Revised April 30, 2007
ALTERNATIVE APPROACHES TO AMT REFORM:
CRITERIA FOR ASSESSMENT
By Aviva Aron-Dine
The Subcommittee on Select Revenue Measures
of the House Ways and Means Committee recently held hearings on the Alternative
Minimum Tax, and Subcommittee Chairman Richard Neal has said he is developing a
proposal for permanent, revenue-neutral AMT reform. According to news accounts,
the proposal will take the form of an AMT exclusion for households with incomes
below a certain level (which would remove all such households from the AMT),
likely paid for with an increase in taxes on high-income taxpayers.
Senate Finance Committee Chair Max Baucus,
meanwhile, has suggested that he intends to address the AMT issue by providing a
two-year extension of the AMT “patch.”
The AMT patch is the temporary AMT relief measure that has kept the number of
AMT taxpayers from rising rapidly over the past few years and that expired at
the end of 2006.
This analysis sets out three tests by which
to judge different approaches to AMT reform.
It also offers some preliminary thoughts on how the AMT patch and the emerging
House proposal might fare on these tests.
1. AMT Reform Should Be Paid For
The first and most
fundamental test of any AMT reform proposal is whether its costs are fully
offset. The AMT relief provided in 2001-2006 was not paid for and, as a
result, has already added more than $100 billion to deficits. Moreover, the
costs of AMT relief rise sharply each year. Thus, if Congress were to continue
the strategy of patching the AMT without paying for it, this approach would add
almost $800 billion to deficits over the next ten years (2008-2017), if the 2001
and 2003 tax cuts expire, and about $1.3 trillion to deficits if the tax cuts
are extended. (The 2001 and 2003 tax cuts push millions of additional taxpayers
onto the AMT and dramatically increase the cost of providing AMT relief.)
Paying for AMT reform
is required under the Pay-As-You-Go (PAYGO) budget rules reintroduced in the
House in January and included in the Senate budget resolution. Given the
nation’s bleak long-term fiscal outlook, adhering to the PAYGO rules is
essential. With the federal government facing escalating budget deficits in
future decades, it would be irresponsible to add to these deficits the cost of a
massive, unpaid-for AMT fix. The added deficits that would result from
unpaid-for changes to the AMT would have negative economic consequences over
time.
In addition, since the nation’s long-term budget shortfall must eventually be
addressed, adding to that shortfall now will force deeper program cuts or
steeper tax increases later.
Fortunately, paying
for AMT reform is feasible. The Urban Institute-Brookings Institution Tax
Policy Center recently published a menu of options for offsetting the cost of
reform. The possibilities range from modest increases in ordinary income tax
rates to reforms to the AMT itself.
Both the Senate and House budget resolutions
and statements by Representative Neal and Ways and Means Committee Chairman
Charles Rangel reflect a commitment to paying for AMT reform. If Congress
adheres to that plan, this will be a major advance over the previous two
Congresses’ approach to the AMT issue.
2. AMT Reform Should Be Well-Targeted
A paid-for AMT fix is
still costly: it consumes offsets that could be used to pay for other national
priorities, ranging from improvements in health care and education to deficit
reduction. Policymakers can conserve these scarce offsets by ensuring that the
tax benefits provided by AMT reform proposals are carefully targeted toward
addressing the core concern motivating current AMT reform efforts: stemming the
growth in the number of middle-income households who are subject to the AMT. A
proposal that protects the middle class from the AMT at a lower cost leaves more
resources available to address the nation’s many other important needs.
The
AMT “Patch” Is Not Especially Well Targeted
Since 2001, Congress has kept the
number of AMT taxpayers from rising rapidly with a series of AMT “patches.”
These AMT patches have increased the AMT exemption level: the amount of a
household’s income that is exempt from tax under the AMT.
Increases in the AMT exemption reduce some households’ taxable income under the
AMT to zero, automatically pushing them off the AMT. For other households,
increases in the AMT exemption lower AMT taxable income and thereby tentative
AMT liability below regular income tax liability; these households, as well, are
pushed off the AMT. Finally, increases in the AMT exemption level also
benefit many households that remain on the AMT, since they owe less in AMT taxes
than they would with a lower exemption level.
The AMT exemption phases out for higher
income households but is fully phased out only at quite high income levels. As
a result, increases in the AMT exemption level deliver a significant share of
their benefits to households with very substantial incomes. For example, the
2006 AMT patch (which increased the AMT exemption to $62,550 for married couples
and $42,550 for singles) benefited married couples with AMT income of up to
$400,000 (and single filers with AMT income of up to $300,000). The Tax Policy
Center estimates that about one third of the benefits of the 2006 AMT patch went
to households with cash income above $200,000.
