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9 IMPACT OF THE CORPORATE 

ALTERNATIVE MINIMUM TAX: 

A MONTE CARLO SIMULATION STUDY 

Lowell Dworin 

I. INTRODUCTION 

The corporate attributes that tend to increase a finn 's exposure to the 

minimum tax have been identified by Harter ( 1986). Although Harter's analysis 

was based on the House version of the minimum tax. his observation remains 

valid that a finn with a low marginal profitability and a high rate of growth 

in depreciable assets is more likely to be on the minimum tax. Similar 

results were noted by Lucke, Eisenach. and Dildine (1986). Based on a 

multiyear simulation st.udy of several hypothetical representative firms. they 

found that the chances of being subject to the AMT depends on the nature of 

the mix of assets held by the finn. and are greatest in the first several 

years after the imposition of the tax. 

Because of the assumed constancy of the parameters in their model, whatever 

minimum tax exposure their representative firms faced was immediate. relatively short in duration. and gave rise to an AMT credit which was rapidly 

utilized once the firm went off the minimum tax. In most of the cases they 

examined the net impact of the minimum tax on corporate tax liabilities was 

found to be relatively modest. Their results (which reflect the Senate 

version of the minimum tax) indicate that although a number of factors (a high 

concentration of depreciable assets. a high degree of financial leverage. 

rapid growth, etc.) can increase a firm's exposure to the AMT, the ability to 

credit the excess AMT payments significantly reduces the burden of this tax. 

In short, their study appears to suggest that the impact of the AMT is largely 

a transient one. and for many firms (especially the more established ones). is 

relatively unimportant. However. once both positive and negative annual 

nuctuations in income are considered. firms may be more frequently subject to 

the AMT, although rhe duration of their exposure may be shorter. 

Till' author thanks Gordoll WiiSOII for Iris progrOIIIIIIillg assr~tuiiCt . narbaru Parsons for her 

assistance in pn•paration of 1/w manuscripl. and Don Fullerton }or his crilical n!vit•ll' of 

1/re papa. 

253 
254 Lowell Dworin 

In addition to their neglect of stochastic economic fluctuations, neither 

of these prior studies considered the possible re-sponse of the finn to the 

imposition of the AMT. Because a firm's exposure to the AMT is rather 

sensitive to its investment and financing decisions. the results obtained may 

thus be somewhat misleading. Indeed. the entire pattern of the firm's 

investment and financial decisions may have to be specified before the impact 

of the AMT can be fully determined. The most relevant pattern to consider 

would be that which maximizes the value of the firm. A significant part of 

this study thus examines how the optimal levels of investment and leverage 

vary as a function of changes in tax policy under uniform (non-stochastic) and 

stochastic economic conditions. These results, which are of interest in their 

own right, will then be used to examine the adequacy of the Office of Tax 

Analysis' (OTA 's) AMT revenue estimates. 

ll. THE CORPORATE ALTERNATIVE MINIMUM TAX 

A. The Nature of the Tax 

The Tax Reform Act of 1986 introduced a new corporate alternative minimum 

tax (AMT).1 The AMT is essentially a parallel system of corporate taxation. 

with its own depreciation and other tax accounting methods. Because the AMT 

liability is calculated as if the corporation had been subject to the AMT in 

all post-1986 years. even a corporation that only infrequently is subject to 

the AMT must routinely keep track of the adjusted basis of its depreciable 

assets, its stock of unused net operating losses. and all other tax attributes 

under both systems of taxation. 

If a corporation's "tentative" minimum tax (calculated after AMT net 

operating Joss deductions and foreign tax credits) exceeds the fmn's regular 

tax (calculated after regular net operating loss deductions and foreign tax 

credits). the firm is viewed as facing the AMT. In such case, the finn must 

pay the tentative minimum tax, reduced (but not by more than 25%) by any 

allowable investment tax credits. The excess of the tentative minimum tax 

over the regular tax (to the extent attributable to timing differences) is 

allowed as a tax credit (AMT credit) against future regular (but not AMn tax 

liabilities. 

If the regular tax exceeds the tentative minimum tax, the firm is viewed as 

facing the regular tax. Jn this case. the firm pays the regular tax, less any 

available general business or AMT tax credits. Such credits (with the exception of the investment tax credit) cannot reduce the tax below the tentative 

minimum tax; the lTC can reduce the gross tax to 75 % of the tentative 

minimum tax. 

The base of the AMT is calculated by adjusting the finn's taxable income. 

adding certain tax preferences. and reducing the resulting alternative minimum 

taxable income (AMTI) by a $40.000 exemption (which is reduced by 25 % of 

AMTI in excess of $150.000). The various adjustments are designed to replace 

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Impact of the Corporate Alternative Minimum Tax 255 

many of the regular tax accounting methods with AMT accounting methods. In 

particular. for personal assets (equipment. vehicles. etc.) acquired after 

1986, AMT depreciation is calculated using a 150% declining balance method 

over the mid-point ADR service life, and straight line depreciation over 40 

years is required for real property acquired after 1986.2 

A "book income" tax preference. equal to one-half the excess (if any) of 

the finn's book income over its AMTI (calculated before consideration of the 

book income preference) is included for 1987-89. For post-1989 years, this 

book income tax preference is scheduled to be replaced with an "adjusted 

current earnings" tax preference. Certain other tax preferences, largely 

reflective of the preferences under the old "add-on" corporate minimum tax, 

are also included. Although the "book income" tax preference is likely to be 

a significant component (at least in the near term) of the disparity between 

AMTI and taxable income for many firms. for the purpose of this paper this 

preference (and all other tax preferences) are ignored. 

B. Interaction With the Regular Tax 

It is known that the book income reported by corporations frequently varies 

from one year to the next in a seemingly random manner. More precisely. 

percentage changes in book income of plus or minus fifty percent or more are 

not uncommon, and a positive gain of such magnitude by one firm in an industry 

can often arise in the same year that another firm in that same industry 

reports a comparable percentage loss. Analysis of OTA 's Corporate Tax Panel 

indicates that similar fluctuations in taxable income also arise, although not 

necessarily in synchronization with the fluctuations in book income. 

3 

The relationship between the corporate AMT and the regular tax suggests 

that the impact of the AMT might be quite sensitive to such fluctuations. 

Because the regular tax rate (34%) exceeds the AMT tax rate (20%), a 

corporation which experiences an increase jn income unaccompanied by a 

corresponding increase in AMT adjustments or tax preferences (arising, for 

example. from an unanticipated increase in sales which is assumed by the firm 

to be temporary, and thus not accompanied by a commensurate increase in 

investment in depreciable assets) will tend to face the regular tax. and be 

able to utilize its accumulated AMT credits. Conversely, in a bad year the 

corporation is more likely to face the minimum tax (and thus generate 

additional AMT credits which may be used in future years). 

This sensitivity of the AMT to changes in the firm's economic environment 

may create difficulties for conventional revenue estimation studies. In 

estimating the impact of the AMT on tax liabilities. OTA utilizes its Corporate Tax Model. which estimates the future tax liabilities of nearly 90 

thousand corporations from their tax return data from a single prior base 

year. 

4 

In this estimation process. adjustments are made for an anticipated 

behavioral response by the firms to the changes in tax laws. and for expected 

economic growth between the base year and future years. However. these 

adjustments generally take the form of overall scaling factors. which cannot 
256 Lowell Dworin 

capture the impact of fluctuations in the income of individual firms. 

The AMT may also create difficulties for effective tax rate studies, in 

which attention is focused on marginal investment. Because of the AMT, it is 

more likely that each year's investment and financing decisions will affect 

the taxation of the income generated by past and future year

's investments. s 

For example, it may affect the statutory tax rate applicable to the depreciation deductions associated with prior investments. Therefore, it may no 

longer be appropriate to consider the incentive to invest using a constant 

statutory rate, as is typically assumed in measures of marginal effective tax 

rates. Moreover, because of the uncertain nature of a firm's future exposure 

to the AMT, the investment and financing behavior of firms cannot be 

adequately captured by a purely deterministic analysis. 

C. Objectives of This Paper 

This paper reports the results of several numerical experiments designed to 

provide some insight on the impact of the AMT. especially under fluctuating 

economic conditions. These experiments were performed on a corporate Monte 

Carlo simulation model which was developed for this purpose. In particular, 

they were designed to answer the following questions: 

o How would the imposition of the AMT (on top of all other 1986 Tax 

Reform Act changes) affect a firm's investment and financing decisions? 

o Does the avoidance of the minimum tax represent optimal tax planning? 

o Would the AMT significantly increase average effective tax rates? 

o Do extrapolations which exclude stochastic fluctuations in the earnings 

of individual firms significantly impair OTA 's AMT revenue estimates? 

While the answers are far from definitive. they present a picture of the 

AMT that may be somewhat at variance with conventional wisdom. The details of 

this picture may change as more extensive modeling of the AMT is performed. 

but it is not likely that fundamentally different answers will be obtained. 

In the next section of this paper, the corporate Monte Carlo simulation model 

is described. The results of this model for a non-stochastic and stochastic 

economy are compared in section four. where the response of the ftml to the 

AMT is ignored. In section five the behavioral response of the firm to the 

AMT is examined, and its tax implications are discussed. Section six examines 

the importance of utilizing stochastic modeling in estimating AMT revenues 

over the initial five-year budget period. Finally, based on the results of the 

study. some answers to the above questions are provided in the last section. 

