Fundamental Tax Reform Should Be the Fix for AMT

March 7, 2007

On Monday, the Joint Committee on Taxation released a new report on the Alternative Minimum Tax (AMT). The report highlights how the AMT, if left alone, would grow over the next three years, then fall dramatically in 2011 with the expiration of the Bush tax cuts, and then begin to rise again thereafter. The report was prepared by JCT for today’s Ways and Means Committee hearing on the topic. Some highlights from the report:

Allowing the state and local tax deduction under AMT would cost the federal government approximately $576.5 billion over 10 years.

Repealing AMT outright would cost the federal treasury $872.3 billion over 10 years.

Allowing the state and local tax deduction under AMT in 2007 would save taxpayers $51.7 billion, and 82 percent of the tax savings would go to those tax returns with adjusted gross incomes of between $100,000 and $500,000. For the 6.3 million returns that would have been hit by AMT without such a fix who are between $75,000 and $100,000 in AGI, their average tax savings would be around $664 per return. For those returns with adjusted gross incomes between $50,000 and $75,000, their average tax savings from such a fix would be approximately $519.

Despite the rhetoric of many lawmakers about the AMT, this parallel income tax system is not a major issue for middle-income taxpayers. Over 88 percent of the tax revenue generated by the AMT between 2007 and 2010 will be paid by people with adjusted gross incomes over $100,000 even if no changes are made to current law. If, as seems likely, Congress continues to pass annual increases in the exemption level, the percentage of AMT taxes paid by high-income people will be much higher, approaching 100 percent.

The few middle-income people who owe more under the AMT than under the regular tax — usually just a few hundred dollars — are those who live in high-tax areas. They typically have the biggest deductions for state taxes paid under the regular tax code, so when the AMT takes that deduction away, they become AMT taxpayers.

The problem with AMT is that it should be unnecessary in the first place. The reason that AMT was created in 1969 was that a few wealthy individuals were paying nothing in federal income taxes. These wealthy individuals were earning income in ways that were tax-free, and were made tax-free explicitly by Congress. But instead of simply eliminating these loopholes that created this problem in the first place, Congress decided to create a complex parallel tax system that still allowed these loopholes for certain people, but tried to ensure everyone paid some tax amount. But overall, all Congress created was an even bigger mess.

Today, however, these loopholes aren’t the main reason people are being hit with AMT. The two biggest tax take-away preferences putting people into AMT today are the state and local tax deduction and personal exemptions. The solution to AMT should be fundamental tax reform that addresses the issue in two ways: (1) Most of the preferences that are taken away by AMT should not be in the tax code in the first place, and (2) All income should be treated equally, thereby eliminating any loophole Congress created in the past.

For more on the Alternative Minimum Tax, check out our section on the issue here. It includes a breakdown of the tax by local areas, including counties, congressional districts, and major city areas, in addition to states.


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