Repealing The Alternative Minimum Tax Without Offsetting The Cost Would Add $1.2 Trillion To The Federal Debt Over The Next Decade, 6/9/05

That the AMT will hit a growing number of middle-income taxpayers in the years ahead comes as no surprise. Lawmakers have long been aware of this problem but have chosen to avoid dealing with it. Instead, they have knowingly enacted cuts in the regular income tax that greatly exacerbated the AMT problem.

The extent of the problem was certainly clear to lawmakers when they considered President Bush’s tax-cut proposals in 2001.[14] The Joint Committee on Taxation (JCT) provided estimates to the Congress in the spring of 2001 showing that the number of taxpayers affected by the AMT would grow to 17.5 million in 2010 if there were no changes in tax laws. JCT also clearly indicated the extent to which enactment of the President’s proposed tax cuts would magnify the problem with the AMT; JCT estimated in early 2001 that enactment of the President’s tax cuts would nearly double the number of taxpayers subject to the AMT, raising it to 30.2 million taxpayers by 2010.[15]

Lawmakers failed to address the looming problems with the AMT not because they were unaware of those problems, but because they wanted to maximize the size of the regular income tax cuts they were enacting. They assumed they would be able to come back in subsequent years, as the AMT began to affect more taxpayers, and pass AMT relief on top of the other tax cuts.

The Congressional budget resolution adopted in 2001 allowed for a tax cut of up to $1.35 trillion for the ten years from 2002 through 2011. In the absence of the President’s tax cuts, adjusting the AMT so the percentage of taxpayers it affected would not increase substantially in the years ahead would have cost $60 billion to $80 billion over that ten-year period.[16] Congress chose instead, however, to provide relief from the AMT only through 2004, at the very small cost of $14 billion.

This had two results. First, it directly made room in the 2001 tax-cut bill for an additional $50 billion or so in other tax cuts. Second, and much more importantly, it sharply reduced the official cost estimate of the income tax cuts that were included in the 2001 tax-cut legislation, because the Joint Tax Committee (which does the official cost estimates) had to assume that, in the absence of any AMT relief after 2004, the AMT would mushroom in size after 2004 and claw back a substantial portion of the bill’s income tax cuts. For example, the Joint Tax Committee estimated that the version of the President’s tax cuts that the House of Representatives passed in early 2001 (H.R. 3) would have cost $292 billion more than the Joint Committee’s official cost estimate, were it not for the assumption the Joint Committee had to make that a swollen AMT would cancel out a substantial portion of those tax cuts.

How the AMT Works

To determine whether money is owed under the AMT, taxpayers who might be affected by it must calculate their tax liability twice — once under the regular income tax rules and again under the AMT rules. They pay the higher of the two tax liabilities.

The AMT differs from the regular income tax in several ways. One is in the items that reduce taxable income. For instance, taxable income under the regular income tax can be reduced by personal exemptions (in 2005, $3,200 for each family member) and by deductions — either the standard deduction or itemized deductions for certain expenses, such as state and local income taxes paid. Such items do not reduce income for purposes of the AMT.

Instead, under the AMT, taxable income is reduced by a large overall exemption amount, currently $58,000 for married couples and $40,250 for single taxpayers. In addition, taxable income is taxed at different rates under the AMT than the rates that are applied under the regular income tax: the AMT tax rate is 26 percent on the first $175,000 of taxable income above the exemption and 28 percent on income above that level.

The AMT also differs from the regular income tax in that the exemption amounts and the rate brackets are not indexed for inflation. This is one of the two principal reasons for the increase over time in the number and percentage of taxpayers who are affected by the AMT. The other reason is the enactment of legislation in 2001 and 2003 that substantially reduced taxes under the regular income tax without making corresponding adjustments (except on a temporary basis) in the AMT.

Indeed, the Joint Tax Committee subsequently estimated that if no further action were taken on the AMT, the tax cuts actually enacted in 2001 would raise the number of taxpayers subject to the AMT to a whopping 35.5 million in 2010, as compared to the 17.5 million taxpayers who would have been subject to the AMT in that year if the 2001 tax cuts had not been enacted.[17] The 2001 tax cut greatly increased the number of taxpayers who would fall prey to the AMT because it reduced taxpayers’ liabilities under the regular income tax without making corresponding adjustments in the AMT. Because the 2001 tax cut was structured in this manner, it greatly increased the number of people who will owe more under the AMT than under the regular income tax and thus will become subject to the AMT.

