Recessions and the Social Safety Net: The Alternative Minimum Tax as a Counter-Cyclical Fiscal Stabilizer

Abstract

We present an argument from micro-economic foundations suggesting that the federal Alternative Minimum Tax has potentially salutary – and heretofore unrecognized – effects that counteract pathologies of state budgets over the business cycle. AMT liability increases with income, and acts to eliminate federal tax subsidies for state revenue-raising. Thus, as a states’ income grow and the AMT hits more state residents, state spending becomes more expensive in flush times as the federal tax subsidy for state and local taxes is reduced. Conversely, when state fiscal health deteriorates, the federal tax subsidy grows as fewer state residents fall under the AMT, boosting taxpayer support for state spending. This stabilizing mechanism has the potential to overcome problems state politicians face committing to saving during boom times and spending during bust times. We present empirical evidence suggesting that the AMT does indeed provide some degree of fiscal stabilization in accordance with micro-theory. We also provide policy suggestions regarding how the AMT could be modified to leverage this stabilization effect.