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The Individual Alternative Minimum Tax President’s Advisory Panel on Federal Tax Reform 3 March 2005 Leonard E. Burman

The Individual Alternative Minimum Tax President’s Advisory Panel on Federal Tax Reform 3 March 2005 Leonard E. Burman Senior Fellow, The Urban Institute Codirector, The Tax Policy Center Visiting Professor, Georgetown Public Policy Institute.

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The Individual Alternative Minimum Tax President’s Advisory Panel on Federal Tax Reform 3 March 2005 Leonard E. Burman

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  1. The Individual Alternative Minimum Tax President’s Advisory Panel on Federal Tax Reform 3 March 2005 Leonard E. Burman Senior Fellow, The Urban Institute Codirector, The Tax Policy Center Visiting Professor, Georgetown Public Policy Institute

  2. 1966: 155 high-income taxpayers paid no income tax 1969: creation of a minimum tax designed to ensure high income filers did not exploit tax laws to reduce or eliminate their federal income tax liability 2010: AMT will affect 30 million taxpayers, including virtually all upper middle class families with two or more kids. Background

  3. Determination of AMT Liability • Add preferences and adjustments to taxable income • Subtract AMT exemption • Calculate tax using AMT rate schedule and rules • If more than regular tax, pay the difference as AMT • (Many complexities left out of this simplified explanation.)

  4. AMT Exemptions and Schedule • AMT exemption currently $58,000 for couples, $40,250 for singles • In 2006, exemption drops to $45,000/$33,750 • Exemption phases out at higher incomes, creating high implicit tax rates • Statutory rates = 26% and 28%, but exemption phaseout creates phantom rates of 32.5% and 35% • Not indexed for inflation

  5. AMT Preference Items • State and local tax deductions (51% of total) • Personal Exemptions (22%) • Miscellaneous deductions above the 2% floor (20%) • Net Operating Losses (12%) • Incentive Stock Options (2%) • Passive Activity Loss (2%) • Post-1986 Depreciation (1%) • Standard Deduction (1%) • Private Activity Bonds Interest (1%) • Medical Deductions (1%) • Note: Sum adds to more than 100 percent because some adjustments not shown, such as state tax refunds, are negative. • Source: Burman and Weiner, “Suppose they Took the AM out of the AMT.”

  6. Causes of AMT Growth Current Law (extended) Effect of income tax cuts without permanent AMT fix Pre-2001 Law Effect of failure to index for inflation Pre-2001 Law, with indexing Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  7. AMT Projections • Baseline AMT revenue = $1.2 trillion from 2005-15 • $670 billion if the tax cuts are not extended in 2010 • About 4% of taxpayers on AMT in 2005 • 20% in ’06 and 30% in ’10

  8. AMT Demographics (2010) • AMT inflicts large marriage/child penalties • 48% of married couples vs. 3% of singles on AMT • 94% of marrieds with 2+ kids and AGI between $75&100K • Residents of high-tax states are 5 percentage points more likely to be on AMT than those in low-tax states

  9. Drifting Off Target • Though intended to make high-income people pay tax, AMT will increasingly hit middle class • Over 80% of AMT taxpayers will have income < $200K in 2010 • More than 1/3 have income < $100K • Families earning $75-100K 18% more likely to be on AMT than those earning over $1 million • Those earning $100-200K more than twice as likely as millionaires

  10. Problems with the AMT • Good Tax Policy is… • Simple • Efficient • Fair • The AMT violates all of these principles.

  11. Pointless Complexity • Many middle class taxpayers must file AMT Form 6251, but owe no AMT • AMT rules regarding credits, capital gains, dividends, deferral preferences very complex • Most deferral preferences don’t even generate much revenue, just change the timing of tax payments • Vastly complicates tax planning

  12. Efficiency • The AMT raises marginal tax rates for most • 71% of AMT taxpayers face higher marginal tax rates under AMT in 2005 • 92% will be in that situation in 2010 • People creep into higher brackets over time because, unlike the regular income tax, AMT is not indexed • Might enhance efficiency to extent that it deterred tax shelters, but 90% of AMT preferences have nothing to do with shelters