Ill. THE MONTE CARLO SIMULATION MODEL 

In order to study the impact of the AMT on the "typical" firm. a model is 

required of such firm which is capable of providing realistic investment and 

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Impact of the Corporate Alternative Minimum Tax 257 

financial decision rules under a wide variety of conditions. Although the 

specific decision rules incorporated in the model used in this study are 

consistent with those noted in Hayashi's (1982. 1985) papers on the Q theory 

of investment, the results of the model must be viewed as merely suggestive of 

the more complex interactions between the financial and investment decisions 

of actual firms. Nevertheless. the model appears to be a useful addition to 

OTA 's toolkit. In particular, by allowing the interaction between changes in 

corporate tax policy and the investment and financial decisions of hypothetical firms to be studied in a dynamic context. the model can provide helpful 

insights. These insights may be used to enhance the quality of the results 

obtained from multi-period application of OTA 's empirically based. but 

essentially static. Corporate Tax Model. 

The Monte Carlo Simulation Model is based on the following assumptions: 

o The firm owns an existing stock of homogeneous real assets (and. 

depending upon the parameters chosen. may aJso be viewed as holding a 

corresponding stock of homogeneous financial assets). In one version of 

the model all of the firm's real assets are depreciable assets; in a 

second version. only 75% are depreciable. 

o The depreciable assets have a 12 year mid-point ADR life. a 7 year 

modified ACRS property class, and a 10% per year rate of economic 

depreciation. 

o The nominal pre-tax rate of return (net of depreciation) generated by 

the depreciable assets is taken to be a discrete random variable, R. 

Unless otherwise noted, the value of this variable for any firm in any 

period is assumed to be equally likely to be 7% (R-) or 13 % (R+). and 

to be independent of its prior values and also independent of its value 

for other firms. 

o The nominal pre-tax rate of return generated by the financial assets is 

fixed at 9%. 

o The firm may also borrow funds at 9 % (unless its debt to equity ratio 

exceeds 30%; see below). Thus. if the firm both owns a stock of 

financial assets and borrows funds, only the net amount of outstanding 

financial assets is relevant. 

o If the firm's managers wish to change the annual rate of growth of the 

firm's real assets. G. from its assumed "natural" value of 4 %. they 

will incur an investment adjustment cost. This cost is assumed to be 

proportional to the beginning of the period stock of real assets, with 

a proportionality factor equal to 12.5 times the square of the differ- 6 

ence between the chosen growth rate and 4 %. 

o The firm 's managers may make an initial choice of two possible values 

of G (G + and G-). Once these two values are specified. the growth rate 

in each future year will be either G + or G-. depending upon whether the 

firm is experiencing a "good" or ''bad " year. Thus. a growth rateG+ is 

used if the 13 % rate of return has been realized. and a growth rate Gis used if the 7% rate has been realized. The initially specified 
258 Lowell Dworin 

values of G + and 

G- are assumed to have been chosen so as to maximize 

the expected value of the finn. as noted below. It is also assumed 

that the growth rate of the finn's real assets was 5% in all past 

(pre-1987) years. 

o Once the finn's investment in real assets is specified, the finn's 

managers must address the problem of financing such investment. They 

utilize the following rules: 

A "targeted" portion of the next period's stock of real assets 

is financed by debt (or equivalently. the stock of real assets 

is mixed with a targeted portion of financial assets). The 

balance of the investment is financed by retained earnings. As 

in the case of the growth rate. the firm's managers are assumed 

to make an initial choice of two target debt to equity ratios 

(B + and B-). Each future year's target ratio of debt to equity 

(or financial assets to total assets) is either B + or B-, 

depending upon the realized rate of return. Thus. the target 

ratio of B + is used if R + is realized. while the target ratio B- is used if R- is realized. The initial decision parameters 

for the finn are thus the values of G+. G-. B+. and B-.7 

After the required level of retained earnings is determined. 

any excess cash generated during the period is remitted to the 

finn's shareholders as dividends. However. if there are 

insufficient earnings to finance the investment. the level of 

the debt to equity ratio is allowed to increase beyond the 

target values (B + or B-). provided it remains less than a 

critical vaJue. B . taken to be 50%. c 

If the after-tax cash flow is insufficient to keep the debt to 

equity ratio below 50%. the firm is assumed to acquire new 

equity until this critical ratio is reached. Share repurchases 

are ignored. a 

o The firm faces greater interest costs if the achieved ratio of debt to 

equity exceeds the firm's "natura

l" ratio of 30%.9 These costs are 

also assumed to be proportional to the beginning of the period stock of 

real assets. with a proportionality factor given by .25 times the 

square of the excess (if any) of the prior period debt to equity ratio 

10 

over 30%. 0 The pre- 1987 debt to equity ratio is taken to be 30%. so that with a 

$1.000 assumed initial stock of real assets. the initial equity is 

$769.20. 

o The finn ·s managers seek to maximize the expected after-tax net present 

value of the claims of the firm

's shareholders. In particular. they 

maximize the sum of the expected net pre

sent after-tax value of the 

dividend stream over a fifty year horizon and the discounted value of 

the finn's net equity at the end of that period. A derivation of this 

objective function is presented in the Appendix. 

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Impact of the Corporate Alternative Minimum Tax 259 

o In evaluating these discounted present values, the discount rate used 

by the marginal investor is assumed to be 8%. 

Some general comments on the limitations of this model of the fmn may be 

in order. First. like most models. it is rather mechanical. and thus tends to 

exaggerate certain behavioral features. For example, for reasons that are not 

well understood. firms sometimes raise equity capital while paying dividends: 

such behavior is not possible in this model. Second, it treats dividends as a 

"residual". and thus dividend payouts fluctuate with earnings. In fact, 

perhaps as a signaling device. dividends are generally observed to be relatively stable over time. whereas the levels of externa1 financing are more 

uneven than suggested by the model. Third. the pre-tax rates of return and 

the investor's discount rate are assumed invariant to a change in tax policy. 

This assumption may be reasonable in the short term, but is not likely to be 

valid over the much longer period (50 years) that is used in much of the 

analysis. Finally. the model restricts the choice of decision parameters to 

only the four initially chosen values G +. G-, B +. and B-. rather than allowing 

different growth rates and leverage factors to be chosen each period. The 

model likewise restricts the economic conditions facing the firm to be those 

characterized as being equally likely to result in a 13% or a 7% pre-tax rate 

of return (or. in the non-stochastic case, in a uniform 10% rate of return). 

Because of these simplifications. the results of the modeJ may be expected to 

present a somewhat understated picture of the importance of allowing for the 

behavioral response of firms to a change in tax policy. and a somewhat 

overstated picture of the impact of the changes in tax policy and economic 

conditions on the financial success of the firm. 

IV. RESULTS FOR NON-STOCHASTIC VERSUS 

STOCHASTIC CONDIDONS 

In this section. the behavior of the firm under non-stochastic and 

stochastic economic conditions as compared. Specifically. it is first assumed 

that the the pre-tax rate of return on the firm's reaJ assets is a constant 

10% (the mean of the assumed equally likely stochastic returns of7% and 13 %). 

The results for this case are then contrasted with those for the stochastic 

case. In both cases. the behavioral response of the firm to the imposition of 

the AMT is ignored. Thus. the decision parameters are chosen to maximize the 

value of the firm's equity in the absence of the minimum tax. 

A. The Case of an "Airline" 

In the non-stochastit case. there are only two dedsion parameters which 

must initially be specified: the growth rate 0 + = 0-. and the target debt to 

equity ratio B + = B-. Using an optimization routine incorporated in the 
260 Lowell Dworin 

model, it is found that a 5.54% growth rate and a 33.5% debt to equity ratio 

maximize the value of the equity of a firm with only depreciable real assets . h b f th . . 11 

m t e a sence o e mmtmum tax. 

The optimal values of the decision parameters for this case (Case I). and 

other cases to be described below. are noted in Table 9. 1. For each case 

illustrated in this table, values of the financial variables resulting from 

the choice of the specified decision parameters are presented. A number of 

variables which reflect the presence of the minimum tax (and a corresponding 

set reflecting its absence) are shown. Thus. the value of the firm's equity 

(EQVALMT), the number of times during the 50 year period the firm faces the 

minimum tax (NMT), the discounted net present value of the tax payments 

incurred and the dividends remitted over the 50 year period in the presence of 

the minimum tax (TAXDMT and DIVDMT, respectively), the fraction of net 

AMT payments incurred which the finn is able to credit against the regular tax 

Table 9. I Optimal Decision Parameters in the Absence of the 

Minimum Tax and the Resulting Financial Performance 

Under Non-Stochastic (R + = R- = 10%) and 

Stochastic (R + = 13%, R- = 7%) Economic Conditions 

Nondurable Goods 

Airline Manufacturer 

Case 1: Case 2: Case 3: Case 4: 

Non-Stochastic Stochastic Non-Stochastic Stochastic 

Variable Conditions Conditions Conditions Conditions 

G + (percent) 5 .54 5.59 4.88 4.95 

G- (percent) 5.54 5.48 4.88 4.89 

B + (percent) 33.5 33 .8 33.5 33.5 

B- (percent) 33.5 33.2 33.5 33.5 

EQVALMT $816.65 $810.72 $753. 18 $752 .55 

NMT (yearli) J 1.00 27.76 3.00 5.53 

TAXDMT $348.94 $352 .49 $416.26 $420. 15 

DlVDMT $579.96 $575. 15 $580.21 $576.23 

CREDUMT (percent) 100.00 87.36 100.00 100.00 

REV5MT $96.00 $ 86.72 $91.44 $94.74 

EQVALNOMT $836.62 $838.33 $753.33 $755.34 

TAXDNOMT $328.47 $330.48 $416. 13 $417.78 

DIVDNOMT $599.93 $601 .86 $580.36 $579.02 

REV5NOMT $65 .72 $65 .80 $91.42 $90.22 

TINY $38.766.44 $38.733 .96 $34.937.92 $:!5.342.89 

RA TEMT (percent) 16.8 17 . 13 22 .15 22.17 

RA TENOMT ( percent) 15.92 15 .95 22 . 15 22.03 

MTREV5 $30.28 $20.92 $ .02 $4 .52 

REVDMT $20.47 $22 .01 $ . 13 $2.37 

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Impact of the Corporate Alternative Minimum Tax 261 

over the 50 year period (CREDUMT), and the total tax revenues collected from 

the firm during the next five years in the presence of the minimum tax 

(REV5MT) are noted. 

