Moving Beyond the Fight Over the Alternative Minimum Tax

C. Eugene Steuerle

"Economic Perspective" column reprinted with permission.
Copyright 2001 TAX ANALYSTS

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.

© TAX ANALYSTS. Reprinted with permission.

[1] The Alternative Minimum Tax albatross just keeps getting bigger and bigger. Neither political party yet wants to take responsibility. More to the point, neither wants to bear the revenue cost of dealing with it. And so the stalemate continues. Fixes are possible, but they require compromise over articles of faith for both parties. In particular, Democrats have to give up some of their fixation on progressivity and Republicans their fixation on lower statutory rates.

[2] The recent tax bill not only didn't address the AMT problem -- it made it worse. According to the Joint Committee on Taxation, the number of taxpayers paying the AMT will rise from about 1.5 million this year to more than 35 million by 2010 (of course, much growth was scheduled even under the old law). A temporary and very partial fix of the AMT through a higher exemption level expires at the end of 2004.

[3] Like a balloon into which air is constantly being forced, this one's eventually going to pop. The elasticity of the regular tax -- and the increasing ability of computer software to handle complex calculations -- allows the system to be stretched only so far.

[4] It's not just the increased number of AMT taxpayers that's going to be a nuisance. IRS compliance efforts on many items of the AMT are minimal. The Service essentially enforces items that are reported elsewhere on a normal tax return, such as state and local tax deductions and personal exemptions. Then it sends computer- generated letters to taxpayers who appear to owe AMT because these deductions and exemptions are not allowed in the AMT tax base calculation, and the alternative tax (with the smaller base and different rate) is higher than the regular tax.

[5] Now consider what happens as the number of taxpayers who owe the AMT keeps increasing. In effect, Congress has scheduled millions of taxpayers to get letters that they have underpaid their tax (especially if they fill out their returns themselves and don't use computer software). Many will be docked an extra penalty for late payment of taxes. At the same time, the IRS will almost automatically allow millions of taxpayers to get by with some noncompliance on harder-to-detect items.

[6] Some Democrats today complain that the Republicans failed to address the AMT problem in the new tax law -- favoring other changes over a fix. In addition, lowering the statutory rates without lowering the AMT rates makes it more likely that taxpayers will pay the AMT. But the Republicans can counterclaim that the Democrats have been ignoring the AMT for a long time themselves. Former President Clinton preferred to fight for HOPE scholarship tax credits and other special tax breaks rather than simplify the AMT. A bit of history also shows that the Democrats raised the AMT tax rate in 1993 when they raised the statutory rate. Despite an increase in the exemption level, they also allowed that level to decline over time relative to taxpayers' income. In effect, they, too, kept in the budget the expected revenues from a growing numbers of AMT taxpayers.

[7] The politics of blame, therefore, is not going to get us very far toward reaching a solution. The parties end up looking like two parents fighting over who has left the child alone while each one makes new engagements that prevent them from being with the child. While they blame each other, the child remains neglected.

[8] Republicans, of course, would be glad to get rid of the AMT or substantially reduce its reach. They simply don't want to pay for it. Given a choice between lower statutory rates and fixing the AMT, they will choose lower statutory rates. Democrats, of course, would be glad to have some AMT fix also. They simply don't want to give away any more money to those in the upper-income brackets or to give up other tax breaks that they also favor. Given a choice between a bill with an AMT fix and a less progressive distribution of taxes and one without an AMT fix and more progressivity, so far they have chosen the latter.

[9] In a sense, both political parties get what they want: The Republicans get some of the statutory rate cuts they want and the Democrats maintain some of the progressivity they seek. The AMT provides the funding to do both. This is the way it's been for a long time now, with the recent tax bill being only the latest chapter in the drama. Sure, the current tax bill was deceptive in the way that it gave tax cuts with one hand (mainly statutory rate reduction) and then took them back with the other (the AMT). But this wasn't the first time, and both parties have been playing the game for some time now.

[10] What's going to end the game? Previously I have suggested that it might require folding the AMT into a larger package of simplification proposals. With or without a broader agenda on which to hang the AMT reform, it's also going to require the two political parties to move beyond their current positions. For the Democrats, it will require accepting a system that might even be less progressive than otherwise obtainable, while for the Republicans it will require accepting higher statutory rates than otherwise are obtainable.

