NCPA - National Center for Policy Analysis


November 10, 2005

President Bush's tax reform panel has proposed limiting or eliminating the alternative minimum tax (AMT), a parallel tax structure that uses a broader definition of income than the regular tax code and doesn't allow many deductions.

  • The AMT will ensnare 21.6 million taxpayers in 2006, up from 4.1 million in 2005, absent changes.
  • But full repeal of the AMT could cost $1.2 trillion over the next 10 years if the president's tax cuts are made permanent, and $611 billion if they are not.
  • The AMT does not allow deductions for state and local taxes, whereas the regular income tax system does; eliminating the deduction for state and local taxes under the income tax would bring in almost enough revenue to pay for repealing the AMT.

This is perhaps the most likely of the panel's proposals to be enacted, says Princeton University economist Alan Krueger. However, he argues that the deduction actually reduces distortions in the tax code, and eliminating it would increase distortions.

  • Krueger says that "because people are geographically mobile, states and cities lose residents if they set taxes too high. The state and local deduction reduces this distortion."
  • He also argues that eliminating the deduction would cause a distortion between support for charities and government programs that provide similar services. (The tax panel's call for a tax credit for charitable donations, but not for state and local taxes, would worsen this distortion.)
  • Finally, eliminating the deduction would be inequitable, since Americans would be allowed to deduct income taxes paid to foreign governments but not to their state or local government.

Thus, says Krueger, it would make more sense to allow AMT deductions for state and local taxes than to eliminate the deduction from the regular income tax.

Source: Alan B. Krueger, "One Tempting Remedy for the Alternative Minimum Tax Has Flaws of Its Own," Economic Scene, New York Times, November 10, 2005.

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