In addition to these variables, which reflect the presence of the AMT, the 

value of the firm's equity (EQV ALNOMT). the discounted present value of the 

taxes paid and the dividends remitted over the 50 year period (T AXDNOMT and 

DIVDNOMT, respectively), and the total tax revenues collected from the firm 

over the next five years (REV5NOMT) in the absence of the minimum tax are 

noted. In addition, the total gross investment by the firm during 50 year 

period (TINY), which depends only upon the specified growth rates, and not the 

presence or absence of the minimum tax. is also shown. 

Four additional variables which measure the relative impact of the AMT are 

also presented for each case in this table. The firm's average effective tax 

rate in the presence and absence of the minimum tax are noted (RA TEMT and 

RATENOMT. respectively). These represent the ratio of the discounted present 

value of the tax payments during the 50 year period over the corresponding 

discounted present value of the economic income earned. Finally, both the 

increased net tax revenues due to the minimum tax during the next five years 

(MTREV5), and the discounted net AMT revenues over the 50 year period 

(REVDMT). are shown. 

Thus. with the growth rate and debt to equity ratio set at the optimal 

levels noted. the first case in Table 9. I shows that such firm faces the 

minimum tax in 1 1 of the 50 years examined. It thus corresponds to a representive "airline" (at a zero growth rate) in the taxonomy of Lucke et al.12 

The firm fully utilizes its AMT credits generated during the 50 year period. 

As shown in this table. its average effective tax rate in the absence of the 

the minimum tax is 15.92%, and 16.88% in the presence of the minimum tax (a 

6.2% increase). Over the first five years. the additional tax revenues 

collected due to the minimum tax are $30.28 (a 46. 1% increase). However. the 

discounted tax revenues due to the A MT paid over the 50 year period are $20.4 7 

(a 6.2% increase). which is less than the five year total largely because of 

the utilization in the later years of the AMT credits generated in the initial 

years. The 6.2% increase in discounted tax payments is twice as great as the 

3.1 % increase obtained by Lucke et al. , who. however, in addition to the 

differences in model parameters noted in footnote 12, also assume an 11 % 

discount rate in contrast to the 8% discount rate used here. 

In order to examine the consequences of the assumed stochastic economic 

conditions, the model was next run such that the rate of return each year was 

randomly chosen in accordance with its assumed (binary) distribution . The 

resulting financial results were t3bulated. By replicating this procedure one 

thousand times. a frequency distribution of the tabulated variables was 

obtained. The model was designed to either output each of these values into 

an SPSS data file for detailed statistical analysis. or to directly output the 

range. mean. and variance of the calculated values. 

By maximizing the mean (expected) value of the firm ·s equity with respect 
262 Lowell Dworin 

to all four initial decision parameters (G + , G-, B + , 8-), it was found that 

different pre-determined growth rates and different targeted debt to equity 

ratios apply in "good" years (in which the firm realizes a 13% pre-tax rate of 

return on its real assets) and in "bad" years (in which the finn realizes a 7% 

pre-tax rate of return on its real assets). In panicular, for the ,.airline" 

in the absence of the minimum tax, a 5.59% growth rate and a 33.8% debt to 

equity ratio in "good" years and a 5.48% growth rate and a 33.2% debt to equity ratio in "bad" years are optimal. as noted for Case 2 in Table 9.1. As may 

be expected, the average of these two growth rates, and the average of these 

two debt to equity ratios. are approximately the same as the Case I values. 

Table 9.1 shows that the mean average effective tax rate for this case is 

15.95% in the absence of the minimum tax and 17.13% in its presence (a 

7.4% increase). On average, the "airline" faces the minimum tax much more 

frequently under stochastic conditions than under non-stochastic conditions 

(about 28 times as compared to 11 times over the 50 year period). The 

additional tax revenues due to the AMT during the first five years are $20.92 

(a 31.8% increase). The AMT also leads to a $22.0 I increase in the discounted 

present value of the taxes paid over the 50 year period (a 6.7% increase), 

with 87.4% of the AMT credits generated able to be utilized. 

These results show that although an "airline's" frequency of exposure to 

the AMT is significantly increased under stochastic conditions. the five-year 

revenue impact of the AMT is reduced (because the firm more rapidly flips 

between the minimum and regular tax). However. because it cannot as fully 

utilize its AMT credits, the impact of the AMT on the finn's tax liabilities 

over the entire period examined is somewhat greater under stochastic 

conditions. 

B. The Case of a "Nondurable Goods Manufacturern 

Also shown in Table 9. 1 are the corresponding results for the second 

version of the model. in which the firm's depreciable assets comprise only 75% 

of its real assets (Cases 3 and 4). In Case 3. under non-stochastic economic 

conditions and in the absence of the minimum tax. the optimal growth rate is 

4. 88%, and the optimal debt to equity ratio is 33.5%. With these parameters. 

the firm faces the minimum tax in only 3 of the 50 years. It thus corresponds 

to a "nondurable goods manufacturer" in the taxonomy of Lucke et al.13 

Because of its ability to fully utilize the AMT credits generated, the AMT 

does not appreciably increase its average effective tax rate (22. 15% ). 

although it does pay $0.02 more in tax revenues in the first five years and 

$0. 13 more in discounted tax payments over the 50 year period. A negligible 

increase in the discounted present value of the net AMT tax payments was also 

found by Lucke et al. for such finn. 

The corresponding results under stochastic economic conditions for the 

"nondurable goods manufacturer" are presented in Case 4 of Table 9. 1. In the 

absence of the AMT, the optimal growth rate for such firm is 4. 95% in a "good" 

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Impact of the Corporate AJtemative Minimum Tax 263 

year and 4.89% in a "bad" year. while the optimal debt to equity ratio is 

33.5% in both "good" and "bad" years. In this case the average frequency of 

exposure to the AMT is increased to 5.53 years. In contrast to the nonstochastic case, the AMT results in a significant ($4.52, or 5%) increase in 

tax payments over the first five years. Despite the ability of the "nondurable goods manufacturer" to fully utilize its AMT credits in both cases. 

under stochastic conditions the AMT results in a measurable ($2. 37. or 0. 6%) 

increase in the discounted value of the firm's tax liabilities over the entire 

period examined. 

V. RESPONSE OF THE FIRM TO THE AMT 

In the previous section, the initial decision parameters were assumed 

chosen so as to maximize the expected value of the firm's equity in the 

absence of the minimum tax. In this section. the corresponding results are 

presented under the assumption that these parameters are chosen so as to 

maximize the value of the firm's equity in the presence of the AMT. By 

comparing the results of this section with those of the previous section. the 

behavior r r the firm in responding to the AMT may be studied. 

A. The Behavior of an "Airline" 

Turning first to the case of an "airline" under non-stochastic economic 

conditions, a growth rate of 5.22% and a 32.8% debt to equity ratio are found 

to maximize the value of the equity in the presence of the AMT. These 

parameters, and the resulting financial variables. are shown as Case I in 

Table 9.2 (which has the same format as that of Table 9.1). 

In this case the firm faces the minimum tax in 10 of the 50 years. fully 

utilizes the AMT credits generated over the 50 year period, pays an additional 

$16.97 in taxes due to the AMT during the first five years (a 24.0% increase). 

and incurs a discounted present value of $I 3. 97 in additional tax payments 

over the 50 year period because of the AMT. As a result, it experiences a 

17. 17% average effective tax rate in the absence of the minimum tax and a 

17.87% average effective tax rate in its presence. 

