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The Individual Alternative Minimum Tax: No Alternative But Repeal

NTU Policy Paper 114

by
Matthew S. Bailey

Apr 22, 2004

INTRODUCTION

Long after the April 15th lines at the Post Office and the frustration of tax season have subsided, the threat of the Alternative Minimum Tax (AMT) will continue to occupy the attention of the tax-minded in America and in Congress. With between 30 and 35 million taxpayers expected to become AMT-liable in 2010,[1] popular media outlets such as Fortune,[2] CNNMoney,[3] and Bloomberg[4] have already warned and advised Americans to beware of this alternate system of taxation. Both the Taxpayer Advocate and the Commissioner of the Internal Revenue Service (IRS) have also made the problems and pitfalls of the AMT a major topic of testimony. Yet despite the mounting testimony and bipartisan support in favor of altering or repealing the AMT (including more than two-dozen bills introduced to reform or repeal the AMT in the 107^th Congress alone)[5] this emerging tax phenomenon remains a threat.

The AMT is one of the most complicated, misunderstood, and under-publicized items in the Internal Revenue Code (IRC) because, as its name implies, the AMT works as an alternative system of taxation. Like an alternate universe in the twilight zone of IRS rules and regulations, the AMT forces taxpayers to calculate their taxable income and liability under a different set of allowable exemptions, deductions, and credits. [6]

As with many creations of the IRS bureaucracy, this alternate tax universe did not take shape instantly, but evolved over the course of several decades.[7] The AMT was originally designed to "capture" taxes from extremely wealthy individuals who, due to legal loopholes in the IRC created by Congress, were able to escape paying any personal income tax. However, despite extensive alterations to the AMT system, it has expanded over the years to snare even some individuals who make less than $50,000.[8] Whether the AMT was ever intended to intrude on the lives of such individuals is neither a comfort nor a legal protection for the American taxpayer.

Over the past several years America has seen an economic slowdown and recession whose pervasiveness has only recently given way to recovery. By enacting legislation to reduce individuals' tax liabilities and promote investment, Congress and the President took valuable steps toward stimulating the economy and nurturing job growth. Unfortunately, although the Jobs And Growth Tax Relief Reconciliation Act of 2003 (JGTRRA 2003) expedited tax cuts scheduled for the future, decreased the capital gains tax, and enacted other tax credit and exemption relief, it failed to alleviate the AMT burden. Instead Congress enacted legislation delivering only temporary increases in AMT exemptions and deductions -- a band-aid fix for a seeping wound.

Enacting regular Tax Code relief without corresponding action upon the AMT will actually result in increased tax liabilities, increased tax complexity, and, an increased number of Americans who experience an overall "take back" of benefits as they confront AMT liability for the first time. These repercussions will come to a head in 2005 when provisions for increased AMT exemptions and deductions "sunset," leaving the perfect AMT storm looming on the horizon. The relief provided by President Bush's 2003 tax package will be greatly reduced in its effectiveness as more and more middle-class taxpayers find themselves confronted with AMT liability.

Although its rates are above a fiscally and economically responsible level, some have noted that the method in which the AMT broadly defines income with few exemptions and credits, resembles the fairer tax structure pro-taxpayer groups might support. The AMT emphasizes taxing the broadest base of people, on a more expansive (but not ideal) measurement of their income in order to create a system where everyone pays their "fair share."

However, any similarity between the AMT and tax reform ends here. Not only is the AMT little understood or known, but its rules are inconsistent with the "incentives" provided in the regular Tax Code. It is wholly unfair for policymakers to promote certain social and fiscal ideas through exemptions, credits, and deductions, only to take these incentives away when a taxpayer takes advantage of them too well. And, as Rep. Richard Neal (D-MA) said best, "From the Boston tea party to now, tax fairness is firmly parked in the American psyche."[9] According to author Erin Bjork Kiley, this feature of the AMT provides moral reasons for full repeal.

It is important to keep in mind that the AMT is not a system designed to trap people who are avoiding taxes illegally through bogus loopholes or off-shore bank accounts -- there are already mechanisms that enforce against this unlawful activity (i.e., criminal enforcement measures and IRS treaties with foreign countries).

What the AMT does accomplish is to trap people who have taken advantage of legal deductions and exemptions. The AMT allows Congress to step in and decide when an individual has used the established law "too much" to their advantage. The underlying nature is completely political -- avoiding excess taxes legally versus evading them illegally. [10]

Aside from this compelling argument for appeal, the AMT is now contradicting even its original (though flawed) justification. In the words of the IRS Taxpayer Advocate, "the [AMT] problems we identify grew up over time and bring about consequences that no one would deliberately design. These problems are 'errors' in the Internal Revenue Code that beg to be corrected."[11]

Every year, the U.S. Government, as well as taxpayers, expend countless hours of manpower and millions of dollars in dealing directly and indirectly with the AMT. The result is vast inefficiency and a huge deadweight loss to both the taxpayer and the U.S. economy.

