Options for Reforming the AMT
On Thursday, Dec. 6, 2007, the Fiscal Policy Program at the New America Foundation held an event at the Cannon House Office Building entitled "Patch it or Pitch It: Options for Reforming the Alternative Minimum Tax."
Maya MacGuineas, Director of the Fiscal Policy Program and President of the Committee for a Responsible Budget, hosted the event, which featured remarks by House Majority Leader Steny Hoyer (D-MD) and Ranking Member on the House Budget Committee Paul Ryan (R-WI). Following their speeches, there was a discussion featuring:
- The Honorable Bill Frenzel, Former U.S. Representative; Co-Chair, Committee for a Responsible Federal Budget
- Len Burman, Director, Tax Policy Center; Senior Fellow, Urban Institute
- Alex Brill, Research Fellow, American Enterprise Institute
- Aviva Aron-Dine, Policy Analyst, Center for Budget and Policy Priorities
- Bob Carroll, Deputy Assistant Secretary of Tax Policy, US Dept. of the Treasury
- David Wessel, Economics Editor, Wall Street Journal
MacGuineas began the event by welcoming the two Congressmen, whom she praised for doing "much of the heavy lifting" to advance the cause of long-term fiscal responsibility during their tenures, as well as the panelists, whom she called an "all-star lineup." In particular, she praised Congressman Hoyer for his dedication to finding offsets for the cost of the AMT patch, and Congressman Ryan for proposing a tax plan of his own as an alternative to the plans moving in Congress.
Representative Hoyer began with praise for Representative Ryan, whom he lauded as an honest and hardworking Member of Congress, for MacGuineas, whom he extolled as an outspoken advocate of fiscal responsibility, and for Bill Frenzel, whom he said cast his votes while in Congress based on policy rather than politics. He began the substance of his remarks by noting a point of commonality between himself and Representative Ryan: both men agree that the Alternative Minimum Tax (AMT) no longer works as intended. They differ, however, on whether or not proposed fixes for the problem ought to be paid for by offsetting spending cuts and/or tax increases. Representative Hoyer stated that he believed that the decision to patch the AMT without offsetting the cost of that patch was "not only an intellectually bankrupt policy, but also an immoral policy," citing the undue burden it places on future generations to pay for something that benefits current taxpayers.
Hoyer next outlined what he believed to be the widely-held Republican stance on the AMT, which he attributed to both Representative Ryan and President Bush. He said that Republicans view the AMT as a mistake, and feel that they should not have to pay for it because, in their view, it never should have existed in the first place. He likened this position to that of a driver who, after missing a stop sign and crashing into another driver, insists that he shouldn't have to pay for the damage. Someone will have to pay, and if the current Congress decides to pass a patch without offsets, it will be young people who foot the bill, many years down the road.
Next, Hoyer turned to the version of the patch passed by the House on November 9, 2007. Proposed by Ways and Means Chairman Charles Rangel (D-NY), the House patch not only found offsets for the cost of the patch but also cut taxes for millions of middle and lower income families. Hoyer called the bill "one of the best tax bills that I have voted for." The bill locates offsetting funds by closing certain investment income loopholes, raising the ire of many. Hoyer said that the Republican plan, rather than closing these loopholes, was to simply add the cost of the patch to the more than $200 billion funding shortfall already present in the FY 2008 budget. He then closed this analysis by insisting that he would not vote for any AMT patch that did not include methods to offset its cost, "even if I am the only House Member to do so."
Hoyer next praised the Democratic majorities in Congress for reinstating Paygo after several years of absence. Paygo, he pointed out, was first instated through a compromise between President George H. W. Bush and Rep. Dick Gephardt (D-MO). Bush agreed to the legislation after Richard Darman, then-head of the OMB, insisted that current levels of debt accumulation were not tenable. Hoyer then insisted that, over the last 80 months, Republicans have indicated that debt does not matter, and in the process have taken us over $1.6 trillion further into debt. In fact, he pointed out, for 19 years under Republican presidents, the nation ran deficits off $100+ billion. The President, Hoyer asserted, has the power to stop spending, but Republican presidents have not used this power. The Democrats, on the other hand, have employed 80 percent spending cuts, and only 20 percent tax increases, to pay for their new programs under Paygo since 2006.
He closed by saying that he feels that mitigating the effects of the AMT with an annual patch is not good policy, and that the AMT should be permanently eliminated, provided that the cost of that elimination can be offset. Comprehensive reform will not be easy, however, as cutting spending to pay for what you buy requires courage. Still, it may turn out that this effort is the first step towards fundamental tax reform, of which the country is in dire need. Hoyer finished his remarks by saying that he supported such reform efforts and that he believed Representative Ryan would join him in that work.
