State and Local Taxes and the Federal Alternative Minimum Tax
Order Code RL32942
State and Local Taxes and
the Federal Alternative Minimum Tax
Updated September 11, 2008
Steven Maguire
Specialist in Public Finance
Government and Finance Division
State and Local Taxes and
the Federal Alternative Minimum Tax
Summary
The alternative minimum tax (AMT) is a parallel tax to the regular individual
income tax and is intended to help ensure that high-income individuals bear at least
some tax liability. The 2001 and 2003 tax cuts, however, lowered the average tax
liability under the regular income tax such that many taxpayers could have been
captured by the AMT, which is not indexed for inflation. The AMT for individuals
will capture significantly more taxpayers beginning in the 2008 tax year if Congress
does not act to modify or repeal the tax. This report describes the potential impact
on taxpayers and state and local governments if the AMT reverts to pre-2001 rules
or is repealed. Both taxpayers and state and local governments are potentially
affected because state and local taxes are deducted for purposes of the regular income
tax, but are not deducted when calculating AMT liability.
The impact on state and local governments arises because the tax price of public
goods is reduced through federal deductibility. Each tax dollar a taxpayer (who
itemizes) pays to a state or local government reduces the taxpayer’s federal tax
liability by an amount equal to his marginal tax rate multiplied by the taxes paid.
Theoretically, state and local governments can levy higher taxes and provide more
public goods than they would be able to absent federal deductibility. Through
deductibility, state and local governments are also able to “export” part of their tax
burden to all federal taxpayers, high-tax states more than others. Repeal of the AMT
would expand the tax benefit generating more tax exportation. AMT reversion to
pre-2001 rules would reduce the tax benefit and reduce tax exportation.
The variation of tax structures among states will lead to a significant differential
impact by state and by individual. Generally, repeal of the AMT would reduce taxes
for high-income taxpayers and reversion would increase taxes for high-income
taxpayers. Most of the highest-income taxpayers (adjusted gross income over
$500,000), however, would not be affected because their regular income tax liability
exceeds AMT liability.
Generally, high-tax, high-income states would fare relatively better under AMT
repeal and relatively worse under reversion to pre-2001 AMT rules. This report
includes a state-by-state breakdown of the average taxes-paid deduction and the
percentage of AMT filers and itemizers. This information is provided to help
policymakers evaluate the effect of possible reforms of the AMT on constituent
governments.
This report analyzes the broad impact of the AMT and options for its
modification. For information on congressional action with respect to the AMT, see
CRS Report RL34382, The Alternative Minimum Tax For Individuals: Legislative
Activity in the 110th Congress, by Steven Maguire and Jennifer Teefy.
Contents
Effect of the AMT on Individuals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Income Distribution of the State and Local Taxes Paid Deduction . . . . . . . . 3
Income Distribution of AMT Liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Effect of the AMT on State and Local Governments . . . . . . . . . . . . . . . . . . . . . . 8
Potential Issues for Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
AMT Reversion to Pre-2001 Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Repeal of the AMT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
List of Tables
Table 1. Returns by Income Class, Selected Characteristics, 2006 Tax Year . . . 2
Table 2. Taxes Paid Deduction by Income Class, 2006 Tax Year . . . . . . . . . . . . 4
Table 3. Income Distribution of Returns with AMT Liability, 2004 Tax Year . . 6
Table 4. Income Distribution of Returns with AMT Liability, 2006 Tax Year . . 7
Table 5. AMT Filers and the Average Taxes Paid Deduction on
Federal Income Tax Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
State and Local Taxes and
the Federal Alternative Minimum Tax
The alternative minimum tax (AMT) is a parallel tax to the regular individual
income tax and is intended to help ensure that high-income individuals bear at least
some tax liability.1 The 2001 and 2003 tax cuts, however, lowered the average tax
liability under the regular income tax such that many taxpayers could have been
captured by the AMT, which is not indexed for inflation.
The AMT exemption amounts have been increased several times beginning in
2001. Congress temporarily adjusted the AMT exemption amounts in 2001 (through
the Economic Growth and Tax Relief Reconciliation Act, EGTRRA) and 2003
(through the Jobs and Growth Tax Relief Reconciliation Act, JGTRRA). Congress
extended the temporary exemption amount increases in 2004 (through the Working
Families Tax Relief Act, WFTRA) and again in 2006 (the Tax Increase Prevention
and Reconciliation Act of 2005, TIPRA).2 The Tax Increase Prevention Act of 2007
(TIPA) increased the exemption levels and extended the allowance of personal
credits against the AMT for the 2007 tax year. By increasing the AMT exemption
amount, the threshold where regular income tax liability falls below AMT liability
is relatively higher, temporarily reducing the number of taxpayers subject to the
AMT. In addition, some personal credits that were previously not allowed to offset
AMT liability can now be used to offset the AMT.