Congress and the Administration must act to avert this national dilemma now. Every year of delay increases the cost of any solution and merely brings more injustice to American taxpayers. As taxes are the foremost contact that citizens have with the government, this injustice can only lead to further political disillusion, tax evasion, and ultimately increased enforcement costs (which creates further deadweight loss). The following sections will explain what the AMT is, how it came about, how it works, how it will interact with the U.S. economy in the coming years, and ultimately, how it can best be reformed.

HISTORY

From its beginning, the AMT has been a highly volatile and explosive topic. In 1969, Congress enacted the precursor to the AMT after then-President Lyndon Johnson's Secretary of the Treasury, Joseph W. Bar, testified to the Joint Economic Committee that 155 people with Adjusted Gross Incomes (AGI) of $200,000 or more had paid no income taxes in the 1966 tax year.[12] Urged on by then-Committee Chairman Wilbur Mills (D-AR), Congress passed, and President Nixon signed into law, the minimum income tax of 1969.[13] Congressman Mills was not the only person pushing for this "abuse" to be corrected. According to a Joint Economic Committee Study, "In 1969, more people had written to Congress to complain about the 155 people who paid no income tax than had written about the Vietnam War."[14] This original tax was a flat "add-on" of 10 percent to the extent that an individual reduced his or her liability by greater than $30,000.[15] In 1976 Congress raised the tax rate from 10 percent to 15 percent after a new Treasury study found that 244 people with AGIs of $200,000 or more had paid no federal income tax in 1974.[16] Even after enacting tax laws to combat this trend, in 10 years the number of "non-paying" high-earning individuals had increased by 89 people.[17]

By 1978 though, this alteration was met with concern -- Congress believed that the minimum tax was impeding the development of capital formation and subsequently stagnating economic growth. In response, Congress exempted capital gains from the minimum tax, but enacted the first tax to be called the "AMT." This new levy was intended to capture "lost" potential revenues from the taxation of capital gains.

By 1982, this division had caused such confusion and complexity that Congress repealed the outmoded minimum tax and expanded the AMT to cover most of those items that had originally been included in the minimum tax, at a flat rate of 20 percent. Congress claimed this change would help simplify the structure of the tax system and refocus the tax back onto the high-income taxpayers who were its original targets.[18] Between 1982 and 2003, the AMT rate would be revised three times (1986, 1990, 1993) and the structure revised at least four times (1986, 1990, 1993, 2001).[19] These changes brought the AMT rates to their present level of 26 and 28 percent and classified what, and to what extent, exemptions and credits could be used on the AMT.

In 2001, President Bush enacted the last major change to the AMT via the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001. Within this bill, President Bush made permanent a temporary provision allowing the child tax credit to be used when calculating the AMT.[20] This bill, as other legislation has done, also enacted several "temporary" provisions to the AMT.[21]

Despite these numerous changes, at no point in history have the thresholds or exemptions within the AMT been indexed for inflation; even though the regular tax system has been indexed since 1985. [22] The very phenomenon this indexation was designed to fight in the regular Tax Code, the so-called "bracket creep," is a leading reason why more and more lower-income individuals find themselves thrown into the depths of the AMT. Despite occasional Congressional increases in the threshold and exemptions, in the aggregate, these elements of the AMT have failed to keep up with any reasonable measure of inflation.

In 1979 the exemption amount in effect for the AMT was $20,000. As of 1993, the law states that the exemption amount for the AMT is $45,000 for married couples, half if filing separately, and $33,750 for single filers. Adjusted for inflation though, this 1993 amount would not be equivalent to the $20,000 exemption of 1979. Furthermore, if indexed for inflation the 1993 exemption level would have to be approximately $54,000 for married couples and $41,000 for singles in 2001. In 2001, the President and Congress enacted temporary AMT relief (until the end of CY04) by raising the standard exemption to $49,000 for joint returns (half if filing separately) and $35,750 for single filers.[23] Through the JGTRRA (2003), they increased the exemption by an additional $9,000 for married couples (to $58,000 total) and $4,500 for single filers (to $40,250 total). Unfortunately these increases also expire at the end of CY04. This is the first time since its reform in 1993 that the AMT's standard exemption has matched the real dollar value of its 1993 level; however, this is still shy of its 1979 inflation-adjusted level. Indeed, it does not even match the adjusted 1983 exemption (which in 2001 would have meant the exemption being $65,600 for couples and $49,200 for single filers).[24]

