New Study on the AMT

May 18, 2007

We published a new study on the Alternative Minimum Tax (AMT) yesterday, titled “Fixing the Alternative Minimum Tax,” in which Tax Foundation Chief Economist Patrick Fleenor explains that the problem with the AMT actually lies in the regular income tax code:

Why do commentators routinely refer to our income tax code as Swiss cheese, and not cheddar? Because if American income were cheese, the untaxed portions of our income would be large holes caused by exclusions, deductions, exemptions and credits. In fact, the holes in our taxable income are bigger than the holes in Swiss cheese.

The enormous sums of legally tax-free income fall into the two broad categories. More than one quarter of personal income received during 2006 was entirely excluded from the federal individual income tax base. Untaxed government transfers, in-kind compensation of employees, and a plethora of other types of income—none of these is included when the filer tallies his income on his tax form. Another 23.5 percent of personal income was included in the tax base but avoided taxation when filers claimed various deductions, exemptions, credits, and other provisions in the tax code.

It is this zero rate on huge sums that forces tax rates on taxable income up so high, more than twice as high as they could be. Moreover, when we tax some income heavily and some not at all, taxpayers naturally change their financial activities. Often these changes are economically nonsensical, but they make tax sense. The combination of high tax rates and tax-induced economic distortions harms the nation’s economic performance and lowers the nation’s standard of living.

It is the myriad holes in our current income tax code that make is possible for some people to avoid paying taxes under the regular income tax. This is what led lawmakers to create the AMT, but a better solution by far would be to simply repair the holes in the regular income tax.

Read the full study. View chart on the history of AMT returns and liabilities, 1970-2005.

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