number of high-income filers that pay no income tax in a given year. The potential value of other sources of AMT complexity is not readily apparent. Most people who are required to fill out the AMT forms end up owing no additional tax. The tax will impose increasing compliance burdens over time on middle-class taxpayers, who have never been the main target of the AMT. Interactions between the AMT and the regular tax present taxpayers with complex planning problems.

Section IV examines reform options. Indexing the AMT for inflation after 2002 would reduce the number of AMT taxpayers in 2010 by 70 percent, and the number with AGI between $15,000 and $100,000 by 90 percent. But it would cost $440 billion through 2012 under current law, and $100 billion more if last year's tax cut—which is currently slated to expire in 2010—is extended. With a few additional changes that would not increase tax sheltering, AMT participation would be cut by 99 percent by 2010 relative to current law. These changes include eliminating the phase-out of the AMT exemption, allowing exemptions for dependents and deductions for state and local taxes and miscellaneous expenses, and permitting the use of personal nonrefundable credits. This reform package, however, would cost $725 billion over the next decade, and $880 billion if EGTRRA is extended.

Repealing the AMT after 2002 would add $790 billion to the public debt by 2012 under current law, and $950 billion if EGTRRA is extended. Despite the growing share of middle-class taxpayers who are slated to pay at least some AMT, repeal would be regressive, and would raise the number of high-income taxpayers who pay no income taxes by a factor of four or more.

We also examine the financing of AMT reform. If the AMT were repealed and income tax rates changed to hold aggregate tax liability constant in each tax bracket, the resulting rate structure would require higher marginal tax rates for low- and middle-income taxpayers, much higher rates for most upper-income taxpayers, but lower rates for taxpayers in the top bracket.

Because projected AMT growth is due in large part to EGTRRA, freezing the tax cuts enacted in 2001 is a natural way to finance AMT reform. We show that freezing all of the cuts in upper income tax rates and in the estate tax in EGTRRA at their 2002 levels would be just sufficient to finance indexing the AMT after 2002, but would fall about $300 billion short of financing AMT repeal. The AMT could, however, be retargeted at high-income households in a revenue-neutral fashion that spared most of the middle class, but significantly increased taxes on the very affluent.

Section V provides concluding remarks. The Appendix describes our microsimulation model in more detail.

This report is available in its entirety in the Portable Document Format (PDF), which many find convenient when printing.

Note

1. Barr (1969). Adjusted for inflation, $200,000 in 1966 is equivalent to about $1.1 million in 2001.

Acknowledgments

We thank Al Davis, John O'Hare, Peter Orszag, Samara Potter, Dan Shaviro, Gene Steuerle, Frank Sammartino, Jerry Tempalski, David Weiner, Rob Williams, and participants at the National Tax Association Spring Symposium for helpful discussions, Deborah Kobes for expert research assistance, and the Ford, Casey, Mott and Gund Foundations for research funding through grants made to the Tax Policy Center. A version of this paper will be published in the September 2002 issue of the National Tax Journal. Any errors or opinions are our own and should not be taken to represent the views of our funders or the officers, trustees, or staff of any of the Institutions with which we are affiliated.

About the Authors

Leonard E. Burman is a senior fellow at the Urban Institute and co-director of Tax Policy Center. William G. Gale is the Arjay and Frances Fearing Miller Chair and Deputy Director of the Economic Studies Program at the Brookings Institution and co-director of the Tax Policy Center. Jeffrey Rohaly is a research associate at the Urban Institute and director of tax modeling at the Tax Policy Center. Benjamin H. Harris is a research assistant at the Brookings Institution.

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Distributional Effects of the Major Individual Income Tax Provisions of H.R. 3970

Distributional Effects of the Major Individual Income Tax Provisions of H.R. 3970Greg Leiserson, Jeff Rohaly

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.

The text below is an excerpt from the complete document. Read the full paper in PDF format.

