Suppose they took the AM out of the AMT?

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I. Introduction

The individual alternative minimum tax (AMT) was originally intended to assure that high-income people paid at least some tax, but the AMT was poorly designed and affects more and more middle-income people every year.¹ Unless there is a change in policy, about 30 million taxpayers will fall prey to the complicated tax by the end of the decade. Unfortunately, the AMT raises a lot of tax revenue: reforming or eliminating it could cost $500 billion or more over the next decade.

These problems have led some to suggest that the best option would be to make the AMT the regular tax system, rather than an alternative. This option would have several advantages according to its proponents. The AMT is nearly a flat-rate tax—there are only two statutory rates, of 26 and 28 percent. It eliminates a variety of special tax breaks in the regular tax system; that is, it applies to a broader base. And, over the long run, it is a more effective revenue generator than the regular income tax. Indeed, by 2009, it would cost less to eliminate the regular tax than to eliminate the AMT.

There are some problems with this analysis. First, the AMT is not really a flat tax: The AMT has high phantom tax rates—equal to 32.5 and 35 percent—caused by the phaseout of the exempt threshold. Second, some of the base broadeners in the AMT have questionable validity as policy. For example, deductions for certain legal expenses are not allowed under the AMT, with the consequence that some people who win civil damage awards with contingent legal fees can end up worse off after tax than they would have been if they had lost the lawsuit. Parents may not claim deductions for their children against the AMT. And the AMT can impose very large marriage penalties on certain households. Finally, the AMT's power as a revenue generator stems entirely from the fact that its parameters are not indexed for inflation. In consequence, people whose incomes only just keep pace with inflation will face higher and higher average tax rates over time (a phenomenon sometimes referred to as bracket creep).

Nonetheless, there is certainly merit to the notion that taxpayers should not be subject to two tax systems. This paper examines the implications of basing a reformed tax system on the AMT rules. Section II describes how the AMT works and compares the AMT's rules with those that apply under the regular income tax. Section III discusses a variety of policy simulations aimed at illustrating how repealing the regular income tax or splicing the AMT's rules onto the regular income tax structure would affect households and revenues. Several of the options are designed to be revenue-neutral, meaning that they are admissible candidates for reform assuming that revenue neutrality would be a goal of reform. Section IV discusses policy implications.

Notes from this section

1. For a discussion of the problems and trends with the AMT, see Burman, Gale, and Rohaly (2003), Burman, Gale, Rohaly, and Harris (2002), and Harvey and Tempalski (1997).

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