State and Local Taxes and the Federal Alternative Minimum Tax

Publication Date: June 2005

Publisher: Library of Congress. Congressional Research Service

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Research Area: Banking and finance

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Abstract:

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 recent major 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 2006 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describes the potential impact on taxpayers and state and local governments if the AMT reverts to pre-2001 rules or is repealed.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. 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 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 RS22100, The Alternative Minimum Tax for Individuals: Legislative Initiatives and Their Revenue Effects, by Gregg Esenwein.