March, 2013

March 28, 2013

After five years of litigation and appeals, New York's highest court today upheld the state's "Amazon tax" in a 4 to 1 decision (PDF). The law, nicknamed after its most visible target, deems an out-of-state company to be an in-state taxpayer if the company receives commissioned referrals from in-state resident "affiliates." The out-of-state company then must collect sales tax for the state. Generally, just as state services are only provided within their borders, state tax authority (or "nexus") ends at its border, with it only able to require sales tax collection from in-state companies.

On the central question of whether Amazon.com and other online retailers are "physically present" due to their affiliate contracts, despite not being physically present themselves, the Court of Appeals today found it was so:

[E]ven in the Internet world, many websites are geared toward predominantly local audiences -- including, for instance, radio stations, religious institutions and schools -– such that the physical presence of the website owner becomes relevant to Commerce Clause analysis. Indeed, the Appellate Division record in this case contains examples of such websites urging their local constituents to support them by making purchases through their Amazon links. Essentially, through these types of affiliation agreements, a vendor is deemed to have established an in-state sales force.

Viewed in this manner the statute plainly satisfies the substantial nexus requirement. Active, in-state solicitation that produces a significant amount of revenue qualifies as “demonstrably more than a ‘slightest presence’” under Orvis. Although it is not a dispositive factor, it also merits notice that vendors are not required to pay these taxes out-of-pocket. Rather, they are collecting taxes that are unquestionably due, which are exceedingly difficult to collect from the individual purchasers themselves, and as to which there is no risk of multiple taxation.

(p. 9-10.) In short, physical presence means not just having your property or your employees in a state, but now also targeted advertising through others that resembles an in-state local sales force. The Court quickly notes in its next paragraph that "no one disputes" that "passive" advertising does not create phyiscal presence. (p. 10). Consequently, the line the Court draws is between passive advertising (no nexus with the state) and active advertising (nexus with the state).

Judge Robert Smith dissented, saying that the statute unconstitutionally expands the physical presence rule, and rejecting the majority's apparent constitutional distinction between advertising paid per result (tax nexus) and advertising paid as a flat fee (no tax nexus).

This is obviously not the decision we wanted, having filed briefs in the case urging that the statute be struck down as unconstitutional. The parties may yet appeal the case to the U.S. Supreme Court and we'd say the same thing. 

However, three thoughts to keep in mind nevertheless.

  • First, New York's courts remain alone in having upheld these laws; similar ones elsewhere have been struck down (Illinois, North Carolina, Colorado).
  • Second, these state nexus expansion laws remain bad policy, generating far less revenue than expected while failing to solve the overall problem of how to tax Internet commerce in an equitable and non-stifling manner. A federal solution remains the better approach: one that prevents excessive state tax overreaching while establishing a system that allows states to collect taxes owed by their residents in a simplified manner, balancing uniformity of administration with competitiveness in rates.
  • Third, the New York Court of Appeal's decision rejects a facial challenge--the difficult standard of proving that a statute is unconstitutional on its face with no legitimate application. The Court did not address what might be next; an as applied challenge finding the statute's application in a particular context to be unconstitutional. Given how nebulous the line between "passive advertising" and "active advertising" is, the Court might have to rethink that standard when real cases start heading their way.

​Check out everything we've ever done on nexus (including my most recent congressional testimony on the topic) here.

March 28, 2013
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This morning we released an extensive new state-by-state resource guide, How Is the Money Used? Federal and State Cases Distinguishing Taxes and Fees (download PDF version here). This report examines what a tax is, what a fee is, and how public understanding of the difference between the two can strengthen taxpayer protection provisions, minimize distortions caused by hidden or mislabeled taxes, and help increase transparency of the cost of government programs. Hundreds of relevant legal cases, from each state, are summarized.

A tax has the primary purpose of raising revenue. By contrast, a fee recoups the cost of providing a service from a beneficiary.

This is not just a matter of semantics. In order to protect taxpayers, many state constitutions contain additional procedural steps and limitations that apply only to tax increases. These protective measures can be undermined if the legislature can circumvent them by merely relabeling what would otherwise be a tax, so a workable definition of "tax" is necessary to give them meaning.

The report finds that all but two states (North Carolina and Oregon) have adopted these definitions, with Ohio as the most recent addition. The report also reviews which states rule in favor of taxpayers when tax laws are ambiguously worded, which states have rejected the discredited notion that taxes are “mandatory” charges while fees are “voluntary” charges, and the impacts of the Supreme Court's decision finding the health care individual mandate to be a tax.

With April 15th arriving soon, taxes will be on the collective minds of our nation. As taxpayers sign over checks to the government, an understanding of what the word tax means is of upmost importance.

Tax Foundation Background Paper No. 63, “How Is the Money Used? Federal and State Cases Distinguishing Taxes and Fees” by Joseph Henchman is available online.

March 27, 2013

We earlier described Virginia’s passage of new transportation taxes, which include higher sales taxes in the northern Virginia and Hampton Roads regions and higher hotel and real estate taxes in northern Virginia. Although not exactly the plan Governor Bob McDonnell (R) asked for, it looked close enough to most observers and he was expected to sign it into law.

Enter Virginia Attorney General Ken Cuccinelli, widely expected to the 2014 Republican gubernatorial nominee. He noted in an advisory opinion (PDF) last Friday that Virginia’s Constitution contains a uniformity clause, which requires that all taxes imposed by the Legislature be uniform across the entire state.

Because the law does not impose the new taxes equally across the state geographically, but only in certain areas, it violates the uniformity clause. (A similar law was struck down in 2008 for allowing regional authorities to impose new taxes without voter approval, to get around northern Virginia voters’ consistent habit of rejecting regional taxes.)