Congressman Ryan began his remarks by praising Representative Hoyer for his honesty, calling him "a very worthy adversary." He then gave a brief history of the AMT, asserting that its original intent was to force a very small number of people who were legally avoiding paying taxes to pay something -- an admirable goal -- but that it has begun swallowing up millions in the middle class. The AMT, he asserted, is an amazing revenue engine that will automatically increase the size of government significantly if it is not patched. This revenue growth, he went on, was not the purpose of the tax, and should not be permitted, either through the AMT or through another large tax increase that is used to offset the cost of eliminating the AMT. In short, Ryan said, he does not support offsetting the cost because "two wrongs don't make a right."
Ryan said the size of government is so important because, 1) It has an impact on individual freedoms; 2) it cuts down on the pace of economic growth; and 3) increased taxes hurt quality of life. But there is a fourth reason that is new to the argument, which strengthens the case against offsetting the cost of the AMT with higher taxes: globalization. American economic competitiveness is no longer a foregone conclusion, he said, and the federal government must maintain low tax rates in order allow citizens to keep more of their money and encourage risk taking.
Next, Ryan argued that revenue growth of the type represented by the AMT is intimately tied to growth in entitlement spending. These two ideas, in turn, are joined in the concept of the "baseline," a set of economic projections that assume current policy remains fixed, and that are the measuring stick for evaluating whether a bill satisfies Paygo. But while the baseline assumes that spending will continue to grow, we are not obligated to follow those assumptions. The size of government at present is large enough, and need not be augmented further by the AMT or an offsetting tax increase.
Ryan then analyzed Chairman Rangel's Tax Reduction and Reform Act (HR 3970), which has not passed either house but would eliminate the AMT with offsets. Rangel, Ryan acknowledged, is being honest by including a large tax increase in his bill. This tax increase falls primarily on small businesses, which are the engine of American economic growth. Unfortunately, he pointed out, that is what you have to do to offset the cost of eliminating the AMT under Paygo. The alternative is to say that we do not need to offset the cost, that the government should not have these revenues, and that we should not give in passively to the growth in entitlements by generating revenue that sustains it.
Closing his talk, Ryan outlined his tax plan, known as the Taxpayer Choice Act (HR 3818). An alternative to the Rangel bill, it sets the goal of maintaining the size of revenues at its current level of about 18.5 percent of GDP. It gives taxpayers a choice between the current income tax and a simpler system with only two tax levels -- 10 percent for individual incomes below $50,000 and 25 percent for incomes above that level -- and a single, large standard deduction, instead of the host of tax expenditures currently in the tax base. Ryan finished saying that issues with entitlements and the AMT are creating a "perfect storm" for tax reform, an event he welcomes.
MacGuineas then spoke briefly, remarking that she was not convinced that AMT reform should be the top priority of the economy, given that it is "immensely expensive" and that other tax reforms could be both fairer and more efficient, and that the AMT might serve as a political trigger for more fundamental tax and fiscal reform. She then introduced a panel of experts, moderated by David Wessel of the Wall Street Journal.
Len Burman opened the panel, giving a brief history of the AMT. He explained that the tax was introduced in 1967 so that politicians would not have to reform tax shelters in order to force rich Americans from evading taxation. The AMT was terribly designed from the start for a number of reasons, he said. First, its lack of indexing meant that coverage would inevitably grow over time. Second, it has "horrible marriage penalties" because it is more likely to hit taxpayers who have more children, as children are deductible under the standard income tax but not the AMT. Finally, he explained, the AMT has a transition level between around $175,000 and $500,000 where taxpayers are essentially hit with an extra surtax on both earned income and capital gains and thus face higher marginal tax rates under the AMT than under the standard income tax. Burman further argued that the process of having annual patches is terrible policy, because it creates so much uncertainty for taxpayers. It also makes tax-incentives less effective since taxpayers don't know if they are eligible for certain deductions or credits. Burman closed by praising recommendations from the Bush Tax Reform Panel as good policy, but bad politics. He also praised Congressman Rangel's plan to replace the AMT with a surtax as simple and effective, though not "perfect policy".
Bob Carroll spoke next on the importance of enacting a patch as soon as possible. "Every day of delay," he explained, "means that taxpayers who would have gotten their refunds in February or March will now get them later." This means that 17 million people could have to wait weeks or months longer for $40 billion in refunds. If the AMT patch is not passed at all, furthermore, the number of people immediately subject to AMT could increase from 4 million to 25 million. He explained that the uncertainty associated with annual patches is also a problem, as many people fail to estimate their tax burden correctly. He then argued that real AMT reform must be accompanied with regular tax reform. Turning to history, Carroll explained that the real problem with the AMT is that it was not indexed at the same time that the standard tax was indexed in the mid 1980s, resulting in compounding shortfalls between the two taxes over time. In this year, for example, patching the AMT would cost $50 billion -- by 2012 it will be $100 billion and by 2017 it will be $220-$250 billion.