Comparing the results for Case J in Table 9. J with those in Table 9.2 shows 

that the somewhat lower growth rate and lower debt to equity ratio chosen by 

the firm in response to the AMT significantly reduces the tax revenues 

attributable to the AMT paid by the finn during the first five years (from 

$30.28 to $16.97. a 44.0% decrease) and over the 50 year period (from $20.47 

to $13.97 in discounted tax payments. a 31.2% reduction). However. the 

behavioral response does not significantly reduce the firm· s exposure to the 

AMT (which declines from II years to 10 years). Moreover. despite the 

reduction in net AMT payments. the response of the finn does not reduce the 

firm's total tax payments. In fact. after responding to the presence of the 
264 LoweU Dworin 

Table 9.2 Optimal Decision Parameters in the Presence of the 

Minimum Tax and the Resulting Financial Performance 

Under Non-Stochastic (R + = R- = 10%) and 

Stochastic Economic Conditions (R+ = 13%, R- = 7%) 

Nondurable Goods 

Airline Manufacturer 

Case 1: Case 2: Case 3: Case 4: 

Non-Stochastic Stochastic Non-Stochastic Stochastic 

Variable Conditions Conditions Conditions Conditions 

G + (percent) 5.22 5.24 4.87 4.90 

G- (percent) 5.22 5.06 4.87 4.89 

B + (percent) 32.8 33.0 33.5 33.3 

B- (percent) 32.8 32.0 33.5 33.1 

EQVALMT $820.20 $817.11 $753.19 $752.61 

NMT (years) 10.00 26.49 3.00 5.53 

TAXDMT $354.86 $360.51 $416.09 $421.23 

DIVDMT $615.78 $619. 12 $581.17 $578.01 

CREDUMT (percent) 100.00 91 .20 100.00 100.00 

REV5MT $87 .76 $88.92 $91 .52 $95.15 

EQVALNOMT $834. 17 $834.76 $753 .32 $755.33 

TAXDNOMT $340.89 $344.55 $415 .96 $419.00 

DIVDNOMT $629.75 $636.64 $581 . 17 $580.73 

REV5NOMT $70.79 $71 .07 $91.50 $90.75 

TINY $34,208.63 $33.294.32 $24,838.00 $25.088.67 

RA TEMT (percent) 17 .87 18.29 22.18 22.26 

RA TENOMT (percent) 17 . 17 17.42 22. 17 22.12 

MTREVS $16.97 $17.85 $.02 $4.40 

REVDMT SJ3..97 $15.96 $.13 $2.23 

minimum tax. the discounted present value of the taxes paid in the presence of 

the minimum tax over the 50 year period ($354.86. from Case 1 of Table 9.2) 

exceeds the discounted value of the taxes that would have been paid in the 

presence of the minimum tax when the decision parameters are chosen in the 

absence of the AMT ($348.94, from Case 1 of Table 9.1) by 1.7%. While this 

result is inconsistent with tax minimization. it is not inconsistent. as noted 

below. with maximization of the value of the finn. 

Thus, the optimal response of an "airline" to the AMT under non-stochastic 

conditions is not to completely avoid the AMT. but rather to reduce both its 

exposure to the AMT and its net AMT payments. In doing so. the finn reduces 

its total investment over the 50 year period by II . 8%. Because of the reduced 

investment. the finn's total tax payments are slightly higher. but these 

higher tax payments are more than offset by the higher dividend payments (the 

discounted present value of which increase by 6.2% ). Although the resulting 

0.4% increase in the value of the firm's equity (from $816.65 in Case l in 

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Impact of the Corporate Altemative Minimum Tax 265 

Table 9.1 to $820.20 in Table 9.2) is not large, it does confirm the value to 

the firm of the reduced level of investment in the presence of the minimum 

tax. despite the slight increase in total taxes.

14 

In order to determine the impact of the AMT on an "airline" when the 

behavioral response of the finn is allowed for. the tax variables in the 

presence of the minimum tax for Case I in Table 9.2 must be compared to the 

corresponding variables in the absence of the minimum for Case .I in Table 9. I . 

For example, the 15.92% average effective tax rate in the absence of the 

minimum tax (Table 9. 1) should be compared with the 17.87% average effective 

tax rate in the presence of the AMT (Table 9.2). In contrast to the 6.2% 

increase noted in the previous section when the response of the firm is 

ignored. when the response of the firm is considered the AMT results in a 

12.3% increase in the average effective tax rate for an "airline" under 

non-stochastic economic conditions. 

Ukewise, comparing the present value of the taxes paid in the absence of 

the minimum tax ($328.47, from Case I in Table 9.1) with the present value of 

the taxes paid in its presence ($354.86. from Case I in Table 9.2). shows that 

the AMT leads to an 8.0% increase in total tax payments when the response of 

the "airline" to the AMT is allowed for. In a similar fashion, it may be seen 

that when the response of the firm is considered, the AMT is found to result 

in a 33.5% increase in taxes paid during the first five years (in contrast to 

the 46. 1% increase noted in the previous section when the response of the firm 

is ignored). 

As under non-stochastic economic conditions. in responding to the AMT under 

stochastic conditions the firm reduces its level of investment and its 

financial leverage. Thus. as noted in Case 2 of Table 9.2, a 5.24% growth 

rate and a 33.0% debt to equity ratio in "good" years are found to be optimal 

for an "airline" under stochastic conditions in the presence of the minimum 

tax. and a 5.06% growth rate and a 32.0% debt to equity ratio in "bad" years. 

With these parameters. the average effective tax rate in the absence of the 

minimum tax is 17.42%. and 18.29 % in its presence. In this case the mean 

frequency of exposure of an "airline" to the minimum tax is approximately 26.5 

times in the 50 year period. The mean of the additional tax revenues due to 

A MT over the first five years is $1 7. 85. and the mean discounted present value 

of the taxes paid over the 50 year period due to the AMT is $15.96. reflecting 

the fact that on average 91 .2 % of the AMT credits generated are utilized 

during the 50 year period. 

Comparison of the results for these variables in the absence of the minimum 

tax (from Case 2 in Table 9. I) with their corresponding values in the presence 

of the minimum tax (from Case 2 in Table 9 .2) shows that when the response of 

the "airline" under stochastic conditions is considered. the AMT increases the 

mean average effective tax rate by 14.7% (in contrast to the 7.4% increase 

noted in the previous section when the response of the firm is ignored). 

Likewise. the AMT is found to increase the initial five year tax payments by 

35. 1 %. and the mean discounted present value of the taxes paid by 9.1 %. In 
266 Lowell Dworin 

responding to the AMT, total gross investment is reduced by 14.0%, and the 

discounted present value of the dividends paid is increased by 2.9%. As was 

the case under non-stochastic economic conditions, the response of the finn 

may be seen to significantly reduce the net AMT payments (by 14.7% over the 

first five years, and by 27.5% over 50 years). 

Despite the reduction in net AMT payments, the discounted present value of 

the total taxes paid over the 50 year period in the presence of the minimum 

tax is actually increased ($360.51 for Case 2 in Table 2 vs. $352.49 for Case 

2 in Table 9.1). However, comparison of the value of the finn's equity in 

these two cases ($817 . 11 vs. $810. 72) indicates that despite the somewhat 

greater total taxes paid, the reduced level of investment in response to the 

AMT increases the value of the finn. Moreover, the mean exposure to the 

minimum tax when the firm responds to the AMT is about the same as when it 

does not (26.5 years vs. 27.8 years. respectively). 

In other words, as in the non-stochastic case, the optimal response of an 

"airline" to the minimum tax under stochastic economic conditions does not 

call for avoidance of the minimum tax. Rather, by reducing its growth rate 

and debt to equity ratio (especially in "bad" years), a significant reduccion 

in the level of net AMT payments may be achieved. despite the modest reduction 

in the firm's frequency of exposure to the minimum tax. 

8 . The Beha~ior of a "Nondurable Goods Manufacturer" 

In the presence of the minimum tax, the optimal growth rate for the 

"non-durable goods manufacturer" under non-stochastic economic conditions is 

4.87 %. and the optimal debt to equity ratio 33.5%. as noted in Case 3 in Table 

9.2. For these parameter values, the average effective tax rate is found to 

be 22. 18 % in the presence of the minimum tax, and 22. 17% in its absence. 

Comparison of Cases 3 in Tables 9. 1 and 9.2 shows that the response of the 

firm to the AMT results in 0.4% less gross investment. a 0. I% increase in the 

discounted value of the dividends paid. and a negligible decrease in both the 

net five-year AMT payments and the discounted present value of the net AMT 

taxes paid over the 50 year period. Comparison of the average effective tax 

race and the taxes paid in the absence of the minimum tax from Case 3 in Table 

9. I with the corresponding variables in the presence of the minimum tax from 

Case 3 in Table 9.2 shows that. after taking the behavioral response into 

account, the AMT increases the average effective tax rate and the five year 

tax payments of a "non-durable goods manufacturer" by 0. I %. 

Since the "nondurable goods manufacturer" is barely affected by the AMT 

under non-stochastic economic conditions. it is not surprising that taking the 

response of the firm to the AMT into account does not change this result. 

Because the AMT was found in the previous section to have a greater impact on 

such finn under stochastic economic conditions. the response of the "nondurable goods manufacturer" to the AMT might also be expected to be of greater 

importance under stochastic conditions. The results for the "nondurable goods 

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Impact of the Corporate AJtemative Minimum Tax 267 

manufacturer" when the decision parameters are chosen to reflect the minimum 

tax under stochastic economic conditions are presented in Case 4 in Table 9.2. 

In the presence of the minimum tax. the optimal growth rates are 4.90% for a 

"good" year and 4.89% for a "bad" year. with a 33.3% debt to equity ratio in a 

"good" year and a 33. 1% debt to equity ratio in a "bad" year. 

Comparing the results for Case 4 in Tables 9.1 and 9.2 shows that the use 

of slightly lower growth rates and leverage allows the "nondurable goods 

manufacturer" to reduce the additional taxes paid over the initiaJ five years 

due to the AMT by 2. 7% (from $4.52 to $4.40). and to reduce the present vaJue 

of the additionaJ taxes paid over 50 years by 5.9% (from $2.37 to $2.23). 