So, McDonnell exercised his power to amend the statute and expand the new taxes statewide. Sort of. The new taxes apply “statewide” to any region that meets the following carefully convoluted criteria: any planning district with at least 1.5 million people as of 2010, at least 1.2 million registered vehicles, and at least 15 million transit passengers. Not surprisingly, only the Hampton Roads region and northern Virginia fit this criteria. From the Stafford County Sun:

McDonnell's amendments to the bill, filed late Monday night, would: reduce a proposed annual fee on hybrid and alternative fuel vehicles from $100 to $64; trim a 1.3-percentage point increase in the sales tax on motor vehicles to 1.15 percentage points, phased in over three years; decrease new taxes on real estate transactions and overnight lodgings in Northern Virginia for regional initiatives there; and tie the new taxes for regional initiatives — including a higher retail sales tax than the rest of the state — to specific criteria such as population, vehicles, and transit use as proxies for highway congestion and pollution.

"So empirical criteria as opposed to naming regions," said McDonnell, who added that the criteria "theoretically could be met by any region of the state."

Currently, only the Northern Virginia and Hampton Roads planning districts meet the criteria — at least 1.5 million people in the 2010 census, at least 1.2 million registered motor vehicles, and at least 15 million transit passengers a year.

This dodge allows Virginia’s new taxes to get around the Constitution’s requirement that taxes be imposed uniformly across the state. Now they are uniform technically but not for practical purposes. Maybe it’s the right policy, given the greater transportation needs of the two regions in question, but it’s bad constitutional practice.

March 27, 2013
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The Minneapolis Star Tribune has published a scathing denouncement of the proposal to raise taxes on high-income earners, part of the House of Representative’s DFL tax plan and similar to the Governor’s tax plan that we've critiqued here and here:

The House DFL proposal to double down on an upper-income tax increase — albeit temporarily — risks launching the state’s top tax rate into an anticompetitive stratosphere. It’s an idea that ought to disappear faster than March snow.

The paper-of-record's editorial goes on to warn that higher taxes on wealthier taxpayers is poor tax policy, bringing Minnesota into the same camp as high-tax California and Hawaii:

That’s not good company for a state that wants to continue to be home to more Fortune 500 companies per capita than any other. Those big businesses aim to attract top talent from around the country. A supersized state income tax for top earners would make their recruitment more difficult, and could cause some companies to ask whether they ought to do their hiring elsewhere.

States should think carefully about how they decide to collect revenue. The editorial board is right—revenue should be raised in a way that minimizes economic distortions and doesn’t put states at a competitive disadvantage. Governor Dayton and state legislators alike would do well to follow the Star Tribune’s advice.

More on Minnesota here.

Follow Liz on Twitter @elizabeth_malm.

March 26, 2013

This week's map shows the top corporate income tax rate in each state. Iowa has the highest rate at 12%; three states, (Nevada, South Dakota, and Wyoming) have no corporate income tax.

Click on the map to enlarge it.

View previous maps here.

March 26, 2013

Tomorrow, the Supreme Court will hear oral arguments in United States v. Windsor. While the overall issue at stake is the constitutionality of Section III of the Defense of Marriage Act (DOMA), which defines marriage as the union of a man and a woman for federal purposes, the heart of this particular case is the $363,053 federal estate tax bill from which the plaintiff, Edith Windsor, would have been exempt had her marriage to her same-sex partner, Thea Spyer, been recognized by federal law.

The overall effect of DOMA on federal estate tax revenue is hard to measure—estate tax revenues are likely higher than otherwise, because of gay couples in similar situations as Edith Windsor—and its effect on income tax revenue is also unclear. Marriage can cause income tax penalties as well as tax bonuses, and the exact effect depends on a number of factors. Couples with unequal incomes are more likely to receive a tax bonus by getting married, while couples with similar incomes are more likely to face a tax penalty, so DOMA’s effect on income tax revenues depends on the number of married gay couples that would face penalties and bonuses if required to file a joint federal return.

Viewed purely from a tax perspective, DOMA is bad policy. It violates two important principles of sound tax policy—simplicity and neutrality. The law fails from a tax neutrality perspective because of the arbitrariness of the way it imposes complexity on, and withholds possible tax benefits from, particular classes of married couples.

The principle of simplicity is violated because couples whose marriage is recognized at the state level but not at the federal level face an incredibly complex, burdensome filing process. Gay couples living in states that recognize gay marriage must complete four different tax returns every year: one federal tax return per person, one “dummy” joint federal tax return, and then one joint state return. The dummy federal return is necessary so that couples may file their joint state tax return, which requires a joint federal filing be completed first. The dummy return is then discarded (unfiled), constituting a waste of preparation time and costs.

The situation worsens when a same-sex couple jointly owns an asset like rental property, where federal law will permit only one spouse to claim the property for tax purposes because the couple is not recognized as married. In this case, six returns must be completed to determine which spouse should claim the property: the dummy joint federal return, an individual return with the rental property included (for each spouse), an individual federal return without the rental property included (for each spouse), and a joint state return. The spouses then decide who gets the best tax treatment by including the jointly-held asset and then proceed with the appropriate federal returns. Thus, three of the returns completed, the dummy return and at least one of the federal returns completed by each spouse, are discarded without filing. This is pure waste of time, effort, and money.

Gay couples are also placed in a position whereby they must effectively lie on their federal tax return. Marriages are regulated by the states and so couples must indicate whether or not they are married on their federal tax return based on what the law of their state of residence provides. However, for federal purposes, same-sex marriages do not exist. Thus, filers must check the “single” box, even though they are married under the law of the state in which they reside. The penalties for perjury on a tax form can be substantial, so many same-sex couples opt to include a disclaimer form or otherwise make a notation on their form that they are choosing “single” as required by federal law but are married under their state’s law.

March 26, 2013

Good news out of Vermont this week, as the House Ways and Means committee voted 6-5 to kill the proposed $1.28 per gallon sugar-sweetened beverage excise tax that was being considered in the state. Back in late February, I testified to the House Ways and Means and Health Care committees on the bill. While the Health Care committee sent the bill through (after a few shenanigans), the Ways and Means committee seems to have taken the arguments against using the tax code to change behavior to heart.