Since its inception the AMT has caused political controversy, both in its establishment and in discussion over how to ensure that it is working as intended. On August 5, 1999, the House and Senate agreed (in conference) to a bill that would have enacted several changes to the AMT, including its full repeal by 2008. However, President Clinton vetoed this measure on September 23, 1999.[25] This was just one of at least 25 pieces of legislation introduced between 1993-1999 to repeal the individual AMT.[26] On June 29, 2000, IRS Commissioner Charles O. Rossotti identified the AMT as one of the three key areas that contributed to the complexity and public misunderstanding of the U.S. Tax Code. "Our review of the AMT found that it is intricate and ambiguous," Rossotti stated. With this, he also presented options for altering or repealing the tax.[27] In May of 2001, the Joint Economic Committee of the United States Congress, Chaired by Rep. Jim Saxton (R-NJ), suggested that, "[I]f taxpayers and Congress could have foreseen in 1969 how the minimum tax would turn out, it is doubtful they would have approved it."[28] In her 2001 Annual Report to Congress, National Taxpayer Advocate Nina Olson stated that, "[S]everal of the Key Recommendations -- those proposing…AMT reforms -- beg to be enacted immediately…[and are] absolutely critical and [in] essential need [of] reform. Too many taxpayers are impacted by the problems underlying the [AMT], and the IRS expends too much in the way of resources to ensure compliance, for Congress not to act."[29] Accordingly, the National Taxpayer Advocate's Report recommended the repeal of the AMT.

Failing this, Congress and President Bush enacted large tax cuts, with minimal temporary changes to the AMT, via the Economic Growth and Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 2003.

How the AMT Works

The complexity of the AMT has been testified to by a diverse group of organizations including: the Joint Economic Committee of Congress, the National Taxpayer Advocate, the Commissioner of the IRS, the American Institute of CPAs, the National Association of Enrolled Agents, and the American Bar Association Section of Taxation, among others. All are organizations that not only have extensive experience in dealing with the Tax Code, but also rely on the public's need for tax assistance in order to make a profit. However, despite having a financial motivation to keep the Tax Code complex and time consuming, all of these agents have repeatedly identified the AMT as such a nuisance that it should be repealed.

This complexity originates from the very nature of the AMT. It operates in parallel to the regular income tax system but uses a broader measure of income, a bifurcated rate, and a higher standard exemption with fewer allowable tax credits.[30]

An individual can be subject to the AMT in three ways. First, an individual may be directly affected through having AMT liability; over and above that amount calculated through the regular Tax Code. A filer affected in this way would file an IRS Form 6251 for AMT Tax Liability. Second, a filer can be indirectly affected by having certain tax credits, available to them in the regular Tax Code, limited or reduced by the rules of the AMT. [31] In general, the excess of liability under the taxpayer's "Tentative AMT" (TAMT) over their established regular income tax liability (Form 1040) before tax credits (excluding their foreign tax credits), constitutes the taxpayer's AMT liability.[32] Third, a taxpayer may have occasion to be affected both through the loss of credits and higher taxes via the AMT.

Under any of these scenarios a taxpayer will begin by filing their full IRS Form 1040. In the course of this, a prospective AMT filer will fill out a 12-line worksheet[33] to determine whether they even need to complete a Form 6251.[34] The results of this worksheet will not determine whether one will ultimately be subject to the AMT, but merely whether a person must take the next step in preparing Form 6251. Regardless of the outcome of the worksheet though, the tax filer will have to complete their Form 1040 and any of its subsequent schedules.

Assuming the AMT worksheet produces an affirmative result, the filer will have to complete IRS Form 6251. This is a three-section, 65-line form with an accompanying eight pages of instructions that recalculates a person's AGI under the rules of the AMT instead of the regular Tax Code.[35] In short, this means that a person adds back many of the tax preferences, deductions, and adjustments that they -- and most other taxpayers -- received under their ordinary tax filing exercise. Thus, this new AMT Income (AMTI) is typically a larger version of their AGI from the standard 1040 tax form.

This AMTI is now the base of their calculations for their TAMT liability. To figure out TAMT liability he or she must subtract their appropriate AMT standard exemption. The AMT is made further complex by allowing an exemption that is phased out for higher income earners. The AMT standard exemption is reduced by 25 percent for every dollar over a threshold amount ($150,000 for joint filings; $75,000 for married but separate filings; and $112,500 for singles.)[36] Thus, the entire exemption is phased out at a certain level and no personal exemption may be taken.[37] The figures for these exemptions and their reductions can be seen in Table 1.[38]

Table 1. AMT Exemption Levels and Phase-Outs by Filing Status (until end CY04)

Once a filer has calculated their actual exemption amount, they then subtract this amount from their AMTI in order to get their liability based AMTI (Liability Based Income),[40] upon which they will assess their TAMT liability. By applying the AMT tax rate schedule to their LBI, the filer will be able to determine their pre-credit TAMT. Since the AMT is a two-tiered tax schedule, for every dollar of LBI above $0 and below $175,000 a person is taxed at the 26 percent rate. Every dollar of LBI above $175,000 is then taxed at 28 percent.[41] By adding together the liabilities of the two rates, a filer will then have their pre-credit TAMT. Now a filer subtracts their appropriate tax credits, i.e. the child tax credit, the AMT foreign tax credit, the adoption tax credit, and the IRA tax credit. Finally, a person must calculate their AMT tax credit. This credit is designed to ensure that those tax items which receive multi-year tax consideration (i.e. depreciation) are not being taxed one year under the AMT and the next under the regular tax system. Thus, a person can carry forward their AMT tax credit to offset regular income tax liability in future years, under certain conditions. Unfortunately this is yet another multi-step operation that involves more paperwork (Form 8801), which will not be taken up here.[42] After going through this process the remaining tax liability is the filer's TAMT liability. The final step in this process is to compare one's TAMT liability to the liability attained using their standard tax-filing form. The filer must pay the greater of the two liability amounts.