Meanwhile, the Joint Committee on Taxation
estimates that 1.6 million households with adjusted gross income below
$200,000 and 300,000 households with adjusted gross income below $100,000,
remained on the AMT in 2006 even with the patch. Whether a given household
is removed from the AMT by an increase in the AMT exemption level depends not
only on the household’s income but also on how many of the deductions and
exemptions that the household claims under the regular income tax are disallowed
under the AMT.
Continuing the AMT patch would be very
expensive. Extending the patch (adjusted for inflation) just through 2007 would
cost about $45 billion, according to Tax Policy Center estimates; continuing the
patch for two years, through 2008, would cost about $100 billion.
An
AMT “Exclusion” Could Be Better Targeted —
Depending on the Income Level Chosen
The House is reportedly considering an
alternative approach that would simply exclude all households with incomes below
a given level from paying the AMT. In effect, the AMT would be repealed for
households with incomes below the threshold amount: they would not owe AMT even
if they claimed many exemptions and deductions. These households would be
subject to only one income tax system, the regular income tax. The AMT would
remain in place as a backstop tax system for higher-income households.
The exclusion approach has the potential to be
better targeted than the patch if it takes full advantage of a key fact about
the AMT. Under current law, a growing number of AMT taxpayers will be
middle- or upper-middle income households. But the bulk of AMT revenue
will continue to come from high-income households. (See Figure 1.) Thus, an
exclusion could eliminate the AMT for the vast majority of AMT taxpayers
while retaining the majority of AMT revenue. In contrast, an
exclusion that also eliminated the AMT for very high-income households would
lose considerably more revenue, with the additional cost going toward large tax
cuts for these high-income households.
How costly — and how well targeted — an
exclusion proposal is will thus depend crucially on the income level chosen for
the exclusion. In thinking about what might represent an appropriate
income level, it is informative to consider the effects of a few potential
thresholds. The limits specified in Table 1 below are for married couples;
limits for singles are assumed to be half those for married filers.
- With an exclusion of $150,000 of
adjusted gross income ($75,000 for singles), 92 percent of U.S.
households would be automatically exempt from the AMT. Moreover, only
some of the 8 percent of households with incomes above the exclusion level would
actually owe AMT. Thus, the Tax Policy Center estimates show that (if the AMT
were left otherwise unchanged), 7.8 million households nationwide, or 5.2
percent of all U.S. households, would actually pay AMT.
- (Under current law in 2007, the Tax
Policy Center estimates that 23 million households, or 16 percent of all U.S.
households, would owe AMT.)
Table 1:
Effects of Various
Exclusion Levels in 2007 |
Exclusion Level* |
Percent of Households Automatically Exempt |
Number of Households Paying AMT (Millions) |
Percent of Households Paying AMT |
$150,000 |
92% |
7.8 |
5.2% |
$200,000 |
96% |
4.3 |
2.9% |
$250,000 |
97% |
2.8 |
1.9% |
Source: CBPP calculations
based on Tax Policy Center data.
*Exclusion levels
specified are for married filers; thresholds for single filers are assumed
to be half those for married couples. |
- With an exclusion of $200,000 of
adjusted gross income ($100,000 for singles), 96 percent of households
would be automatically exempt from the AMT. Only 2.9 percent of
households, or 4.3 million households, would actually pay AMT.
- With an exclusion of $250,000 of
adjusted gross income ($125,00 for singles), 97 percent of U.S.
households would be automatically exempt from the AMT. Only 1.9
percent of households, or 2.8 million households nationwide, would owe AMT.
Many have noted that
the effects of a given AMT exclusion will vary by state; at any given threshold,
a smaller percentage of households in wealthier states will be automatically
exempt from the AMT. IRS data show, however, that if a $200,000 exclusion
($100,000 for singles) had been in place in 2004 (the latest year for which
these IRS data are available), at least 94 percent of tax filers in every
state (and 92 percent in the District of Columbia) would have been
automatically exempt from the AMT (see Appendix Table 1). In 40 states, at
least 97 percent of taxpayers would have been automatically exempt.
