The alternative minimum tax and effective marginal tax rates.

INTRODUCTION

The Alternative Minimum Tax (AMT) is a provision of the U.S. income tax code that traces its history to the Tax Reform Act of 1969. That tax legislation included a minimum tax, which took effect in 1970. The minimum tax was levied at a 10 percent rate on income tax preferences in excess of $30,000, with a deduction allowed for regular tax paid. Later, the minimum tax became a 15 percent tax on preferences in excess of the greater of $10,000 or one-half of regular tax paid. Preferences included accelerated depreciation, oil depletion, and the capital gains deduction. Net operating losses and retirement income received special treatment.

In 1978, Congress enacted a new "Alternative Minimum Tax" with a base that included all the components of Adjusted Gross Income (AGI), the capital gains exclusion, and preferences. The full amount of regular income tax was allowed as a credit against the AMT. The original minimum tax expired in 1981, but the alternative minimum tax remains in force, with relatively little change in its basic structure or rates. The most substantial change occurred in 1986, when the Tax Reform Act of 1986 expanded the base for both the AMT and the Individual income tax. When a preferential tax rate for long-term capital gains was established in 1991, care was taken to avoid treating capital gains as a preference. The U.S. Congress Joint Economic Committee (2001) provides a historical overview of the AMT. Graetz and Sunley (1988) discuss the origins of both the minimum tax and the AMT, and they also outline the conceptual arguments for, and against, some type of minimum tax.

While the AMT has historically affected relatively few taxpayers, research studies in the last decade have identified the AMT as an increasingly important feature of the federal tax system. Harvey and Tempalski (1997) were among the first to recognize that because the exclusion level for the AMT was not indexed for inflation, while most other key parameters in the tax code were, the AMT would apply to a growing number of taxpayers. Rebelein and Tempalski (2000), the U.S. Congress Joint Economic Committee (2001), Tempalski (2002), and Burman, Gale, and Rohaly (2002) provide further analysis of the growing importance of the AMT.

The Economic Growth and Taxpayer Relief Reconciliation Act of 2001 (EGTRRA), which reduced ordinary income tax liabilities for many households, increased the relative importance of the AMT as part of the federal revenue structure. The EGTRRA tax cuts are currently scheduled to expire in 2010. Beginning in 2011, the tax code is scheduled to revert to its pre-2001 form. This means that 2010 is the year when the EGTRRA changes have their largest effect. The Jobs and Growth Taxpayer Relief Reconciliation Act of 2003 (JGTRRA) accelerates the effect of EGTRRA, because it brings forward some of the tax reductions that were enacted in 2001 but scheduled for implementation in the second half of the current decade. Kiefer, et al. (2002) and Burman, Gale, and Rohaly (2002) show that there are substantial numbers of taxpayers who will be moved from ordinary income tax files to AMT filers as a result of the EGTRRA rate reductions. By speeding the implementation of the EGTRRA rate cuts, JGTRRA speeds the transition of these taxpayers into the AMT regime.

The AMT will reduce the tax saving that many upper middle income households receive from EGTRRA. Burman, Gale and Rohaly (2003a, 2003b) suggest that in 2010, taxpayers will forego 33.8 percent of the tax relief that would otherwise have been associated with EGTRRA because they will face the AMT, and their AMT liabilities will exceed their income tax liabilities. For taxpayers with AGI between $100,000 and $500,000, this AMT recapture will exceed two-thirds of the EGTRRA tax relief.

The AMT is widely denounced in the tax policy community because it adds to the complexity of the tax code and can effectively require taxpayers to prepare two tax returns, and then to pay the higher tax due. It is also derided as confusing and leading to taxpayer uncertainty about applicable marginal tax rates and tax incentives. The National Taxpayer Advocate identifies the AMT as "the most serious problem faced by taxpayers." The IRS estimates that taxpayers who need to file Form 6251, the AMT form, devote 74 minutes to learning about the form, 19 minutes to recordkeeping, 109 minutes to preparing the tax form, and 34 minutes to copying, mailing, and related tasks. Assuming that a taxpayer only needs to learn about the AMT once, these data suggest that on an annual basis, taxpayers who pay the AMT devote an average of just over two and one-half hours to preparing their AMT return. The AMT may also burden taxpayers who are not ultimately AMT filers, but who nevertheless need to compute both ordinary income tax liability and AMT liability, and compare them, before discovering that they do not need to pay the AMT.

The burden of AMT preparation is likely to be very unequal. For some taxpayers, the AMT calculation requires no information that is not already used to calculate ordinary income tax liability. For other taxpayers, however, the AMT requires not just a slightly different combination of the same numbers, but the addition of information that the taxpayer otherwise would not need to know. This can be particularly problematic when there is no information return for the item.

Although it is widely criticized, the AMT may prove difficult to eliminate in the current fiscal environment. The AMT is projected to become a substantial source of federal tax revenue between 2006 and 2010 period. Eliminating the AMT would, therefore, raise the federal budget deficit, place pressure on expenditure programs, or require increases in other taxes. Sullivan (2002) offers a careful review of the issues associated with the potential repeal of the AMT, and the difficult political economy challenges that repeal would encounter.

While much of the debate surrounding the AMT has focused on its complexity and the compliance burden that it may place on taxpayers, there has been much less attention to its impact on incentives. In this paper, we use the NBER's TAXSIM program to evaluate the impact of the AMT on marginal tax rates and on the associated taxpayer incentives to work and to save. We also present our estimates of the number of taxpayers who will face the AMT, assuming that current law remains in force, over the 2004-2013 period. We emphasize calendar year 2010, the year when the AMT is projected to affect the largest number of taxpayers. Although our projections rely on strong assumptions about the future number of tax returns and the level and composition of income on these returns, they offer some insight on the likely future course of the AMT relative to the ordinary income tax.

The paper is divided into six sections. The first describes the basic structure of the AMT and compares alternative minimum taxable income with ordinary taxable income. The second section describes our procedure for projecting future AMT liabilities and presents our projections of the aggregate number of AMT taxpayers as well as the number of taxpayers in various income sub-categories. Our results are broadly consistent with those from other recent studies that project future AMT liabilities. The third section describes the probabilities of facing the AMT for taxpayers in various income categories and studies how various reform proposals would affect these probabilities. The fourth section investigates the impact of the AMT on the weighted average marginal tax rates that apply to wages, interest income, and dividend income, as well as the marginal subsidy rates that apply to several classes of income tax deductions. We consider federal marginal income tax rates as well as combined federal and state marginal income tax rates. The fifth section explores the effect of various reform proposals on the weighted average marginal tax rates on income and deduction flows. There is a brief conclusion.

THE STRUCTURE OF THE ALTERNATIVE MINIMUM TAX