July 2007 SGE Monthly Luncheon
“The AMT: Why it Matters and Why it is Hard to Fix”
Review of Remarks by Len Burman
Senior Fellow, The Urban Institute / Director, Tax Policy Center
Rapporteur: Kevin Perese *
With major tax reform building as a significant policy issue in the upcoming Presidential contest and a likely focus in Congress shortly thereafter, tax economist Len Burman from the Urban Institute / Tax Policy Center spoke at the July SGE Luncheon on the Alternative Minimum Tax (AMT). In his presentation, he provided a quick review of what the AMT is, why it was created, the flaws in its design, and the looming threat it poses to the middle class if it is not abolished or reformed. At the end of his presentation, he reviewed several reform options and their associated costs.
In short, the AMT was created in the late 1960s because of constituent outrage at 155 tax filers with incomes over $200,000 who did not pay any income tax. What was originally designed to ensure that the richest tax filers paid at least some income tax each year has grown into a tax policy that affected over 4 million tax filers in 2006. And while 4 million may be significantly more than the original intent, with out an annual "patch" it would have affected over 20 million tax payers last year and threatens to do so again in 2007 if Congress does not act.
The AMT is essentially a parallel tax system that requires middle to upper income tax filers to calculate their taxes twice - once under the "regular" tax system and then again under the AMT system. The major differences between the two tax systems are the calculation of taxable income (AMTI) and the marginal tax rates. Starting with taxable income under the regular tax system, AMT preference items such as state and local taxes, exemptions for dependents and children, and other miscellaneous items that are deductible under the regular tax system are added back and are taxable under the AMT. Then a fixed, nominal exemption is subtracted to arrive at the AMTI. As legislated, the exemptions are $45,000 for married filers and $33,750 for single filers (although in recent years Congress has raised these amounts on a year-by-year basis to prevent millions more households from being subject to the higher AMT). The other major difference is the marginal tax rates. Under the AMT, the marginal tax rate is 26% below $175,000 and 28% above $175,000, so they are relatively flat compared to the regular tax system. After calculating taxes under the regular tax system and then again under the AMT system, the tax filer must pay whichever is higher.
The fundamental flaw in the design of the AMT is that the exemption amounts and income thresholds are not indexed for inflation (or held constant in terms of a market basket of goods). As such, as real income rises, more and more tax filers fall onto the AMT and pay higher taxes. Another significant flaw is that the system doesn't effectively accomplish what it was intended to -- to tax the rich. Because the marginal tax rates in the regular tax system at the high end of the income distribution are higher than the top rate under the AMT (28%), the vast majority of very rich households are not paying any of their taxes in the form of AMT liability.
Burman also pointed out that these inherent differences between two separate tax systems masks the effect of any tax cuts and the recent Bush Administration tax cut specifically. While it may be politically convenient to say that tax rates are being cut across the board, the AMT actually recaptures a significant portion of the lost revenues. When tax rates are cut in the regular system without a concurrent reduction in AMT rates or increase in AMT exemptions, more filers will fall onto the AMT and not reap the benefit of the tax cuts.
Finally, the AMT contains inequities which are by-and-large not socially acceptable. For example, because the exemption amount of married filers is less than twice the exemption for a single filer, the AMT contains a marriage penalty. In addition, personal exclusions for spouses and children are not allowed under the AMT. Thus married tax filers and large families make up a disproportionate share of the families affected by the AMT.
With all of these glaring problems, it would seem that policy makers would want to reform or abolish this system and perhaps create a new one that more effectively achieves the original purpose of the AMT. The problem with abolishing or reforming the AMT, however, is that it is extremely expensive to do so. In fact, by 2008, it would be considerably more expensive to the federal government to repeal the regular tax system than to repeal the AMT. Assuming the Bush tax cuts expire in 2011, repealing the AMT would reduce federal revenues over 10 years by $850 billion. If, on the other hand, the Bush tax cuts were to be extended, the cost would be nearly twice as much.
Toward the end of his presentation, Mr. Burman quickly reviewed a host of reform options, most of which came from a recent report he co-authored: "Options to Fix the AMT", and a more recent reform option that would replace the AMT with a 4% surtax on single filers with income over $100,000 and married filers over $200,000 (unlike the current AMT, each threshold would be indexed for inflation). This policy option would be approximately revenue neutral and would be highly progressive.
Mr. Burman summarized his views succinctly: "I don't like the AMT." As method for collecting revenue from high income households, it is pointlessly complex and increasingly ineffective as it falls more and more on middle income households rather than upper income households. He pointed out that policy options do indeed exist to replace or repair this flawed system, even in ways that are relatively budget neutral. And although such a policy change would likely produce sets of winners and losers, the inherent flaws and associated costs of the current system are sufficently large enough to require change.
* The analysis and conclusions expressed in this summary are those of the author and should not be interpreted as those of the Congressional Budget Office.