As I argued in my testimony:

[…] the influence of soda taxes on obesity outcomes is questionable. We know from the law of demand that raising the price of a product will make people consume less of that product, but people don’t behave in a vacuum. A 2010 study found that soda taxes do reduce soda consumption, but that children and adolescents tend to perfectly substitute in calories from other sources. This resulted in no net change in caloric consumption. A 2007 study found that an increase of 1 percentage point in the state soft drink tax rate would lead to a decrease in BMI of just 0.003 points. For perspective, the CDC defines a “healthy” BMI for a six foot tall adult male as between the large range of 18.5 and 24.9.

There is also evidence that taxes on soda lead people to drink more beer. A 2012 study by economists at Cornell University showed that for households prone to buying alcohol, there was a 172.4 ounce increase in beer consumption per month when a 10 percent tax was applied to soda. This equates to a heightened intake of 1,930 calories in the same time frame. This raises concerns about potentially switching one public health problem for another. As an interesting side note, Vermont currently taxes beer at a rate of 27 cents per gallon. The proposed rate on soda would be almost five times as high as the current tax on beer.

I think the overarching lesson to learn from this is that people respond to tax changes, but not necessarily in the way policymakers would want them to.

[…] this debate centers around moral questions. Reducing obesity is an important goal, but policy actions have costs. My largest concern is that placing a tax on soda is a blanket policy that would affect all Vermonters. There are many people that enjoy sodas regularly and make adjustments in their diet elsewhere to maintain a healthy lifestyle. These people will be affected by an excise tax as well, and I think that is why the tax code is far too blunt an instrument to address something as comprehensive and subtle as nutrition choices.

UPDATE: The final tax package that the House will vote on may expand the sales tax base to include candy and sugar-sweetened beverages (my arguments here), and also includes a 50 cent per pack hike on cigarettes (comprehensively addressed here). The budget will ultimately have to be signed by Governor Shumlin, who has expressed his opposition to tax hikes.

More on soda taxes here.

Follow Scott Drenkard on Twitter @ScottDrenkard.

March 25, 2013

As part of “Vote-o-rama” this past Saturday, the U.S. Senate voted 51-48 to “require the Congressional Budget Office to include macroeconomic feedback scoring of tax legislation.”  Even though this is likely non-binding, it shows the majority of the Senate recognizes that CBO revenue estimates are unrealistic in that they do not account for any effects on the larger, “macro”, economy.  That is, when income taxes go up, for example, the CBO ignores for purposes of revenue estimation how this might change incentives to work, save, or invest.  This is clearly wrong by any school of economics, yet this “static” analysis is what determines the official revenue estimates for every tax bill passed by Congress.  It is a shame that 48 Democrats, including chief Senate tax writer Max Baucus, voted to continue ignoring how taxes actually affect the economy and how that in turn feeds back into tax revenue. 

It is not as if the CBO is unprepared to do a more realistic analysis, which is sometimes called “dynamic” or “macroeconomic” analysis.  The CBO relies on the Joint Committee on Taxation (JCT) to estimate revenue changes from legislation, which has at its disposal three macroeconomic models that all take into account to some degree how taxes affect the labor supply, savings and investment, and GDP.  These macroeconomic models could be used to provide more realistic estimates of revenues, as a supplement to JCT’s standard analysis.  However, it appears the last time JCT used these macroeconomic models at all was in 2009 to estimate the effects of the Affordable Care Act. 

To be clear, JCT in their standard analysis does account for certain behavioral effects which they describe as “dynamic”, namely:

  • Tax planning behavior to minimize taxes, such as income shifting or timing changes.
  • Shifts in consumption or production that do not affect the overall aggregate measures of the economy, such as a cigarette tax that reduces cigarette consumption and shifts employment and investment out of the tobacco industry and into other sectors.

However, JCT’s standard analysis explicitly ignores any of the big effects of tax changes that affect the overall size of the economy, such as higher income taxes causing less work and investment overall:

“A conventional JCT estimate incorporates behavioral responses in projecting tax revenues, but assumes that these tax and behavioral changes do not change the size of the U.S. economy, as measured by the Gross National Product (“GNP”).”

Failing to account for these big effects biases tax policy against economic growth, as it pretends that higher income taxes in particular won’t hurt the economy.  JCT’s macroeconomic models hold the potential to do a much better job, and Congressional tax writers should at least demand they be used and the results published.  Additionally, Congress should look to outside groups such as ours to independently estimate the effects of tax changes.  An open discussion of the various models, and their underlying assumptions, would greatly improve the tax writing process.  

Follow William McBride on Twitter @EconoWill 

March 25, 2013

Just before 5:00 AM on Saturday, the U.S. Senate passed a budget for the first time in four years in a 50-49 vote. (Sen. Frank Lautenberg (D-NJ) stayed at home on doctor's orders.)

The budget blueprint, opposed by all Senate Republicans and four red-state Democrats facing re-election in 2014, sets a level of $3.7 trillion in federal spending for fiscal year 2014. Over a ten year timeframe, the budget cancels $1.2 trillion in planned spending cuts, substitutes $975 billion in reduced projected spending, and raises taxes by $975 billion.

The budget vote sent Washington scrambling because of the "Vote-o-rama" that comes with it: every senator is able to propose amendments that the entire Senate will vote on. Lots of ideas have been sitting un-voted on after four years of no budgets, so 572 amendments were filed. The Senate methodically worked through them, one by one, into the wee hours, ultimately doing 43 roll call votes and a number of voice-only votes and unanimous consent approvals. Because the budget would need to be meshed with a House version to become law (which is unlikely), the amendments were considered by all to be non-binding in nature.

Among the tax-related votes included approving 79-20 the repeal of the "Obamacare" medical device tax, approving 51-48 the inclusion of dynamic scoring analysis in revenue estimates, rejecting 46-53 the repeal of the federal estate tax, and approved 80-19 a separate amendment to repeal or reduce the federal estate tax in a revenue-neutral manner.

The Senate also approved 75-24 a modified version of the Marketplace Fairness Act, a proposal to authorize states to collect sales tax on Internet and catalog transactions between their residents and out-of-state retailers. Presently, state tax authority over retail transactions extends only to retailers with a physical presence in the jurisdiction (just as one must have a physical presence in the jurisdiction to receive state services). The hotly controversial amendment has been pushed by an alliance of big-box retailers and state officials, and opposed by some Internet retailers and conservative groups.

