The Alternative Minimum Tax (AMT) was established to prevent certain Americans and corporations from using otherwise available deductions to reduce (and in some cases eliminate) their income tax liability. The very existence of the individual AMT and its corporate version makes the already complicated tax code all the more inexplicable and frustrates every effort to comprehensively improve our system of taxation.

The individual AMT was intended to act as a failsafe mechanism to ensure that a small number of upper income individuals had to pay income tax. However, the tax is now hitting the middle class – and hitting them hard. In the past decade, the number of filers paying AMT increased tenfold to 1.3 million people. The next eight years will witness even more pronounced and explosive growth. Indeed, nearly one out of three tax filers will be subject to the AMT by 2010.

This onerous tax will be slapped on average American families largely because the AMT is not indexed for inflation – consequently, taxes will be pushed upward through bracket creep. Furthermore, the AMT has an extraordinarily expensive compliance cost relative to the revenue that is generated from the tax. While consensus is moving toward a simpler tax filing system, the AMT acts in quite the opposite manner, forcing families to fill out two forms, which adds approximately six additional hours of tax preparation time.

On the corporate side, corporations become particularly vulnerable to the AMT when they invest in capital equipment. Capital investment by corporations is a key component of economic growth, yet firms that continually invest in capital equipment are subject to stricter depreciation rules under the AMT than under the normal corporate tax. As a consequence, the corporate AMT has placed an unwarranted and highly significant negative effect on economic growth and capital formation. Corporations that invest in equipment, which increases labor productivity, and subsequently the income growth of American workers, are not rewarded but are punished.

Moreover, if the economy enters a cyclical downturn, less taxable income results in companies paying additional taxes via AMT. Less funding is then available for capital investment and job creation, which further exacerbates economic slowdowns. Ultimately, the AMT depreciation rules expose American businesses to an extraordinarily hostile capital-cost recovery system.

Evidence and experience overwhelmingly indicates that either immediately or gradually repealing (instead of merely modifying) both the corporate and individual versions of the AMT is the best policy option, if the widely shared objective of tax simplification is to be reached.

35,500,000 Angry Americans

We have seen far too often that fine-tuning the AMT is more dilatory than corrective.

For example, on October 29, 1999, the Senate hurriedly inserted a provision in an $8.5 billion tax package to allow families to use certain tax breaks so that they could avoid paying the dreaded – but surprisingly little-known at the time – AMT. Senate Finance Committee Chairman William Roth (R-DE) and ranking member Sen. Daniel Patrick Moynihan (D-NY) issued a joint statement earlier in the week, declaring "If we fail to extend the AMT relief, millions of middle-income taxpayers will face an unintended and unexpected tax increase." [2] (A similar tweaking of the law took place with the Tax Relief Act of 2001, which increased the exemption from AMT by $4,000 on a joint return to $49,000, and by $2,000 for unmarried individuals to $35,750, but only through 2004.)

Why would such pre-emptive (not to mention one-time-only) moves be necessary? The AMT, much like the federal progressive income tax, was designed to ensure that better-off individuals and corporations would pay their "fair share" of taxes; and like the income tax itself, the reach of the AMT has been extended to those at the other end of the economic spectrum. Washington has thus far reacted to this potentially explosive, and might we add ongoing, development with occasional adjustments no better than superficial bandaging, and always followed by intentions of enacting a programmatic overhaul which have never been fulfilled.

Any given segment of the US tax code is, obviously, difficult to adequately describe and much harder to truly comprehend. [For evidence of this, consider the enterprising and mischievous reporters who send identical income tax information to dozens of accountants and other tax professionals, only to receive dozens of different returns – all of which are "wrong" by IRS standards.] But there\’s one fact that is brutally easy to understand: today the Alternative Minimum Tax affects one out of every 100 taxpayers; however, by 2010 government analysts project the AMT will affect one out of three – or 35.5 million taxpayers.[3]


Chart 1: AMT Filers 1994 – 2010


Data Source: Joint Committee on Taxation, Joint Economic Committee

And they will be 35.5 million very, very upset voters. Will they accept yet another small-scale, short-term solution?

This nasty, obscure tax could stoke the fires of popular frustration with the tax code more than anything recently witnessed, and its future economic and political implications therefore merit serious contemplation.

Giving With One Hand, Taking With The Other

The US tax code, particularly as it pertains to income, is legendarily fraught with exceptions to its own rules. Due to this complexity, many individuals were once able to avail themselves of many allowable tax deductions in order to substantially reduce their income tax, and in several instances escape paying income taxes altogether.

