Alternative to the Alternative: The Economic Effects of AMT Reform

Abstract

This article examines the economic benefits of alternative minimum tax reform relative to the current policy baseline. The authors find that AMT reform can lead to improved progressivity, greater efficiency, and a lessened compliance burden while raising an equal amount of revenue.

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

Introduction

In many ways, the alternative minimum tax has evolved into as poor a tax as could be imagined. It raises marginal tax rates (MTRs) on wages and investment income for millions of taxpayers. It is complex and rarely understood by those who pay it, and often takes taxpayers by surprise. The AMT doesn't affect the taxpayers it was originally designed to tax and doesn't fulfill its original purpose of ensuring that the wealthiest households pay at least some tax. Instead, the AMT increasingly is hitting those who either have children or live in a state with high income taxes. These negative characteristics led the national taxpayer advocate to classify the AMT as one of the top problems facing taxpayers and "the poster child for tax-law complexity." ¹

But the AMT isn't all bad. It is progressive through most of the income distribution, even though the wealthiest tax units tend to escape it. The AMT lowers MTRs on wages and investment income for some taxpayers and it limits taxpayers' ability to take deductions that some consider unjustified. The AMT's biggest virtue is simply that it raises a great deal of revenue — about $550 billion over 10 years if the Bush tax cuts aren't extended and $1.2 trillion over 10 years if they are (Congressional Budget Office 2010).²

Although policymakers and economists understand some of the threats posed by the AMT, there has been little effort to propose reforms that both maintain the revenue generated by the tax and strengthen the role of theAMT as a "minimum tax." Recent comprehensive reforms, such as Roadmap for America's Future designed by House Ways and Means Committee member Paul Ryan, R-Wis., and the tax plan introduced by Senate Finance Committee member RonWyden, D-Ore., and Senate Budget Committee Chair Judd Gregg, R-N.H., propose to eliminate the AMT rather than reform it; the 2005 President's Advisory Panel on Federal Tax Reform reached the same conclusion. In the tax policy arena, the two options for AMT reform appear to be either comprehensive reform that includes repeal of the AMT or the status quo of continually indexing the AMT exemption.

In this study, we propose and analyze two alternatives to the current system. The alternatives are similar in nature: both establish a minimum level of tax for income above a particular threshold. The first alternative adopts a minimum tax rate of 20 percent; the minimum rate in the second alternative is 17 percent, but the threshold is lower. The proposals are revenue neutral compared with a current policy baseline that includes extension of the 2001 and 2003 Bush tax cuts and continued indexation of the AMT parameters at 2009 levels.

We find these alternatives to be superior to the existing AMT. Reforming and simplifying the AMT can lead to improved progressivity, greater efficiency through lower MTRs, a lessened compliance burden, more equitable taxation for taxpayers with children and high state tax burdens, and better fulfillment of the AMT's original role as a true minimum tax.

End of excerpt. The entire report is available in PDF format.)

Usage and reprints: Most publications may be downloaded free of charge from the web site and may be used and copies made for research, academic, policy or other non-commercial purposes. Proper attribution is required. Posting UI research papers on other websites is permitted subject to prior approval from the Urban Institute—contact publicaffairs@urban.org.

If you are unable to access or print the PDF document please contact us or call the Publications Office at (202) 261-5687.

Disclaimer: 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. Copyright of the written materials contained within the Urban Institute website is owned or controlled by the Urban Institute.