AMT Update

Alternative Minimum Tax (AMT) reform continues to gain support in Congress, particularly among both Republican and Democratic members of the Ways and Means Committee. AMT relief was proposed in the Republican "Contract With America." AMT reform is expanded in Chairman Bill Archer's "mark," which was released March 9. The Chairman's mark provides for phasing out the corporate AMT over a six-year period. In addition, depreciation deductions are no longer required to be included in the calculation of alternative minimum taxable income (AMTI) after March 13, 1995. Other adjustments to AMTI are also phased out. These reforms would substantially reduce the cost of capital and cash flow disadvantages faced by firms paying the corporate AMT during the AMT's phaseout.

Prior to the release of the Chairman's mark, Ways and Means Committee member Phil English (R-PA) sent a letter to the Committee Chairman Bill Archer (R-TX) calling for the elimination of depreciation as a component in the calculation of AMT liability. The letter was cosigned by ten additional Republican Ways and Means members: Philip M. Crane (IL), E. Clay Shaw (FL), Wally Herger (CA), Melton D. Hancock (MO), Dave Camp (MI), Sam Johnson (TX), Jennifer Dunn (WA), Rob Portman (OH), Jon Christensen (NE), and Bill Thomas (CA).

A Democratic bill for AMT reform was introduced in March by Democratic Committee members Benjamin Cardin (MD) and Sander Levin (MI). The bill, H.R. 1092, provides for the elimination of depreciation as a preference under the AMT.

AMT's Economic Impact

Investment Spending

A study by Joel Prakken, Chris P. Varvares, and Laurence H. Meyer (PVM) argues that the AMT has the potential to reduce investment spending in one of two ways.1 First, AMT filers pay a higher average tax rate and, consequently, generate less internal cash flow than they would under the regular tax. This, in turn, may curb investment by firms with impeded access to capital markets. Second, the AMT affects the marginal tax rate on capital, and hence may discourage investment by raising what in neoclassical investment theory is known as the rental price of capital (or the "cost of capital"). The "rental price" is defined as the annual cost (interest plus depreciation) per unit of capital, after adjusting for the real purchase price of capital, risk, and allowing for corporate taxes, including deductions for depreciation and interest.

PVM's results show that firms permanently on the AMT face capital costs significantly higher than firms that pay only the regular corporate income tax. PVM's econometric simulations show that if all firms were to face the AMT indefinitely (the worst case scenario), the result would be to reduce the level of output by approximately $60 billion annually relative to the case in which all firms paid the regular income tax. Ultimately, the equipment/output ratio would fall by 3 percent. In absolute terms, the stock of equipment would be 3.9 percent lower.

Value of Depreciation Allowances

Capital cost recovery provisions for pollution-control equipment are much less favorable now than prior to the Tax Reform Act of 1986 (TRA). For example, the present value of cost recovery allowances for wastewater treatment facilities used in pulp and paper production was 100 percent prior to TRA. Under regular TRA income tax, the present value dropped to 81 percent, while for AMT payers the figure is 63 percent. Scrubbers used in the production of electricity fared even worse. Prior to TRA, the present value was 90 percent. Today, the present value is only 55 percent; for AMT taxpayers the figure drops to 42 percent. As is true in the case of productive equipment, loss of the investment tax credit and lengthening of depreciable lives both raise effective tax rates.

Capital Cost Disadvantage

While the repeal of the adjusted current earnings (ACE) adjustment to depreciation contained in the Omnibus Budget Reconciliation Bill of 1993 (OBRA 1993) was a positive step, the capital cost disadvantage faced by firms on the AMT remains (see Figure 1). AMT firms with assets depreciated over seven years face capital costs 10 percent higher than for firms on the regular corporate income tax. Had the reform proposed by the Clinton administration in 1993 been enacted, AMT firms' capital cost disadvantage would have fallen to less than 4 percent.

Note

1. Joel L. Prakken, Chris P. Varvares and Laurence H. Meyer, "Investment, Economic Growth and the Corporate Alternative Minimum Tax," Tax Policy for Economic Growth in the 1990s, American Council for Capital Formation Center for Policy Research, 1993.

U.S. Productivity Growth Lags

U.S. manufacturing productivity growth lagged behind that of most major industrial countries over the 1979-1993 period, according to a new report by the Bureau of Labor Statistics, U.S. Department of Labor. Labor productivity, or output per worker per hour, grew at only 2.4 percent in the 1979-1993 period compared to 4.3 percent in Japan and Belgium, and 4.1 percent in the United Kingdom (see chart). In fact, U.S. manufacturing productivity growth was matched or exceeded by eight of the twelve countries surveyed. Lagging U.S. labor productivity growth is a concern because of its role in helping to increase real living standards for U.S. workers.