That is, until the Tax Reform Act of 1969 introduced a comparatively weaker version of the individual AMT we have today (it was a 10% add-on tax to the regular income tax, and not a wholesale replacement for what is deemed an unacceptably low regular income tax, as it is currently). The modern AMT obligates individuals claiming many sizable deductions to calculate two tax returns – first, a regular form with all tax preference items deducted and an AMT form with all tax preference items included; whichever is greater is the payable tax.

The Tax Reform Act of 1986 put a wicked set of teeth into the jaws of the individual AMT. The pre-1986 AMT had been applicable to a fairly small tax base (the 1969 AMT, for example, had all of eight tax preference items), whereas the base of the new AMT was significantly broader. And over time, as more deductions were enacted and became widely allowed, the AMT began to loom ever larger.

Of all the Devilish Details lurking in the AMT after its grasp was lengthened, perhaps the most politically relevant fact is that the structural components of the AMT are not indexed for inflation. As a result, since 1990 the number of tax returns subject to AMT has increased ten-fold. And the rate of increase in the number of AMT returns is getting steeper. Consequently, more and more people are subject to the AMT due to bracket creep.

Chart 2: Had the AMT Been Indexed for Inflation in 1993.


Data Source: Lawrence Lindsey, Tax Priorities Presentation at the American Enterprise Institute

Arguably, this is the real explanation for why the AMT has become an important and very, very sneaky source of revenue for the federal government. It\’s not because the AMT affects its intended targets more efficiently than the regular income tax, it\’s because it has new and unwitting targets every year. And that will soon translate into a protracted and hard-to-reverse tax increase by stealth. Though the AMT presently accounts for less than 1% of total individual income tax revenue, its share is expected to leap to 2.3% by 2010, which will make the federal government even more dependent on the AMT than it is now.

The AMT is covered with a layer of political insulation, albeit one that is rapidly thinning. Originally, "the rationale for enacting the original individual minimum tax in 1969 and revising it in 1986 were perceptions that some taxpayers were able to avoid paying tax on relatively large incomes."[4] But cracks are appearing in its facade. Since the AMT pursues "horizontal equity" by taxing members of the same general income groups differently because they "choose to engage in different patterns of tax-favored activities,"[5] the federal government actively discourages certain increasingly popular financial activities (and even frowns upon personal and family concerns). Consider the following examples:[6]


·        Regular taxpayers who itemize on their returns can claim a deduction for state and local tax, including property tax and state income tax. However, these deductions are not allowed under the AMT, and moreover, residents of places where state and local taxes are high are more likely to be subject to the AMT.

·        The AMT allows a deduction for interest on mortgage borrowings used to buy, build or improve one\’s home – but for no other purposes.

·        The AMT allows a medical expense deduction more limited than the deduction under the regular income tax.

·        Itemized deductions such as tax preparation fees and many investment expenses are allowed if the total in the "Miscellaneous Itemized Deductions" category is more than 2% of one\’s adjusted gross income. But these items can\’t be deducted under the AMT, which itself can be unleashed by claiming a large amount in that category.

·        Interest exempted from the regular income tax is often not exempt from the AMT. The interest on most municipal bonds is exempt from tax, but interest on private purpose municipal bonds (housing, industrial development, pollution control, airport and student loan bonds) is subject to the AMT.

·        Employees exercising incentive stock options (ISO\’s) leave themselves wide open to AMT liability unless those stocks are unloaded by the end of that year. If employees retain their stocks but the value of those stocks plummets after their ISO\’s were exercised, the AMT is applied at the value of exercise instead of at the stock\’s current (i.e. lower) value. In many instances, their AMT bill alone is more than their stock\’s value. [visit for more on the subject on ISO\’s and the AMT]

·        The AMT disallows exemptions taxpayers otherwise claim for themselves, their spouses, and their dependents. Families with large numbers of dependents are therefore particularly vulnerable to the AMT\’s bite.

As we can see, the AMT is forcing taxpayers to jump through technical hoops and leap over puddles of jargon, just to allow the taxman to take a second swipe at their pocketbooks if the first one didn\’t do the trick. Should they be put through all this? And is their collective misery justified by the oft-asserted need for "fairness", whether vertical or horizontal?

