Corporate AMT Reform: What Are the Facts?

June 1997

by Margo Thorning, Senior Vice President and Chief Economist of the American Council for Capital Formation. Summary The Revenue Reconciliation Act of 1997 (H.R. 2014), passed by the U.S. House of Representatives, includes provisions to reform the corporate alternative minimum tax (AMT). Neither the Senate legislation nor the President's June 30, 1997 tax proposal includes provisions to reform the corporate AMT. The ACCF prepared this Special Report in order to encourage informed debate on the economic impact of the AMT. Background The Tax Reform Act of 1986 created a comprehensive corporate AMT system that exists separate from, but parallel to, the regular tax system. Under the AMT scheme, taxable income is modified by an intricate series of "adjustments" and by "preference items" to arrive at alternative minimum taxable income. Depreciation allowances for firms paying the alternative minimum tax are generally much less favorable than those for firms paying the regular corporate income tax. In fact, U.S. firms paying the AMT face the slowest capital cost recovery in the industrialized world for equipment used in manufacturing and pollution prevention and control (see Table 1). Although the corporate AMT rate is 20 percent compared to 35 percent for the regular tax, it is applied to a broader base. Consequently, the AMT frequently results in a higher tax payment than required by the regular corporate income tax system.

Table 1	International Comparison of the Present Value of Equipment Used to Make Selected Manufacturing Products and Pollution Control Equipment (as a percent of cost)
	Factory Robots	Crank- shafts	Continuous Casting for Steel Production	Engine Blocks	Wastewater Treatment for Chemical Production	Wastewater Treatment for Pulp and Paper Equipment	Scrubbers Used in Electricity Plants
United States
1985 Law	100.1	100.1	100.1	100.1	100.1	100.1	89.7
MACRS1	80.8	80.8	80.8	80.8	85.2	80.8	54.5
AMT2	68.8	64.6	59.0	60.8	70.0	62.7	41.5
Brazil	74.7	74.7	88.3	74.7	74.7	74.7	79.4
Canada	74.0	73.8	74.2	73.6	85.3	85.3	85.3
Germany	82.7	83.9	74.2	83.9	71.8	69.7	68.9
Japan	83.4	83.9	81.4	83.7	84.6	83.7	82.4
Korea (w/ 3% ITC)	82.6	80.1	77.7	79.6	95.2	93.9	92.2
Singapore	91.7	91.7	91.7	91.7	91.7	91.7	91.7
Taiwan	79.0	64.3	63.5	63.7	147.0	147.0	147.0
Notes: 1. MACRS = Modified Accelerated Cost Recovery System (Current Law) for regular taxpayers 2. AMT = Alternative Minimum Tax (Current Law) Source: Stephen R. Corrick and Gerald M. Godshaw, "AMT Depreciation: How Bad Is Bad?" in Economic Effects of the Corporate Alternative Minimum Tax (Washington, D.C.: American Council for Capital Formation Center for Policy Research, September 1991); and unpublished data incorporating the AMT provisions of OBRA 1993. Updated by Arthur Andersen LLP, Office of Federal Tax Services, Washington, D.C., January 1995.

Corporate AMT Reform: The Facts Critics of corporate AMT revision argue that reforming the AMT will allow companies to escape paying corporate income tax. Nothing could be further from the truth. In fact, firms paying the AMT are "prepaying" tax that would be due in succeeding years if they were allowed to take advantage of the more generous depreciation schedule regular corporate income tax payers enjoy. Critics argue, despite several econometric analyses by top public finance scholars, that the AMT does not increase the cost of capital for new investment. In fact, a new study by University of Maryland scholar Andrew B. Lyon shows that AMT firms face capital costs which are 10 percent higher than firms paying the regular tax. Studies by DRI/McGraw-Hill and Joel Prakken at Macroeconomic Advisers, Inc. also conclude that the corporate AMT raises the cost of capital by about 10 percent for new investment (see Figure 1).