In short, by refusing to include AMT relief (beyond 2004) in the 2001 tax-cut bill, lawmakers were able to squeeze a total of about $350 billion more in regular income tax cuts into that legislation without breaching the $1.35 trillion tax-cut ceiling set for that bill.[18] House Ways and Means Committee Chairman Bill Thomas essentially acknowledged in 2001 that by using maneuvers such as failing to provide AMT relief beyond 2004, phasing in some of the tax cuts, and sunsetting the entire bill in 2010 — all of which artificially lowered the official cost estimate for the bill — he was able to pack more tax cuts into the bill. Thomas referred to his task as squeezing “a pound and a half of sugar into a one pound bag.”[19]

The President and Congress enacted additional tax-cut bills in 2003 and 2004. In those tax bills, as well, Congress employed the same gimmick — it extended AMT relief for just one more year, through 2005. Once again, the decision to put off permanent AMT reform (along with the decision to sunset the dividend and capital gains tax cuts at the end of 2008) allowed lawmakers to squeeze more tax cuts into these bills without appearing to breach the tax-cut ceiling the Congressional budget had set. Although the 2003 tax bill was officially scored as costing $350 billion over ten years, House Speaker Dennis Hastert frankly admitted the cost estimate had been gamed. Hastert said: “The $350 [billion] number takes us through the next two years, basically. But also it could end up being a trillion-dollar bill, because this stuff is extendable.”[20]

Altogether, the AMT maneuvers that were employed in the 2001 and 2003 tax-cut bills had a large effect in camouflaging the true dimensions of the revenue losses those bills will engender. The Tax Policy Center now estimates that if AMT relief were actually allowed to expire on schedule at the end of 2005, the AMT would, by 2010, cancel out 29 percent of the regular income tax cuts enacted in 2001 and 2003. For taxpayers with incomes between $200,000 and $500,000, the AMT would cancel out a stunning 71 percent of the tax cuts.[21]

Of course, as is now abundantly clear, the President and Congressional supporters of the 2001 and 2003 tax cuts never intended to allow the AMT to affect an increasing number of taxpayers and to cancel out a growing portion of the tax cuts. The plan always was to come back and shrink, or eliminate, the AMT at a later time. Indeed, in 2001 and 2003, whenever the President or Congressional supporters of the tax cuts described the benefits of their tax cuts for illustrative families, they ignored the effect that the AMT would have in reducing the tax cuts for many of those families. They sought to have it both ways: they kept the official cost estimate of the tax-cut bills artificially low by designing the bills so that the cost estimates would be based on the assumption that the AMT would cancel out a substantial portion of the tax cuts, while simultaneously promoting the tax cuts to the public by describing the full tax cuts that taxpayers would receive if none of the tax cuts were cancelled out.

Now some of these same lawmakers talk indignantly about the fact that the AMT will affect increasing numbers of taxpayers and offset a significant portion of the regular income tax cuts that taxpayers were told they had been given. (This brings to mind the scene in the movie Casablanca, where Captain Reynaud, the police prefect, professes to be “shocked” to discover that gambling is going on at Rick’s as he pockets his winnings from the roulette table.) They argue that the situation is so intolerable that the AMT must be repealed, regardless of the effect on federal deficits and debt.

Lawmakers clearly were determined to extract the maximum amount of tax cuts in the regular income tax out of the amounts allotted for tax cuts in the 2001, 2003, and 2004 budgets, without regard to the eventual need to make changes in the AMT. These conscious decisions to delay dealing with the AMT makes a mockery of the claim that Congress now confronts a need to push through repeal or a major scaling back of the AMT without regard to the fiscal impact of doing so.

After several years of tax cuts that have substantially increased federal deficits and debt and overwhelmingly benefited higher-income taxpayers — all the while ignoring the need for AMT reform — it would be highly inappropriate to repeal or reform the AMT without offsetting the cost. Doing so would further swell deficits and debt in order to provide further tax cuts primarily for taxpayers with well-above-average incomes.