However. the firm's frequency of exposure to the AMT remains unchanged. 

AJiowing for the finn's behavioraJ response. its mean average effective tax 

rate is increased due to the AMT by 1.0%. its initial five year tax payments 

are increased by 5. 5%. and the discounted present value of the taxes paid by 

the firm over 50 years is increased by 0.8%. In responding to the AMT. the 

firm reduces its investment by 1.0%. and the net present value of its dividend 

payments is decreased by 0.2 %. 

Thus, as in the case of an "airline". the behavioral response of the 

"nondurable goods manufacturer" to the AMT is to reduce its growth rate and 

financiaJ leverage. In so doing. its net AMT payments are reduced. but its 

frequency of exposure to the AMT is not aJtered. When such response is 

allowed for, a greater impact of the AMT is noted (e.g .. a 1.0% vs. a 0.6 % 

increase in average effective tax rate under stochastic conditions). although 

even this measure indicates that the "nondurable goods manufacturer" is only 

slightly affected by the AMT. 

VI. CONVENTIONAL AND STOCHASTIC 

AMT REVENUE ESTIMATES. 

In this section the importance of stochastic modeling in estimating the 

revenues collected from the AMT is addressed. However. to simplify the 

analysis, the behavioral response of the firm is partially ignored. In 

particular. the AMT revenues will be obtained from the difference between the 

taxes paid by a finn during the first five years in the presence and absence 

of the minimum tax, holding the decision parameters equal to those found 

optimaJ under stochastic economic conditions in the presence of the AMT. 

The following (somewhat simplistic) paradigm of the conventional revenue 

estimation process is adopted: a set of tax data for a single year (the base 

year) is obtained. and the income and expense items for each firm in the set 

are assumed to be extrapolated to each of the following five years in a 

uniform manner. Specifically. the growth rate and financial leverage observed 

for each firm in the base year is assumed to apply in all future years. The 

effects of a change in tax policy are imputed hy superposing the new tax law 

on top of the uniformly extrapolated pre-tax earnings for each firm . 
268 Lowell Dworin 

This paradigm. together with the assumption of uniform firm size, implies 

that the average five year net AMT liability as obtained from the conventional 

revenue estimation process corresponds to the weighted average of the fiveyear net AMT liabilities for firms with different (but constant) pre-tax rates 

of return, with a weight based on the relative distribution of such rates of 

return among the firms in the base year data set. The "actual" average fiveyear net AMT liability under stochastic conditions corresponds. however, to 

the mean of the stochastic five-year net AMT liability as obtained from Monte 

Carlo simulations. 

A. Extrapolation of the Financial Results for an "Airline". 

Although only the five-year budget period is relevant for the revenue 

estimates, the financial results for the first 12 years as extrapolated for an 

"airline" are examined in this section in order to illustrate certain features 

of the AMT. Thus, the first portion of Table 9.3 presents the results for an 

"airline" which always realizes a 13% rate of return on its real assets (i.e .. 

always has a "good" year), and the second portion presents the corresponding 

results for an "airline" which always realizes a 7% rate of return (i.e .. 

always has a "bad" year). As noted. the initial decision parameters are taken 

to be those which maximize the value of the firm's shares under stochastic 

economic conditions in the presence of the minimum tax (see Case 2 in Table 

9.2). 

A number of features exhibited in Table 9.3 are worth noting. First. the 

firm which realizes a constant 13 % return (which shall be referred to hereafter as a "13%" firm) is able to maintain its target 33% debt to equity 

ratio, and thus, by the logic of the model. pays a dividend each year. 

Second, in the presence of the minimum tax. the 13% firm faces the AMT in 

three of the 12 years (years 2. 3 and 7). and is able to utilize the AMT 

credit generated in the following years. Third. by dividing each year's tax 

paid by the economic income earned. an annual average effective tax rate may 

be defined. The maximum tax rate experienced by a" 13%" firm (28.35% in year 

5) is less than the statutory regular tax rate (34% ). 

In the case of an "airline" which realizes a 7% rate of return (referred to 

hereafter as a "7%" firm). the results are different. First. the "7%" firm 

cannot maintain its targeted 32% debt to equity ratio (which grows to 37.5% by 

the tenth year). Thus the "7%" firm ceases to pay dividends after the second 

year. Second. the ''7%" firm faces the minimum tax in each of the twelve 

years. Third. the annual average tax rate. obtained by dividing the tax paid 

by the economic income earned. increases beyond the 20% statutory minimum tax 

rate in the third through ninth years. This is due to the fact that the lower 

depreciation on the firm's pre- 1987 assets is not allowed to offset the 

depreciation adjustments for its post- 1986 assets. 

This aspect of the AMT was noted by Christian. Schutzer. and Nilles ( 1986). 

The magnitude of this effect decreases with higher pre-tax rates of return. 

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.. • .. .. • • • • - • • • • • - .. • • • 

Table 9.3 Financial Results for an "Airline" Earning a Constant Pre-tax Retu rn: The 7% and 13% Cases 

ear 2 3 4 5 6 7 II 9 10 I I 12 

At IJ'k : 

With Minimum Tcu 

Ocht E4uitv Rl!tio 33.00'{, 33.00W> 33 00~ 33 00~ 33 00~ 33.00% 33.00% 33 00~ JJ.OO'it 33.00% 33.00% 00~ 

Cash Generated $207.3 1 $216.29 $227.63 $239.55 $252. 11 $265.32 $279.22 $293.85 $309.25 $325.45 $342.51 $360.45 

New Det>t $30.35 $13.611 $14.40 $15.16 $15.95 $16.78 $17.66 $18.59 $19.57 $20.59 $21.66 $22.81 

Gfoss Investment $152.40 $160.39 $168.79 $177.63 $186.94 $196.74 $207.0.5 $217.90 $229.31 $241.33 $253.98 $267.211 Tn~ Pllid $19. 14 $19.34 $23.48 $211.31 $36.69 $34. 11 $32.75 $32.23 $34.25 $36.60 $38.52 $40.54 

Oivit11!nd> $66. 12 $50.24 $49.76 $411 .77 $44.42 $.51.25 $57.011 $62.31 $65.25 $68. 11 $71.68 $75.43 

E.:on,>mic: lnc:orne $107.31 $111.05 $116.87 $122.99 $129.44 $136.22 $143.36 $1.50.87 $158.78 $167. 10 $175.8.5 $18.5.07 3 - Avcr;.l!e Ta;'( Ra te 17.1!4\l 7.42% 20 09~ 23.02\l 28.35\l 2.5.04\t 22 84~ 21.36% 21..57~ 21.90% 21.91% 21.91 ~ 

AMT 'CreditS $.13 $.611 $1.35 $.53 ~ 

0 

Without Minimum TaA - Ocht Equity Ratio 33.00% 33.00% 33.00% 33 00~ 33 00~ 33.00% 33 00~ 33.00% 33 00~ 33.00'1 33 00~ 33.00% 0 

Ca,h Generated $207.31 $216.29 $227.63 $239 . .55 $2.52. 11 $26.5.32 $:!79.22 $293.8.5 $309.25 $32.5.45 $342.51 $360.45 ...... 

New Det>t SJO 35 $13.68 $14.40 $15.16 $15.9.5 $16.78 $17.66 $18.59 $19.57 $20 . .59 $21.66 $22.111 -::r 

G•os' lnve,tment $152.40 $160.39 $1611.79 $177.63 $186.94 Sl96.74 $207.05 $217 .90 $229.31 $241 .33 $253.98 $267.21! ~ 

Ta~ Paid $19 14 $19. 21 $22.93 $~11911 S36.69 $34. 11 S31 .40 $33.0.5 $34.711 $36.60 $311.52 $40.54 (') 01\ klcnd, $66. 12 $50.37 $.50.30 $41!.09 $44.42 $.51.25 $511 .43 $61 .49 $64.72 $611. 11 $71 .68 $7.5.43 ~; mmli<.: lm:orne $107.31 $111.05 $116.117 $122.99 $129.44 $136.22 $143.36 SlSO.IF $158 7~ Slti7, 10 S\75.115 $18.5.07 0 

Avcl'ii\!C Tax Rate 17 K4~ 17.30% 19.62% 23.5ti'it 21!.35% 25.04% 21 90'k 21.91% 21 .90'k 21 .90'1 21 .91 'it 21.91% 0 

At 7<;t ; 

With Minimum Ta~ . . . • . • ., ~ ~ . • • -

~ 

Od•r E4uin· Ratio 32.00% 32.00% 32.00% 32. 19% 34.20'k 3.5.29% 36. 16'1 36.113% 37 27~ 37 50~ 37 50~ 37 .27!{ ~>h Gcmcratt.."\1 $147.1!3 $154. 10 $161.90 $169.95 $178.00 SHI5.117 $194.20 $203.07 $212.55 $222.73 $233.611 $245.51 ,_ 

~ Nc\\ Dc.ht $!.3.92 Sl~.l!9 $14.1!1 $19.15 $24.62 $24.58 $24.47 $24.26 $23.93 $23.39 $22.61 $21.55 ~ 

Gms' Investment $1.50.60 $\58.22 $166.23 $174.64 $1113.47 $192.76 $202 . .51 $212.76 $223.52 $234. 113 $246.72 $259.20 3 T1" P<1ic.l $4.31 $7.00 $10.48 $14.47 $19. 15 $17.69 $16. 16 $14.58 $12.95 $11.211 $9.58 $7.86 ~ Oho,knc.l~ 

E<.:,'lhlii11C: lnc:ome S47

$16.

