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Tax Fairness, the 2001-2006 Tax Cuts, and the AMT

Testimony before the U.S. House Committee on Ways and Means

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Document date: September 06, 2007
Released online: September 06, 2007

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.


Abstract

In this testimony Burman discusses the issues of tax fairness, the 2001 to 2006 tax cuts, and the individual alternative minimum tax. Burman argues that while the federal tax system mitigates economic inequality, the recent tax cuts have disproportionately benefited those at the top, while also increasing the number of people potentially subject to the AMT. He concludes with a brief discussion of how to fix the AMT in a fiscally responsible manner.


The text below is Burman's oral testimony.
Read the full written testimony in PDF format.

Testimony

Chairman Rangel, Ranking Member McCrery, Members of the Committee: Thank you for inviting me to discuss the issues of tax fairness, the 2001 to 2006 tax cuts, and the individual alternative minimum tax (AMT).

Economic inequality is rising dramatically. Middle class families are working harder than ever and productivity is soaring, but almost all of the gains are going to a tiny sliver of the population at the very top of the income scale.

What explains rising inequality? Increased globalization, information technology, the decline in labor unions, and the development of a winner-take-all society where top performers receive almost all of the economic rewards are all candidate explanations. None of these factors is likely to reverse, so the trend in inequality appears inexorable.

This is a problem. First, it is demoralizing for families to work so hard and fall further and further behind. Second, even if you believed that most economic growth arises from the efforts of a few highly talented individuals who deserved their outsized pay, rising inequality spurs populist calls for measures that could be very damaging to the economy, such as trade restrictions.

By comparison, a progressive income tax is a relatively efficient way to reduce the disparity of after-tax incomes. But at the same time that income inequality has been approaching levels not seen since the great depression, the federal tax system has become much less progressive.

Congress has enacted more than $2 trillion in tax cuts since 2001, disproportionately concentrated on the rich. In 2006, the bottom 20 percent of income earners got on average $20—0.3 percent of their income. Most in that income group got nothing. The top 20 percent got an average tax cut of almost $5,800, or 5.4 percent of income. At the very top, where the big winners in the economic lottery reside, the average tax cut was more than 6 percent of income.

The tax cuts had another unfortunate side effect: they threaten to throw millions of American families onto the AMT. Under current law, over 23 million taxpayers will owe AMT this year. That is more than twice the number who would have been subject to the tax if the Bush tax cuts had not been enacted. The tax now hits families with very modest incomes and no special deductions. For example, a couple with four kids earning $75,000 would see their tax more than double in 2007 because of the AMT.

The AMT also—at least in theory—takes back a substantial portion of the Bush tax cuts. Unless Congress prevents it, the AMT will slice 20 percent off of the tax cuts in 2007. Because they’re on the AMT, that hypothetical family of six would get no benefit from the lower tax rates or higher standard deduction enacted in 2001.

Of course, Congress doesn’t want to face the wrath of 23 million angry AMT taxpayers. If past practice is a guide, you will again raise the AMT exemption for a year or two to spare most of the middle class from the tax.

But this means that the 2001 to 2006 tax cuts were really a lot bigger than budgeted. The total bill includes the cost of the periodic, increasingly expensive, patches. In 2007, the patch would reduce revenues by over $50 billion. Put differently, the AMT masked a big part of the tax cuts, and probably allowed Congress to enact cuts much larger than it would have, had all of the costs been considered.

The ironic fact is that, even though the AMT appears to be a money machine, it has actually undermined fiscal discipline by hiding the full cost of large tax cuts.

The AMT has other notorious defects. It is hideously complex. It actually raises marginal tax rates on most of its victims, undermining economic efficiency. And it is unfair—hammering married couples, especially those with children—and disallowing legitimate deductions. It is the perfect storm of bad tax policy.

What to do about this mess? The best approach would be to finance repeal of the AMT by broadening the tax base—for example, eliminating the deductibility of state and local taxes—rather than raising rates. Even better, AMT repeal could be part of fundamental tax reform, but there are obvious political challenges to either approach.

Fortunately, intermediate options exist that would help a lot. I have suggested financing AMT repeal with a surtax that would apply only to high-income taxpayers (Burman and Leiserson 2007). It would be very simple for taxpayers to comprehend and comply with. The Ways and Means Committee majority staff has reportedly considered retargeting the AMT at those with very high incomes and offsetting the revenue loss through an additional income tax.

Any repeal or reform option should be budget neutral, as the PAYGO rules require. Repealing the AMT without offsetting tax increases or spending cuts would drain federal tax revenues just as the baby boomers start retiring and demands on the federal government begin to swell. Outright repeal of the AMT without any other offsetting changes would reduce tax revenues by more than $800 billion through fiscal year 2017, assuming that the 2001–2006 tax cuts expire as scheduled. If the tax cuts are extended, the revenue loss nearly doubles to almost $1.6 trillion.

The text above is Burman's oral testimony.
Read the full written testimony in PDF format.

The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.



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