I'm writing a piece for later this week on what's missing from the Marketplace Fairness Act, omissions that could threaten interstate commerce and economic growth unless remedied.

Here's the vote breakdown on the Internet sales tax vote (Enzi Amendment 656):

YEAs ---75

Alexander (R-TN)
Baldwin (D-WI)
Begich (D-AK)
Bennet (D-CO)
Blumenthal (D-CT)
Blunt (R-MO)
Boozman (R-AR)
Boxer (D-CA)
Brown (D-OH)
Burr (R-NC)
Cantwell (D-WA)
Cardin (D-MD)
Carper (D-DE)
Casey (D-PA)
Chambliss (R-GA)
Coburn (R-OK)
Cochran (R-MS)
Collins (R-ME)
Coons (D-DE)
Corker (R-TN)
Cowan (D-MA)
Crapo (R-ID)
Donnelly (D-IN)
Durbin (D-IL)
Enzi (R-WY)

Feinstein (D-CA)
Fischer (R-NE)
Franken (D-MN)
Gillibrand (D-NY)
Graham (R-SC)
Hagan (D-NC)
Harkin (D-IA)
Heinrich (D-NM)
Heitkamp (D-ND)
Hirono (D-HI)
Hoeven (R-ND)
Isakson (R-GA)
Johanns (R-NE)
Johnson (D-SD)
Johnson (R-WI)
Kaine (D-VA)
King (I-ME)
Kirk (R-IL)
Klobuchar (D-MN)
Landrieu (D-LA)
Leahy (D-VT)
Levin (D-MI)
Manchin (D-WV)
McCain (R-AZ)
McCaskill (D-MO)

Menendez (D-NJ)
Mikulski (D-MD)
Moran (R-KS)
Murphy (D-CT)
Murray (D-WA)
Nelson (D-FL)
Portman (R-OH)
Pryor (D-AR)
Reed (D-RI)
Reid (D-NV)
Risch (R-ID)
Rockefeller (D-WV)
Sanders (I-VT)
Schatz (D-HI)
Schumer (D-NY)
Sessions (R-AL)
Shelby (R-AL)
Stabenow (D-MI)
Thune (R-SD)
Udall (D-CO)
Udall (D-NM)
Warner (D-VA)
Warren (D-MA)
Whitehouse (D-RI)
Wicker (R-MS)

 

NAYs ---24

Ayotte (R-NH)
Barrasso (R-WY)
Baucus (D-MT)
Coats (R-IN)
Cornyn (R-TX)
Cruz (R-TX)
Flake (R-AZ)
Grassley (R-IA)

Hatch (R-UT)
Heller (R-NV)
Inhofe (R-OK)
Lee (R-UT)
McConnell (R-KY)
Merkley (D-OR)
Murkowski (R-AK)
Paul (R-KY)

Roberts (R-KS)
Rubio (R-FL)
Scott (R-SC)
Shaheen (D-NH)
Tester (D-MT)
Toomey (R-PA)
Vitter (R-LA)
Wyden (D-OR)

 

Not Voting - 1

Lautenberg (D-NJ)


 

 

Note: Blog updated to correct the medical device tax vote.

March 22, 2013

This week marks the third anniversary of President Obama signing into law the Patient Protection and Affordable Care Act, aka "ObamaCare." Peter Suderman has a good round-up of the current state of the debate over health care policy and the impacts of the ACA:

The president’s health care overhaul has already had a rough life. Since passage, it’s survived a Supreme Court challenge, more than two dozen repeal votes in Congress, and host of implementation hurdles and political controversies. And that’s just the beginning: The law’s major coverage provisions — a Medicaid expansion and private health insurance subsidies administered through state-based health exchanges — won’t kick in until later this year.

I recently interviewed economist Alan Viard of the American Enterprise Institute for the Tax Policy Podcast on the ACA's 3.8% Medicare tax on high-earners. This is the same tax that has been frequently (and erroneously) cited as a tax on home sales. The provision, technically the "Unearned Income Medicare Contribution," has been so controversial that a previous post by former Tax Foundation economist Gerald Prante debunking it has been one of the most widely-read in our 8-year blog history. Small business owners looking for practical advice on how they could be impacted by the tax should take a look at this Forbes piece from earlier in the year.

More recent updates include "Obamacare Medical Device Tax Still Baffling Business" by economist Kyle Pomerleau and "Obamacare Tax Increases Will Impact Us All" by government relations associate Andrew Lundeen.

March 22, 2013

NBC may be a successful, profitable company but that's not stopping New York legislators from offering them taxpayer subsidies to lure The Tonight Show back to 30 Rockefeller Plaza from California. NBC is rumored to be replacing Jay Leno as host of the late night mainstay with comic Jimmy Fallon.

The New York Daily News first reported on a carefully worded provision inserted into the state budget that can only mean The Tonight Show:

The provision would make state tax credits available for the producers of “a talk or variety program that filmed at least five seasons outside the state prior to its first relocated season in New York,” budget documents show.

In addition, the episodes “must be filmed before a studio audience” of at least 200 people. And the program must have an annual production budget of at least $30 million or incur at least $10 million a year in capital expenses.

In other words, a program exactly like “The Tonight Show.”

Aides to Gov. Andrew Cuomo (D) denied to the Daily News that the provision was written with The Tonight Show in mind.

Altogether, New York provides $420 million in tax subsidies each year for the film and television industry, one of the highest levels of taxpayer support in the country.

March 22, 2013
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There’s a quirky way to introduce legislation in the Washington State legislature and that’s via something called a “title-only bill.” A title-only bill is exactly what it sounds like—a piece of legislation that has a vague title but no body. There are currently 26 title-only bills filed in the legislature, all introduced by Representative Ross Hunter (D–District 48), Chair of the House Appropriations Committee, and Senator Andy Hill (R–District 45), Chair of the Senate Ways and Means Committee. Descriptions of the legislation are below:

  • “An act relating to education,”
  • “An act relating to fiscal matters,”
  • “An act relating to health care,”
  • “An act relating to human services,”
  • “An act relating to natural resources,”
  • “An act relating to revenue,” and
  • “An act relating to state government.”