Potential changes to the AMT would have a significant effect on the taxes levied
on individuals and on the tax structure of state and local governments. Specifically,
the distribution of the federal tax burden on individuals would change if either
extreme, reversion to pre-2001 rules or repeal of the AMT, is implemented. State
and local governments would either see the tax price for public goods increase
(reversion) or decrease (repeal).
The report includes a state-by-state breakdown of the average “taxes paid
deduction” and the percentage of AMT filers and itemizers. This information is
provided to help policymakers evaluate the effect of possible reforms on constituent
governments. The report concludes with a discussion of how congressional action
on the AMT could affect state and local governments and taxpayers if Congress takes
action dealing with the AMT in 2008.
1 For more on the AMT, see CRS Report RL30149, The Alternative Minimum Tax for
Individuals, by Steven Maguire.
2 The WFTRA AMT extension is through the 2005 tax year. The TIPRA extension is
through the 2006 tax year.
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Effect of the AMT on Individuals
The potential distributional effects of AMT reform or repeal on individuals is
the focus of this section. There are two primary avenues through which the tax
burden would be shifted: through the treatment of state and local taxes paid and
through the distributional burden of the AMT generally. A secondary effect would
arise as states and individuals respond to any new treatment of state and local taxes
under the AMT or without an AMT. How the burden is currently distributed will
help frame how burden would change under proposals to repeal or reform the AMT.
Table 1 provides a distribution of taxpayers based on the utilization of itemized
deductions, the taxes paid deduction, and the presence of AMT tax liability for all
returns, for the 2006 tax year. The AMT “patch” for 2006 kept the number of AMT
filers under 4 million.
Table 1. Returns by Income Class, Selected Characteristics,
2006 Tax Year
Returns
Returns
Returns
Returns in
Adjusted Gross Income
with
with Taxes
with
Income
Class
Itemized
Paid
AMT
Class
Deductions
Deduction
Liability
less than $5,000
14,308,964
345,274
322,484
7,641
$5,000 to $10,000
11,786,747
577,704
551,708
2,336
$10,000 to $15,000
11,711,680
1,029,474
980,400
850
$15,000 to $20,000
10,937,694
1,276,531
1,232,624
2,202
$20,000 to $25,000
9,912,261
1,536,608
1,498,621
2,668
$25,000 to $30,000
8,749,761
1,821,779
1,766,088
1,513
$30,000 to $40,000
14,151,824
4,363,179
4,471,818
3,811
$40,000 to $50,000
10,687,193
4,546,362
4,494,623
7,815
$50,000 to $75,000
18,854,917
10,818,922
10,761,866
87,680
$75,000 to $100,000
11,140,408
8,297,996
8,281,651
129,240
$100,000 to $200,000
12,088,423
10,655,930
10,642,872
1,096,666
$200,000 to $500,000
3,121,485
2,962,237
2,960,017
2,242,146
$500,000 to $1,000,000
589,306
552,797
551,385
269,527*
$1,000,000 to $1,500,000
150,431
142,284
142,087
40,938*
$1,500,000 to $2,000,000
64,007
61,068
60,950
16,710*
$2,000,000 to $5,000,000
98,724
95,326
95,169
24,043*
$5,000,000 to $10,000,000
24,975
24,348
24,299
6,518*
$10,000,000 and over
15,956
15,735
15,696
4,632*
All Returns
138,394,754
49,123,555
48,660,923
3,966,540
Source: IRS, Statistics of Income, Individual Complete Report 2006, Publication 1304, July 2008.
* The number of filers for these income groups is the number of itemizers with AMT liability, which
is slightly less than total AMT filers for these groups. IRS Publication 1304 does not provide the total
number for all AMT filers for these income groups. There are 19,604 AMT filers not accounted for
in the AGI groups listed here. They are likely concentrated in the $500,000 to $1 million cohort.
CRS-3
Generally, as adjusted gross income increases, so to does the prevalence of
returns with itemized deductions, a taxes paid deduction, and AMT liability. Note
that the vast majority of taxpayers with AGI greater than $75,000, itemize and claim
a deduction for state and local taxes paid.