Costs Rise at Higher Exclusion Levels
Since the average
amount of tax owed under the AMT increases with household income, the cost of
any reform plan will rise steeply as households at higher and higher income
levels are removed from the AMT. Tax Policy Center estimates show that the
direct cost of excluding married couples with adjusted gross incomes below
$150,000 from the AMT (singles with AGI below $75,000) in 2007 would be about
$21 billion. If the exclusion level were increased from $150,000 to $200,000,
the direct cost would increase to $32 billion. If the exclusion were increased
to $250,000, the direct cost would rise to $40 billion.
Table 2:
Costs of Various
Increases
in the Exclusion Level, 2007 |
Increase in the Exclusion Level |
Approx. Cost Per Household Removed from AMT |
$150,000-$200,000 |
$3,000 |
$200,000-$250,000 |
$5,500 |
Source: CBPP calculations
based on Tax Policy Center data. |
Further, as Table 2 shows, the cost per
additional household removed from the AMT also would climb. Increasing the
exclusion level from $150,000 to $200,000 costs $3,000 per household in the
$150,000 to $200,000 range that is removed from the AMT. Increasing the
exclusion level from $200,000 to $250,000 costs $5,500 per additional household
removed from the AMT.
It is important to
recognize that, in reality, the cost of any exclusion proposal would be somewhat
higher than the “direct costs” listed above, since it would not be
possible — or desirable — to simply exclude households with incomes below a
given threshold from the AMT, with no other changes. Doing so would create
steep “cliff effects:” that is, situations in which a $1 increase in a
taxpayer’s income (for instance, an increase in AGI from $150,000 to $150,001,
if $150,000 were the selected exclusion level) could result in thousands of
dollars of additional tax liability. This could occur because, at an
income level of $150,000, the taxpayer would be automatically exempt from the
AMT, but at an income level of $150,001, she would become liable for her full
AMT tax bill.
To avoid such cliff
effects, some graduated AMT relief would need to be provided to taxpayers with
incomes above the exclusion (so that the exclusion would in essence be phased
out). But even with the added costs of such relief taken into account, it still
would almost certainly be possible to design an AMT reform that was more
effective than the patch at protecting middle-income households from the AMT,
and at a lower cost.
3. AMT Reforms Should Be Permanent
Assuming that both are paid for, a permanent AMT
reform has significant advantages over another temporary fix. As a
matter of both responsible budgeting and responsible tax policy, it would be far
better to figure out what sort of AMT fix the nation can afford over the longer
term than to provide a generous temporary fix but defer the questions of whether
the cost of that fix is sustainable and how the AMT issue should ultimately be
resolved.
- Even if the cost of a temporary AMT
fix were offset, when it expired it would leave the nation facing the same
costly AMT problem it faces today. And there is no guarantee that the next
AMT fix — and the one after that — would be paid for. Many in Congress have
consistently favored extending expiring provisions such as the AMT patch without
offsetting the costs. In addition, many members of Congress continue to oppose
applying the Pay-As-You-Go rules to tax cuts, and there is no assurance that
PAYGO will endure over the years. At some point, Congress may allow the PAYGO
rules to lapse, or may choose to waive those rules when extending expiring tax
provisions because it proves difficult politically to secure agreement on
revenue-raising measures that could serve as offsets.
This seems a particularly serious risk given that, if Congress enacts another
temporary AMT fix, it is likely to pay for it with permanent offsets; that is,
Congress may pay for a one- or two-year AMT fix with offsets that recoup the
revenue over five or ten years. If this occurs, it will not be possible
to simply extend those offsets to pay for an extension of the AMT fix.
The full savings from the offsets would already have been used up to pay for
the one- or two-year patch. In addition, the supply of permanent offset
measures will have been depleted: there will be fewer politically viable
offsets left on the table. This may make it more likely that Congress
would choose to deficit finance the continuation of AMT relief after the one-
or two-year patch expired.
- Another disadvantage of a temporary
fix is that it leaves taxpayers in the same position of uncertainty they are in
today. A permanent reform would offer middle-income households permanent
protection from the AMT and make the tax code more predictable for all
taxpayers. It would represent a welcome departure from Congress’s practice of
the past several years, during which Congress has routinely enacted expensive
tax cuts and then sunset them to mask their true costs. This has created
uncertainty for taxpayers and also introduced considerable uncertainty into the
nation’s finances.
Despite the disadvantages of a temporary fix, and the advantages of permanent
reform, some policymakers have argued that Congress should pass a temporary AMT
fix this year so that the larger AMT issue can be dealt with as part of a
comprehensive overhaul of the tax code. Virtually all tax policy experts agree
that the ideal tax system would have a broad tax base with few special
exemptions, exclusions, or deductions and would therefore have no need for an
AMT. Thus if lawmakers at some point reform the U.S. tax code to bring it
closer to that ideal, they may be able to significantly scale back, or even
dispense with, the AMT as part of that reform.