It is important to note that a taxpayer may be affected by the AMT in ways other than through a direct AMT tax liability. Beginning in 2004 numerous tax credits within the regular Tax Code are limited in scope and amount to the extent a person's AMT liability exceeds their regular tax code liability. Examples of these credits include the HOPE Scholarship and Lifetime Learning credit, the dependent care credit, and the credit for the elderly and disabled, among others.[43] Further, people are affected in the simple completion of the form, especially when they have no AMT liability. In 1997 4.4 million people filed Form 6251, even though only about 20 percent of those individuals actually had any AMT liability.[44] This does not even take into consideration the number of people who completed the form and did not file it. Some estimates bring the number of people who actually had AMT liability, versus those who completed Form 6251, down to less than 10 percent.

It should also be noted which taxpayers are affected by the AMT. Currently, the tax predominantly affects those individuals who have an AGI of between $100,000 and $500,000.[45] Typically these taxpayers are the individuals whose AMT liability is greater than their "regular" tax liability, or whose use of credits are limited via the AMT. Individuals above $500,000, taken as a whole, generally have a higher "regular" tax liability than their AMT liability due to their much higher tax rates (now 33-35 percent). However, individuals who are both above and increasingly below these levels are subject to the AMT due to bracket creep, tax cuts, and other phenomena.

Because many tax benefits available under the regular tax system are reduced or eliminated when computing AMTI, a combination of deductions and/or exemptions an individual claims that are disallowed under the AMT (so-called "preferences") can trigger AMT liability. Deductions for state and local taxes (including property tax) fall under this category as do many personal exemptions, making taxpayers with large families (3 or more dependents) residing in high-tax states (New York, California, and Massachusetts) especially vulnerable to the AMT. These two factors are, aside from income, the largest indicators of a person's likeliness to be entrapped by the AMT.[46]

The Impact of JGTRRA (2003)

The most recent legislation to have a direct or indirect effect upon the AMT was the Jobs and Growth Tax Relief Reconciliation Act of 2003. In spite of delivering a welcome dose of tax relief, JGTRRA contains a "poison pill" that will increase the number of Americans incurring AMT Liability,[47] the size of taxpayer AMT liability, and the cost to implement solutions to the AMT.

The predominant effect of this bill on the AMT was to temporarily increase the standard AMT exemption amount, before phase-out, by $9,000 for couples and $4,500 for single filers. This direct provision serves to decrease both the amount of AMT liability and the number of people who are subject to the AMT. However, the increased exemption protections are weakened due to the exemption phase-out threshold[48] going unchanged and unindexed. This means that the exemption will continue to be phased out at an income level that is worth less and less in the real world, thus increasing a person's real tax liability.

This is further aggravated because these increased exemption levels and the levels of the 2003 law, are set to expire at the end of this year. The exemption amounts will then return to their pre-enacted levels of $45,000 for married couples filing jointly (a decrease of $13,000) and $33,750 for single filings (a decrease of $6,500). The result will be an explosion in AMT liability and incidence.

The indirect effects of the JGTRRA upon the AMT are through other provisions that extend to the end of CY09, such as reductions in capital gains taxes and expansion of the 10 percent and 15 percent brackets. The impact of JGTRRA upon marginal tax rates, under the regular tax system, can be seen in Table 2.

Table 2. Lower Marginal Tax Rates for 2003 for Married Taxpayers Filing Jointly -- EGTRRA/JGTRRA comparison.[49]

Note: Emphasis has been added to those categories of taxpayers most likely to be affected by the AMT.

However, this reduction in marginal rates merely reflects expedited implementation of already-enacted cuts. In the words of the Office of Management and Budget, "The Act accelerated many of the tax reductions passed in the 2001 EGTRRA that were scheduled to take effect several years from now."[50] Thus, projections made under the EGTRRA for the number of taxpayers and extent of liability from the AMT still bare solid weight in the present discussion. It is with this in mind that one should consider the following passage:

Preliminary estimates indicate that by 2010, when the effects of both inflation and the legislative changes contained [in] the Economic Growth and Tax Relief Reconciliation Act of 2001 are taken into account, the number of taxpayers falling under either the AMT or AMT limits on their tax credits under the regular income tax will grow to 35 million (33% of total taxpayers). If the EGTRRA provisions are made permanent, then by 2012, 41 million taxpayers (37% of total taxpayers) would be affected by the AMT.