Income Distribution of the State and
Local Taxes Paid Deduction
Under the regular income tax, individuals who itemize deductions may deduct
state and local taxes paid. Taxpayers must choose to deduct either income or sales
taxes, not both.3 In the 2003 tax year, before the sales tax deduction option was
available, 43.1 million returns deducted $310.9 billion in taxes paid.4 In the 2004 tax
year, the first year for the sales tax deduction option, 46.0 million returns deducted
$362.6 billion.5 In the 2005 tax year, 47.4 million returns deducted $400.4 billion.6
And, in 2006, 48.7 million deducted $432.8 billion.7 The increase in number of
returns claiming the taxes paid deduction and in the amount deducted is likely due
in part to the sales tax deduction option. In contrast to the regular income tax
treatment, under the alternative minimum tax (AMT), state and local taxes paid are
considered a preference item and are included in the base of the tax. According to
the Joint Committee on Taxation (JCT), approximately 4 million taxpayers “added
back” approximately $90.9 billion in state and local taxes paid for purposes of
calculating AMT liability in 2006.8
The taxes paid deduction is most common for returns in the higher income
brackets. Out of the 27.3 million total returns with reported AGI of over $75,000,
22.8 million itemized deductions (see Table 1). Itemized returns with AGI over
$75,000 represented 46.4% of itemized returns and claimed 75.7% of the total taxes
paid deduction (see Table 2). Itemized returns with AGI over $100,000 represented
29.5% of itemized returns yet accounted for 62.8% of the taxes paid deduction.
As is often the case with federal tax policy, different parts of the tax code
contradict one another. The treatment of state and local taxes is one example. The
policy objective behind the tax preference for state and local taxes paid under the
regular income tax has been supported with the claim that to disallow the deduction
3 Under current law, the option to deduct sales taxes in lieu of income tax expired at the end
of 2007.
4 Internal Revenue Service (IRS), Statistics of Income, Individual Complete Report 2003,
Publication 1304, Oct. 2005. The sales tax deduction option was not available in 2003; it
became available for the 2004 tax year.
5 IRS, Statistics of Income, Individual Complete Report 2004, Publication 1304, Sept. 2006.
6 IRS, Statistics of Income, Individual Complete Report 2005, Publication 1304, July 2007.
7 IRS, Statistics of Income, Individual Complete Report 2006, Publication 1304, July 2008.
8 U.S. Congress, Joint Committee on Taxation, “Present Law and Background Relating to
the Alternative Minimum Tax,” JCX-38-07, June 25, 2007.
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would amount to a “tax on a tax.”9 Proponents of the deduction suggest that taxes
paid to state and local governments are not available to pay federal income taxes and
thus should not be included in taxable income. In short, proponents of deductibility
claim that “taxing a tax” is inequitable. If the AMT were to revert to the pre-2001
rules, this tax preference would be reduced, contravening the original intent of the
tax deduction under the regular income tax. In a recent analysis, if not for the patch,
the AMT would have reduced the “value” of the taxes paid deduction by over one-
quarter.10 The analysis also estimated the lower tax rates enacted in 2001 and 2003
further diminished the “value” of the deduction by roughly 20%.
Table 2. Taxes Paid Deduction by Income Class, 2006 Tax Year
Percentage
Percentage
Returns
Amount of
of Taxes
of Taxes
Adjusted Gross Income
with Taxes
Taxes Paid
Paid
Paid
Class
Paid
Deduction
Deduction
Deduction
Deduction
(in $ 000s)
Returns
Amount
less than $5,000
322,484
1,091,230
0.7%
0.3%
$5,001 to $10,000
551,708
1,530,443
1.1%
0.4%
$10,000 to $15,000
980,400
2,461,698
2.0%
0.6%
$15,000 to $20,000
1,232,624
3,391,832
2.5%
0.8%
$20,000 to $25,000
1,498,621
4,168,222
3.1%
1.0%
$25,000 to $30,000
1,766,088
5,227,676
3.6%
1.2%
$30,000 to $40,000
4,278,384
14,401,327
8.8%
3.3%
$40,000 to $50,000
4,494,623
17,811,669
9.2%
4.1%
$50,000 to $75,000
10,761,866
54,984,402
22.1%
12.7%
$75,000 to $100,000
8,281,651
55,727,801
17.0%
12.9%
$100,000 to $200,000
10,642,872
111,054,876
21.9%
25.7%
$200,000 to $500,000
2,960,017
64,770,705
6.1%
15.0%
$500,000 to $1,000,000
551,385
27,064,821
1.1%
6.3%
$1,000,000 to $1,500,000
142,087
11,483,609
0.3%
2.7%
$1,500,000 to $2,000,000
60,950
7,079,805
0.1%
1.6%
$2,000,000 to $5,000,000
95,169
17,761,193
0.2%
4.1%
$5,000,000 to $10,000,000
24,299
10,024,660
0.0%
2.3%
$10,000,000 and over
15,696
22,738,131
0.0%
5.3%
All Returns
48,660,923
432,774,100
100.0%
100.0%
Source: IRS, Statistics of Income, Individual Complete Report 2006, Publication 1304, July 2008.