On October 25, 2007, Ways and Means Committee Chairman Charles Rangel (D-NY) unveiled H.R. 3970, The Tax Reduction and Reform Act of 2007, sweeping tax reform legislation that would provide for a revenue-neutral repeal of the individual alternative minimum tax (AMT). This paper describes the proposal and provides distribution tables that analyze the impact of the major individual income tax provisions in the bill.

On October 25, 2007, Ways and Means Committee Chairman Charles Rangel (D, NY) unveiled sweeping tax reform legislation that would provide for a revenue-neutral repeal of the individual alternative minimum tax (AMT). The bill would also increase the standard deduction, expand the earned income tax credit (EITC) for childless individuals, and increase the availability of the refundable child tax credit. These changes are projected to reduce individual income tax revenues by about $882 billion over ten years.

The cost of these cuts would be largely offset by three provisions designed to raise about $867 billion over that same period: a surtax on high-income taxpayers; reinstating the limitation on itemized deductions and personal exemptions; and further limiting the deductibility of miscellaneous itemized deductions such as employee business expenses.

All of the above provisions would be effective beginning in 2008. For 2007, the bill extends, and indexes for inflation, the AMT relief that was in place for 2006. It also extends for one year certain expiring provisions such as the R&D credit, the deduction for state and local general sales taxes, and the above-the-line deduction for qualified tuition and related expenses.

Our distribution tables include the impact of all the broad-based individual income tax provisions of the bill described above. The legislation also makes several other more narrowly targeted individual income tax changes, including the taxation of carried interest as ordinary income. It also makes changes to corporate taxes including a reduction in the top corporate marginal tax rate from 35 percent to 30.5 percent, repeal of the domestic production activities deduction, and repeal of the last-in, first-out (LIFO) accounting method.

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The Individual Alternative Minimum Tax : A presentation to the President's Advisory Panel on Federal Tax Reform

Leonard E. Burman

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.

Note: This testimony is available in its entirety in the Portable Document Format (PDF).

Background

1966: 155 high-income taxpayers paid no income tax1969: creation of a minimum tax designed to ensure high income filers did not exploit tax laws to reduce or eliminate their federal income tax liability2010: Alternative Minimum Tax (AMT) will affect 30 million taxpayers, including virtually all upper-middle-class families with two or more kids.

Determination of AMT Liability

Add preferences and adjustments to taxable incomeSubtract AMT exemptionCalculate tax using AMT rate schedule and rulesIf more than regular tax, pay the difference as AMT(Many complexities left out of this simplified explanation.)

Note: This testimony is available in its entirety in the Portable Document Format (PDF).

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The Individual Alternative Minimum Tax

The Individual Alternative Minimum TaxLeonard E. Burman

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.

Leonard E. Burman is director of the Tax Policy Center and a senior fellow at the Urban Institute.

A precursor to the current individual alternative minimum tax (AMT) was originally enacted in 1969 to limit the amount of tax sheltering that taxpayers could pursue and to assure that high-income filers paid at least a minimal amount of tax. However, the current AMT has strayed far from those original goals and threatens to grow from a footnote in the tax code to a major component affecting tens of millions of taxpayers every year. This testimony outlines how the AMT works, whom it affects, and why it demands attention. It also discusses possible ways of reforming the AMT and why financing AMT reform or repeal is important.

The text below is Burman's oral testimony. Read the written testimony in PDF format.

Chairman Neal, Ranking Member English, Members of the Subcommittee: Thank you for inviting me to share my views on the individual alternative minimum tax.

In January 1969, Treasury Secretary Joseph Barr testified that 155 high-income individual taxpayers had paid no federal income tax in 1966. The news created a political firestorm. Members of Congress received more constituent letters in 1969 about those 155 taxpayers than about the Vietnam War.

Lawmakers could have responded in one of three ways. They could have explained that the non-taxpayers were taking advantage of tax incentives that advanced worthwhile social objectives and thus should not have to owe tax. That would have been a hard sell. They could have closed the loopholes that allowed rich people to avoid tax, but those loopholes had some pretty powerful constituencies, so that didn't happen either.