.

114 

K3 $49

$1.77 .04 $51.52 

$.00 

$53 

$.00 

99 $56

$.

.

00 

18 S.57

$.

.

00 

8K $59

$.

.

00 

73 $61.80 

$ .00 

$64

$ .

.

00 

13 $66

$.

.

00 

79 $69

$ .

.

00 

116 S73

$ .

.

00 

39 -

~· 

Avcr.ll!t! Tax Rate 9.01'it. 14.27% 20 34~ 26 110~ 34 09~ 30 56~ 27.06% 23 . .59% 20. 19'it 16.89% 13.71% 10.71 ~ ~ 

AMT 'Credits $4.31 $11.31 S21.7R S31 .n $38.58 $411. 111 $60.66 $71 .69 $111 . 19 $119.04 $95.12 $99.30 3:: 

Wlth,>ut Minimum T11x ::l -· Dcht E4uitv Ratio 32.00% 32.00% 32.00% 32.00'it. 32.32% 32.07% 32.00% 32.00% 32.00% 32.00% 32.00% 32 00~ -· Ca,h Generatoo $147.83 $154. 10 $161.90 $170.09 $178.70 $187.48 $197. 17 $207.22 $217.70 $228.72 $240.29 $252.45 3 

New Oeht $23.92 $12.89 $13.54 $14.22 $17.31 $13.91 $15.92 $17.33 $18.21 $19.13 $20.09 $21.11 c 

Gn''' lnve~un nt $150.60 $158.22 $166.23 $174.64 $183.47 $192.76 $202.51 $212 .76 $223.52 $234.83 $246.72 $259.20 3 

Ta" Pai,J $.00 s.oo $.00 $4.58 $12.53 $1!.63 1;.70 $4.96 $S. 21 $5.47 p,.75 $6.04 

~ 01\ i\lcnc.Js $21.15 $8.77 $9.21 $5.10 s.oo $.00 .89 $6.113 $7.18 $7.54 .92 $1!.32 

Ec,,n,>mic: lm:oone $47.83 $49.04 $St.S2 $54.10 $56.73 $.59. 10 S61.91 $64.74 S67.70 $70.88 $74.33 $78.09 

A\l:ragl.' Tux Rate .00% .00% .00% 11.47% 22.09% 14.60% 59~ 7.66% 7.70% 7.72% 7.74% 7.73% 

N 

0\ 

*Years in which the firm faces the AMT are noted with asterisk. t\0 
270 Lowell Dworin 

This may be seen by comparing the average tax rate for the "13%" firm in year 

seven (when it faces the AMT). which is only 2.84 percentage points in excess 

of the 20% statutory AMT rate, with the 14.09 percentage point excess for the 

"7% " firm (in year five). Even this 34.09% maximum tax rate for the "7% " firm 

is barely above the 34% statutory rate for the regular tax. and is unlikely to 

reach the values suggested by Christian et aJ. (who implicitly assume a very 

low 1.5% pre-tax rate of return in much of their paper by ignoring the income, 

but not the depreciation, generated by the pre-1987 assets). Nevertheless, 

this feature reflects the fact that the base of the AMT differs from economic 

income. 

B. Revenue Estimates for an Airline 

The variables relevant to the issue of the importance of stochastic 

fluctuations in five year AMT revenue estimates are presented in Table 9.4. 

These include the five year taxes paid by the " 13%" and "7%" firms with and 

without the AMT (and the resulting five year AMT revenue pick-up, obtained as 

the difference between these two amounts), the stock of unused AMT credits 

available at the end of the fifth year, and the AMT credit utilization rate 

for the five-year period. Also shown in Table 4 is the average of these 

results for the two fixed-return cases. together with the mean value of the 

stochastic variables and the percentage differences between these average and 

mean values. Table 9.4 shows that the five-year total tax payments for the· 

"13%" firm are the same with and without the AMT ($126.96), since the AMT 

Table 9.4 Five-Year AMT Revenue Estimates From Conventional 

(Approximate) and Stochastic (Exact) Procedures, 

and Percentage Differences 

Tax 13% 7% Average Mean Percentage 

Variable Firm Firm (Approx.) (Exact) Difference 

Airline: 

Tax Paid with AMT $126.96 $55.41 $91.19 $88.92 2.55 % 

Tax Paid without AMT $126.96 $17.11 $72.04 $71.07 1.36% 

AMT Revenue $.00 $38.30 $19.15 $17.85 7.28% 

AMT Credit Balance $.00 $38.58 $19.29 $18.22 5.87 % 

AMT Credit Utilization 100.00% .00% 50.00% 15 .02% 232 .89% 

Nondurable Goods Manufacturer: 

Tax Paid with AMT $147.71 $54.49 $101.10 $95.15 6.25% 

Tax Paid without AMT $147.71 $35.52 $91 .62 $90.75 .95% 

AMT Revenue $.00 $18.97 $9.49 $4.40 115.57% 

AMT Credit Balance $.00 $19.06 $9.53 $1.28 30.91 % 

AMT Credit Utilization 100.00% .00% 50.00% 69.89% -28.46% 

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Impact of the Corporate Alternative Minimum Tax 271 

credits generated in years 2 and 3 are utilized in year 4 . By contrast. the 

"7%" finn incurred an additional $38.30 in tax payments due to the AMT during 

the first five years. The average net five year AMT payment for the two 

fixed-return cases ($19. 15) somewhat overstates the mean value as obtained 

from the Monte Carlo simulations ($17 .85). As a result. it may be inferred 

that the conventionally calculated average five-year AMT revenues overstate 

the actual revenues (the mean of the stochastic values) by 7. 3%. 

At first glance. it would appear that the conventional AMT revenue estimation process may not be significantly impaired by the absence of explicit 

stochastic modelling.

1 5 However, because the mean stochastic value of the 

five-year AMT credit utilization rate is only 15.02%. this result may not be 

of general validity. The ability to utilize previously generated AMT credits 

adds to the potential disparity between the conventional and stochastic AMT 

revenue estimates. A greater difference in estimated AMT revenues might thus 

be observed for a firm which. on average. faces the minimum tax somewhat less 

frequently over the first five years than an "airline". This hypothesis is 

tested by examining the revenue estimates for a "nondurable goods manufacturer". 

C. Revenue Estimates for a "Nondurable Goods Manufacturer" 

The financial results for a "nondurable goods manufacturer". where the 

decision parameters are those found to be optimal under stochastic conditions 

in the presence of the minimum tax (Case 4 of Table 9.2) are somewhat different from those noted above for an "airline". In the case of a "nondurable 

goods manufacturer" , the "13%" firm does not face the AMT in any of the first 

twelve years. while the "7%" firm faces the AMT in each of the first eleven 

years (but not in the twelfth year). As in the case of an "airline". the debt 

to equity ratio of the "7% " firm quickly exceeds the target value. and thus 

the firm does not pay any dividends after the third year. The maximum average 

tax rate for the "7%" firm is 30.75 % (10.75 percentage points above the 20% 

AMT statutory rate). 

Table 9.4 presents the total tax revenues paid by the " 13 %" and "7%" finn 

during the first five years. both with and without the minimum tax. It also 

shows the AMT credit balance at the end of the five year period. and the 

five-year AMT credit utilization rate (which is taken to be unity in the case 

of the" 13 %" finn. which does not face theAMT during this period). The mean 

value of the AMT credit utilization rate is 69.9%. This is a much greater 

utilization rate than was observed for the "airline" and thus a greater 

difference between the conventional and stochastic revenue estimates may be 

anticipated for such firm . Indeed. comparison of the average of the two 

fixed-return cases with the mean stochastic value as shown in the table 

indicates that the conventional five year AMT revenue estimate ($9.49) 

overstates the mean stochasic value ($4 .40) by 115.6%. 
272 Lowell Dworin 

These disparate results for the "airline" and the "nondurable goods 

manufacturer" clearly indicate that the importance of utilizing stochastic 

revenue estimation depends upon the nature of the firm. If firms which face 

the minimum tax are more like an "airline" . it is likely that no significant 

five-year revenue estimation error would result from the conventional estimation procedure. However, if most firms resemble the "nondurable goods 

manufacturer", serious errors might arise. despite the lower AMT payments 

attributable to such firms. While the results may thus be somewhat ambiguous 

with respect to the importance of incorporating stochastic modelling in 

estimating AMT revenues over a five year period. significant errors almost 

certainly would result from the neglect of stochastic fluctuations when 

calculating the relative impact of the AMT on tax liabilities over periods 

much greater than five years. Thus. for example. the average of the "J 3%" and 

"7%" present values of the discounted excess AMT payments for an "airline" 

over the 50 year period examined is $41.32, which is approximately 158% 

greater than the actual (mean stochastic) value of $15.96. This is a much 

greater disparity than the 7.3% overstatement of the initial five-year AMT 

revenues noted for such firm. and is largely due to the inadequate picture of 

the actual AMT credit utilization provided by averaging the results of the two 

fixed-return cases. 