9 See CRS Report RL32781, Federal Deductibility of State and Local Taxes, by Steven
Maguire.
10 Gilbert Metcalf, “Assessing the Federal Deduction for State and Local Tax Payments,”
National Bureau of Economic Research, Working Paper 14023, May 2008.
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In contrast, if the taxes paid to state and local governments are viewed as
payments for services (e.g., education services and garbage collection) some assert
that a deduction for these taxes would not be justified. Reversion to pre-2001 AMT
rules would be more consistent with this view. The characteristics of the goods and
services provided by jurisdictions, in this view, determine the theoretical
appropriateness of the deduction for the taxes used to pay for them. For example,
consider jurisdiction “A” that provides foreign language classes and a government
operated fitness center and jurisdiction “B” which does not offer either. If A funds
these services with local property taxes, taxpayers (who itemize) are allowed to
deduct the cost of these services through the federal deduction for state and local
taxes paid. Alternatively, taxpayers in jurisdiction B who purchase similar services,
albeit from private providers, cannot deduct the expenditure. From a distributional
perspective, jurisdictions that provide more services (jurisdiction “A” in our
example) — likely wealthier jurisdictions — are able to export some of the burden
to all federal taxpayers, including to those in poorer jurisdictions. Generally, the
greater the likelihood of a private provider of a good or service, the less appropriate,
some argue, is the federal deduction for the taxes used to fund those services.
The previous discussion touches on another justification for the deduction for
state and local taxes: the indirect subsidy to state and local governments. The lower
“tax price,” theoretically, allows the local government to impose a tax rate that is
higher than would be the case without deductibility.11 For example, if a taxpayer is
allowed to deduct property taxes, it is likely the case that these taxpayers would be
more willing to accept a marginally higher property tax rate. For each dollar of
property tax paid, the federal tax burden is reduced by the taxpayer’s marginal tax
rate. A taxpayer in the 28% tax bracket would have federal tax liability reduced by
28 cents for each dollar paid in property taxes.
Economic theory predicts that more public services would be provided than
would otherwise be the case without deductibility.12 The taxpayer has more
disposable income (lower federal taxes), and thus would demand more public
services. And, the relative price of government provided goods would decline,
increasing the quantity of public goods demanded.13
From a state distributional perspective, high-tax, high-income states would
benefit the most under expanded deductibility of state and local taxes (e.g., AMT
repeal). This report provides a more detailed discussion of the effect on state and
11 Douglas Holtz-Eakin and Harvey Rosen, “Federal Deductibility and Local Property Tax
Rates,” Journal of Urban Economics, vol. 27, 1990, pp. 269-284.
12 An alternative view of the property tax is that the tax acts as a tax on capital. The higher
capital taxes would in turn discourage business capital investment. In theory, business
capital would flee the high tax jurisdictions, ultimately lowering tax receipts. Thus, it is
argued, local governments may rely less on the property tax and actually invest less in public
goods and services to avoid business flight to other jurisdictions. Total local government
investments in public goods and services, in turn, is lower than it otherwise would be absent
the property tax.
13 Economists refer to these effects as the income and substitution effects, respectively.
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local governments of the taxes paid deduction under AMT reform (and repeal)
proposals in a later section.
Income Distribution of AMT Liability
The AMT affects considerably fewer taxpayers than the itemized deduction
for taxes paid; 4.0 million and 49.1 million, respectively, in 2006. The distribution
of those affected by the AMT, however, is more concentrated than the taxes paid
deduction. The aggregated data produced by the Internal Revenue Service (IRS) and
summarized in Table 3 and Table 4 clearly exhibit the concentrated (and
progressive) nature of AMT liability; roughly 84.1% of AMT returns reported AGI
between $100,000 and $500,000.
