Prognosis for AMT: Minimal change ahead

The alternative minimum tax (AMT), enacted in 1986 to make sure that a handful of millionaires paid at least some federal income tax, has come to affect tens of millions of taxpayers — most not even close to being millionaires. But even though the AMT is taking a tax bite out of a burgeoning number of filers, the outcry most likely will continue to be addressed by temporary annual fixes, not the abolishment of the AMT, according to Charles Christian and Donald Goldman, tax experts at the School of Accountancy in the W. P. Carey School of Business.

The alternative minimum tax (AMT), enacted in 1986 to make sure that a handful of millionaires paid at least some federal income tax, has come to affect tens of millions of taxpayers — most not even close to being millionaires. But even though the AMT is taking a tax bite out of a burgeoning number of filers, the outcry most likely will continue to be addressed by temporary annual fixes, not the abolishment of the AMT, according to tax experts at the School of Accountancy in the W. P. Carey School of Business.

Charles Christian, Director of the School of Accountancy, says a temporary increase to the AMT exemption amount in 2006 kept upper-middle-income taxpayers from being gouged. Congress is expected to adjust the exemption again — to some degree — for the 2007 tax year. If they do not, an estimated 23 million taxpayers will be subject to the AMT this year.

"We have no idea what they'll come up with this year," Christian says. The congressional process involves plugging in various numbers, estimating the revenue effect, then gauging the AMT exemption accordingly. The fact that the AMT has affected more and more filers is not just because of the prior failure to adjust the AMT to inflation for the better part of two decades; it is also because of the more than $2 trillion in Bush tax cuts that started in 2001.

"One of the biggest factors is that the cuts in the regular tax rate pushed so many people into the AMT," Christian says. The AMT affected 4 million filers in 2006, but that number is expected to rise to at least 23 million and perhaps as many as 26 million for tax year 2007. W. P. Carey School of Accountancy Senior Lecturer Donald Goldman explains that interrelated factors propel AMT creep.

"The regular tax brackets are indexed for inflation, so it takes higher income each year before the taxpayer becomes subject to tax at a higher rate," Goldman says. "The AMT exemption amount has not been indexed for inflation. So a taxpayer with the same income over time has seen his regular tax decrease significantly, but his tentative minimum tax (TMT) has remained the same. A taxpayer is subject to AMT when his TMT exceeds his regular tax. So, you can see the problem."

The AMT's original aim was to prevent high-income taxpayers from sheltering their income with deductions, Goldman says. "In fact, if I remember correctly, the AMT was created because '19 millionaires' — persons with at least $1 million of positive income before losses or deductions — paid no tax.

So, the AMT has a broader base than the regular tax but a lower rate than the regular tax top rates." What would happen if the AMT were abolished? "There would be a very large increase to the annual deficit," Christian says. "Those who favor abolishment have a low estimate of the cost. Those who oppose it have a large number."

Those annual deficits in the federal budget add to the accumulated national debt, which recently topped the $9.1 trillion mark, up from $5.6 trillion when Bush took office. Is growth in AMT revenues a major reason the annual deficit has been getting smaller the past few years after the record high of $412 billion in 2004?

"I would say that the deficit has not grown as much as it would have as a result of enacted tax cuts because the AMT limits the benefits that taxpayers have gotten from those tax cuts," Goldman says. In his Sept. 6 testimony before the House Ways and Means Committee, Leonard E. Burman, director of the Urban Institute's Tax Policy Center, said the AMT has masked the cost of the Bush tax cuts.

"In principle, the AMT will take back almost 20 percent of the income tax cuts enacted for 2007," Burman testified. "In practice, Congress is almost sure to spare tens of millions of families from this ultra-complicated tax, so the price tag for the tax cuts is much higher than advertised." Christian says the consensus is that the tax system would be less progressive without the AMT; that fact — and the expected larger deficits — make abolishment politically unpalatable.

