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Friday, April 26, 2024

Weekly SSRN Tax Article Review And Roundup: Elkins Reviews The Policy And Politics Of Alternative Minimum Taxes By Gamage & Glogower

This week, David Elkins (Netanya, Google Scholar) reviews David Gamage (Missouri-Columbia; Google Scholar) & Ari Glogower (Northwestern; Google Scholar), The Policy and Politics of Alternative Minimum Taxes, 78 Nat’l Tax J. _ (2024).

Elkins (2018)

The first Alternative Minimum Tax (AMT) was enacted in 1978 following reports that wealthy taxpayers were able to avoid paying any income tax by exploiting numerous preferences available to them. Whatever the policy justifications for each particular preference, there was a widespread sentiment that wealthy taxpayers should nevertheless pay some income tax. Congress therefore provided that the minimum tax that one must pay is a certain percentage of one’s “alternative minimum taxable income,” which is equal to what one’s taxable income would have been were it not for a number of specified tax preferences. Such AMTs, in which Congress restricts with one hand the use of preferences that it grants with the other, are frequently met with derision among tax scholars. If the preferences are appropriate, in the sense that society is better off (by whatever measure one chooses to determine societal well-being) with them than without them, then there is nothing wrong with taxpayers actually benefiting from such preferences. 

On the other hand, if the use of such preferences is detrimental to societal welfare, then the proper response is to eliminate the preferences, not to leave them on the books and arbitrarily restrict taxpayers from using them.

In this week’s feature article, Profs. Gamage and Glogower examine the conditions under which AMTs can be justified as a design structure for effectuating tax policies and tax reforms. They begin their analysis by considering the use of AMTs by what they refer to as a social planner, a supercomputer that replaces Congress and all other democratic governance institutions and acts benevolently to promote some social welfare function. The supercomputer would not have perfect information on taxpayers, but would only have access to the information generally available to policy makers. The purpose of the exercise is to illuminate how real-world governments ought to act in designing tax policies. The advantage of using AMTs is that it could supply the social planner with additional distributionally-relevant characteristics of taxpayers and allow it to achieve a more optimal balance of its efficiency and distributional goals. The primary disadvantage of AMTs is the increased administrative, compliance, and complexity costs. Thus, for a social planner, evaluating an AMT depends upon whether the advantages of the additional information outweigh the associated costs.

In this light, the authors consider three existing or proposed AMTs: the individual AMT, the current corporate AMT (CAMT), and the proposed Billionaire’s Minimum Income Tax (BMIT). Preference disallowance AMTs, such as the individual AMT, are easily dismissed from the social planner perspective. Because this type of AMT starts with the same information as the regular tax system, there generally will not be any informational advantages from incorporating such AMTs. Any limitations that need to be placed on the use of preferences should be designed to achieve the policy goals of the limitations while minimizing complexity and the associated administrative and compliance costs.

In contrast, the CAMT does provide additional information unavailable in the regular income tax. The CAMT requires that corporations pay tax of no less than 15% of their adjusted book earnings. Because corporations are incentivized by the market to inflate their book earnings while deflating their earnings for tax purposes, book earnings can provide information on distributionally-relevant characteristics of corporate taxpayers beyond the information contained in the earnings reported for regular corporate tax purposes. On the other hand, the costs of CAMT compliance is likely to be small because the corporation in any case needs to compute and report its financial statement income. Nevertheless, the authors argue that instead of the CAMT as an alternative to the regular corporate income tax, it might be better to subject certain corporate taxpayers to both the CAMT and the regular corporate income tax, but at reduced rates. The key reason for such an approach is the standard theorem of optimal tax theory that the economic loss from a tax distortion grows with the square of the size of distortion. Consequently, all else being equal, it is better to introduce two small tax-distortion wedges than one large one.

The BMIT (which one of the authors appropriately discloses that he advised on and co-drafted) would have applied to individual taxpayers with more than $100 million in assets. As opposed to the regular income tax base that includes only realized income, the alternative tax base would have included also unrealized gain. Taxpayers would pay tax equal to 20% of the alternative tax base if such tax were greater than their regular tax liability, subject to appropriate adjustments to account for gain accrued in one year and realized in another. The authors argue that the contours of the proposed BMIT appropriately balance the information advantage with the disadvantage of additional complexity and costs.

While the social planner thought experiment is a helpful analytic tool, the authors argue that the primary arguments in favor of AMTs arise from electoral political concerns and from governance collective action problems. In particular, they review organizational and informational constraints and uncertainty with regard to interactions among various provisions as they apply to different types of taxpayers. In light of these challenges, they argue, AMTs can entail a number of practical advantages, even when their theoretical justification is questionable.

This essay offers a fresh view into one of the more bewildering aspects of the tax system. By categorizing the various types of AMTs, by explaining which are theoretically sound and which can only be justified as a response to practical political reality, and by describing how one might seek to balance the advantages and inevitable costs, the authors make a significant contribution to the literature.

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2024/04/weekly-ssrn-tax-article-review-and-roundup-elkins-reviews-the-policy-and-politics-of-alternative-min.html

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