Instead, Congress decided to create an extra tax for high-income people who didn't pay enough under the regular income tax system to avoid such embarrassing disclosures in the future. Thus was born the AMT.

It was a bad choice. The AMT doesn't do much to rein in tax shelters. Because of poor design, millionaires are actually less likely to owe AMT than middle-income people with kids. It's inefficient. And it undermines support for the tax system because it's the poster child for pointless complexity. Taxpayers can't understand it, but they think it is unfair.

Before getting into how to fix the AMT, I'd like to address some shibboleths:

"The AMT is virtually a flat tax with two low rates of 26 and 28 percent."

No. Those are the rates written into the law, but because the AMT exemption phases out with income, the effective rates are actually 26, 32.5, 35, and 28 percent—in that order. The highest rates don't apply to the highest-income people, which is why the AMT hits almost everyone with incomes between $200,000 and $500,000, but not so many millionaires.

"Since the AMT is becoming the de facto tax system, why not just eliminate the regular income tax?"

The AMT would be a terrible tax system. First, high tax rates apply at relatively modest incomes, and high-income people would get a big rate cut (from 35 percent to 28 percent). Second, there are horrendous marriage and child penalties. Third, it is not indexed, so inflation would cause people's average tax bills to increase every year, even if their real incomes weren't changing.

"Software and paid preparers make AMT complexity no big deal."

There are at least three problems with this argument. First, as the AMT consumes the middle class, it will hit more and more people who do their taxes by hand, or try. Second, even with software, it's complex as I explain in my written testimony. Third, you might want people to understand how the tax system affects them. With the AMT, the tax system becomes an inscrutable black box.

"It's not the Bush tax cuts that have pushed people onto the AMT, but the failure to index it for inflation."

Actually, it is both. It's certainly true that the AMT was on a path to cause problems even before the 2001 tax cuts were enacted, but EGTRRA doubled the problem. Without the tax cuts, 16 million people would be on the AMT in 2010, which is way too many. With the tax cuts, the number balloons to 32 million. Cutting the regular income tax without fixing the AMT at the same time is the tax policy equivalent of throwing gasoline on a fire.

"The AMT is a 'blue state' tax."

Although in 2006, it is true that taxpayers in relatively high-income, high-tax coastal states are more likely to owe AMT than those in the interior, the AMT is going to hit people in all states hard if it isn't fixed. It might be better to call it a "soccer mom tax" or a "swing voter tax." It's in all of your interests to do something about it.

What to do about it?

A serious fix to the AMT would, at a minimum, adjust it for inflation and retarget it at the higher-income people who were intended to pay it. The ideal solution might be to repeal the tax and include any valid anti-tax-shelter provisions in the regular income tax.

The problem, as you are all painfully aware, is that any of these solutions would reduce federal tax revenues dramatically. The JCT estimates that repeal would reduce federal revenues by almost $900 billion over ten years; the cost would nearly double if the President's tax cuts were extended. Indexing alone would reduce federal tax revenues by about $500 billion over ten years, and "broad reform," which includes indexing and allowance of dependent exemptions and standard or itemized deductions against the AMT, would cost about $700 billion.

Repeal would also be a very regressive tax change; 96 percent of the benefits of repeal would go to the top fifth of the income distribution.

We have looked at a number of options to pay for reform, including an increase in top income tax rates, elimination of the AMT tax preference for capital gains and dividends, and repeal of the deduction for state and local taxes under the regular income tax.

Eliminating the tax break for capital gains and dividends would make a lot of sense as a matter of tax policy. Prior to 1987, the tax break on capital gains was the single largest tax preference under the AMT. If the purpose of the AMT is to limit tax shelters, this makes sense since virtually any individual income tax shelter you can imagine involves converting ordinary income into lightly-taxed capital gains or dividends. Taxing gains and dividends under the AMT would also be highly progressive.

