Arnold Kling  

Alternative Minimum Tax Puzzle

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The graph in this Wall Street Journal piece shows a steep rise in the proportion of middle-income taxpayers who will be subject to the Alternative Minimum Tax. Greg Mankiw reproduces the graph. I could not think of a reason for such a sharp rise. Andrew Chamberlain and Patrick Fleenor offer a hint.

A far more important factor causing the AMT’s recent expansion is the effect of the 2001 and 2003 Bush tax cuts. Ironically, by reducing regular income tax liabilities without substantially changing the AMT, the Bush tax cuts will be responsible for most of the expansion of the AMT through 2011 (see Figure 1). Since taxpayers must pay the greater of either their AMT or regular tax liability, the decline in income tax liability without any change in the AMT pushed many taxpayers into the AMT.

So, if you were just humming along, earning your usual income and taking your usual deductions, your tax liability was reduced by the Bush tax cuts, which made you subject to the AMT. In that case, the Bush tax cuts were not really tax cuts (or at least, not as much as one might think) for a lot of folks. There are all sorts of subtle implications of this. It's making my head hurt trying to keep them straight. For example, would a straight repeal of the Bush tax cuts move people from the AMT back into the regular tax system, but not gain much revenue?

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The author at Roth & Company, P.C. in a related article titled GOING OVER THE AMT CLIFF writes:
    The Wall Street Journal, in a rare editoral page convergence with the Des Moines Register, ripped the alternative minimum tax... [Tracked on December 7, 2006 11:37 AM]
COMMENTS (9 to date)
KipEsquire writes:

Let's not forget the basics too: Unlike the FIT, the brackets for the AMT are not adjusted for inflation, so plain old bracket creep explains at least some of the increase in incidence.

It's also noteworthy that tax preparation software presents, somewhat inaccurately, AMT liability as a "surcharge" above the regular FIT liability (e.g., "You must pay an additional $1,000 in AMT.") When presented like that, the AMT is far more likely to spark indignation if not outrage, especially among the very middle-class taxpayers most likely to use such software.

Miracle Max writes:

You only just heard about this!?!?

spencer writes:

I have to agree with miracle max

You only just heard about this!?!?

Maybe you should double check you last couple of years tax returns.

You could owe a lot.

ryan writes:

Does this mean tax cuts are actually pretty cheap for the vote-maximizing but budget-constrained politician? You look like you're cutting taxes, and it's only that rascally AMT keeping them from taking effect. (Come to think of it, isn't this a pretty brilliant stealth strategy for eliminating tax deductions? Eventually, everyone should be subject to the AMT and, ta-da, tax reform!)

Surely inflation drives the share of people falling under the AMT upwards, but this rate need not be steady even if inflation and income growth are steady. Since income distributions are roughly log-normal, we should expect the AMT-coverage to appear to grow exponentially (since the AMT's position would be constantly moving towards denser portions of the income distribution curve). I suppose this might blow my stealth tax-reform plan.

Joe Kristan writes:

The incidence of AMT skyrockets because the exemption amount, which has been increased on a temporary basis, is scheduled to fall dramatically next year. I discuss the problem here .

Michael Sullivan writes:

I have a suspicion on reading that chart that ought to be right up the alley of the folks here.

What surprised me most was the low rate at which people with incomes in the 1m-2m range pay AMT. My initial assumption in reading about the AMT crunch was that people in the 100k-400k range were now going to be paying AMT at similar rates to those who declare very high incomes. But that turns out not to be the case at all. They will, according to this chart, be paying it at much *higher* rates.

I see two possible explanations for this. The first is that very high income earners have made adjustments to their lives and the way in which they earn their income that minimize the affects of AMT, while middle-class people who haven't had to face paying it (or who pay only a small additional amount because of it) have ordered their financial lives around the non-AMT structure. If we then plot their chances of paying AMT, assuming they do not change anything, then of course, lots of them will be expected to pay AMT in the future. But who says they won't change anything? Isn't it more likely that those who would have a large increase in their taxes due to AMT would start adopting the same measures that the very rich have already adopted which let them avoid paying AMT most of the time? Which means this chart's predictions would be inaccurate.

The second possibility I can think of is that this is an artifact of housing costs. The single biggest deduction is mortgage interest. It may be that lots of upper middle class folks have stretched to buy the most house they can possibly afford, and taken a very large tax deduction, and this causes them (or will cause them when trends are extrapolated) to tip the scale, while very high income earners rarely spend enough of their income on housing for this to matter (and I believe there is a cap on the amount of interest that's deductible anyway).

In any case, I think the gap between middle-high incomes and very high incomes which leads to the very high rarely paying AMT (which IIRC was the whole point of AMT, to keep very income earners from avoiding too much income tax) is something which requires explanation.

Steve writes:

Michael Sullivan,

I think one possible explanation you've overlooked is that up to 80% of itemized deductions are phased out for regular income tax purposes, so really high income people don't feel the sting of the AMT. The deductions that aren't allowed under the AMT regime weren't taken anyway, so there's less of a difference.

Matt writes:

I forget where I first saw it, but the most devious suggestion I've read about what to do about the AMT is..... nothing.

Why? 1) It's a flat tax. 2) It's simple and straightforward. 3) No favored gimmicks that create waste through tax-avoidance. In other words, it's precisely the tax system a libertarian/ small gov't conservative would want to implement. And because it's not indexed to inflation, it is gradually superceding the regular tax code.

The bottom line being, if you would like to scrap the existing tax code and replace it with a simple, non-waste generating, flat tax, then all you need to do is get Congress to do..... nothing, i.e. what it does best.

Noumenon writes:

For example, would a straight repeal of the Bush tax cuts move people from the AMT back into the regular tax system, but not gain much revenue?

Some Treasury guys calculated once, tongue in cheek, that it would be cheaper to abolish the income tax and keep the AMT than the reverse.

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