But
comprehensive tax reform is nowhere on the immediate horizon. Moreover,
reforming the AMT now would not prevent Congress from returning to the
issue if at some point it does engage in a major tax reform effort. The fact
that Congress may engage in more significant tax reform at some future date is
no reason not to reform this aspect of the tax code this year, in a fiscally
responsible manner.
APPENDIX TABLE 1:
Percent
of Households Automatically Exempt from the AMT
Had a $200,000 Exclusion
Threshold ($100,000 for Singles)
Been in Place in 2004 |
State |
|
Alabama |
98% |
Alaska |
97% |
Arizona |
97% |
Arkansas |
98% |
California |
95% |
Colorado |
96% |
Connecticut |
94% |
Delaware |
97% |
D.C. |
92% |
Florida |
97% |
Georgia |
97% |
Hawaii |
97% |
Idaho |
98% |
Illinois |
96% |
Indiana |
98% |
Iowa |
98% |
Kansas |
98% |
Kentucky |
98% |
Louisiana |
98% |
Maine |
98% |
Maryland |
95% |
Massachusetts |
95% |
Michigan |
97% |
Minnesota |
97% |
Mississippi |
99% |
Missouri |
98% |
Montana |
98% |
Nebraska |
98% |
Nevada |
96% |
New Hampshire |
97% |
New Jersey |
94% |
New Mexico |
98% |
New York |
95% |
North Carolina |
98% |
North Dakota |
98% |
Ohio |
98% |
Oklahoma |
98% |
Oregon |
97% |
Pennsylvania |
97% |
Rhode Island |
97% |
South Carolina |
98% |
South Dakota |
98% |
Tennessee |
98% |
Texas |
97% |
Utah |
98% |
Vermont |
98% |
Virginia |
96% |
Washington |
97% |
West Virginia |
99% |
Wisconsin |
98% |
Wyoming |
98% |
|
|
United States |
97% |
Source: CBPP calculations based on Internal Revenue
Service data. Due to the effects of inflation and real income growth, the
percentages of households automatically exempt likely would be slightly,
but not significantly, lower if the $200,000 exclusion were implemented in
2007. For example, the Tax Policy Center estimates that, nationwide, 96
percent (rather than 97 percent) of households would be automatically
exempt under a $200,000 exclusion in 2007. |
End Notes:
Lori Montgomery
Democrats Craft New Tax Rules, New Image: Plan Tries to Shield Middle Class
from Paying High Rates,” Washington Post, April 23, 2007.
Alan K. Ota,
“Top Democrats Back Two-Year Tax Patch,” CQ Today, March 2, 2007.
These tests are
not the only considerations that should be taken into account in assessing
AMT reforms. They are, however, three especially important criteria.
See Aviva
Aron-Dine, “Myths and Realities About the Alternative Minimum Tax,” Center
on Budget and Policy Priorities, February 14, 2007,
https://www.cbpp.org/2-14-07tax.htm.
See Aviva
Aron-Dine and Robert Greenstein, “The Economic Effects of the Pay-As-You-Go
Rule,” Center on Budget and Policy Priorities, March 19, 2007,
https://www.cbpp.org/3-19-07bud.htm.
Leonard E.
Burman, William G. Gale, Gregory Leiserson, and Jeffrey Rohaly, “Options to
Fix the AMT,” Tax Policy Center, January 19, 2007,
http://www.taxpolicycenter.org/publications/template.cfm?PubID=411408.
The AMT patches
have also allowed households to claim certain tax credits (e.g. education
tax credits) under the AMT. The cost of allowing taxpayers to claim these
credits under the AMT in 2006 was $2.8 billion, according to Joint Committee
on Taxation estimates, which is less than a tenth the cost of the increase
in the AMT exemption level.
Cash income is a
more inclusive measure of income than adjusted gross income or AMT income;
for example, it includes non-taxable pension income and contributions to
tax-deferred retirement saving accounts. Thus, more households have cash
income above $200,000 than have AGI or AMT income above $200,000. The Tax
Policy Center issues distributional estimates based on cash income because
it provides a more comprehensive measure of the income that households have
available to them and thus is generally a more accurate measure of economic
status.
Due to the
effects of inflation and real income growth, the percentages of households
automatically exempt likely would be slightly, but not significantly, lower
if the $200,000 exclusion were implemented in 2007.
|