Figure1	Comparison of the Increase in Cost of Capital for Equipment Incurred by AMT Firms Compared to Firms Paying the Regular Income Tax
Note: Depreciation systems for an asset depreciated over 7 years under regular law. Current Law (OBRA 1993): 150% declining balance recovered over 13-year period. Clinton's 1993 AMT Proposal: 120% declining balance recovered over 7-year period. AMT Provisions in H.R. 2014: 200% declining balance recovered over 7-year period. Explanation: A firm on the current AMT faces a cost of capital 9.87 percent higher than a firm paying the regular income tax; the 1993 Clinton AMT proposal would have reduced the penalty on investment to 3.6 percent for an AMT firm. The provisions in H.R. 2014 would reduce the penalty to about 1.5 percent. The analysis assumes that firms are permanently on the AMT. The capital cost calculations use the pretax return required by an investor and are net of economic depreciation. Source: Capital cost calculations by Macroeconomic Advisers, Inc. and Andrew Lyon, University of Maryland. Chart prepared by ACCF Center for Policy Research, June 1997.

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. The House bill (H.R. 2014) would reduce the penalty on investment to approximately 1.5 percent. Contrary to critic's assertions, the AMT reforms in the House bill will reduce the cost of capital for new investment and increase cash flow, enabling U.S. businesses to make larger capital expenditures and thus enhancing productivity growth and job creation. The impending retirement of U.S. baby boom generation makes strong economic growth imperative because only two workers will be supporting each retiree, compared to the current three workers per retiree. Critics charge that business investment has not been negatively impacted by the AMT. In fact, studies by Andrew Lyon, DRI/McGraw-Hill, and Macroeconomic Advisers conclude that the corporate AMT has reduced fixed business investment by 5 to 10 percent per year. Critics of AMT reform also ignore the fact that the United States has one of the highest tax rates on new investment in the industrialized world, even before the AMT is factored into the calculations. For example, a study by the Progressive Foundation, the think tank affiliate of the Progressive Policy Institute, shows that the marginal tax rate on domestic U.S. corporate investment for regular corporate taxpayers is 37.5 percent, exceeding every country in their survey except Canada (see Figure 2).

Figure 2	Effective Tax Rates on Domestic Corporate Investment, 1991

Critics also argue that the House provisions for AMT reform would be regressive for lower income taxpayers because upper income taxpayers typically receive more income from capital. In fact, reducing the tax burden on U.S. corporations could help raise real wages, according to an analysis by Professor Arnold Harberger, who is widely considered to be the "dean" of public finance economists. Professor Harberger concludes that in today's international, open economy, labor actually bears a large portion of the tax nominally paid by corporations because capital is mobile while labor is not. In other words, countries with high corporate tax rates will tend to see investment moving offshore; lower levels of investment tend to depress real wages because productivity grows more slowly. Thus, when corporate tax burdens are high, U.S. workers employed in sectors whose products and services are traded in world markets will experience slower growth in real wages than those living in countries with a more attractive investment climate. Conclusion The House provisions for AMT reform are an important step in putting U.S. firms on an equal footing with their international competitors. AMT reform is needed to increase U.S. living standards, allow U.S. firms to be more competitive in today's global economy, and help ensure the economic growth needed as the baby boom generation begins to retire. References Corrick, Stephen R. and Gerald M. Godshaw. 1991. AMT Depreciation: How Bad Is Bad? In Economic Effects of the Corporate Alternative Minimum Tax, 1-31. Washington, D.C.: American Council for Capital Formation Center for Policy Research. DRI/McGraw-Hill. August 1995. Report on the Macroeconomic Impacts of the House and Senate Proposals Regarding the Corporate Alternative Minimum Tax. Harberger, Arnold C. 1995. The ABCs of Corporation Tax Incidence: Insights Into the Open Economy Case. In Tax Policy and Economic Growth, 51-73. Washington, D.C.: American Council for Capital Formation Center for Policy Research. Lyon, Andrew B. 1996. Cracking the Code: Making Sense of the Corporate Alternative Minimum Tax. Washington, D.C.: Brookings Institution. Prakken, Joel L. 1994. Investment, Economic Growth, and the Corporate Alternative Minimum Tax. In Tax Policy for Economic Growth in the 1990s, 123-148. Washington, D.C.: American Council for Capital Formation Center for Policy Research. Also unpublished material. Progressive Foundation. October 1994. Enterprise Economics and Tax Reform. Washington, D.C: Progressive Policy Institute.