Aviva Aron-Dine offered a background on the AMT, and advocated that reform meet the principles of fiscal responsibility and fairness. Aron-Dine explained that we are currently in a standoff as to whether Paygo should apply to the AMT. Those against applying Paygo, she explained, argued that the AMT is an accidental problem which need not be paid for. However, she explained, around two thirds of the cost of the patch is due to the 2001 and 2003 tax cuts, rather than the lack of indexing with the AMT. In enacting those tax cuts, she explained, policy makers were very aware of the new revenue which would come from the AMT, and used it in order to make the tax cuts look cheaper. She then argued that real fiscal responsibility should dictate that any changes be paid for. She explained that, because of the rising costs of health care, the United States will soon face a choice between keeping historical rates of taxation constant, and maintaining historical levels of government services, as it will soon become impossible to do both.
Alex Brill discussed the geographical implications of the AMT. He explained that a major factor which drives people to the AMT is the amount of deductions they receive based upon family size and state and local income taxes. This results in people from high-tax states being more likely to hit the AMT. In New Jersey, New York, and Connecticut, he explained, between 7 percent and 9 percent of taxpayers were hit by the AMT, yet in Alabama, Tennessee, and Alaska, less than 2 percent of people are hit. Because of these differences, he explains, the AMT is very much a "blue state" issue -- in each of the top 6 states hit by the AMT, both Senators are Democrats. Brill suggested that there is a legitimate argument over whether to use historical tax levels or historical levels of services, but it doesn't make sense to use the result of "do-nothing" policies as the baseline. He closed by suggesting that limiting state and local tax deductions could raise enough revenue to permanently index the AMT.
Former Congressman and CRFB co-chair Bill Frenzel closed the panel. He began by explaining that the AMT was enacted because politicians were unable to get rid of the tax exempt feature of maniple bonds, although they were a major devise in helping wealthy earners from taxation. He argued that the AMT must be eliminated, but that PAYGO needs to be maintained. Although our PAYGO rules are imperfect, he explained, we must cling to them or lose all vestige of control. He finished by commenting on Ryan's bill, suggesting that giving taxpayers a choice might be a little gimmicky, but might also be more politically realistic.
Wessel opened up the Q&A section by asking what political strategies might allow for real reform. Burman suggested that real reform would be hard, but that the expiring tax cuts and creeping AMT might serve as a stimulus, especially if there is Presidential support and a bi-partisan process in 2009. Wessel then asked why the Bush reform panel failed. Carroll suggested that the demand for budget neutrality, coupled with the large cost of offsetting the AMT, created too many powerful losers. Bill Frenzel jokingly remarked that the panel failed because he was on it, and then suggested that there wasn't strong public support for tax reform, nor was there much Presidential leadership on the issue. Wessel's last question was on how panelists felt about the Ryan tax plan, to which Burman replied that the math didn't add up, and that the plan would certainly increase the deficit.
The first questioner in the audience asked why the AMT wasn't being discussed in the Presidential campaign. Burman suggested that most people don't know they could potentially be hit for it, and that this might change if the patch was not enacted for a year. Frenzel agreed, suggesting that the people hit by the current patched AMT can afford it, and so the AMT doesn't create a huge amount of pain. Brill refuted this a little, suggesting that tens of millions are affected by the AMT due to the potential that they will have to pay it, even though only four million actually pay it. Aron-Dine followed up on this by suggesting that although this might be a blue-state/red-state issue for actual payers, potential payers are more evenly divided between states.
The next questioner asked about the distributional consequences of not patching the AMT for the year 2008 (as opposed to well into the future). Carroll explained that the average family of four making over $68,000 would face some new taxes from the AMT. Burman tried to demonstrate that the AMT hits the upper middle class, but not the super rich, who tend to face similar tax burdens with or without the AMT.
Wessel then asked if confusion over the AMT makes a real economic difference, and Burman suggested that it did, especially with regards to tax incentives (the hybrid tax credit for example), which become useless under the AMT. Burman also proclaimed that people should understand how the AMT is affecting them.
Another questioner asked if the benefits of the patch would go to the wealthy. Burman explained that those in the 80th to 90th income percentile would experience on average a 0.9 percent tax cuts, those between 90th to 95th income percentiles would experience, on average, a 1.3 percent cut. Those between the 95th and 99th percentile, meanwhile, would experience an average of 1.8 percent in cuts. The top 1 percent, on the other hand, would only experience an average of a 0.1 percent tax cuts. The patch, therefore, would go to the wealthy -- but not to the super rich (top 1 percent), and the distributional effects of the patch really depend on where the offsets come from. Wessel explained that an AMT patch would not be a way to help the people at the bottom, but a way to stop something from hitting people near the top. Aron-Dive showed that about one third of benefits from the patch goes to those households making between $200,000 and $500,000, around one half goes to those between $100,000 and $200,000, and only 14 percent goes to those making between $50,000 and $100,000. She also notes that the Rangel AMT reform would also expand the standard deduction, the child tax credit, and the earned income tax credit, which all help poorer Americans.
-Paul McLaughlin and Marc Goldwein, Research Associates for the Fiscal Policy Program
210 Cannon House Office Building
Washington, DC, 20515