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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 Alternative Minimum Tax : Assault on the Middle Class

The Alternative Minimum TaxAssault on the Middle ClassLeonard E. Burman

"Milken Institute Review" column reprinted with permission.

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.

In a tax code with no shortage of ironies, the alternative minimum tax (AMT) stands out. Created by Congress in 1969, it was aimed at millionaires, but relatively few millionaires pay it. It is billed as a low-rate levy, but most of its victims face higher taxes because of it. It undermines two widely lauded reforms of the income tax—restoring both bracket creep and the marriage penalty. And though nobody favors keeping this Frankenstein alive, it will be very difficult to kill. Welcome to the tax policy twilight zone.

In a tax code with no shortage of ironies, the alternative minimum tax (AMT) stands out. Created by Congress in 1969, it was aimed at millionaires, but relatively few millionaires pay it. It is billed as a low-rate levy, but most of its victims face higher taxes because of it. It undermines two widely lauded reforms of the income tax—restoring both bracket creep and the marriage penalty. And though nobody favors keeping this Frankenstein alive, it will be very difficult to kill.

Welcome to tax policy in the Twilight Zone.

At first glance, the AMT may seem simple and fair. But for reasons nobody imagined when it was created, the AMT bull's-eye hangs not on folks with Cayman Islands bank accounts, but on upper-middle-income families with lots of kids who happen to live in high-tax states. And it doesn’t just raise their taxes. It plagues them with mind-numbing complexity.

Tax analysts have proposed a dozen ways to wring the perversities out of the present AMT law. All, however, present political challenges, and some would sharply cut revenue even as federal spending obligations begins to swell with the retirement of the baby boomers. But I get ahead of myself.

The AMT is conceptually straightforward. First, you compute your regular income tax. Next, you add back some of the deductions that reduce taxable income, deduct a flat $45,000 ($33,750 for singles) and calculate the tax on the balance at rates of 26 or 28 percent. Then you compare the two figures and pay whichever is higher.

But there's a big catch: the bulk of the AMT's taxable income adjustments have nothing to do with anybody's notion of loopholes, which is what the AMT was supposed to plug. The largest is the deduction for state and local income and property taxes, which accounted for 63 percent of all AMT adjustments in 2006 tax returns. Personal exemptions—the $3,300 deduction (in 2006) for each family member and dependent—accounted for another 22 percent of AMT addbacks, while miscellaneous itemized deductions like employee business expenses make up 11 percent of the total.

"Milken Institute Review" column reprinted with permission.

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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.

View the original article here

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 15 Percent Rate on Capital Gains: A Casualty of the Alternative Minimum Tax

The 15 Percent Rate on Capital Gains: A Casualty of the Alternative Minimum TaxGreg 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.

Tax rate reductions on long-term capital gains and qualifying dividends were a key, highly touted component of the tax cuts passed in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). However, like the 2001–2006 tax cuts more broadly, taxpayers affected by the individual alternative minimum tax (AMT) may not pay the advertised lower rates. This article explains the interaction between the capital gains rate and the AMT and provides example tax calculations for two sample taxpayers.

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

Tax rate reductions on long-term capital gains and qualifying dividends were a key, and highly touted, component of the tax cuts passed in the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). However, like the 2001–2006 tax cuts more broadly, taxpayers affected by the individual alternative minimum tax (AMT) may not pay the advertised lower rates. Even when the AMT is patched so as to prevent it from affecting middle-income taxpayers, as it was in 2006, it can substantially increase the marginal tax rate affecting capital gains and dividends.

The essential interaction creating this rate increase arises because capital gains are included in alternative minimum taxable income (AMTI), and can therefore reduce the taxpayer’s AMT exemption, even though the gains are not taxed at AMT rates. When calculating the additional tax owed on the next dollar of capital gains, AMT taxpayers first pay the statutory 15 percent rate on the gain directly. Then, since the increase in AMTI will decrease the value of their AMT exemption, they pay additional tax on the portion of their other income that is no longer sheltered by the AMT exemption. As a result, the actual tax burden on additional realizations is the 15 percent rate on gains plus the applicable AMT rate (26 or 28 percent) multiplied by the exemption phase-out rate (25 percent). Depending on what AMT bracket the taxpayer is in, this interaction increases the effective marginal rate on long-term capital gains and dividends from 15 percent to either 21.5 or 22 percent.

The attached tables illustrate this interaction for two families, one affected by the 26 percent AMT rate and the other by the 28 percent rate.

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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 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).

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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.

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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.

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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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