Completely Missing the Mark

In examining the individual AMT, the first analysis must be to determine if the AMT is achieving its intended goal. The evidence clearly demonstrates that the answer is no – it is only subjecting more and more middle-class families to heightened economic hardship. According to the Joint Economic Committee (JEC),


[T]he AMT added just one additional taxpayer to the income tax rolls for every 6,600 already paying the regular income tax.3,572 people with incomes of $200,000 and above paid no regular income tax.after the AMT, 1,467 of them still paid no income tax, either regular or AMT. The difference – 2,105 taxpayers – is the number of high-income people who would have paid no income tax if not for the AMT. So, the AMT added just one high-income taxpayer to the income tax rolls for every 1,000 already paying the regular income tax.[7]

However, most of the "high-income" individuals that were not subject to paying taxes were small business owners swallowing losses and/or receiving tax-exempt interest on municipal bonds. (It is important to note that individuals who invest in state and local government bonds are investing for a lower rate of return relative to corporate bonds. To entice investors, taxes are exempted to compensate for the lower rate of return, and the purchase of those bonds reduces borrowing costs for state and local governments as well as provides much of the funding for local roads and school construction.)

Despite the inefficient targeting of the AMT (or perhaps because of it?), federal policymakers have neglected to index its threshold for inflation. This act of omission has increased the number of middle-class families exposed to the AMT through rising incomes. Indeed, as Chart 3 demonstrates, the AMT threshold has slipped below the median family income.[8]

Chart 3: Income Growth Outpacing AMT Threshold


Data Source: National Center for Policy Analysis

The median family income is now $10,000 more than the AMT\’s lowest applicable income level. Those unfortunate families may soon have to wrestle with the most conspicuous source of irritation for individual AMT payers: the labyrinthine Form 6251. [We encourage you to see for yourself by downloading this form from the IRS website –] The additional layer of paperwork places a significant deadweight loss on the economy by burdening individuals with additional preparation expenses and sheer consumption of time.

According to the JEC, Form 6251 adds an additional 6 hours of paperwork for the average filer. (AMT time preparation costs, relative to the revenue raised, is 9 percent of AMT revenue generated. This equates to more than five times the general income tax cost compliance.)[9]

Not surprisingly, as the General Accounting Office (GAO) discovered, 93 percent of AMT filers paid for their taxes to be prepared, compared to just 52 percent of all people filing their income taxes.[10] Slapping the AMT on top of the pile adds additional costs for the tax professionals to complete, which then raises ever higher the cost of filing for individuals struggling with the AMT. But interestingly, even though the AMT presumably drums up a good bit of business for those aforementioned tax professionals, even they are hopelessly exasperated by it. For instance, the National Association of Enrolled Agents, who are authorized to represent taxpayers before all administrative levels of the Internal Revenue Service, has labeled it the "tax headache of the year" two years in a row.[11]

And this headache is being felt with increasing intensity by our entire economy.

How to Punish Productivity

A bad idea for individuals became a bad idea for the notion of free enterprise as a whole when Congress replaced the old add-on minimum tax with the corporate AMT in 1986 to ensure that corporations could not use many deductions, exclusions, and credits to avoid paying taxes. Yet those very same deductions, exclusions, and credits were created by Congress to spur the sorts of new investment that provide jobs. As a result, the corporate AMT converts incentives into liabilities by means of a contradictory tax code that can punish corporations for investing in capital equipment.

Although corporations that pay the AMT pay a lower tax rate of 20 percent (as compared to 35 percent under the regular corporate income tax) the base of income subjected to the AMT is much broader and typically leads to higher tax bills for such firms. Corporations paying the AMT therefore face one of the highest tax rates on new investment in the industrialized world.[12]

The corporate AMT has significantly restricted economic growth in the United States by discouraging capital investment, which diminishes labor productivity, and undermines overall GDP growth.

US firms that plan for long-term expansion, invest their earnings in capital, and reduce their taxable income under the regular corporate income tax feel the AMT\’s pinch most acutely. This dampens future investment by significantly increasing the real cost of capital for these firms. For example, corporate spending on capital such as structures and equipment would have increased by $8-10 billion per year from 1996-2005 had the corporate AMT been repealed, according to a DRI/McGraw Hill study conducted for the American Center for Capital Formation.[13]

Adding insult to injury, corporations are often subjected to the AMT at times when they (and the economy) can least afford it: in times of economic downturn, which decreases taxable income, which in turn pulls the AMT trigger. In short, under the AMT, corporations are taxed at a higher rate when they can least afford it.

The importance of these negative effects stemming from the corporate AMT cannot be adequately emphasized. Roughly 20 percent of all economic growth since 1929 has been the result of gains in labor productivity. The AMT essentially stifles the capital investment needed to develop new technologies, which drives the productivity of workers, and hence, economic growth. Greater labor productivity increases the wages of employees, produces more goods and services at a lower cost, and ultimately increases the standard of living for workers and consumers.