Table 3. Income Distribution of Returns with AMT Liability,
2004 Tax Year
Amount of
Returns
Percentage
Percentage
Adjusted Gross
AMT
with AMT
of AMT
of AMT
Income Class
Liability
Liability
Returns
Liability
(in $ 000s)
less than $5,000
4,762
$88,815
0.2%
0.7%
$5,001 to $10,000
35
612
0.0%
0.0%
$10,000 to $15,000
3,082
1,782
0.1%
0.0%
$15,000 to $20,000
1,672
3,386
0.1%
0.0%
$20,000 to $25,000
972
1,537
0.0%
0.0%
$25,000 to $30,000
1,339
1,171
0.0%
0.0%
$30,000 to $40,000
1,664
448
0.1%
0.0%
$40,000 to $50,000
11,818
19,019
0.4%
0.1%
$50,000 to $75,000
89,396
116,192
2.9%
0.9%
$75,000 to $100,000
155,065
224,349
5.0%
1.7%
$100,000 to $200,000
1,095,242
2,058,479
35.4%
15.8%
$200,000 to $500,000
1,529,159
6,831,014
49.4%
52.4%
$500,000 to $1,000,000
149,042
1,645,295
4.8%
12.6%
$1,000,000 to $1,500,000
24,574
452,148
0.8%
3.5%
$1,500,000 to $2,000,000
9,720
257,229
0.3%
2.0%
$2,000,000 to $5,000,000
13,423
538,675
0.4%
4.1%
$5,000,000 to $10,000,000
3,258
269,065
0.1%
2.1%
$10,000,000 and over
2,077
520,024
0.1%
4.0%
All Returns
3,096,299
13,029,239
100.0%
100.0%
Source: IRS, Statistics of Income, Individual Complete Report 2004, Publication 1304, September
2006.
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Because regular income tax liability increases as income increases, eventually
surpassing AMT tax rates, the share of taxpayers with AGI greater than $500,000
subject to the AMT would not change significantly if the AMT reverts to pre-2001
rules. In contrast, the share of taxpayers subject to the AMT in the $50,000 to
$100,000 cohort and the $100,000 to $200,000 cohort would rise dramatically. For
these cohorts, the AMT rates are higher than the regular income tax rates. Taxpayers
in the over $500,000 cohort encounter higher tax rates under the regular income tax
than under the AMT and thus would not be affected by AMT reversion to pre-2001
rules.
Table 4. Income Distribution of Returns with AMT Liability,
2006 Tax Year
Amount of
Returns
Percentage
Percentage
Adjusted Gross
AMT
with AMT
of AMT
of AMT
Income Class
Liability
Liability
Returns
Liability
(in $ 000s)
less than $5,000
7,641
187,200
0.2%
0.9%
$5,001 to $10,000
2,336
316
0.1%
0.0%
$10,000 to $15,000
850
1,138
0.0%
0.0%
$15,000 to $20,000
2,202
3,649
0.1%
0.0%
$20,000 to $25,000
2,668
2,880
0.1%
0.0%
$25,000 to $30,000
1,513
11,746
0.0%
0.1%
$30,000 to $40,000
3,811
11,993
0.1%
0.1%
$40,000 to $50,000
7,815
17,190
0.2%
0.1%
$50,000 to $75,000
87,680
105,899
2.2%
0.5%
$75,000 to $100,000
129,240
180,430
3.3%
0.8%
$100,000 to $200,000
1,096,666
2,128,778
27.6%
9.9%
$200,000 to $500,000
2,242,146
10,982,445
56.5%
50.9%
$500,000 and over
381,972
7,930,923
9.6%
36.8%
All Returns
3,966,540
21,564,586
187,200
100.0%
Source: IRS, Statistics of Income, Individual Complete Report 2006, Publication 1304, July 2008.
Estimates of the anticipated AMT liability distribution if the current laws
governing the AMT are not changed is a principal concern of many observers and
policymakers. According to analysis from the Joint Committee on Taxation (JCT),
under current law, taxpayers with AGI under $200,000 will pay almost 48% of AMT
liability in 2010, compared to less than 13% that the group paid in 2006.14 In
addition, the same analysis estimates that the number of AMT taxpayers will increase
14 U.S. Congress, Joint Committee on Taxation, “Present Law and Background Relating to
the Alternative Minimum Tax,” JCX-38-07, June 25, 2007. Since this JCT publication,
actual data for 2006 have been released and these data are used instead of the JCT estimates.
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to 30.9 million in 2010 from 4.0 million in 2006. Although the AMT would still be
relatively progressive in 2010, the increased burden on less wealthy taxpayers and the
greater absolute number of taxpayers subject to the AMT, would diminish the overall
progressivity of the federal tax system.
Effect of the AMT on State and Local Governments
This section describes and analyzes how possible congressional action on the
AMT may affect state and local governments. Generally, under the AMT, state and
local taxes paid do not receive a federal tax preference. In contrast, the repeal of the
AMT combined with the scheduled repeal of the regular income itemized deduction
phase-out would significantly increase the tax benefit conferred on states through
deductibility.15 For these reasons, state and local governments are actively following
congressional action on the AMT.
