The Individual AMT: More Than a Small Fix Is Needed

The Individual AMT: More Than a Small Fix Is NeededC. Eugene Steuerle"Economic Perspective" column reprinted withpermission.Copyright 1998 TAX ANALYSTSThe 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.The typical taxpayer thinks that the individual alternative minimum tax will never apply to him. A small fix in1998—which essentially prevented some individuals from paying the AMT because they claimed the child andother personal credits—may even have reinforced that impression. The purpose of the AMT, after all, is tocollect tax from those who invested in tax shelters and had extraordinary levels of questionable deductions,wasn't it?Well, perhaps that was the original purpose, but that's not the law. Under current law, all of the following aretrue. First, because many dollar amounts in the AMT are not indexed for inflation, more taxpayers becomesubject to it every year. Within a decade, many typical middle-income households with no involvementwhatsoever in tax shelters will owe AMT. Second, typical and normal deductions and credits, many of whichare not considered in any way abusive, are actually treated as "preference" items subject to the AMT. Everytaxpayer, in fact, has one or more of these preferences because they extend even to the personal anddependency exemptions allowed for all persons in the taxpayer's family. Third, many more individuals oweAMT than probably pay it or even know they should pay it. That creates considerable problems of complexityand enforcement for the IRS.How could these developments have occurred? Wasn't the goal of tax reform to achieve some simplification,at least for taxpayers not engaged in shelters or complex transactions? Well, in the beginning, that was true.But the process of tax reform was one where the continual set of compromises made along the way led to abacking away from broader reforms and then to backdoor approaches to recoup the lost revenues and stillkeep statutory rates low. More and more revenue raisers were added through devices such as expanding theAMT. Congress also knew that by failing to index the AMT it was booking long-term revenues that would behard to maintain.Many efforts at reforming the AMT deal only with the failure to index. Under current law, for instance, manymarried couples with two children, average income, and no more deductions than their state and local taxesare scheduled to pay AMT in the future. As their income and state and local taxes—which are counted aspreference items—grow with normal inflation and economy-wide growth, these taxpayers are less likely to beexcluded from the AMT. But while a reform that indexes the AMT is worthwhile, it still ignores whether or notthe tax makes sense, whether its base includes items that should not be subject to taxation, and whether theadministrative hassle and complexity are worth the trouble in the first place.A few of the preference items in the AMT have attributes associated with preferential treatment, such asgenerous depletion allowances or the tax exemption for interest received on private activity bonds. In thosecases the taxpayer may be excluding from taxable income a significant portion of real income received. Butmost of these items are not large in terms of alternative minimum tax collections. Other items included atdifferent times, such as an alternative depreciation schedule, are more debatable since they seem to deny tosome taxpayers even those deductions that would be allowed if economic income were calculated accurately.Some of these provisions are enormously complex, as well, for they require the taxpayer to keep multiplerecords for years under alternative methods of calculation.There is little excuse for inclusion of items that are legitimate deductions reflecting a lower ability to pay tax.The standard deduction allowed to nonitemizers is treated as a preference item under the AMT. So also areextraordinary and legitimate work expenses when deducted as miscellaneous itemized deductions. Theinclusion of personal exemptions as a preference item implies Congress believes that a dependency exemptionis not an appropriate adjustment to ability to pay tax, but instead accords the taxpayer special treatment. Ineffect, for AMT purposes, the law implies that a family of four has the same ability to pay tax as a family oftwo with equal income.Document date: November 30, 1998Released online: November 30, 1998 Finally, there are those items that under some theories might not be deductions under an income tax, butunder other theories are quite reasonable. It is inconsistent and arbitrary to try to tax them through an AMT.These include state and local tax deductions and those few medical deductions allowed for regular tax, butnot minimum tax, purposes. If there is a rationale for further limiting these deduct