The President's tax reform panel recommended eliminating the deduction for state and local taxes. That change, by itself, would raise enough revenue to pay for repealing the AMT and would even allow for a small cut in income tax rates. I know that those of you in high-tax states recoil in horror at the thought, but the fact is that many of your constituents are losing the benefit of this tax break under current law. The 60 percent of households that don't itemize get no benefit from it, nor do the people on the AMT. Increasingly, this is becoming just a tax break for people who are so rich that the AMT doesn't apply any more.

Any of these changes would make the tax system slightly more progressive and would not add to the deficit.

I understand that fixing the AMT is not easy. If it were, it would have been done a long time ago. I applaud the subcommittee for taking the first steps toward what I hope will be a permanent solution.

The written testimony is available in PDF format.

The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.

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The Future of Individual Tax Rates: Effects of Economic Growth and Distribution : Leonard Burman's Testimony before the Senate Committee on Finance

The Future of Individual Tax Rates: Effects of Economic Growth and DistributionLeonard E. Burman

The text below is an excerpt from the complete testimony. Read the full written testimony in PDF format.

Leonard Burman's testimony before the Senate Committee on Finance on whether and how to extend the 2001 and 2003 tax cuts.

Chairman Baucus, Ranking Member Grassley, Members of the Committee: Thank you for inviting me to share my views on whether and how to extend the 2001 and 2003 tax cuts. I am speaking for myself alone. My views should not be attributed to any of the organizations with which I am affiliated.

The expiration of the "Bush tax cuts" at the end of 2010 creates a number of decision points for the Congress: Should all or some of the tax cuts be extended? If so, should they be made permanent? If not, how long should they be extended for? And, if only some of the tax cuts are to be extended, which ones?

In short, I believe it would be a serious mistake to make any of the tax cuts permanent now. The income tax is a mess and is badly in need of an overhaul. It doesn't raise close to enough revenue to pay for current governmental expenditures and is needlessly complex, unfair, and inefficient. A system-wide reform along the lines of the Tax Reform Act of 1986, but with the goal of eventually raising enough revenue get the national debt out of the red zone should be a top priority for the Congress. Permanent extension of the tax cuts would make such a reform far more difficult and would signal to markets that our budget problems are only going to get worse.

However, I also think it would be a mistake to allow all of the tax cuts to expire as scheduled in 2011. The economy is in a very precarious state and a major tax increase would slow the economic recovery. With credit still in very short supply, low- and middle-income households are facing serious cash flow constraints. A tax increase would result in less spending, which would ripple through the economy, costing jobs and threatening the nascent recovery.

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The Expanding Reach of the Individual Alternative Minimum Tax

Leonard E. Burman, William G. Gale, Jeff Rohaly

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.

This article was originally published in Volume 17, Number 2 (Spring 2003) of the Journal of Economic Perspectives and is re-published with permission.

This report is available in its entirety in the Portable Document Format (PDF).

In January 1969, Treasury Secretary Joseph W. Barr informed Congress that 155 individual taxpayers with incomes exceeding $200,000 had paid no federal income tax in 1966. The news created a political firestorm. In 1969, members of Congress received more constituent letters about the 155 taxpayers than about the Vietnam War. Later that year, Congress created a minimum tax to prevent wealthy individuals from taking advantage of tax laws to eliminate their federal income tax liability.