Lawmakers argue that this is a way for them to beat strict legislative deadlines. For example, if a bill’s language isn’t quite right and introduction deadlines are looming, a legislator can introduce a title-only bill to act as a placeholder until the final bill is complete.

The only other states for which I could find reference to similar practices are North Carolina and California. A Raleigh, NC article from 1989 pointed out that “[i]n the harried world of the state legislator, these blank or ‘dummy’ bills are aces in the hole. They allow a legislator to meet deadlines—and worry about the details later.” The piece also argues that “[i]t leaves open an opportunity if something pops up.” The author agreed that “the method might theoretically be abused by lawmakers wishing to hide a bill’s purpose until it was taken up in committee,” but said that this was unlikely.

A related practice also seems to occur in California. A blog post last year on the Los Angeles Times website described a situation where the legislature enacted 78 blank budget bills. The legislators argue it allows the budget process to be expedited. Politically, it’s no surprise that opposite parties accuse one another of using the tactic to sneak bills through the chamber.

From what I can tell, there hasn’t been any real foul play in Washington because of this practice, but the potential is certainly there. There has been concern that the public within the state isn’t given enough notice on when legislation will be discussed. This, in combination with the title-only bill practice, could be problematic. The Washington Policy Center (WPC) frequently reports on the issue. I stumbled upon a particularly interesting description of events that occurred during the 2009-2010 legislative session. Senate Bill 6853 was a title-only bill that was discussed in committee—before it even had any text. As described by WPC: 

On the same day [of introduction] it was subject to a public hearing in the Senate Ways and Means Committee (after waiving Rule 45) and was also adopted by the Committee. [Author’s note: Senate Rule 45 says that at least five days of notice are required for all public hearings and that a draft of the legislation must be made available to the public at least 24 hours in advance.] The bill contained no text, just a blank page below the printed title. It was not until the bill had already been passed to the Rules Committee for second reading that any actual bill text was posted on the Legislature’s website. In fact, it was not until a [later] work session…that the bill text was made available in a public meeting. Even then, that text was different than the one posted online while the bill sat in the Rules Committee…. Although SB 6853 was not ultimately adopted by the Legislature, many of the provisions from the…hearing were incorporated in the [final] budget bill…. This means the public was never allowed to comment on the policies adopted.

It seems that title-only bills are a way for legislators to get around deadlines, but I would argue that they have the potential to be used for less honorable reasons. Transparency and public trust in the legislative process is of the utmost importance, and this procedural move violates both. Lawmakers should be required to follow the rules, even if it is difficult to do so.

More on Washington here. More on North Carolina here. More on California here.

Follow Liz on Twitter @elizabeth_malm

March 21, 2013
By 

It’s not often that state lawmakers agree on tax reform, but Rhode Island seems to be an exception. Governor Lincoln Chafee (I) has proposed lowering the state’s corporate income tax rate from 9 percent to 7 percent, phased in over three years. The measure would make Rhode Island’s rate the lowest among its neighbors and in the greater New England area. Revenue losses would be offset by closing or reducing certain carve-outs, such as the Jobs Development rate reduction.

In 2010, the state enacted a significant income tax reduction measure that flattened the state’s five individual income tax brackets into three and brought the top rate down from 9.9 percent to 5.99 percent. Certain progressive and labor groups have rallied to raise taxes on high-income earners this legislative session, however, by means of a new top bracket (HB 5196, HB 5751, HB 5805, and SB 527). All await action in the each chamber’s respective finance committee. 

Despite the pushback on the former tax changes, the legislative leadership seems to be in favor of keeping the cuts. Senate President M. Teresa Paiva Weed (D–District 13) has voiced reluctance at raising individual income taxes. According to the Providence Journal, she “repeated her opposition to changing the state income tax so close on the heels of the 2010 revisions lawmakers made,” making the important point that “businesses need predictability and consistency in tax policy.” The chair of the Senate Finance Committee, Daniel Da Ponte (D–District 14), noted that the new system was “a simpler, fairer tax formula.” House Finance Committee Chair Helio Melo (D–District 64) was one of the sponsors of the 2010 legislation.

Hopefully Rhode Island can add to its past tax reform success. The House Finance Committee is set to discuss the governor’s budget recommendations next week, but business leaders have already testified in favor of the corporate rate reduction. Governor Chafee had the right idea when he asserted that lowering the corporate rate would promote business growth and investment. One of the reasons Rhode Island scores poorly on our State Business Tax Climate Index (it ranks 46th overall) is its high top corporate income tax rate—lowering it would most certainly give the state a competitive edge

More on Rhode Island here.

March 21, 2013

While the U.S. maintains the developed world’s highest corporate rate at 40 percent, and frets about how to “pay for” a rate cut even when it would likely pay for itself, the rest of the world continues to pass us by.  According to tax-news, the U.K. is reducing their corporate rate from 23 percent currently to 20 percent in 2015 and making some other pro-growth reforms:

UK Chancellor George Osborne has unveiled his 2013 budget, introducing tax measures that he claims puts the UK on the path to having the "most competitive business tax system of any major economy in the world" while promising action against tax avoidance.

In his Budget Speech, delivered in the House of Commons, Osborne announced that corporation tax will be reduced to 20% from April 2015. The rate will not only be the lowest in a large economy and in the UK's history, he explained, but will unify the small company and main rates and therefore abolish the need to make complex marginal relief calculations. Businesses will also benefit from a new Employment Allowance from April 2014, which will reduce the National Insurance bill of each business by GBP2,000; companies, charities, and community sports clubs will be able to hire someone on GBP22,000, or four people on the minimum wage, without paying anything in what Osborne referred to as "jobs tax."

Other measures for business include an extension of the Capital Gains Tax holiday, as well as CGT relief for sales of businesses to employees. Above the line Research and Development credit will rise to 10%, and Osborne also reminded the House about the 10% corporation tax rate for profits on patents, which will come in from next month. Also, the amount that employers can loan to employees tax-free for the purchase of items such as season tickets will be doubled, to GBP10,000.

