AMT and the Long-Term Budget Outlook

June 23, 2011

Yesterday Ezra Klein highlighted the CBO’s most recent release of its Long-Term Budget Outlook. This document looks into the future to compare tax revenues and spending under different scenarios. CBO’s starting point, the “extended-baseline scenario,” includes everything that is currently written into law and represents what would happen if Congress took no action on taxes or spending. This scenario is then compared to the “alternative fiscal scenario.”

Citing the above chart, Klein notes, as he has in the past, that the extended-baseline scenario shows that

If Congress lets the Bush tax cuts expire or offsets their extension, implements the Affordable Care Act as scheduled and makes or offset the Medicare cuts prescribed by the 1997 Balanced Budget Act — which CBO calls the “extended baseline scenario” — the national debt will be totally manageable. If Congress passes laws extending the Bush tax cuts without offsetting the cost, repealing the Affordable Care Act and its cost controls and protecting doctors from Medicare cuts without making up the savings elsewhere — the “alternative fiscal scenario” — the national debt will be totally out of control.

Klein’s ultimate conclusion is correct, but the policy picture he paints is not quite complete. In addition to the policies mentioned, the extended baseline scenario also assumes that Congress stops patching the alternative minimum tax (AMT). I won’t delve too far into the details, but the AMT is basically a parallel, two-rate (26% and 28%) tax system that lacks some popular benefits such as the deduction for state and local taxes paid. Taxpayers must pay the larger of the regular income tax and the AMT. When Congress first enacted the AMT in 1969 they did not inflation adjust parameters such as the exemption (similar to, but larger than, the standard deduction in the regular income tax), meaning that as inflation and real income growth increased households’ nominal income, more and more taxpayers were subjected to the AMT (20 thousand in 1970, and 4 million by 2011). The number of AMT payers would be several times higher still if Congress had not begun temporarily increasing the AMT exemption, keeping the number of AMT payers relatively constant, starting in the early 2000s.

This so-called “AMT patch” has become an annual tradition in Washington. Some believe that Congress opts for one- or two-year fixes because a permanent fix would appear too costly, though Obama has actually proposed a permanent fix in his 2012 budget.

The point here is that Ezra Klein forgot to mention that, in addition to letting the Bush cuts expire, sticking to the extended baseline scenario (i.e. the “do nothing” scenario) would require Congress to let the AMT patch expire. If this happened not only would the AMT hit millions more households in 2012, but it would eventually take over the personal income tax, as inflation and real income growth continued to push more taxpayers into the AMT. Moving towards and continuing past the 2035 date, the world of the AMT would increasingly become the norm: no EITC, no child tax credit (currently these credits are only allowed against the AMT because of the Bush tax cuts), and relatively flat tax rates (26% for everyone under $175K and 28% thereafter). Two charts from the same CBO report illustrate this point. The first is a chart of individual income tax revenues under various scenarios:

In the near term the chart shows that continuing the Bush tax cuts is more expensive than continuing the AMT patch. But as time goes on, the AMT patch becomes much more significant than the Bush tax cuts. In 2035 the Bush cuts would reduce income tax revenue by about 1% of GDP, while AMT relief would cost about another 2%. Clearly letting the AMT patch expire is not an insignificant part of the equation. A second chart from the CBO report shows the ever-expanding reach of the AMT under the extended-baseline scenario:

By 2035 50% of households would be subject to the AMT. If the chart went farther into the future, that number would only continue to increase. Len Burman of the Tax Policy Center recently described the future of the AMT well: it “engulfs the middle class in a web of higher taxes and mind-numbing complexity.”

Whatever the flaws or merits of the AMT, leaving it out of the discussion on the budget-balancing, “do-nothing” scenario incorrectly implies that this scenario is simply a return to income taxes as they were under Clinton. In reality, without action by Congress the AMT will automatically and increasingly play a larger role than it ever has in the past.

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