Both the original minimum tax and its successor, the individual alternative minimum tax (AMT), have applied in the past to a small minority of high-income households.1 But barring a change in law, this "class tax" will soon be a "mass tax." Current projections show the number of AMT taxpayers skyrocketing from one million in 1999 to 36 million in 2010.2 Without reform, virtually all upper middleclass families with two or more children will be paying the AMT by decade's end. The AMT is notoriously complex, and its record on fairness and efficiency is mixed at best. But because of its widening reach, fixing the AMT will be expensive. By the end of the decade, repealing the AMT will cost more than repealing the regular income tax. This paper explains how a tax originally designed to target 155 taxpayers could grow to cover 36 million, discusses economic issues related to the alternative minimum tax and examines options for reform.3

1. A separate alternative minimum tax applies to corporations. See Lyon (1997).

2. Throughout this paper, we compare current or recent data to projections for 2010. We choose 2010 because all of the provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA, the 2001 tax cut) are scheduled to expire, under current law, by the end of 2010. This creates considerable uncertainty about projections after 2010. For example, if EGTRRA were extended, 43 million taxpayers would face the AMT in 2013. If EGTRRA were allowed to expire in 2010, 26 million taxpayers would be on the AMT in 2013.

3. This paper draws from Burman et al. (2002). The reader interested in learning more might also start with Graetz and Sunley (1988), Harvey and Tempalski (1997), Joint Committee on Taxation (1970, 2001a), Joint Economic Committee (2001), Karlinsky (1995), Kiefer et al. (2002), Rebelein and Tempalski (2000), Shaviro (2001) and Tempalski (1996).

This report is available in its entirety in the Portable Document Format (PDF).

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The Future of Individual Tax Rates: Effects on Growth and Distribution : Donald Marron's Testimony Before the Senate Committee on Finance

The Future of Individual Tax Rates: Effects on Growth and DistributionDonald Marron

The text below is an excerpt from the complete testimony. Read the full written testimony in PDF format.

Donald Marron's testimony before the Senate Committee on Finance on the individual tax system.

Chairman Baucus, Ranking Member Grassley, and Members of the Committee: Thank you for inviting me to appear today to discuss our individual income tax system.

As this committee knows well, our nation faces difficult economic and fiscal challenges. In the aftermath of the worst financial crisis since the 1930s, almost 15 million workers are unemployed, about one-tenth of our work force. Almost 7 million of those workers have been unemployed for six months or longer. And millions more lack jobs but don't count in the statistics because they're too discouraged to look for work. Moderate economic growth is expected to lower those figures only gradually over the next few years.

At the same time, budget deficits have rocketed to 60-year highs because of the financial crisis, the weak economy, and subsequent policy responses. As a result, the federal debt has grown from about 40 percent of gross domestic product (GDP) at the end of 2008 to about 60 percent of GDP today, the highest since just after World War II.

Deficits should narrow in coming years as the economy recovers and as policy responses to the recession wind down. Our long-term fiscal outlook remains daunting, however, because of a fundamental imbalance between spending and revenues. Because of an aging population and rising health care costs, spending is expected to grow significantly faster than revenues over the next 25 years, pushing our nation deeper into debt.

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The Individual Alternative Minimum Tax (AMT): 11 Key Facts and Projections

Leonard E. Burman, Julianna Koch, Greg Leiserson

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.

Note: This report is available in its entirety in PDF Format.

The individual alternative minimum tax (AMT) was originally enacted in 1969 to guarantee that high-income individuals paid at least a minimal amount of tax. Middle- and upper-income taxpayers must add a number of so-called "preference items" to their taxable income, subtract a special AMT exemption, and calculate their tax according to the AMT tax schedule. If the tax under that schedule is higher than the regular income tax, taxpayers pay the difference as AMT.

1. AMT is exploding. In 2007, unless Congress acts, 23.4 million taxpayers will be affected by the AMT. In 2006, only 3.5 million taxpayers will owe the tax because of a temporarily higher exemption, which expires at the end of the year. By comparison, back in 1970, just 20,000 taxpayers were affected. If the 2001-2006 tax cuts expire as scheduled at the end of 2010, 39 million taxpayers (more than one-third) will be hit by the AMT in 2017. If the tax cuts are extended, the number jumps to 53 million taxpayers (49 percent). (Tables T06-0266 and T06-0267)