In relation to financial services, Osborne announced the abolition of the Schedule 19 Stamp Duty Reserve Tax, which is charged on UK domiciled unit trusts and open-ended investment companies, and of Stamp Duty on shares traded on growth markets such as the Alternative Investment Market. He quipped: "In parts of Europe they're introducing a financial transaction tax; here in Britain we're getting rid of one."

By the way, Citizens for Tax Justice doubts that a corporate rate cut would pay for itself:

Of course, if there was any possibility that we could actually get more revenue by paying less in taxes, we would all support that. The idea is so appealing that many lawmakers cling to it despite overwhelming evidence that it’s wrong.

Well, the evidence in the U.K. indicates 30 years of rate cuts have not put a dent in corporate tax collections or total tax collections as a share of GDP.  The following charts show corporate and total tax revenue today is about where it was in 1981, when the corporate rate was more than double its current rate.

Follow William McBride on Twitter @EconoWill

March 20, 2013
By 

According to OECD data on Non-Targeted Corporate Income Tax Rates, in 2012 the United States had an adjusted central income tax rate of 32.77% and a sub-central corporate income tax rate of 6.36% for a combined effective tax rate of 39.13%, for the second highest rate in the OECD. Although this number is relatively high today, historically, the corporate income tax rate is lower than in previous years. In 1981, the adjusted central government corporate income tax rate was 42% and the sub-central corporate income tax was 6.9% for a combined rate of 48.9%. However, in today’s world of increasing globalization, our comparatively higher rate puts the United States at a disadvantage.

Though corporations consider many factors when making decisions about where to locate and how to allocate their profits, but they increasingly consider the corporate tax rate of a country compared to other similar countries. In order to remain competitive and to enhance growth, many OECD countries have reformed their corporate income tax by decreasing the rate and broadening the base. The United States reduced rates as part of the 1986 Tax Reform Act. Germany responded in 2000 and 2008 by reducing their statutory corporate income tax rate from 45% to 25% to 15%. Similarly, the United Kingdom has lowered their corporate income tax rate gradually from 52% in 1981 to 24% in 2012 The corporate income tax rate will continue to fall in the United Kingdom to 21% in 2014 and then to 20% in 2015.

In general, a lower rate decreases the distortion and deadweight loss created by the corporate income tax rate. Distortion arises when businesses opt to remain as sole-proprietors, partnerships, or S-corps in order to avoid the corporate tax instead of expanding and structuring themselves as a corporation. Deadweight loss results from the increase in the price and the reduction in the quantity of goods or services produced by corporations below the welfare maximizing market equilibrium. The cost of the taxes can be passed on to consumers through higher prices and fewer goods and services, to the employees through lower wages or fewer jobs, or to capital holders through lower rent or returns on property, stocks, bonds, dividends etc. Thus, society, as a whole, loses.

This graph shows that the United States combined corporate income tax rate has not fallen as drastically as other OECD countries.  The combined corporate income tax rate for the United States has only fallen by 10.57% from 1981 and 2012. Given that the United States already had a high corporate tax rate in 1981, the United States corporate income tax rate remains substantially higher than comparable OECD countries.

Although the OECD adjusted combined corporate income tax rate of 39.54% for Japan was slightly above the United States’ rate in 2012, the Japanese Ministry of Economy, Trade, and Industry estimates that their state’s statutory corporate income tax reduction from 30% to 25.5% will lower their effective combined corporate tax rate to 38.01% and then to 35.64% in 2015 after a temporary surtax.

Thus, with the highest effective corporate income tax rate among comparable countries, the United States will need to address whether the excess revenue gained (if any) from maintaining the highest corporate income tax justifies the losses incurred to society from lower employment and wages, lower capital investment and returns, higher prices and lower quantity of goods, and slower economic growth.

See also: Japan’s New Rate

Tax Topic 
March 20, 2013
By 

New Mexico lawmakers have passed tax legislation that overhauls portions of that state’s corporate income tax code, in addition to making changes to the state’s film production credit program and the way the state funds certain local governments. The bill originally only addressed the film production tax credit program, but was amended to become a more comprehensive tax package. The Governor is expected to sign the legislation into law shortly.

The most promising portion of the measure is the reduced corporate income tax rate. The bill lowers the top rate from 7.6 to 5.9 percent over a five year period. New Mexico has the highest rate among all of its neighbors, so bringing the rate down will most definitely make the state more business-friendly.

In addition to the corporate income tax reduction measure, other major provisions in the bill include:

  • Allowing manufacturing companies to utilize single sales factor apportionment (will be phased in over five years);
  • Implementing combined reporting requirements for certain retailers within the state (it was optional for “big-box retailers” previously);
  • Changing the state’s “high-wage jobs” credit to include more strict eligibility requirements (as well as extending the timeframe to 2020);
  • Capping film production tax credit at $50 million per year, allowing for a portion of credits to carry over across years, and allowing for the credit of an additional five percent of certain film projects; and
  • Phasing out certain local government funding to compensate for lost food and medical services sales tax over 15 years.

There’s a lot going on this tax package—some good, some not so good, and some controversial. The state was smart to reduce the corporate income tax rate. Corporate income taxes are the most volatile source of tax revenue, and the fact that New Mexico only derived a mere 1.9 percent of total tax revenues from corporate income taxes in 2010 means that moving away from the tax isn’t an irresponsible move.

The local government funding provision is sure to draw criticism from local governments who are concerned about lost revenue. A portion of this particular provision allows affected local governments to raise the local portion of gross receipts taxes to cover losses. We’ve been vocal about the issues with gross receipts taxes. They’re complicated, non-neutral, and create inefficient economic distortions. Shifting local government funding back to local governments themselves has merits, but increased reliance on gross receipts taxation is a poor way to do so.

Governor Susana Martinez (R), who originally championed corporate income tax reductions, also pushed for the overhaul of inefficient and poorly-monitored tax credit programs such as those included in the final tax package. The first, the high-wage jobs credit, has been slammed by the Pew Center on the States. A report noted how the credit’s cost has ballooned over time due to “businesses…learning they could claim credits for jobs they had created years earlier without knowing about the tax credit” rather than as a result of economic growth and the employment that accompanies it.

