The majority party in Congress threatens to use the annual
ordeal of extending the alternative minimum tax (AMT) patch as a
ruse to raise taxes. Policymakers and the public need to expose
this ruse, reject the tax hike, and turn to practical, substantive
reform to end this pernicious tax.
The AMT patch is an increase in the AMT exemption amount
that kept the AMT at bay for about 18 million taxpayers in 2006. The
patch expired at the end of 2006, and unless Congress acts, a
married AMT filer may face a tax increase of up to $5,026. This
tax hike would fall almost exclusively on middle-class and
upper-middle-class families and would be a big and unhappy surprise
Fortunately, broad bipartisan agreement deems an AMT tax hike
unacceptable. However, Congress may try to raise taxes through an
AMT patch ruse that may not be immediately apparent from the
official scoring because of an oddity in the Congressional Budget
Office (CBO) revenue baseline. Specifically, the CBO includes the
revenues from a lapsed but long-standing tax provision in the
baseline, which is absurd--so absurd that it does not apply the
same methodology to spending programs.
Another problem with the AMT patch ruse is that it diverts
attention from the important matter of resolving the AMT
issue, preferably by repealing the AMT altogether. The AMT today is
a tax policy without a purpose, a complication without a
One device often used to avoid positive action is to argue that
the AMT issue is complicated and can be solved only by a massive
overhaul of the tax code. This device has been used to delay repeal
of the AMT, and it is incorrect. The AMT can be repealed on a
revenue-neutral basis (properly defined) by reforming one or two
other aspects of the individual income tax that distort
economic decision making. A number of options are available,
and the last section of this paper describes the best option for
Three Policy Choices
Congress faces three policy choices on the AMT patch. First, it
could enact a huge tax hike to "pay for" extending the AMT patch
through 2007. This approach, which relies heavily on confusion
about the CBO revenue baseline, is advocated by Representative
Charles Rangel (D-NY), chairman of the House Ways and Means
Committee, and Senator Kent Conrad (D-ND), chairman of the Senate
Budget Committee. Mr. Rangel looks to extend the patch through 2008
and then repeal the AMT altogether thereafter by raising taxes on
other taxpayers such as savers, investors, and entrepreneurs.
Senator Conrad leans toward retaining the AMT while extending the
AMT patch and using the extension as an excuse to raise taxes. Both
approaches would increase taxes by nearly $1 trillion over the next
The second choice is to extend the patch without raising
taxes. Extending the AMT patch is a minimalist but acceptable
policy in that it prevents a massive tax hike. If Congress can
do nothing else, then it should at least extend the patch for
The third and best choice is to avoid the trap of the CBO
baseline by adjusting it downward to reflect a permanent extension
of the AMT patch. Using the corrected baseline as a point of
reference, Congress should then repeal the remainder of the AMT on
a revenue-neutral basis through a sensible reform of the income
tax. This reform should recognize the importance of preserving
economic incentives while leaving the distribution of the tax
burden as steady as possible. Such a reform is discussed in the
final section of this paper.
Setting the Stage for the AMT
The budget deficit for fiscal year (FY) 2007 was $163 billion,
according to the U.S. Department of the Treasury, down from $248
billion in 2006. This is a remarkable achievement considering the
enormous sums still being spent on Katrina recovery efforts
and the far greater sums spent on the wars in Afghanistan and Iraq.
If not for this extraordinary spending, the budget would have been
essentially balanced in 2007.
Recent spending restraint has contributed somewhat to the
improved budget picture. For example, total federal outlays grew
only about 2.8 percent between 2006 and 2007. Yet the real story
is how the tax cuts of 2001 and 2003 restored the economy to robust
growth, which has resulted in an enormous growth in tax
receipts. Federal receipts in 2005 were up 14.5 percent from the
year before. Federal receipts increased by 11.8 percent in 2006 and
by 6.6 percent in 2007. Although the economy will face
extraordinary hurdles from time to time, such as the current
housing slump and its associated credit crunch, the economy
will soon resume a pace of steady growth, generating in turn steady
growth in government receipts.
To be sure, $163 billion is still a significant sum, but the
deficit should be interpreted in context. For example, the deficit
was about 1.2 percent of gross domestic product (GDP), compared to
the average postwar deficit-to-GDP ratio of about 2.2 percent. The
decline in the deficit along with continued economic growth
means that the ratio of publicly held debt to GDP is falling, a
standard indicator for good near-term fiscal health. As long as the
economy continues to expand and the federal government maintains a
modicum of spending restraint, the federal budget should reach
balance by 2012, if not well before.
