This is the fourth in a series of postings about the alternative minimum tax or AMT. In prior postings, I have discussed the function of the AMT, its expansion to a broader segment of taxpayers due to the changes to the regular tax and lack of indexation, its origins as a backup system to the regular tax system intended to ensure that wealthy taxpayers pay at least some tax on their economic income in spite of their ability to aggregate substantial "preferences" (or tax expenditures) that significantly reduce their taxable income, and the fiscal context against which any changes to the AMT must take place, including especially the long term fiscal damage caused by the 2001-2004 Bush tax cuts.
This posting will briefly outline the status of the current debate about AMT reform and point out some of the bills now before Congress that may come up for consideration this fall. Among commentators, there are those who say the AMT should be repealed outright, those who argue for retaining the AMT and kicking out the regular income tax system, and those who argue for fixes to a particular area of concern.
There is no shortage of commentators who urge the immediate repeal of the AMT, though these proponents of repeal differ widely on their goals and accompanying changes they would make. Yoram Keinan, with Ernst & Young's National Tax Office, countered my points for retention of the AMT in an ABA Tax Section publication, reprinted in Tax Notes early this summer. Point and Counterpoint: Should the Individual AMT Be Repealed?, 107 Tax Notes 1723 (June 27, 2005). We both believe the tax system should be transparent, as simple as possible, progressive and should provide a safety net for ordinary Americans. We merely envision different pragmatic solutions to the quandary of the present system. The conservative Tax Foundation argues for repeal from quite a different perspective to Mr. Keinan, in that it wants attention to be focused on broadening the base and lowering the rates of the regular tax to the organization's preferred flat tax, non-progressive rate structure in which even those at the poverty level pay a minimum tax. (There is almost an animosity towards single moms and the poor, as I noted in a prior post about a fairness conference.) The President's Advisory Panel on Federal Tax Reform, of course, is expected officially to recommend repeal of the AMT. The panel's statement this summer of its support for repeal provided no clear answers, however, for paying for the cost of repeal. And Congress already has before it bills for full repeal of the AMT, without having considered how to offset the cost, estimated by the Center for Budget and Policy Priorities at $1.2 trillion over ten years if the tax cuts are made permanent. Sponsors of Senate 1103, introduced on May 23, include Senate Majority Leader Frist, Finance Chair Grassley, Ranking Finance Democrat Max Baucus, and Finance member John Kyl (who is also pressing hard for repeal of the millionaire's estate tax).
Some commentators have argued for retention of the AMT and repeal of the regular tax. See, for example, The Economist's recommendation to treat the AMT as the opportunity for repeal of the regular tax. Not unexpectedly, these commentators are generally supportive of "flat rate" taxes that eliminate progressivity in the system and of consumption taxes that leave returns to capital outside the tax system, as evidenced in the piece in the Economist. Since the AMT has only three rates (a zero percent rate that applies to those whose income is within the exemption amount and the 26% and 28% rates as described in the earlier post), it is closer to a flat rate structure than the regular tax. It is also applied on a broader base, which is necessary to generate sufficient revenues when rates are flatter and lower, but that base currently treats capital gains and dividends at the preferential rate applicable under the regular tax. One might expect most proponents of the repeal-the-regular-tax option to argue for reducing the rate on capital income to zero as part of the package, as indeed is proposed by this Roth & Company commentary. Another commentator urging that we read the AMT's impending explosion as the knock of opportunity is Yale Professor Michael Graetz, whose proposal for (i) replacing the regular tax with the AMT as the main income tax system and (ii) adding a 10-12% value-added-tax system is also discussed in The Economist article linked above and in more detail in a report of the Tax Court's judicial conference this spring.
Another perspective on the fringe (one hopes permanently so) of both AMT and regular tax repeal is Stephen Moore's proposal for an optional maximum 20% flat tax--the Cato Institute's ideal world would have people freely choose whether to pay any tax at all, so perhaps we should be delighted that Moore acknowledges the need for some revenues to the federal fisc.
There are also those one-issue people who would be happy with repeal or with the specific fix for "their" problem. The best example of this group is ReformAMT, created for the purpose of lobbying for elimination of the treatment of incentive stock option (ISO) gains as an AMT preference. Members of the group beat down the doors of Congress to tell their stories of seeing their millions in stock compensation, that they had hoped both to defer and to translate into capital gains, vanish in the dot-com bust. They think it unfair that they have to pay tax under the AMT when, after the crash, they no longer have the stock riches to back them up. Yet, these ISO recipients made millions that would have been current compensation income taxed at ordinary rates but for the special tax expenditure for ISOs in the regular tax system. While they didn't have to pay regular tax on exercise, many of them did have to pay tax under the AMT, since the AMT treats the ISO benefit as a preference. They lost their invested compensation because they were still holding the stock (hoping to convert to lower-taxed capital gains) when it tanked. That's no different from the experience of many others who paid tax on compensation income, puchased stock with those dollars, and lost their investments when the stock tanked. Congress acted reasonably when it treated ISOs as one of the goodies that it could give away too much of and lumped the ISO benefit in with private-activity bond interest and other tax expenditures that, if they add up to a substantial amount, result in more of a taxpayer's economic income being taxed under the AMT. ReformAMT's sad stories have gotten a bill now before the House that they expect to be the package for their desired cure--guaranteeing them a refund, albeit over five years, of the AMT taxes they paid.
This, then, is the state of the discussion within Congress and among tax pundits today. My next posts on the AMT will deal with two questions. First, with democratic egalitarianism as our beacon, should we retain or jettison the AMT? I will argue in a future post that a pragmatic solution could retain the AMT as a simplifying function for those ordinary taxpayers who are the special focus of fairness concerns that appropriately limits tax expenditures for those with substantial benefits from those tax expenditures. Second, once we decide to retain the dual system, how do we prevent the AMT from engulfing ordinary taxapayers in the lower four quintiles and at the same time assure that it continues to fulfill that appropriate, tax-expenditure-limiting function? I will argue in a future post that both AMT and regular tax reforms are required to make the dual system function properly, and that these reforms can actually further simplification and efficiency goals while making the U.S. tax system more progressive.