The individual income tax rate reductions and the marriage penalty tax relief provisions of the 2001 Act are expected to increase the number of taxpayers subject to the AMT. Indeed, many taxpayers in the middle income ranges will find that the AMT will "take back" much of the tax reductions contained in the 2001 Act. [51]

In its release, "For Everyone Willing to Work, a Job" the Office of Management and Budget stated (regarding the JGTRRA): "…the Administration proposes to change the individual Alternative Minimum Tax (AMT) to prevent the AMT from depriving taxpayers of the tax relief intended for them."[52] Unfortunately, the temporary increases in AMT exemptions do not provide sufficient protection for all taxpayers to partake in JGTRRA's provisions without penalty. In fact, these increases only serve to bring the AMT exemption to its 1993 level (the real tax liability, versus its 1979 level, is greater). Indeed, as millions of Americans benefit from the tax-cut package, many others will slip down the rabbit hole into the not-so-wonderful-"wonderland" of AMT.

The AMT was originally designed to capture high-end taxpayers' personal income, particularly emphasizing their capital gains income; and, despite changes to the structure, this original emphasis has not faded. History has shown that one of the surest ways to increase the number of people subject to the AMT is to alter the capital gains rate of the normal tax system without altering the AMT capital gains provisions. Provisions of the JGTRRA that sunset at the end of CY09 do precisely this. Although the JGTRRA lowers and changes the treatment of capital gains tax under the regular income tax system, it makes no change to the AMT treatment of the capital gains tax.

Of particular concern are the discrepancies in the way the AMT and the regular Tax Code treat Incentive Stock Option (ISO) plans. This popular form of vestiture and employment compensation is one way in which a person is almost instantly subject to the provisions of the AMT.[53] In light of recent cash shortages and bonus freezes, companies have increasingly been using items like ISOs to compensate and retain employees. ISOs not only alleviate monetary pressures on cash-strapped companies, but also provide employees with the chance to place their confidence in the economy and its impending recovery. Unfortunately, employee willingness to accept a non-liquid asset (timed stock options), in lieu of highly liquid cash, may shrink as the threat of AMT grows, ultimately causing monetary demands to mount on a weakened economy. Strapping ISOs with the burden of the AMT discourages employee investment and engagement in companies exactly when they are needed the most.[54]

In addition to the link between capital gains rates and the AMT, there is a direct correlation between decreases in the marginal rates of the "regular" tax system and an increase in the number of people subject to the AMT and their liability. Because a taxpayer completing Form 6251 must use the higher of his or her liabilities (regular 1040 versus AMT) as their actual liability, reducing a taxpayer's 1040 liability increases the likelihood that the AMT liability will be triggered. In the numerous examples of how the AMT will, or could, affect taxpayers, the majority deal with precisely this situation -- taxpayers who are thrust into AMT liability due to a reduction in their normal tax rates.[55]

Although it is Washington's goal to reduce this effect by increasing the exemption amount, this is only a short-term fix. The JGTRRA's reduction in marginal rates, in conjunction with reduced rates for capital gains and reduced AMT exemption amounts, is bound to erupt into an AMT liability explosion. For many middle income Americans it is quite conceivable that these alterations in the Tax Code will cause not just a "take back" of their benefits, but an outright increase in their tax burden versus the original system.[56] By frontloading the effects of JGTRRA, the Administration and Congress have set up middle and higher income taxpayers for a substantial fall. Extensive media coverage of the Bush tax cut has undoubtedly left many Americans counting upon their tax refunds or their minimal tax payment at the end of the tax season as a part of their annual budget. However, when the number of AMT taxpayers jumps from 4.2 million people to 19.9 million people in 2005, many Americans will be put into a financial strangle hold.

Not only will this be a problem for the American taxpayer, but it will also present a problem for policymakers. As AMT liability increases, the amount of revenue the U.S. Treasury receives from that liability will go up. With each increase in receipts from the AMT, defenders of the status quo can make even more ominous projections of future revenue "losses" to repeal, index, or otherwise "fix" the system. In 1997 the IRS estimated the "cost" of fully repealing the individual AMT would be in the range of $9 and $11 billion.[57] Another estimate from the year 2000 pegged the "cost" of repeal from 2000-2010 at approximately $62 billion.[58] The most recent estimate, which assumes gradual AMT phase-out and making EGTRRA provisions permanent, sets the amount at $800 billion over the 2003-2012 period.[59] Given that the JGTRRA permanently enacts some of the EGTRRA provisions, as well as enacting other measures relevant to the AMT, the static amount of future revenue involved in fully repealing the AMT over the 2004 -- 2013 period could range between $850 billion and $1 trillion. Of course, in this context the term "cost" can be misleading. None of these estimates account for the benefits to economic growth (and in turn other revenues) that would occur by repealing the AMT. Furthermore, most taxpayers don't view money they get to keep in the future as a "cost."