State and local government representatives generally support the deductibility
of state and local taxes under the regular income tax because of the indirect subsidy
to sub-national governments delivered through a lower federal tax burden.
Generally, state and local governments are able to “export” part of their tax burden
to all federal taxpayers — some states more than others. Exporting the state and
local tax burden can be measured by the amount of tax revenue that is deductible.
The greater the amount of deductible taxes, the greater the exportation.
Tax cut legislation, the American Jobs Creation Act of 2004 (AJCA 2004,
P.L. 108-357), expanded the deductibility of the state and local taxes to include an
option to deduct sales taxes in lieu of income taxes for taxpayers that itemize.16
Taxpayers choose the greater of sales taxes or income taxes when itemizing
deductions. The new provision primarily benefits taxpayers in states that do not levy
an income tax. The provision expired after 2007.
A variety of methods can be used to compare the relative tax burden of state
and local taxes. For this report, state and local taxes that could have been deductible
under AJCA 2004 rules were chosen as the instrument of comparison. The greater
of sales taxes or income taxes was added to property taxes for each state. This
amount was then divided by the number of 2006 tax returns filed in each state to
produce an average amount for each state. The third column of Table 5 presents
these estimates of the average “deductible” taxes per return, by state. Note that
because businesses pay a large portion of sales and property taxes, the averages
overstate the burden on individual returns, yet the estimates are useful for
comparative purposes.
15 Under current law, through 2009, certain high-income taxpayers are required to reduce
itemized deductions (limited to up to 80% of allowable deductions). This itemized
deduction reduction is phased out beginning in the 2006 tax year until completely repealed
beginning in 2009.
16 For more, see CRS Report RL32781, Federal Deductibility of State and Local Taxes, by
Steven Maguire.
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Potentially deductible taxes (under the AJCA rules) would have been $8,372,
on average, for returns filed in New York state; $2,844 in Alabama (see Table 5).
The U.S. average was $4,606 per return.17 Recall that state and local governments
that rely more on deductible taxes pay a relatively lower “tax price” for public goods.
Jurisdictions in New York state, for example, pay a lower tax price and export more
of their tax burden to federal taxpayers than do jurisdictions in Alabama.
Table 5. AMT Filers and the Average Taxes Paid Deduction on
Federal Income Tax Returns
Total
AMT
Property,
Percentage of
State
Average Taxes
Filers as
Income or
Filers
(* indicates no
Paid
Percentage of
Sales Taxes
Itemizing
broad-based state
Deduction
all Returns
per Return
Deductions
income tax)
2006
2006
Filed
2006
2006
United States
2.96%
4,606
35.62%
9,595
New York
5.50%
8,372
38.40%
17,589
California
4.60%
5,532
39.74%
14,481
Connecticut
5.65%
7,785
45.21%
13,773
New Jersey
6.47%
7,342
45.28%
13,673
District of Columbia
5.22%
8,501
42.49%
12,136
Massachusetts
4.57%
6,778
41.86%
11,217
Maryland
4.68%
5,818
50.14%
10,308
Rhode Island
3.04%
5,625
37.89%
10,042
Virginia
3.54%
5,059
41.74%
9,984
Illinois
2.68%
4,786
36.68%
9,322
Oregon
2.88%
5,440
41.73%
9,199
Wisconsin
2.25%
5,088
38.35%
9,024
Vermont
2.49%
5,297
31.20%
8,957
Maine
2.21%
5,646
32.12%
8,772
Minnesota
2.90%
4,768
41.42%
8,685
Ohio
2.51%
4,775
34.77%
8,648
Pennsylvania
2.53%
4,394
32.35%
8,577
Nebraska
2.03%
4,658
31.47%
8,375
Kansas
2.14%
4,734
31.30%
8,275
North Carolina
2.47%
4,107
36.90%
7,960
New Hampshire
2.26%
4,329
37.42%
7,564
Texas
1.79%
5,452
26.20%
7,460
Georgia
2.51%
4,524
39.45%
7,247
Delaware
2.34%
3,901
37.81%
7,244
Michigan
1.91%
4,641
36.74%
7,141
Hawaii
2.10%
5,230
33.61%
7,125
Kentucky
1.55%
3,479
31.29%
7,116
Missouri
1.78%
3,645
31.76%
7,107
South Carolina
1.93%
3,717
33.27%
7,030
Idaho
1.97%
3,840
35.61%
6,984
Colorado
2.37%
4,518
42.16%
6,844
17 Note that these estimates are considerably less than the standard deduction in 2005,
$10,000 for married taxpayers and $5,000 for single taxpayers. This explains in part the
relatively small number of taxpayers that itemize.