2. The AMT is encroaching on the middle class. Although the AMT is highly progressive, the distribution of AMT liability will shift toward tax units with lower incomes. In 2006, tax units with $500,000 or more in income will pay 47 percent of the tax; by 2010, they will pay only 16 percent. More than 80 percent of households with incomes between $100,000 and $200,000 and almost half of those with incomes between $75,000 and $100,000 will pay the AMT by 2010 (compared to 4.8 percent and 0.7 percent in 2006). (Tables T06-0268 and T06-0270)

3. The average AMT liability in 2006 is $6,782. Next year, the average is projected to decline to $2,985 as millions of middle class families join the ranks of AMT taxpayers. (Table T06-0269)

4. Two main factors behind the explosive growth in AMT: it is not indexed for inflation and the 2001-2006 tax cuts cut regular income tax without a permanent AMT fix. The AMT is not indexed for inflation and, therefore, it affects taxpayers with lower real incomes over time. The 2001-2006 tax cuts more than doubled the projected share of taxpayers who will face the AMT in 2010, from 16.0 percent to 33.6 percent. If the tax cuts had not been enacted and the AMT had been indexed for inflation along with the regular income tax in 1985, the number of AMT taxpayers would have remained between 300,000 and 400,000 through 2010. (Table T06-0266)

5. The AMT raises effective marginal tax rates. Marginal tax rates affect the incentive to work, save, and comply with the tax system. In 2006, 71 percent of AMT taxpayers face higher effective tax rates because of the AMT. In 2010, 89 percent will face higher rates. (Table T06-0271)

6. The AMT claws back the 2001 - 2006 tax cuts. In 2010, the AMT will take back almost 28 percent of the regular income tax cut that taxpayers otherwise would have received. Three percent of taxpayers will have their tax cuts completely eliminated by the AMT. This assumes that the AMT remains in full force. If it is scaled back or eliminated, it will turn out that the tax cuts are much more generous than originally estimated. (Table T06-0272)

7. The AMT is notoriously and pointlessly complex. The Internal Revenue Service and the Taxpayer Advocate have flagged the AMT as one of the most complicated tax provisions to comply with and administer. Most people required to fill out the AMT forms end up owing no additional taxes. The AMT also creates complicated interactions with the regular income tax.

8. Because the AMT disallows certain deductions and credits, it hits some taxpayers harder than others. Families with children are more likely to be subject to the AMT than those without children because the AMT eliminates dependent exemptions. Married couples will be more than 12 times as likely as singles to face the AMT in 2010. AMT participation for married families with two or more children and AGI between $75,000 and $100,000 will increase dramatically from less than 1 percent in 2006 to 89 percent in 2010. Since the state and local tax deduction is also disallowed by the AMT, residents in high tax states are currently almost three times more likely to face the AMT than those in low tax states. (Table T06-0268)

9. Repeal would be expensive and regressive. Repealing the AMT in 2007 would reduce revenues by $750 billion through 2016 if the 2001-2006 tax cuts expire as scheduled, and $1.3 trillion if they are extended. Almost 90 percent of the benefits of repeal would go to households with income above $100,000 in 2010. (Tables T06-0266 and T06-0270)

10. Simple reforms could spare most AMT taxpayers. Indexing the AMT for inflation and allowing personal credits against the AMT would reduce the number of AMT taxpayers in 2010 by over 85 percent.

11. Paying for reform is a key issue. Without revenue offsets, the reform above would reduce revenues by $520 billion over the next ten years (if the tax cuts sunset, $940 billion if they are extended). Rolling back the high-income rate cuts and the lower tax rates on dividends and capital gains enacted since 2001 would offset more than half of the revenue loss. If the tax cuts sunset, repealing the deduction for state and local taxes, as proposed by President Bush's tax reform panel, would more than offset the cost of reforming or repealing the AMT.

Note: This report is available in its entirety in PDF format.

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 policy issues for the public, journalists, policymakers, and academic researchers. For more tax facts, see http://www.taxpolicycenter.org/taxfacts.

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