Film production tax credits also generate warranted scrutiny. They create temporary jobs that don’t allow for upward mobility. They’re costly and don’t achieve long-term economic growth. Tax policies shouldn’t just encourage the temporary movement of business to a state, but should instead create an environment that is favorable to business without the use of high-cost, low-return gimmicks such as these. There was speculation as to what would come of this credit—the Governor opposed expansion of the program initially but then accepted it as a portion of a greater tax package that included corporate income tax reductions.

Reduction of the corporate income tax rate is a positive move. Increased oversight on costly incentive programs is, too. Getting rid of targeted carve-outs for certain industries and activities would have been even more promising because it could have lowered the rate even more by broadening the tax base. New Mexico’s plan is a mixed-bag, but is admittedly the outcome of legislative and executive compromise—something that is often hard to come by.

March 20, 2013

The House of Representatives is about to vote on a series of Budget Resolutions.  One will be the Paul Ryan budget proposal and other will be the Senate budget plan proposed by Senator Murray.

Budget Resolutions specify a revenue floor and a spending target for each budget area, but cannot dictate to the various Committees exactly how they are to hit their targets.  Therefore, modeling the economic results of a budget proposal is problematic.  In this instance, we have a fairly detailed list of tax changes proposed in Representative Ryan’s blueprint for restoring a balanced budget.  The plan is less specific on spending reductions.  The Murray plan is more vague, on both sides.  Nonetheless, one can make a broad comparison of the two approaches. 

The Ryan plan would reduce tax rates and spending significantly.  The Murray plan would have far smaller reductions in spending and would raise taxes significantly.  History and sound economic theory tell us that a smaller government and lower tax rates mean a larger private sector and larger overall level of GDP.  A larger government and higher tax rates mean a smaller private sector and total GDP. 

We have modeled the economic consequences of tax changes roughly consistent with the two policy proposals.  We do not model the economic effects of the proposed government spending reductions.  Government transfer payments add nothing to production and national income, and, through the disincentive effect of promising benefits without people having to work and save for them, probably reduce output.  Government spending on goods and services is part of GDP, but does not add to it.  It diverts resources from private to public use, and displaces private production and consumption.  On balance, it probably reduces the value of national output by diverting it to products the public would not normally favor.  Government spending would add to GDP primarily in those limited cases of infrastructure investment that adds more to productivity and GDP than private investment would do.  These are a small fraction of the federal budget.

The Ryan plan:

We have modeled the following Ryan proposals:

  • Lower the 15% Statutory Individual Income Tax Rate to 10%
  • Lower all higher Individual Income Tax Rates to 25%
  • Repeal Obama Care HI Surtax
  • Repeal Obama Care Investment Income Surtax
  • Repeal AMT
  • Cut the Corporate Income Tax Rate to 25%

The Ryan tax reductions would raise GDP and labor income by a bit over 6% after all adjustments (about five to ten years after full implementation).  That is roughly equivalent to 8 million additional full time jobs at current wages.  GDP would rise by $6.20 for each dollar of net tax increase (saving the taxpayers $7.20).  Over half of the assumed revenue loss would be recovered from increased GDP and employment.  To be clear, the growth calculated for the Ryan plan assumes the residual revenue losses (after feedback from the added economic growth) are covered by restraining spending, or by reducing tax preferences that are unrelated to incremental economic effort and would not discourage capital formation, hours worked, or labor force participation.

The static distribution of the tax cuts would be skewed toward the upper income, in large part because the plan repeals the Obama Care tax increases and some of the fiscal cliff tax hikes that were skewed toward the upper income.  (Relative to the 2012 tax system, the tax changes would be much more uniform across income levels.)   The static distribution table does not include the corporate tax rate changes, which are more broadly distributed throughout the economy.  After accounting for the positive economic changes, including the increased work hours and wages, after-tax income rises substantially across all income classes under the Ryan proposal.  See tables below.

The Murray plan:

We have modeled the Murray tax plan as a limitation on the benefits of itemized deductions to 15% of the amount, as if they were applied solely against income in the 15% tax bracket.  This in the spirit of a proposal in the President’s FY 2012 budget submission.  In addition to tax increases on the upper income, Murray also recommends extending a number of refundable credits.  These have limited economic effects, and are not modeled.  The deduction limitation raises about as much revenue on a static basis as is needed to cover the stimulus proposals, sequestration repeal, refundable credits, and net revenue gains in the Murray plan.  Note that there are many alternative ways in which the tax committees could achieve the revenue targets.

The tax increase would reduce GDP and labor income by a bit under 1% after all adjustments.   That is roughly equivalent to a loss of a million full time jobs at current wages. GDP would fall by $1.60 for each dollar of net tax increase (costing the taxpayers $2.60).  Over a quarter of the assumed revenue gains would be lost to reduced GDP and employment.

The static revenue estimates show the Murray tax increase falling mainly on people in the upper income brackets.  After adding in the negative economic effects, including the reduced work hours and wages, it can be seen that after-tax income would fall at all income levels (excluding refundable credits). See tables below.

Conclusion

The economy would be stronger under the smaller government and lower tax rates of the Ryan Budget than under the Murray budget.  Congress should be aware that the health of the economy is enhanced as the federal budget is reduced (certainly from the historically high levels that have existed since 2009).  The idea that a larger federal sector is good for economic growth was a mistaken lesson dating back to the Great Depression.  It is time we moved on.

Comparison of Economic and Budget Changes Versus 2013 Law

(billions of 2012 dollars except as noted)

 

Ryan Budget

Murray Budget

GDP

6.29%

-0.82%

Private business GDP

6.68%

-0.92%

Private business stocks

15.62%

-1.26%

Wage rate

3.96%

-0.13%

Private business hours of work

2.62%

-0.79%

Federal revenue (dynamic)($ billions)

-$175.7

$86.3

Federal spending ($ billions)*

$31.4

-$2.5

Federal surplus (+ = lower deficit) ($ billions)

-$207.1

$88.8

Static revenue estimate ($ billions)

-$366.5

$116.9

% Revenue reflow vs. static

-52.1%

-26.2%

$GDP ($ billions)

$992.9

-$130.1

$GDP gain/$net tax decrease (dollars)

$6.2

-$1.6

*Spending here reflects how tax changes affect federal workers' wages.  It does not include the spending proposals by Ryan or Murray.