Nonetheless, there will be political pressure to implement AMT reform that is generally "revenue neutral" in the conventional Washington sense. This may only be possible through increases in the marginal tax rates, expansion of the tax base, reform of the tax system, or reducing government expenditures. The increase of marginal tax rates would be unhealthy for the economy. The expansion of the tax base and reform of the tax system have been encouraged (and thwarted) longer than the AMT has even been in existence. Reducing government expenditures, the most desirable option, will provoke howls of protests from some constituency groups. The analysis and policy recommendation sections to follow will show how a benign policy of AMT repeal could be achieved.

Analysis and Evaluation of the Alternative Minimum Tax System

Introduction

There are a few conceptual points which need to be stated before beginning this analysis. Since the passage of the JGTRRA is so recent, there are few existing reports on its overall effect within the bounds of policy and the economy. Furthermore, unlike official government reports, this NTU analysis did not have access to the Treasury Department's Individual Tax Model. All estimates are intended to be conservative. Economic projections and impact statements are at best educated guesses. Putting together enough data to create a "most likely" scenario is the work of many different people. The computation is conducted via the best information available at the time of publication of this report.

A significant problem with the AMT is that it results in a higher tax liability just when the taxpayer is experiencing an economic low point. In general, tax payments should help minimize their always-adverse impact on the economy by falling as the economy's performance declines, and thereby reducing their drag on consumption, investment, and production. Instead, the AMT, working in parallel to the regular tax system, tends to impose an increased tax burden during an economic downturn, which prolongs periods of weakness. The AMT especially aggravates attempts to stimulate the economy via tax cuts, by reducing the number of people that receive "real" relief and by increasing "real" tax liability. [60]

In addition, from an economic perspective, the AMT poses a dilemma because under a tax system consistent with economic theory, there would be no need for it.[61] Ideally, the tax system employed by the United States would accurately and fairly measure the "true" income (or, in the case of retail sales tax, consumption) of all individuals and each individual would pay their "fair share" as determined by their democratically elected representatives. Therefore, numerous experts and scholars have advised Congress that reform of the actual Tax Code should be the emphasis of their efforts.

The AMT is not completely devoid of merits. It is designed to create a broad measure of taxable income, with few deductions, exemptions, preferences, and credits and using a flatter streamlined bracket structure. It is important to note that despite similarities to the Flat Tax, the AMT includes a greater amount of exemptions and deductions than the flat tax would ideally have, and the rate of the AMT is nearly double the rate proposed for most flat tax legislation.

As one commentator put it, "What's so offensive about the AMT is that it fosters a giant lie -- a lie that's only getting bigger."[62] Under the regular tax structure, Congress has created a system that promotes certain policy agendas. However, through the AMT, the government punishes the very activities Congress seeks to encourage, merely because a person becomes successful. This is discouraging to the individual and destabilizing to the tax system.

The following analysis, within the context of both the EGTRRA and the JGTRRA, is designed to illustrate the real world impact of the AMT. Here, the government is both the producer and the receiver of taxes. Government manufactures the "product" of government. This includes entitlement programs, defense, and everything else that the government provides for citizens.[63] The "consumer" is the taxpayer who both uses the product of government and pays for those services rendered in the form of taxes.[64] The deadweight loss is the "measure of the value that consumers and producers of a good lose from the imposition of the tax. Because of deadweight losses, the taxpayers' losses exceed the government's gain."[65] All of these areas are components of the modern U.S. economy. The following is a measure of the effects of the AMT, in a macro sense, upon each of these areas.

Explanation of the Above Graph

Figure 1[66] represents both the "ideal" tax situation and the situation incurred under the AMT.[67] Under this "ideal" system, it must be accepted that there will be those who have paid professionals to file their return (thus reducing utility), that government will expend time and money to collect taxes, and that, in the aggregate, this system is efficient with no inherent deadweight loss. The measure then of any "loss" is based on the additional costs imposed by the AMT that this "ideal" system could avoid incurring if the AMT did not exist. This ideal system is represented by the line DFK. Points will be referred to below as the system is shifted. A quick key is:

Consumer surplus before tax = triangle ADF; after tax = triangle ABC.

Producer surplus before tax = triangle DFO; after tax= triangle GHO.

Government revenue resulting from tax = rectangle BCHG.

Deadweight loss resulting from tax = triangle CFH.