  13. Equity • Nasty marriage/child penalties • Some legitimate adjustments to ability to pay are disallowed under AMT (e.g., contingent legal fees) • AMT makes the tax system more progressive, but less so over time • Relatively little tax collected from very rich

  14. Conclusions • Pointless complexity and bizarre pattern of taxes • Increasingly a tax on the upper middle class • Better to build anti-tax shelter provisions into regular tax and adjust rates to hit revenue target

  15. Appendix • Supplemental tables and charts • Further reading

  16. AMT Exemptions and Schedule

  17. Rate Schedule for Couples, AMT vs. Regular Tax: 2004

  18. Total AMT Revenue, 2005-15 Current Law (extended) Pre-EGTRRA Law Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  19. By 2008, it will cost more to repeal the AMT than the regular income tax. Cost of repealing the regular tax Cost of repealing the AMT Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  20. AMT Projections by Individual Characteristics Percent on AMT Current Law 2005 2006 2010 Characteristic Percent of Taxpayers 3.8 20.4 30.4 Percent of Tax Filers 2.7 14.6 22.6 by Filing Status Single 0.8 1.6 2.9 Married Filing Joint 5.2 30.7 47.9 Head of Household 0.8 4.2 7.9 Married Filing Separate 5.9 29.0 45.9 Addendum: AMT Revenue in $billions, 2005-2015 Current Law Current Law Extended Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  21. AMT Projections by Individual Characteristics AMT Participation Rate (percent) Current Law Characteristic 2005 2006 2010 Filers By State Tax Level* Low 0.8 10.5 18.3 Middle 1.3 13.9 22.6 High 2.7 15.8 23.8 Filers by Number of Children 1.8 8.3 15.6 0 2.5 27.9 17.6 1 5.0 40.6 31.4 2 8.4 47.7 37.0 3 or more Married Couple, 2+ kids, 75k<AGI<100k 1.6 94.4 77.2 • *Excludes effect of sales tax deduction, in effect for 2005. • Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  22. AMT Projections by Income AMT Participation Rate (percent) Cash Income (thousands of 2003$) Current Law 2005 2006 2010 Less than 30 0.0 0.0 0.0 30-50 1.1 0.1 2.9 50-75 6.0 16.9 0.5 75-100 53.4 0.8 31.8 6.8 100-200 81.0 63.0 200-500 53.4 87.0 93.9 500-1,000 39.3 51.8 62.6 1,000 and more 26.7 33.4 35.3 Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  23. Percent of AMT Taxpayers who Face Higher Marginal Tax Rates Under the AMT Source: Urban-Brookings Tax Policy Center Microsimulation Model, 2005

  24. Distribution of AMT versus Regular Tax Liability: 2005 & 2010

  25. Further Reading Burman, Leonard E. and David Weiner. 2004. “Suppose They Took the AM out of the AMT?” available at www.taxpolicycenter.org. (examines issues raised if the AMT were a standalone income tax) Burman, Leonard E., William G. Gale, Jeffrey Rohaly, Matthew Hall, and Mohammed Adeel Saleem. 2004. “AMT: A Data Update” available at www.taxpolicycenter.org. (includes estimates of some reform options) Burman, Leonard E., William G. Gale and Jeffrey Rohaly. 2003. “Policy Watch: The Expanding Reach of the Individual Alternative Minimum Tax,” with Journal of Economic Perspectives 17(2): 173-186. Burman, Leonard E., William G. Gale, Jeffrey Rohaly, and Benjamin H. Harris. 2002. “The Individual AMT: Problems and Potential Solutions,” National Tax Journal 55(3): 555-596. Feenberg, Daniel R., and James M. Poterba. 2004. “The Alternative Minimum Tax and Effective Marginal Tax Rates,” National Tax Journal 57(2): 407-427. General Accounting Office. 2000. “Alternative Minimum Tax: An Overview of its Rationale and Impact on Individual Taxpayers.” Report to the Chairman, Committee on Finance, U.S. Senate (GAO/GGD-00-180). August. Harvey, Robert P. and Jerry Tempalski. 1997. “The Individual AMT: Why it Matters.” National Tax Journal 50(3): 453-473. Rebelein, Robert and Jerry Tempalski. 2000. “Who Pays the Individual AMT?” U.S. Department of the Treasury, OTA Paper 87.  

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