Consequently, on the current spending trajectory, there is
no budgetary case for hiking taxes. On the contrary, Congress
should consider additional pro-growth tax cuts, allowing Americans
to retain more of the fruits of their labor and giving the American
economy more opportunity to grow and raise family incomes.
However, Congress apparently does not intend to keep to the
current trajectory on spending. The spring 2007 supplemental
spending bill to fund the troops in Iraq and Afghanistan included
$20 billion in unnecessary domestic spending. The
congressional budget resolution laying out the budget
blueprint for 2008 calls for increasing non-defense
discretionary spending by more than $40 billion (about 9.0
percent). This is an extraordinary increase in
spending at a time when inflation is forecast at 2.7
percent. In addition, Congress is anticipating
up to $190 billion in increased spending on farm programs, the
State Children's Health Insurance Program, and other
To enact all of this spending without reversing progress on the
budget deficit, Congress would need to raise taxes--a lot. The
expiration of the AMT patch provides a convenient and usefully
complicated field in which to harvest a lot of tax revenue.
However, the correct course of action is to forgo these spending
increases, thereby eliminating any need for a huge tax hike.
The AMT and the Patch
The AMT has always been bad tax policy, but today it stands
utterly stripped of its original policy justification as an extra
tax on a small number of targeted high-income taxpayers. It
remains relevant only because the federal government is addicted to
the enormous stream of AMT revenues. Even with a patch, the AMT is
believed to have brought in almost $20 billion in 2006.
Structurally, the AMT is just another poorly designed income
tax. Taxpayers calculate their tax liability under the regular
income tax and again under the AMT, and pay whichever tax is
higher. The AMT differs from the regular income tax in that its top
rate is 28 percent compared to 35 percent for the regular income
tax. Although it has a lower marginal rate, the AMT also has a
larger standard exemption amount ($45,000 for married filers) to
keep lower-middle-income taxpayers out of its reach; but there is
no personal exemption for children, so larger families are
more likely to be AMT payers. It also denies certain deductions,
the most noteworthy of which is the deduction for state and local
The AMT patch is a significant bump up in the AMT exemption
amount. The original patch, set at $4,000 for a married filer, was
devised as part of the 2001 tax relief bill. The 2001 tax bill
reduced income tax rates, increased the child tax credit, and made
other tax changes that had the net effect of significantly lowering
regular income taxes. The reduction in regular income tax liability
created potential AMT taxpayers out of some who previously had
paid no AMT. The original AMT patch was intended to reduce AMT
liabilities somewhat in tandem with the reduction in the regular
income tax, ensuring that few taxpayers would lose this regular
income tax relief by falling into the AMT.
Since 2001, the "temporary" AMT patch has been extended time and
again, preventing a significant tax hike on millions of
taxpayers. Congress has also increased the patch over the years,
first to index it for inflation and subsequently to hold the number
of AMT filers constant. For 2006, the patch was $17,550, raising
the total exemption to $62,550. However, from the outset,
the patch was at best a crude policy fix, a placeholder waiting for
the Administration and Congress to offer a more intelligent means
of stopping AMT creep.
Even with the AMT patch extended and indexed for inflation, the
number of AMT taxpayers will increase steadily in future years. One
cause of this increase is that the base AMT exemption of $45,000 is
not indexed for inflation. Furthermore, some income tax deductions
that are allowed under the regular income tax but disallowed under
the AMT--especially the deduction for state and local taxes--tend
to grow faster than inflation.
Thus, even if Congress extends the AMT patch and indexes it for
inflation, the AMT will remain a nagging annoyance for taxpayers
and contribute to the steady rise in the overall tax burden.
Permanence of the patch is a good first step, but Congress
needs to finish the job by repealing the AMT.
The Administration has consistently acknowledged the need
for a smarter solution to the AMT, repeatedly suggesting in its
budget submissions and testimony that the problem demanded prompt
attention and that the large revenues involved would require a more
fundamental reform of the federal income tax. In November 2005, the
President's Advisory Panel on Fundamental Tax Reform made a
number of good suggestions, included abolishing the AMT. The
Treasury continues to "study" the panel's report, pending a green
light from the White House to propound substantive proposals.