Consumer Surplus Loss

Every year, millions of people file income tax returns. Taxes are unique in that there is a loss to the consumer (the taxpayer) in order to receive the benefits of their own money. The Tax Code puts the primary responsibility upon the individual to comply and be informed of their tax liability. In trying to reconcile their tax liability over 60 percent of taxpayers choose to have professionals complete their returns[68]. In effect then, more than half of all people paid someone money in order to get back their own money or figure out what they rightfully owed the government. This is a loss of "consumer surplus." Under the ideal tax system, people would know how much they owe and the tax process would be such as to eliminate the need for paid preparers. Thus, people would not lose money that could be spent on their own "utility."[69]

However, for the sake of this argument, it will be assumed that the current system is the "ideal" system. Under this "ideal" system there is a consumer surplus represented by the triangle ADF. This means that there are people who would be willing to pay more for the services they are receiving.[70] However, the AMT taxes people above this level and imposes, essentially, a new or greater tax ("price" in terms of this discussion) upon people.

In part, this is representative of the increase in the number of people who have professional tax personnel file their AMT returns. Over 80 percent of all AMT returns will be prepared by professionals; moreover, the average price charged by a leading tax preparer to file a standard tax return has increased 77 percent, after accounting for inflation, over the last 20 years.[71] AMT returns are typically more complex and therefore are even more expensive. Even using 1997 return estimates, before the complexity of the recent tax packages were added in, the monetary cost of preparing returns for AMT filers above "regular" filers was at least $135 million.[72]

But there's more. Money is not the only thing lost through the AMT filing process. There also is a great amount of time. The IRS estimated in 2000 that taxpayers spent more than 29 million hours annually completing and filing Form 6251. This computes to an average of 6 hours for every person who files the form and almost 63 hours per taxpayer who actually ends up with an AMT liability.[73] This time is forever lost to those filers. They could have spent this time with family, working, or doing other productive functions.

As a side note to this, the IRS seems to have taken steps to reduce this consumer surplus loss. In 2001, it took approximately 6 hours for the filing of Form 6251. It took approximately an additional 6 hours for Form 8801 (AMT tax credit).[74] However, without any reason in law, the IRS now estimates that it takes just under 4 hours to complete Form 6251.[75] By most accounts, this is one of the most complex forms and part of law to understand. In comparison, the IRS estimates that the 1040EZ, one of the easiest and most common forms, takes 3 hours and 43 minutes.[76] In the estimation of the IRS, it takes roughly as much time to learn about the law and keep records for the 1040EZ than the AMT. As is evidenced by this paper, this figure is highly suspicious.

In addition to the time and money lost to filing the AMT, several other factors contribute to the loss of consumer surplus. In the above graph, these combine for a real loss to the consumer of approximately $1.15[77] for every $1 of taxation. This is multiplied by every dollar of AMT liability that the government receives. In 2000 then, estimates show that the government received AMT revenue of $5.8 billion. This was an actual loss to the consumer of $6.67 billion, not including the millions of hours of productivity that would have been critical in the wake of September 11th and the economic slowdown.

This loss in consumer surplus means that items went unpurchased, people were less productive, utility was decreased, and people were forced to perform functions within the economy that were inefficient. This has significant impacts, including reduced business transactions, reduced jobs, reduced salaries, reduced productivity, and overall reduced economic growth.

Producer Surplus Loss

The consumers (taxpayers) are not the only ones losing more than they are gaining. Among the many who have forwarded requests to repeal the AMT, almost all have cited the high cost of enforcement by the IRS and associated agencies to regulate and enforce the AMT. In 1999, despite all of the professional tax preparers hired to complete AMT returns, more than 6,400 calls for help with the AMT were made to IRS Service Centers.[78] Further, while the IRS can verify some of the AMT filing calculations via computers, a majority of them must be inspected via office and field audits. These audits are both time and resource consuming. And with more than 10 percent of the AMT returns having errors, these audits are often necessary.[79] Further, the complexity of the AMT, and the increase in the scope and number of people filing under the AMT, have led to additional tax court cases. When, between 1969-1979, the system was a relatively simple "add-on" tax, virtually no cases were heard in Tax Court concerning the AMT. However, between 1990-2000, 260 individual AMT cases were heard in Tax Court.[80] Lawyers, agents, specialists, experts, judges, and administrative personnel are all committed to the process of justice involved in these cases. Effectively, this not only reduces the IRS's ability to enforce other provisions of tax law, it also burdens the Tax Court justice system. In effect the government, through the AMT, loses surplus and costs itself a great deal of money to enforce a system that is, by the Taxpayer Advocate's own admission, faulty and operating outside its design.

The AMT also adds to the complexity of the tax system. Inherently, the more complex the Tax Code, the more benefit there is to avoid taxes and, in turn, the more rational[81] people who will avoid paying their taxes. This complexity also causes government spending and private mandates such as those outlined in the Taxpayer Advocate's 2002 report to Congress. This recommendation was to increase pro-bono filing services and grant filing programs. This is real loss of "producer surplus," which creates the gravest and most avoidable of deadweight losses.[82]

All of this loss is encompassed in Figure 1. Before the AMT, the triangle DFO represents the government's producer surplus. However, after the AMT, this is reduced to triangle GHO. This can be computed by a loss of $0.25 per tax dollar collected.[83] Based on the same figures used above, this means that the government actually decreases the economy by $1.45 billion to generate $5.8 billion in revenues. This lost revenue is neither used by the private sector to stimulate the economy, nor is it "captured" by the government to redistribute and fund government spending. Essentially, it disappears into the void of mismanagement.