VII. CONCLUSIONS 

The numerical experiments described in this paper were performed to shed 

additional light on the impact of the corporate AMT. especially under stochastic economic conditions. While the results are somewhat ambiguous regarding 

the importance of stochastic modelling in estimating AMT revenues over a five 

year budget period, they clearly reveal the importance of allowing for both 

stochastic fluctuations and the behavioral response of firms when evaluating 

the overall impact of the AMT. 

More specifically. a corporation with the characteristics of an "airline" 

faced the AMT in ll of the 50 years examined under non-stochastic conditions. 

but is on average exposed to the AMT in nearly 28 of the 50 years examined 

under stochastic conditions. Likewise, a corporation with the characteristic 

of a "nondurable goods manufacturer" faces the AMT in only 3 out of the 50 

years under non-stochastic conditions. but on average is exposed to the AMT in 

nearly 6 of the 50 years under stochastic conditions. 

In response to the AMT. firms are likely to reduce their average growth 

rate and their target debt to equity ratio, although the magnitude of the 

response varies with their degree of exposure to the AMT. Thus the "airline" 

reduced its total investment over the 50 year period examined by 11 .8% under 

non-stochastic conditions. and by 14.0 % under stochastic conditions. Much 

smaller reductions in investment (0.4% and 1.0%. respectively) were found for 

the "nondurable goods manufacturer". which is only barely affected by the 

AMT. 

Although the behavioral response reduced both the firm's exposure to the 

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Impact of the Corporate Alternative Minimum Tax 273 

minimum tax (very slightly in the case of the "airline", but somewhat more 

significantly in the case of the "nondurable goods manufacturer") and the 

magnitude of the resulting net AMT payments, the optimal response cannot be 

characterized as an attempt to avoid facing the AMT. Moreover, because of 

the reduced level of investment in depreciable assets in response to the AMT, 

in some cases the finn's total tax payments increased slightly (despite the 

significant reduction in net AMT payments). While such result may appear 

perverse to those accustomed to think in terms of tax minimization, it is 

consistent with the maximization of the value of the finn's equity, which is 

taken to be the objective of the finn in this paper. 

Conventional simulation studies (see, e.g., Lucke et al.) suggest that the 

impact of the AMT on corporate tax liabilities will be relatively modest, 

largely because the higher payments will rapidly be credited against future 

regular tax liabilities. However, such view is based on a comparison between 

the tax liabilities with and without the AMT under arbitrary assumptions about 

the firm's (assumed fixed) growth rate and financing decisions. As the 

results of this study indicate. a much greater impact of the AMT is found when 

the response of the finn to its tax environment is considered. Thus. for 

example, when the finn is allowed to optimize its investment and financing 

decisions to reflect the presence or absence of the AMT, the AMT is seen to 

increase the average effective tax rate of an "airline" by 12.2% under 

non-stochastic conditions. and by 14.7% under stochastic conditions. By 

contrast. had fixed investment and financial parameters been assumed, the 

resulting increase in the average effective tax rate would have been about one 

half of these values. 

The importance of stochastic extrapolation in estimating AMT revenues over 

a five year budget period is not clearly demonstrated. In the case of an 

"airline". which is subject to relatively high AMT payments. the conventional 

five-year AMT revenue estimate overstated the actual value by only 7.3%. 

However, the conventional AMT revenue estimate resulted in a 115.6% overstatement fora" nondurable goodsmanufact urer" (although thenetAMTpayments 

for such finn are relatively modest). The magnitude of the disparity between 

the conventional and stochastic revenue estimates may be partially explained 

by the difference in the mean AMT credit utilization rates: a higher utilization rate ponends a greater disparity in revenue estimates. 

APPENDIX 

In this Appendix. the objective function noted in Section Ill will be 

derived. A shareholder's after tax rate of retum Rt is a mix of di\'idend . d . I . 16 mcome an capita gams: 

(9.A I) 
274 Lowell Dworin 

where Dt denotes the dividends paid in period t, Vt is the total value of the 

firm in period t, v:. 1 is the period t +I value of the shares outstanding in 

period t. m is the investor's marginal tax rate on dividend income, and z is 

the investor's marginal effective tax rate on capital gains. 

The total value of the firm in period t + 1. V t+ 1 • is the sum of V:.1 and the 

value of new shares issued in period t. V:. If the rate of return, Rt, may be 

taken to be a constant (P ). then Equation (9.Al) may be written as: 

vt = (l+p/l-zf

1

l6Dt-V:+vt+tJ. (9.A2) 

where 6 =(1-m)/(1-z). ~uation (9.A2) may be solved iteratively, under the 

condition that (l+p/1-z) Vt+j -+ 0 as j-+ •. Thus, 

(9.A3) 

Equation (9.A3) is the well known "fundamental value equation" for the 

firm. The finn's managers may be expected to make investment and financial 

decisions which maximize Vt. In performing our Monte Carlo simulation we 

shall be evaluating the individual terms in the sum on the right hand side of 

Equation (9.A3) for each of the approximately one thousand trial runs. It 

would obviously be helpful to be able to terminate the sum after a reasonable 

(say T) number of terms. Had Equation (9 .A2) merely been iterated forward to 

period l + T, we would find: 

T-1 -1)+1 ) .ft -T 

vt = rj•o (I+ p/1-z) 16 Dt+j-Yt+) I+ (I+ p/1-z) vt+T . (9.A4) 

Thus, 1f a reasonable approximation can be obtained for Vt+T, the 

computational efforts required can be significantly reduced. By making a few 

additional assumptions regarding the behavior of the finn in period t + T and 

later years. such an approximation may be obtained. In particular. we shall 

suppose that for period T and all later periods the finn earns only the 

(certain and constant) marginal return. that it maintains a constant debt to 

equity ratio e. and that its dividend payout grows at a constant growth rate 

g. Since the firm is assumed to be paying dividends in year T and all later 

years. it follows from our model that it does not issue any new stock in any 

of these years ~+T+j = 0 for all j).

17 

From Equation (9.A3) we may thus express the value of the stock in period 

t + T in terms of the dividend payment in that period and in all later periods: 

(9.A5) 

In our model dividends are a residual: 

(9.A6) 

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Impact of the Corporate Alternatjve Minimum Tax 275 

where Xt+T is the pre-tax operating earnings, )\.T is the interest payment on 

the beginning of the period debt (Bt+T). lt+T is the gross investment, and 

Tt+T is the tax liability. all for period t+T. Because of our model assumptions. each of these terms are proportional to Kt+T. the capital stock in 

period t+T.18 Thus. we may write Equation (9.A6) for Dt+T as: 

Dt+T = {lr·-i(l-6)(0/l+E>)](J-t.)-g-(i6-g)E>Il+E>}Kt+T' (9.A 7) 

• where r is the (certain and constant) pre-tax rate of return, i is the 

interest rate. e is the debt to equity ratio. and t" is the average effective 

tax rate. Substituting this expression into Equation (9.A5). we obtain: 

V =6~--K [ (

r -g J e ] 

t+T iS-g I +0 1:+T' (9.A8) 

where the first bracketed expression on the right hand side of Equation (9.A 7) 

has been denoted by r

0 • Our assumption that the finn earns only marginal 

returns in period T and later years implies that this rate of return equals i6 

so that Equation (9.A8) may be written: 

vt+T = .s[ 1- ( 1!e)] Kt+T = cS <Kt+T -Bt+T> = 6Et+T ' (9.A9) 

where Et+T is the period t + T equity value of the finn. By substituting this 

expression for Vt+T into Equation (9 .A4 ). we finally obtain our objective 

function: 

t-1 -(j+l) .)1 -T 

vt = E. (l+p/1-z) I6Dt .-Vt. j I + (I +p/l-z) SEt T' (9.Al0) )&0 +) + + 

FOOTNOTES 

1

The alternative minimum tax technically refers only to the excess of the tentative minimum 

tax over the regular tax . In this paper. such excess shall be denoted as "net AMT". while the 

phrase "alternative minimum tax" (or AMT) shall be used to refer in a conceptual sense to the 

entire minimum tax (and not merely its excess over the regular tax). 2 Other adjustments have the effect of repealing the completed contract method of accounting 

for long term contracts and the installment method of accounting for the sale of goods for AMT 

purposes. Neither of these adjustments are relevant for the examples considered in this 

paP._er. 3

TheCorporate Tax Panel. which was developed by Paul Dobbins. contains complete multiyear tax data (covering the period 1970-82) for approximately 6.000 firms. A greater than 50% 

increase in tax net income is observed in 28.4% of the cases. and a corresponding increase in 

book net income in 25% of the c.1ses. A greater than 50% dl!crease in tax net income is observed 

in 21 .7% of the cases. and a corresponding decrease in book net income in 16.3% of the cases. 

