Simplicity and Transparency Versus the Dread AMT

No doubt, taxes are complicated. A good example of this complexity is the Alternative Minimum Tax or AMT which is part of our income tax. This is a flawed tax that ignores principles of good tax policy and generates revenue beyond expectation. While Congress is currently trying to keep millions of individuals from paying AMT in 2007, outright repeal would be best.

The income tax has always had "preferences" that reduce one's tax bill. Today these include deductions for dependents, mortgage interest, state income taxes, manufacturing and charitable contributions. Preferences also include tax credits that are dollar-for-dollar reductions in tax owed. There are many credits including ones that encourage research, energy efficiency and low-income housing. Generally, preferences either encourage certain behavior (such as buying a hybrid car) or take ability to pay into account (such as a deduction for dependents).

In 1969, Congress determined that some individuals and corporations were using a combination of preferences to reduce their tax below a perceived minimum. Congress did not want to repeal any preferences though because each served an important purpose. So an alternative tax calculation was created with fewer preferences. In later years, the AMT was broadened. Unlike the tax brackets for the regular individual income tax, the AMT brackets are not indexed for inflation. This and the addition of more preferences led to today's AMT crisis where every year, more individuals become subject to AMT including many for whom this tax was never intended.

Congress' Joint Committee on Taxation reports that in 1987, about 140,000 individual taxpayers owed AMT. The projection for 2017 is that about 31 million will owe almost $90 billion of AMT -- four times more than was owed in 2006.

Put bluntly, the AMT is a disgrace to our tax system. For the past few years, legislators, taxpayers and tax professionals have called for its repeal. The biggest obstacle to repeal though is the revenue loss, a problem that grows each year.

Tax policy reasons for repealing the AMT include:

1. Simplicity: Tax laws should be simple so taxpayers can compute and understand their tax liability and keep compliance costs to a minimum. AMT calculations are complicated and even taxpayers who do not owe AMT must complete the AMT form to know that. AMT also requires extra record-keeping.
2. Transparency: Tax laws should be transparent so taxpayers can understand how much they owe and how transactions affect tax liability. The AMT's separate set of computations misleads taxpayers who think they know how the income tax works. For example, most individuals know that state income taxes are deductible. However, that deduction is not allowed in computing AMT. Some people think they will get a tax credit for buying a hybrid car. Not so if you owe AMT.
3. Rational design: There should be only one minimum tax. The AMT produces the odd result of two minimums -- the regular tax and the AMT, with the higher minimum being the one owed. The regular tax should be the minimum. That is, the reasons for preferences should justify one's tax bill. Otherwise, the purpose of each preference is not fully realized. AMT resulted from trying to do far more with the tax law than raise revenue. Lawmakers must stop adding preferences if doing so causes taxpayers to pay less than the perceived minimum. Or, they should only add new preferences if others are removed.

How to repeal the AMT:

1. Examine spending and recent tax cuts. The AMT was never expected to raise so much revenue. Yet, the money seems to be spent. Spending should not rise to match excess revenues. Also, tax cuts of the past few years, most of which expire soon, should not be renewed if AMT revenues are needed to pay for them. Paying for tax breaks with "alternative taxes" is not honest.
2. Reduce the number of preferences. Today there are over 150 preferences. Many have existed for years yet their effectiveness has not been reviewed. With so many preferences, no wonder some taxpayers pay less than a perceived minimum. Lawmakers need to make tough decisions about which preferences to cut so that taxpayers pay the perceived minimum with just one tax.

Important principles of good tax policy, particularly simplicity and transparency, are in a tough battle against AMT. Action is needed to ensure that simplicity and transparency are victorious.