The Threatened AMT Tax Hike
If the AMT patch is allowed to expire and no other changes are
made in tax policy, then taxes on about 18 million taxpayers will
increase by up to $5,026 in 2007.
Congress is responsible for tax policy. Under the Constitution,
tax legislation must originate in the House of Representatives, and
historically, the House has appropriately and zealously defended
this prerogative. The President can sign or veto tax legislation,
but only Congress can enact tax legislation. If the patch or
its tax relief equivalent is not extended, then Congress bears the
full responsibility for the massive tax increase.
Some advocates for higher taxes, both in and out of Congress,
argue that allowing the patch to expire or allowing the 2001 and
2003 tax cuts to expire is not really a tax increase because the
expirations are already the law.
For its part, the Administration has maintained a muddled
position on the AMT patch, supporting an extension of the patch in
the short term but cloaking its expiration thereafter in vague
references to fundamental reform. By contributing to the
confusion rather than stating a clear position on taxes, the
Administration has been at least complicit in current efforts
to raise taxes.
Regrettably, certain CBO scoring rules, as established by
Congress, contribute to this confusion. Under the scoring rules,
allowing the patch to expire is not classified as a tax hike. The
CBO scores the tax law as it stands. If the AMT patch were extended
for 20 years and allowed to expire in year 21, CBO scoring would
show higher receipts in its baseline in the 21st year, and any
legislation that extended the patch for the 21st year would
therefore be shown as a tax cut.
The purpose of constructing a revenue or spending baseline is to
indicate the future consequences of current policy, assuming
that current policy is maintained. This is why the spending
baseline is sometimes called the current services baseline. The
federal government's day-to-day spending is authorized and
appropriated annually, yet the spending baseline assumes that
current spending levels will continue from one year to the
next, adjusted for inflation and population growth.
Similarly, some spending programs, such as the highway bill
and the State Children's Health Insurance Program, are authorized
for multiple years. Such programs are likewise assumed to continue
in the spending baseline. The reasonable presumption is that
these programs reflect current policy and that, by assumption,
current policy continues in the baseline.
The revenue baseline is constructed based on current law.
The spending baseline is constructed based on current
services. This lack of symmetry is utterly without
justification. This is not a criticism of the Congressional Budget
Office, which is carrying out the dictates of Congress, but it
is important for correcting the record when advocates of tax hikes
attempt to explain away a tax hike.
Confusing revenue baselines may carry the day in congressional
caucus rooms, but they will not fool American taxpayers. This is
the tax policy equivalent of the old carnival game of "watch the
pea." If the patch is allowed to expire or if other taxes are
raised in its stead, then there will be no question about the
reality of a tax hike to the taxpayers facing higher tax
bills. The proof will be in black and white in their reduced
paychecks and on their Form 1040 tax filings. If taxpayers and
policymakers do not watch the pea carefully, this is exactly
what will happen.
Table 1 provides a guide for determining whether the net result
of the AMT legislation is a tax hike. The first line shows the CBO
baseline revenue forecast, which reflects all tax provisions as
slated under current law, whether elements of the tax law expire,
phase up, phase down, or are indexed for inflation.
The second line, "Tax Cuts Extended," shows the CBO revenue
forecast year by year assuming that Congress and the Administration
extend the 2001 and 2003 tax provisions. This line is
constructed using the Joint Tax Committee (JTC) estimates
included in the CBO's analysis of the President's FY 2008 budget.
The third line in the table, "Corrected Baseline," makes the
further adjustment of extending the AMT patch indexed for inflation
through 2012. The Corrected Baseline shows total federal tax
collections if Congress neither increases nor cuts taxes.
In today's debate, another way to gauge whether or not taxes are
rising through legislation is to look at the resulting five-year
growth rates in receipts. If the CBO's receipts forecast shows
receipts growing at an average of less than 4 percent per year over
the next five years, then Congress is adhering to the Corrected
Baseline. If receipts are forecast to rise by
closer to 5.5 percent per year, it is because Congress has
raised taxes by the equivalent of allowing the AMT patch to expire,
not because the CBO has assumed faster economic growth and thus
faster revenue growth. If receipts are forecast to increase by
around 6 percent or more per year over the next five years, then
Congress has enacted a massive tax hike equivalent to allowing the
AMT patch and all of the 2001 and 2003 tax cuts to expire.