CRS-10
Total
AMT
Property,
Percentage of
State
Average Taxes
Filers as
Income or
Filers
(* indicates no
Paid
Percentage of
Sales Taxes
Itemizing
broad-based state
Deduction
all Returns
per Return
Deductions
income tax)
2006
2006
Filed
2006
2006
Iowa
1.66%
4,263
32.18%
6,835
Indiana
1.46%
4,628
30.69%
6,783
West Virginia
1.18%
3,060
18.67%
6,710
Utah
2.04%
3,997
41.02%
6,581
Montana
1.81%
3,923
31.45%
6,557
Oklahoma
1.53%
3,230
30.45%
6,503
Florida
1.95%
5,201
33.64%
6,409
Arkansas
1.42%
4,152
25.34%
6,372
Arizona
1.97%
5,002
38.80%
6,361
North Dakota
1.16%
3,638
19.69%
5,933
Washington
1.81%
6,204
37.71%
5,735
Louisiana
1.72%
4,786
24.28%
5,700
New Mexico
1.33%
3,859
26.49%
5,570
Mississippi
1.13%
4,152
24.89%
5,287
Nevada
1.50%
4,815
37.80%
5,055
Wyoming
1.44%
6,935
23.81%
4,875
Alabama
1.18%
2,844
30.81%
4,834
Tennessee
0.99%
4,497
26.28%
4,504
South Dakota
0.96%
4,449
19.87%
4,256
Alaska
1.02%
3,342
26.82%
4,019
Source: Internal Revenue Service, Census of Governments 2004-2005, and CRS calculations.
Table 5 also presents data on the percentage of AMT filers by state and the
average state and local taxes paid deduction by state in 2006. The states are ordered
by the amount of potentially deductible taxes. Note that taxpayers in states that do
not levy an income tax will have a greater incentive to itemize and claim the
deduction for taxes paid.18 The average taxes paid deduction will almost certainly
rise in these states as existing itemizers simply add the sales tax paid to other
itemized deductions. The IRS reported that in 2006, 11.2 million taxpayers took
advantage of the sales tax deduction option, deducting $18.9 billion. There are likely
many taxpayers in these states who did not itemize before AJCA was enacted, but
were relatively close to the threshold where itemized deductions could exceed the
standard deduction.
According to the tables in IRS, the state sales tax deduction for a family of
four in Knoxville, Tennessee, with income between $100,000 and $120,000, would
have been $1,696 in 2007.19 In addition, this family could deduct another $545 in
2007 for local sales taxes paid. Further, if this family had purchased a $20,000 car
(or boat), they could deduct another $1,850. In sum, this Tennessee family could
18 See CRS Report RL32781, Federal Deductibility of State and Local Taxes, by Steven
Maguire.
19 The state sales tax rate in Tennessee is 7%, and the local rate for Knoxville is an
additional 2.25% for a combined sales tax rate of 9.25%.
CRS-11
have deducted an additional $4,091 under the sales tax deduction option. With the
standard deduction for joint filers at $10,700 in 2007, it seems reasonable to assume
that the additional sales tax deduction would have induced itemizing for many
taxpayers in a similar situation.
The data from the U.S. Census Bureau in the third column of Table 4 include
the property tax and either the sales tax or income tax. The tax which generates the
most revenue, either income or sales, was added to the property tax to simulate a
state’s reliance on deductible taxes. Comparing states based on what current law
would allow seems to be a reasonable proposition.
Potential Issues for Congress
Congress might ultimately choose one of three basic approaches to address
the AMT. The first is to allow the AMT to revert to the pre-2001 rules. If no further
action is taken on the AMT in 2008, the reversion would occur beginning with the
2008 tax year. The second approach is continued modification of the AMT to
capture roughly the same number of taxpayers every year. This would require annual
adjustment of the higher AMT exemption amounts through indexation or a similar
process and could include changing the deductions allowed against AMT liability.
Thirdly, the AMT could be repealed outright.
If the AMT is repealed, federal revenue could decline considerably. Current
budget forecasts predict repeal would generate an $872 billion revenue loss over the
2007-2017 budget window, assuming the EGTRRA and JGTRRA tax cuts are not
extended.20 If the other regular income tax cuts are extended and the AMT is
repealed, the federal revenue loss over the same budget window would be
approximately $1.16 trillion.21
The second option, extension of the AMT exemption and indexation, would
essentially maintain the status quo and would not significantly shift the burden of
federal taxation among the states. But, because current law does not index the AMT,
the cost of indexation under this option (beginning with the higher AMT exemption
amounts) would be approximately $500 billion over the 2009-2017 budget window
assuming the regular income tax cuts are not extended beyond 2010.22 If the tax cuts
are extended, the cost of this proposal would rise significantly. In contrast to
indexation, the two extremes, reversion and repeal, would likely have significant
impact on state and local governments and would significantly alter the burden of
federal taxation.