A significant correlation between the annual changes in tax and book net income is evident. 
276 Lowell Dworin 

4 As described in Nester ( 1977). the Corporate Tax Model is essentially a tax calculator which 

utilizes an I.R.S. Statistics of Income corporate tax file as an initial data base. Tax law 

changes are programmed into the calculator. Such changes are either calculated directly from the 

original file values (as in the case of a change in tax rates) or exogenously determined (such as 

changes in depreciation deductions. which are imported from OT A's Depreciation Model; see the 

paP._er by Gerardi. Milner. Whitaker. and Wyscarver in this Compmtiium). 5

The possibility that current investment may alter the taxation of the income generated by 

prior (and future) investment is already a feature of tax law. See. e.g .. Hughes and McFetridge 

( 1985) for a discussion of the implications of the incremental R&E tax credit on investment. or 

Auerbach ( 1986) for an analysis of the net operating loss provisions on investment. While the 

NOL provisions have been incorporated in the model used in this paper. the R&E credit bas been 

ignored. 6 A quadratic investment adjustment cost function has been used by Summers ( 1981) and by 

Poterba and Summers ( 1983) in their studies of the importance of dividend taxation. which were 

also based on the Hayashi model of the firm . While the specific parameters characterizing the 

adjustment cost function used in this paper and those in each of these earlier papers differ 

somewhat from each other. the resulting adjustment costs are all of the same magnitude. 7 Although the model allows the firm's level of investment and its level of debt (or financial 

assets) to vary (in a pre-determined manner) in accordance with the realized profit margin , it 

does not allow the firm to "fine-tune " its investment plans according to whether it might or 

might not otherwise face the minimum tax. The model thus does not fully replicate the tax 

planning available to firms. and might therefore overstate the impact of the AMT. 8 Shoven ( 1986) has stressed the increasing importance of share repurchases as a mechanism 

for distributing cash from the corporation to its shareholders. His analysis of the tax 

advantage of this mechanism neglects the possibility that such repurchases might be treated as 

dividend distributions under I.R.C. Section 302. Moreover. the tax advantage of such 

mechanism has been reduced by the Tax Reform Act of 1986. Nevertheless. the neglect of this · 

alternative use of corporate funds must be recognized as a limitation of the model. 

~Fullerton and Gordon ( 1983) note that the average 1973 debt to capital ratio across all 

industries is approximately .4. which in turn implies an average debt to equity ratio of .67. 

However. this value, which is based on market (rather than book) values of the firm's debt and 

equity secuntJes. reflects in part the high debt ratios for financial institutions: lower 

ratios are observed for most of the manufacturing sectors. As used in this paper. "debt" 

actually refers to the excess of the firm· s interest bearing financial liabilities over its 

interest yielding investments. The corresponding .J "natural" debt to equity ratio used in the 

model is the average ratio for manufacturing firms. as obtained (after adjustment for deferred 

taxes and other reported non-interest bearing liabilities) from the 2nd quarter 1986 Quarterly 

Financial Report published by the U. S. Depa1rtment of Commerce ( 1986). 10 Alternative leverage cost functions have been used in other studies. e .g .. Gordon and 

Malkiel (1980) and Fullerton and Gordon (198>). and have generally been viewed as reflecting 

the risk premium associated with the increasing possibility of bankruptcy with greater leverage. 11The investment adjustment cost function and the financial leverage cost function are 

responsible for "interior" solutions being obtained from the model. In their absence. both the 

firm's optimal growth rate and its debt to equity ratio would tend toward infinity. 12 The "airline" in the paper by Lucke. et al. is characterized as having IS % of its property 

in inventories and land. 10% in real property. I 0% in computer equipment (6-year ADR midpoint life). and 65% in aircraft (12 year ADR mid-point life). ln the case noted in this paper. 

more of the firm 's property ( 100% vs. 85%) is assumed to be depreciable. and a higher nominal 

growth rate (5 .54% vs 4%) and lower nominal pre-tax rate of return (I 0% vs. II %) are also 

assumed. However. the lower debt to equity ratio (33.5% 's. 41.9 %) and the different asset mix 

assumed results in ao equal frequency of exposure to the AMT under non-stochastic conditions. 

Whereas Lucke et al. sought to explicitly model a representative airline. it is only because of 

this equality that the firm modeled in this paper is referred to as an "airline". 

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Impact of the Corporate Alternative Minimum Tax 277 

13 In the paper by Luckeet at.. 20% of the property of the "nondurable goods manufacturer" 

is non-depreciable. The balance of the property consists of real property (30%). special tools 

with a 4-year ADR mid-point life (5%). machinery with a I 0 year ADR mid-point life (20% ). and 

machinery with a 12 year ADR mid-point life (25% ). As in the case of the "airline". the lower 

debt to equity ratio and difference in asset mix appears to offset tbe differences in the other 

assumed parameters (as noted in footnote 12). resulting in an equal frequency of exposure to the 

AMT. It is only because of this equality that the firm represented in the second version of the 

model of this paper is referred to as a " non-durable goods manufacturer". 

14 Likewise. by comparing the value of the firm's equity in the absence of the minimum tax for 

the initial (Case I in Table I) decision parameters ($836.62), with the corresponding value for 

the new decision parameters ($834. 17 for Case I in Table 2). the advantage of the initial parameters over the altered parameters in the absence of the minimum tax may be confirmed. 

15 In order to investigate the robustness of this result for an "airline" , the corresponding 

error under alternative stochastic conditions has been examined. In cases where the independence 

of the returns across firms is maintained, the average pre-tax return kept at 10%. and the 

decision parameters for Case 2 of Table 2 are used, this result appears somewhat sensitive to 

the assumed distribution of pre-tax returns. For example. a 0 .7% error was observed with 12 % 

and 9% pre-tax rates of return (the 9% return being twice as likely). and a ·.6% error was 

observed in the case of an II % and 8% rate of return (the 11 % return being twice as likely). 

However. with a 12% and 6% pre-tax rate of return (with the 12% return twice as likely). a 

-23.0 % error was observed. Moreover. if the returns for different firms are correlated. a 

greater error may easily arise. For example. if 13 %. 1 I %. 9%. and 7% pre-tax rates of return 

are equally likely (with the 13% or 9% returns occurring in "good" years. and the II% or 7% 

returns occurring in " bad" years. and with "good'' or "bad" years equally likely). a -3 1. 1% 

error would arise if the initial data year were a "good" year. and a 28.7% error would arise 

if the initial data year were a "bad" year. Such errors largely reflect the failure in this 

case of projecting future economic conditions on the basis of a single year's data. 16We are following, to the extent possible. the discussion and notation of Poterba and 

Summers (1985). References to the future value of the firm's outstanding shares or future 

dividend payments should be understood as the expected value of such variables. 17 Undertheseassumptions. the investor's required return p for year t + Tand later years may 

be taken to be i(l-m). where i is the nominal pre-tax interest rate {assuming that the marginal 

tax rate on interest income is the same as that on dividend income). 18This is not quite valid. The tax liability in period t+T may well involve terms (e.g .. the 

stock of unused AMT credits) which are not proportional to Kt+T . 

REFERENCES 

Auerbach. A.J. "The Dynamic Effects of Tax Law Aysymmetries" . Review of Eco11omic 

S111dies 53 (1986). pp. 205-226. 

Christian. E.S .. Schutter. G.J .. and Nilles. K.M. "Fundamental Flaws in the Minimum Tax 

Depreciation Tax Preference" . Tax Notn (July 14. 1986). pp. 151 - 160. 

Fullerton. D .. and Gordon . R.H . "A Reexamination of Tax Distortions in General Equilibrium Models" . ln lJt'luwioraf Simulation Mt•thods in Tm Pofi( \' Analyst~. ed. by 

Martin Feldstein. Chicago. Ill. : Uni,ersity of Chicago Press. Chicago. Ill. . 1983. 

pp. 369-420. 

Gordon. R.H .. and Malkiel. B.G . "Taxation and Corporatt' Finance " . NIIER Wor/.:111,1! fJapt•r 

No. 576 (1980). 

Harter. G.A. "How Tax Reform Would Affect Companies With Difft:rent Growth and Profitability Characteristics ". 7ax Nott'!J (April 2 1. 1986). pp. 297-301 . 
278 Lowell Dworin 

Hughes. E .• and Mcfetridge. D .G . "A Theoretical Analysis of Incremental Investment 

Incentives With An Application to the Case of Industrial R&D". Journal of PubliC' 

Economics 21 (1985). pp. 311-329. 

Hyashi. F . "Tobin's Marginal q and Average q: A Neoclassical Interpretation" Econometrica 50 (1982). pp. 213-224. 

. "Corporate Finance Side of the Q Theory of Investment". Journal of Public 

~onomics 27 (1985). pp. 261 -280. 

Lucke, R.B., Eisenach. M .R .. and Dildine. L.L. "The Senate Alternative Minimum Tall: 

Does it Snare Only the Tu Abusers?" Tax Notes (August 18. 1986). pp. 681-690. 

Nester. H . "The Corporate Microdata File Employed by the Office of Tu Analysis". 

National Tax Journal 30 (1977), pp. 293-306. 

Summers. L.H . "Tuation and corporate investment: A q-tbeory approach". Brooking 

Papers on Economic Activity (1981 ), pp. 67-127. 

Poterba, J .M .• and Summers. L.H. "Dividend taxes, corporate investment, and Q." Journal 

of Public Economics 22 (1983), pp. 135-167. 

. "The Economic Effects of Dividend Tuation". In &unt Advancts in Corporatt 

-,;[nanct.ed. byE . I. AltmanandM. G . Subrahmanyam. Homewood,IIl. RicbardD. Irwin. 

1985. pp. 227-284. 

U. S. Department of Commerce. Bureau of the Census. Quartuly Financial Rtport. Stcond 

Quarter 1986. Washington. D.C.: U.S. Government Printing Office. 1986. Table 1. 1. 

p. 4 . 

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