Rhys Kesselman is professor emeritus at the School of Public Policy at Simon Fraser University. His study is published at Finances of the Nation.
The recent federal budget delivered on the government’s promise of a reformed alternative minimum tax (AMT), with higher taxes for some people with incomes above $300,000, but it missed a major opportunity for simpler reforms that would achieve a far better balancing of tax liabilities with total incomes for all top earners.
The government heralded its AMT reform as achieving its goal of getting the rich to “pay their fair share,” in the words of Finance Minister Chrystia Freeland. Media reporting – even by The Globe and Mail – bought the government’s official line that this change would constitute a major burden for top earners. However, for most high earners, the AMT reform will have little impact and will still contribute less than half a per cent of total personal income tax revenues.
From its outset in 1986, the AMT has been called a “toothless tiger” and critiqued by expert tax analysts for its limited bite on high earners and its complexity in applying a parallel tax system alongside regular income tax. Yet the AMT reform will impose only a modest burden on a minority of high earners while further increasing overall tax complexity. So it is natural to ask: Is there a better alternative?
The AMT reforms entail a targeting of tax on higher-income filers – with a fourfold hike to an antiquated exemption level, a 5.5-percentage-point rise in its flat rate and a broadening of its taxable base. But taxpayers face the AMT only to the extent that it exceeds their regular income tax, and they can recover AMT in future years whenever their AMT is less than their regular tax.
Just how large is the impact on top earners? This will of course hinge on how much a taxpayer has been exploiting current tax concessions. The official projection is that 99 per cent of the reformed AMT will be borne by some 32,000 taxpayers with incomes more than $300,000, but that’s only about one out of 10 such taxpayers.
The most affected will be among the 8,200 filers with incomes above $1-million, who will pay 80 per cent of the total increased annual revenue of $600-million (versus the $300-million total today). So this group, with an average income around $2-million, will pay an average of $60,000 more, or just about 3 per cent of their incomes. The budget does not even tell us what the average tax hike will be at the half-million-dollar level, which most people would deem to be very high.
Of the many changes to the income base subject to the AMT’s flat 20.5-per-cent rate, some are notable and others are just curious. Among the notables are expanding the base to 100 per cent of capital gains (the largest item) but allowing only 50 per cent of capital loss carryforwards, business investment losses and deductions for investment interest expense. In short, taxpayers affected by the reformed AMT could end up paying tax even when their losses exceed their gains.
Among the curious items are disallowing from the AMT base 50 per cent of deductions for disability supports, workers’ compensation, social assistance and guaranteed income supplements. The exemption level for the AMT reform is projected at $173,000 in 2024, its first year, and very few people above that income would have any of those types of deductions.
These reforms will further complicate an already very complex system, necessitating expansion of the current eight-page schedule T691, and provincial AMTs will likely follow suit by replicating many of the federal reforms.
A fundamental alternative would be to scrap the AMT entirely, incorporate its key points in the regular tax system and institute a much simpler system with a threshold based on total income or capital gains. For filers above that threshold, the gains tax inclusion rate would be raised to 75 per cent from the current 50 per cent, and tax credits on dividends from large corporations would be capped. Companion reforms would include the restoration of income averaging for all taxpayers (which was abolished in 1988 when tax rates were flattened) and limiting deductible interest expense on investments to the associated taxable income (as Quebec already does).
This alternative approach would be far simpler than AMT reform, its effects on investment tax incentives far more transparent and its impact on top earners and revenues far larger. The exact revenue increase would hinge on the thresholds and design chosen but, based on available estimates, could be as much as eight times that of the AMT reform. Since these changes would be embedded in the federal income tax base, provinces could also scrap their own AMTs.
The proposed AMT reform undeniably restores a few teeth to the tiger, but making all very high earners pay a commensurate share of taxes requires at least a full set of implants. Yet, much preferable would be a simpler, direct reform of the regular tax that will restore a truly effective bite.