Federal Reserve Chairman Alan Greenspan explains the benefit of capital investment thusly:

Standards of living rise because the depreciation and other cash flows of industries employing older, increasingly obsolescent, technologies are marshaled, along with new savings, to finance the production of capital assets that almost always embody cutting-edge technologies. This is the process by which wealth is created incremental step by incremental step. It presupposes a continuous churning of an economy in which the new displaces the old.[14]

While productivity increases allow national living standards to improve, without question the AMT has worked against this effect by making capital investment an unnecessarily risky proposition. By inhibiting the combination of new capital with labor, productivity has been restricted within those corporations subject to the tax. Labor productivity growth would have shot up by an additional 1.6% over the McGraw Hill report\’s 1996-2005 period according simply because the AMT increases the cost of new capital investment.

According to Professor Arnold Harberger of the University of Maryland, the overall macroeconomic effect of the AMT is to depress real GDP growth by preventing real-wage growth, which logically results from investment and increased productivity.[15]  Additionally, corporations facing AMT liability often choose to relocate abroad in nations where the corporate income tax rate is as little as half that faced in the US, further impeding growth of the national economy. (Indeed, such corporate AMT quirks as its back-loaded depreciation rules allow higher-tax countries in Europe, for example, to compete with the United States for significant investment despite inflexible labor markets and greater regulatory burdens.)

And much like the individual AMT, the corporate AMT is thoroughly ineffective in achieving its goal. Since corporate AMT payers get tax credits that can be used in years when firms have no AMT liability, and can then recoup some of the money already paid, the levels of revenues received from some corporate sources and the credits claimed by others will often cancel each other out, rendering the entire exercise basically pointless.

Chart 4: Corporate AMT Revenues


Data Source: Internal Revenue Service, National Center for Policy Analysis

So we have a Money-Go-Round masquerading as revenue-maximization, inhibiting investment and job creation when they\’re needed most. Those 35,500,000 Angry Americans would be even more upset if our economy got stuck in the mud and stayed there because the corporate AMT dissuaded companies from investing in a way out of it. Besides, they\’ll probably own stock in those same companies that are being taken for a ride on the corporate AMT carousel. 

Crunch Time

Abolishing the AMT and (finally!) enacting long overdue, large-scale tax reform are mutually dependent: you can\’t have one without the other. Our convoluted system of taxation won\’t be overhauled, nor will America\’s productive capacity be realized, if the AMT remains, whether altered or left as is. Important people are taking notice.

The IRS\’ own National Taxpayer Advocate has concluded, "The repeal of the individual AMT would greatly simplify the tax code."[16] Rep. Phil English and Sen. Kay Bailey Hutchison have taken the lead in their respective chambers and become co-chairs of ATR\’s AMT Abolition Caucus. And President George W. Bush recently declared, "we need to stimulate investment by allowing for enhanced expensing of capital expenditures, and.eliminate alternative minimum tax on corporate America."[17]

Rank and file Americans are taking notice as well. Gordon Klein of UCLA\’s Anderson Graduate School of Management observed that "[The AMT has] become a trap for the unwary.It used to focus on people using tax shelters, but now it\’s starting to come down to the little guy."[18]

And when taxpayers discover that they are that Little Guy, they will be more motivated to go to the polls and register their complaints through the ballot. Moreover, there will be a heightened sense of apprehension on the part of those who are not AMT payers, but know that they have reason to think that they will be by April 15 of the next year.

Many voters support certain policies, both those in practice and those still only the stuff of theory, even if they don\’t have a direct stake in those policies. But when they do have a direct stake, their intensity of support becomes magnified. The AMT will start weighing heavily on the minds of more and more taxpayers every year. The pressure is building, and Washington would do the rest of America a service by acting while it still has time, before it has neither time nor any other choice.

Indexing would help, but it won\’t be enough, for "Even with indexing, one would expect some growth in AMT taxpayers as real (i.e. inflation-adjusted) incomes rise over time."[19]

Retooling the AMT only forestalls the inevitable. Keeping it in any form whatsoever would leave the overall problem of complexity unresolved and the availability of crucial deductions perpetually in doubt. Unless serious and concerted action is taken, there will be a seismic political outcry because millions upon millions of taxpayers will be yearning for the bygone days when they only had to fill out a "simple" Form 1040.

Abolition of the AMT is the only real solution. This failed tax experiment will have to be abandoned in favor of tax reform. Sooner would be preferred over later.