An even simpler way to test congressional actions is to look at
the basic pattern of receipts over time. To the extent that
Congress resorts to using expiring tax provisions to cover raising
taxes, the growth in receipts in coming years will look much like
the top line in the graph. If Congress holds the line on tax cuts,
both with respect to the AMT patch and with respect to the 2001 and
2003 tax cuts, then the growth in tax receipts will look much like
the Corrected Baseline.
The Corrected Baseline depicts the receipts forecast assuming
that tax policy is treated symmetrically to spending policy. That
is, it assumes extension of the 2001 and 2003 tax cuts and the 2006
AMT patch indexed for inflation. As such, it depicts the true
policy-neutral forecast for tax receipts. However, the Corrected
Baseline is not the target outcome for tax policy. At 18.8 percent
of GDP, federal tax receipts are again well above their postwar
average of 18.3 percent. This historic average should be regarded
as a ceiling above which Congress should not permit the tax share
A Smart Path to AMT Repeal
The expiration of the AMT patch should not be used as a cover to
raise taxes. However, it does offer a goodopportunity to examine
smarter alternatives to extending the AMT patch.
The starting point on the smart path to reform is to measure
changes in the level of tax collections against the Corrected
Baseline that assumes extension of the AMT patch. The next
step in reform is to repeal the AMT. This can be done without
raising or lowering taxes in the aggregate through offsetting
income tax changes. These income tax changes would shift tax
liability among some taxpayers but would not create a net tax
increase as long as the level of aggregate receipts is held at or
below the Corrected Baseline.
The best revenue offset for an AMT repeal would be to phase out
the income tax deduction for state and local taxes. There are many
ways to phase out the deduction. A simple way would be to allow
married filers to deduct the full amount of state and local taxes
on the first $14,300 of income, 50 percent of taxes on the
next $14,300, and nothing for taxes paid on income above $28,600.
The combination of repealing the AMT and phasing out the
deduction for state and local taxes respects economic
incentives, minimizes the shifting of tax burdens among
taxpayers, and minimizes the shifting of tax burdens among
There are good tax policy arguments both for and against
preserving the state and local tax deduction, but a review of
these arguments is beyond the scope of this paper. However,
respected voices on both the left and the right have suggested
repealing the state and local deduction in the context of AMT
These theoretical and political arguments aside, one crucial
fact makes the phaseout of the state and local tax deduction the
logical "payfor" to eliminate the AMT: The AMT itself is repealing
the deduction already. Taxpayers lose some income tax deductions in
calculating their AMT liability. One such deduction is the
state and local tax deduction. The projected steady rise in
AMT receipts is due in part to the AMT's steady de facto
repeal of the state and local tax deduction.
Eliminating the AMT and offsetting the revenue effects by
phasing out the state and local tax deduction would have other
important advantages as well. For example, it would offer
significant, real simplification of the tax system by eliminating
the AMT altogether without significantly changing effective
marginal tax rates.
The combination of AMT repeal and the phaseout of the state
and local tax deduction also has the advantage of minimizing the
tax shifting involved. Those taxpayers whose income tax liabilities
would rise without the state and local tax deduction would often be
the same taxpayers who would receive relief from repealing the AMT.
There is no reason to allow revenue-neutral AMT reform to produce
significant shifts of federal tax liability among taxpayers.
Likewise, there would be relatively little shifting of the
federal tax burden among taxpayers in their respective states with
this formulation. States that impose lower tax burdens on their
citizens also have fewer citizens subject to the AMT. These low-tax
states also tend to have fewer citizens choosing to itemize in lieu
of taking the standard deduction and thus have fewer citizens
materially affected by the phaseout of the state and local tax
deduction for upper-income taxpayers.
A strong consensus exists to reform the AMT and, preferably, to
eliminate it altogether. While the consensus is not new, there is a
renewed drive for results. This newfound enthusiasm for serious AMT
reform is rooted in part in the desire by the majority in Congress
to kill not just two, but possibly three birds with one stone:
resolving the AMT issue, raising taxes to fund a splurge in
new federal spending, and possibly shifting even more of the tax
burden onto upper-income taxpayers.