Goldman puts it this way: "If the AMT were abolished with no other changes to the tax law, federal tax revenues would decrease by $45 billion to $55 billion this year. That number is projected to grow every year. Since tax bills are scored based on their revenue impact over a 10-year period, the repeal of AMT might be viewed as a $700 billion or so tax cut. Politically, there is no way that will happen."

One-year AMT patches worry pay-as-you-go advocates who say the national debt already is too big. But a patch offers relief to those at the bottom end of the earnings scale who are affected by the AMT, filers who most need relief. Such patches make the tax system more progressive.

"While the periodic temporary increases in the AMT exemption have blunted the tax's impact on the middle class, they also lead to great uncertainty about individual income tax liability and can undermine fiscal discipline," Burman told Congress. "The tax system is a tradeoff between complexity and equity," Christian notes. "Tax progressivity is closely related to the AMT; it makes the system somewhat more progressive."

The concentration of income in the United States is increasing, Christian says, despite the fact the progressivity of the tax system relative to the top 1 percent of earners has increased slightly. Christian points to Congressional Budget Office numbers. In 2004, the top 1 percent of earners made 16.3 percent of the nation's income and paid 36.7 percent of the federal income tax.

In 1979, the top 1 percent of earners made 9.3 percent of the income and paid 18.3 percent of the tax. Goldman sees a high likelihood of a one-year "fix" to the AMT exemption for 2007, resulting in about 4 million taxpayers (instead of 23 million or more) being subject to AMT. "The issue is whether Congress will pay for that fix with other tax revenue raisers, as the Democrats generally want, or whether it will just increase the deficit, as is generally the position of the Republicans," Goldman says.

The proposed repeal of the individual AMT as part of a comprehensive tax bill is "dead on arrival," Goldman says, until after the 2008 presidential election. "There are too many losers — those whose tax preferences would be repealed or whose tax rates would be raised — for it to move forward as we lead up to a presidential election."

Christian advises against expecting the 66,000-page federal tax code to be simplified anytime soon. "A simpler tax system is an elusive goal that has been around even longer than the modern AMT," Christian says. "I don't think there's ever been a meaningful simplification bill."

And, he says, there is a reason for that: "Economic transactions are becoming more and more complex, so the tax system reflects the underlying complexity of our economy." Further complicating the tax picture are the heavy influences of lobbying and campaign finance. Do special interest groups affect the tax system? "The answer is an unequivocal yes," Christian says. Goldman says that after the 2008 elections, change may proceed, including a serious attempt to repeal the individual AMT.

"It may take a form similar to that recently proposed by Rep. (Charles) Rangel, eliminating targeted tax breaks, lowering the top corporate tax rate, raising the top individual tax rate, and increasing third-party reporting to try to capture some of the 'tax gap,' especially if the Democrats control Congress and the White House," Goldman says.

"It is also likely that, at the same time, they will address the many tax provisions that expire in 2010, such as the estate tax, the lower rates on dividends — currently taxed at a rate no higher than 15 percent but historically taxed at the same rate as other ordinary income — the lower rates on capital gains, etc.," Goldman adds. "If the Congress is split or the Congress and the White House are split, I suspect that any broad-based solution will be difficult to get passed, and we may continue to see a series of patches."

Bottom Line:

• The alternative minimum tax (AMT) kicks in when a filer's tentative minimum tax (TMT) exceeds his regular tax.
• For nearly 20 years, the AMT was not adjusted for inflation, so the small number of very high-income earners originally targeted has swollen to include 4 million filers in 2006, many of them upper-middle-income earners, not millionaires.
• Cuts in the regular tax rate enacted since 2001 have moved many filers into the AMT.
• Temporary one-year "patches" spare upper-middle-income filers from being gouged and maintain progressivity in the tax system but such "fixes" cost the government revenue.
• Abolishment or major overhaul of the AMT will not occur at least until after the 2008 elections.