20 U.S. Congress, Joint Committee on Taxation, “Present Law and Background Relating to
the Alternative Minimum Tax,” JCX-38-07, June 25, 2007.
21 U.S. Department of Treasury, Fact Sheet: A Tale of Two Taxes, Regular Income Tax and
the AMT, March 2, 2005.
22 Congressional Budget Office, Budget Options, Feb. 2007, Revenue Option 5, p. 264.
CRS-12
AMT Reversion to Pre-2001 Rules
If the AMT is allowed to revert to the structure in place before 2001, and the
regular income tax cuts (EGTRRA and JGTRRA) are made permanent, then the role
of state and local taxes in determining federal tax liability would change
significantly. Under this scenario, the AMT would capture many more taxpayers as
regular income tax liability falls below the floor established by the AMT. State and
local taxes paid, as noted earlier, would become taxable, reducing the implicit federal
transfer to state and local governments. Because the deduction for state and local
taxes paid varies by state, so too would the impact of AMT adjustments.
For example, the average taxes paid itemized deduction for filers residing in
New York was $17,589 in 2006 whereas in Tennessee, the average taxes paid
itemized deduction was $4,504 (see Table 5). The reason for the disparity arises
from the following two factors: the level of state and local taxes and the average
income in the state. Generally, higher state and local taxes and higher income would
both contribute to a higher likelihood of itemizing and claiming a deduction for state
and local taxes paid.
States with the highest average amount of state and local taxes deducted (New
York, California, Connecticut, New Jersey, District of Columbia, Massachusetts, and
Maryland are the top seven) would be the most negatively affected if the AMT were
to be allowed to revert to pre-2001 rules. In contrast, states with relatively low taxes
paid deductions would be the least negatively affected. Note that states with the
relatively small taxes paid deduction are typically states without broad-based income
taxes. If the AJCA 2004 sales tax deduction option were extended beyond 2007,
reversion to pre-2001 AMT rules would have a greater negative impact on these
states. The burden of federal taxes would shift from the low tax states to the high tax
states if the AMT reverts unchanged to pre-2001 rules. Note that reversion to pre-
2001 rules would result in a significant increase in the number of AMT filers in all
states, regardless of state and local taxes.
Repeal of the AMT
In contrast to allowing the AMT to revert to pre-2001 rules, Congress could
repeal the AMT and state and local governments would continue to receive an
indirect benefit through deductibility of state and local taxes. The elimination of the
phase-out of itemized deductions under the regular income tax in 2009 would also
enhance the taxpayer benefit derived from deducting state and local taxes.
If the AMT is repealed, the loss in revenue would necessarily result in one or
more of the following: greater federal debt, an increase in other federal taxes, and/or
reduced federal spending. If federal debt is increased, the cost of borrowing for both
the government and the private sector, would also increase. State and local
governments, which typically rely on debt to fund public infrastructure, such as
schools, roads, and bridges, would likely face higher interest costs as the supply of
all types of government bonds expands. The long-run drag on the economy
generated by government dissaving, however, could be partially offset by the short-
term stimulative effect of lower taxes.
CRS-13
The impact of increasing other federal taxes to replace the lost AMT revenue
depends on the tax raised and how the tax is increased. If the base of the regular
federal income tax (personal or corporate) is expanded (e.g., the elimination of
special deductions or exclusions), many states could receive a slight windfall. A
windfall arises because most states use the base of the federal income tax (both
individual and corporate) as the starting point for state income taxes. For this reason,
if state and local tax rates remain constant, the expanded federal base would increase
state and local tax revenue. Alternatively, an increase in federal rates or the
elimination of lower tax brackets would have little effect on most state income tax
revenue. Other federal tax changes, such as changes in excise taxes, would likely
have little direct effect on the state and local government finances.
Spending cuts would likely include some reduction in grants-in-aid to state
and local governments. These grants comprised approximately 13.2% ($358.6
billion) of total federal government current expenditures in 2006.23 In addition, cuts
in federal spending, other than direct grants, may also adversely affect states if states
must increase spending to provide what was once provided by the federal
government.
Many observers agree that the AMT issue will need to be addressed again in
2008. In addition, proposals addressing fundamental tax reform could include reform
of the AMT. The direction of any congressional choice would have a significant and
varied impact on taxpayers and on state and local governments.
23 Economic Report of the President, Feb. 2008, Table B-82, p. 323.