The necessity of dealing with the AMT should not be used to
disguise a tax hike. The deficit is falling as a result of
economic growth and modest spending restraint. The only
justification for raising taxes is to jack up spending without
worsening the deficit picture, but there is no justification for
At 20.3 percent of GDP, the federal government already consumes
over one-fifth of total output in the United States. If new
spending priorities arise, as they inevitably will, then Congress,
at a minimum, should reprioritize existing levels of spending
while holding the aggregate total unchanged. Better yet, Congress
should take this occasion to reprioritize spending and give
relief to taxpayers by slowing the growth in total spending.
The AMT should not be reformed; it should be eliminated. To the
extent that elimination of the AMT must be accompanied by
offsetting revenues without raising receipts above the corrected
baseline, the best "payfor" is to phase out the income tax
deduction for state and local taxes. This reform would avoid
increasing the disincentives to economic growth in the tax
system and significantly simplify the tax code. It would also
minimize the shifting of the tax burden among taxpayers across
income levels and across states.
J. D. Foster, Ph.D., is Norman
B. Ture Senior Fellow in the Economics of Fiscal Policy in the
Thomas A. Roe Institute for Economic Policy Studies at The Heritage
Joint Tax Committee, Present Law and Background Relating to the
Individual Alternative Minimum Tax, staff report, JCX- 38-07,
June 27, 2007, at www.house.gov/jct/x-38-07.pdf (October
is the estimated amount of tax relief provided in 2007 when an AMT
payer at the 28 percent rate uses the full amount of the AMT patch.
The AMT patch for 2006 was $17,550. Through the third quarter of
2007, the Consumer Price Index was up 2.4 percent over the third
quarter of 2006. Assuming that this rate of inflation carries
through the year, the 2007 patch indexed for inflation would be
$17,950 using the usual rounding convention, which would be worth
$5,026 to an AMT taxpayer in the 28 percent bracket.
Total federal spending rose by just 2.8 percent
from 2006 to 2007. See Ibid.
Congressional Budget Office forecast for 2007 GDP deflator is 1.7
percent. Congressional Budget Office, "The Budget and Economic
Outlook: Fiscal Years 2008 to 2017," January 2007, at www.cbo.gov/ftpdoc.cfm?index=7731&type=0 (October
Joint Tax Committee, Present Law and
Background Relating to the Alternative Minimum Tax, p. 9,
Ibid., p. 9, Figure 1.
There are three noteworthy caveats associated
with this table, each of which essentially implies that the figures
in this table will change from time to time as the CBO and the JTC
update their estimates. First, baseline revenue forecasts change
periodically, sometimes significantly. For example, in August, the
CBO updated its revenue forecast for 2007 and beyond, raising the
forecasts somewhat. Thus, the figures six months or a year from now
could look somewhat different. Second, the JTC has not updated its
estimates of the effects of extending the 2001 and 2003 tax cuts in
light of the new CBO economic forecast and new data on tax
receipts. Based on the new CBO forecast, the JTC would likely
modestly alter its forecast for the amount of tax increase
prevented by extending the 2001 and 2003 tax provisions. Thus, in
the details there is a modest degree of incomparability between the
first line and the second. The third caveat is that the CBO has
provided a scoring for only a 2007 AMT patch. The revenue estimates
for a 2008 AMT patch were developed for this paper and reflect the
expected rapid growth in the AMT in the coming years. The
implication of these caveats is that the exact figures will change
in the coming months, but the basic pattern will hold true.
These benchmarks are all relative to the
CBO's receipts forecasts and do not necessarily reflect the
author's views on how receipts are likely to grow.
These figures are estimated for 2008 and were
provided by the Center for Data Analysis at The Heritage
Foundation. The corresponding figures for single filers are half of
the amounts for joint filers.
Leonard E. Burman, William G. Gale, and
Jeffrey Rohaly, "The Expanding Reach of the Individual Alternative
Minimum Tax," testimony submitted to the Subcommittee on Taxation
and IRS Oversight, Committee on Finance, U.S. Senate, May 23, 2005,
at www.urban.org/UploadedPDF/900812_Burman_052305.pdf (October
29, 2007), and Daniel J. Mitchell, "Sales Tax Deduction Would
Subsidize Bigger Government, Undermine Tax Reform," Heritage
Foundation WebMemo No. 520, June 9, 2004, at www.heritage.org/Research/Taxes/wm520.cfm.