Deadweight Loss

In Figure 1, triangle CEF represents consumer loss while triangle FEH represents producer loss. In addition, rectangle BCHG represents the tax revenue received by the government from the AMT. Continuing with our 2000 example, this revenue is $5.8 billion. As stated above though, the amounts actually lost by both the consumer and producer are significantly greater than the $5.8 billion. Hence, the remaining loss (the addition of the excess above $5.8 billion in each) is the "deadweight loss." In our example, that is approximately $2.3 billion. This reduction of $2.3 billion is the amount people pay to their tax preparer, the loss of time, the cost to the government to enforce and collect tax payments, etc. Readers may have noticed that the government is listed as both the producer and the receiver of taxes. It is helpful in this regard to consider though that the producer side of the government and the "tax collector" are two separate faces of the same person. While it is true that people are employed in the course of the deadweight loss (tax attorneys, accountants, IRS auditors, etc.), this deadweight loss is net of their benefit. Under the AMT, it is inefficient to have these agents, auditors, etc., working for a system that need not exist. Rather, if the system were eliminated, their functioning in other jobs, or to other purposes, would increase the entire system's efficiency, and thus reduce deadweight loss.

Yet, larger numbers of people will become subject to the AMT. This increase in people and ensuing complexity will dramatically increase the deadweight loss the AMT imposes upon the American economy. The deadweight loss of the AMT, due to its deviation from its design, is evident when it is considered that in 1998, 25 percent of the taxpayers subject to AMT (mainly wealthy taxpayers) paid 81 percent of its liabilities.[84] This amount is so great, as is their income, that it offsets the contributions of the 75 percent who were never intended to be captured by the AMT. This pattern will continue as the number of filers' increases. Already, the growth in the number of AMT filers far outstrips the growth in receipts.[85]

Therefore, it can be concluded that deadweight loss will only worsen as the AMT runs its full course. This will result in a weakening of the economy and an erosion of the very support of the law and the Tax Code that the National Taxpayer Advocate discussed in her 2002 report to Congress.[86]

Congress has repeatedly attempted to repeal the AMT but to no avail. When a Republican Congress successfully passed a bill for its repeal, a Democratic President vetoed the measure. Now though, with a Republican controlled Congress and White House and unprecedented tax cut packages, the AMT remains a festering sore in the American Tax Code. It has failed to "capture" all high-income earners into paying at least some income tax. It has failed to strictly entrap high-income earners, instead entrapping people of lower and lower means. It has added untold complexity to the tax laws. Moreover, it has caused numerous losses to the economy. All of this the AMT has done with little to no real benefit to the government or the people of the United States.

In early 2003, the U.S. Congress was advised that, "…any future reductions in the federal income tax burden without modifications to the AMT will likely increase the number of taxpayers subject to the AMT or subject to the AMT limitations on their personal tax credits. For example, proposals to stimulate the economy through reductions in the individual income tax would likely push more taxpayers into the AMT."[87] Despite this warning, and the expressed concerns of numerous experts, Congress and the President enacted only temporary reforms. After 2004, the "sunset" of these provisions in conjunction with the reduced marginal and capital gains rates will create a perfect storm that will result in nearly 16 million people being directly affected by the AMT in 2005 alone.

A cornucopia of agencies, individuals, organizations, and businesses have advocated for the repeal of the AMT. In addition to the National Taxpayers Union, among the most notable are: The National Taxpayer Advocate, the Tax Executives Institute, the American Institute of Certified Public Accountants, the American Bar Association Section of Taxation, Fortune Magazine, and Money Magazine.

While it is politically tempting to ignore this issue until it becomes an item of greater impact to Americans, it is this temptation which will lead the AMT to a continued problematic existence. Continued delay will merely result in further losses to the economy and further corrective costs. It will also lead to a political motivation to design a solution which is "revenue neutral" and thus cause further damage to the fiscal stability of the nation.

Taxpayer Advocate Nina Olson was correct when she said "[W]e are seeing an erosion in the confidence and compliance of the taxpayer on the street with the tax system because the tax system has lost its relevance to that taxpayer."[88]

The repeal of the AMT will greatly reduce administrative complexity, compliance costs, and deadweight loss, all while simplifying tax law. The benefits to the economy, the taxpayer, and the government will, in the long run, more than repay any foregone short-term revenues. It may also act as an impetus to Congress to reform other areas of the tax code to make it less complex and more efficient. Indeed, getting rid of the AMT could be one of the greatest boons to overall government reform in decades.

About the Author

Matthew S. Bailey served as an Associate Policy Analyst at the National Taxpayers Union Foundation in 2003.

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