Comparison of Income Distribution Effects

(2012 dollars)

AGI Class

Ryan Budget

Murray Budget

Average after-tax income per return

Average after-tax income per return

Static
Change

Static
% Change

Dynamic
Change

Dynamic
% Change

Static
Change

Static
% Change

Dynamic
Change

Dynamic
% Change

< 0

$183

-0.19%

-$6,316

6.54%

$0

0.00%

$877

-0.91%

0 - 5,463

$1

0.02%

$176

6.23%

$0

0.00%

-$22

-0.78%

5,463 - 10,925

$0

0.00%

$503

6.18%

$0

0.00%

-$65

-0.80%

10,925 - 21,850

$10

0.06%

$988

6.10%

$0

0.00%

-$126

-0.78%

21,850 - 32,775

$163

0.60%

$1,766

6.53%

$0

0.00%

-$202

-0.75%

32,775 - 43,700

$429

1.13%

$2,638

6.94%

-$30

-0.08%

-$301

-0.79%

43,700 - 54,625

$708

1.45%

$3,409

6.96%

-$286

-0.58%

-$617

-1.26%

54,625- 81,938

$1,135

1.69%

$4,784

7.13%

-$453

-0.67%

-$901

-1.34%

81,938 - 109,250

$1,925

2.04%

$6,881

7.29%

-$1,124

-1.19%

-$1,709

-1.81%

109,250 - 163,875

$2,430

1.85%

$8,747

6.66%

-$2,415

-1.84%

-$3,212

-2.45%

163,875 - 218,500

$3,072

1.64%

$12,113

6.48%

-$3,694

-1.98%

-$4,809

-2.57%

218,500 - 273,125

$6,327

2.61%

$18,143

7.48%

-$4,290

-1.77%

-$5,631

-2.32%

273,125 - 546,250

$18,246

4.98%

$35,884

9.78%

-$5,756

-1.57%

-$7,787

-2.12%

546,250 - 1,092,500

$55,353

7.49%

$91,343

12.35%

-$16,013

-2.17%

-$19,977

-2.70%

> 1,092,500

$343,625

9.55%

$524,789

14.59%

-$69,636

-1.94%

-$90,380

-2.51%

 TOTAL FOR ALL

$1,987

3.28%

$5,141

8.48%

-$752

-1.24%

-$1,132

-1.87%

 

March 20, 2013

In the spirit of March Madness, the Business Round Table put together a bracket of their own to “see how the U.S. fares in the global competitiveness challenge.” (Hint: The results don’t look great.)

The field of sixteen consists entirely of OECD countries, selected based on size of GDP and those with the highest tax rates. The countries were seeded based on GDP, with the U.S. taking the number one spot in a first round match-up against number 16 seeded Norway.

The winners of each match-up are determined by who has the lower combined corporate tax rate. I won’t share the results and spoil the fun – but with the highest corporate tax rate in the world, things look bleak for the U.S.

Click here to fill out your bracket. 

March 20, 2013

It is March 20th, 79 days since Obamacare’s medical device tax went into effect, and firms are still not sure if they are in compliance, according to Tax Analysts (subscription required):

John Seabrook of Deloitte Tax LLP said he thinks there are still many manufacturers that have not made deposits (of the tax). "Some companies are putting a lot of time and effort into compliance, but many more are still struggling," he said. "Companies should be making deposits now," he added, saying that he thinks failing to make deposits would not be considered a good-faith attempt at compliance.

Lew Fernandez of PricewaterhouseCoopers LLP said some manufacturers will probably overpay the tax in the early going, in part because it is hard to calculate some items that should be deducted from the tax base, such as rebates, price adjustments, warranty costs, and training provided by the manufacturer. Overpayments can be claimed as credits against the tax or refunds.

This is even after the IRS has published guidance twice to manufacturers on the tax in late 2012, assuming they would have enough time to prepare.

The reason there is still so much confusion is that the medical device tax is very complex. It places a large burden on medical device manufacturers to calculate and determine their tax liability.

One of the biggest complexities in the law is the “constructive sales pricing.” Normally, firms will pay tax on the sale price of their taxable medical device. Constructive pricing is supposed to allow manufacturers that do not normally make sales to outside companies to “construct” a sales price in order to levy the tax based on fair market pricing and safe harbor rules. (I know- it already sounds confusing).

However, this is proving to be even more difficult due to the complexity inherent in the medical device industry: “Compared with other industries subject to similar taxes, the medical device industry is newer, is not as integrated, has complex distribution channels, and sells a wider variety of products.”

Firms will need to spend a lot of money and resources in order to just figure out on what price they must pay their taxes, making the total cost of this tax much more than the $29 billion dollars it is supposed to raise over the next ten years. The additional resources lost due to compliance are a loss to society that could have gone to more productive uses, such as research and development or hiring more workers.

As one could imagine, this complexity will have different burdens on different size manufacturers. Small firms that do not have the additional resources to hire accounting firms to navigate the constructive pricing regulations will be hit a lot harder as they have to shift more resources from production to compliance.  Indeed, the total cost of this tax is likely to exceed 100 percent of profits for many small companies.  As a result, medical innovation will take a hit.

Complexity is one costly aspect of tax policy that is often overlooked. If the cost of complying with the tax makes up a substantial portion of the tax’s total cost, there is something fundamentally wrong. Good tax policy should not have provisions that take more than 80 days for an industry of more than 12,000 companies to figure out.

March 20, 2013

Yesterday the House Ways and Means Committee held a hearing on the state and local tax deduction and municipal bond interest exemption. The state and local tax deduction, a provision that allows individuals to deduct certain taxes they paid to their state or local government from their federal taxes, didn’t get as much attention as the municipal bond exemption, but still elicited one interesting comment from Congressman Charles Rangel (D-NY).

In response to a claim by the Tax Foundation’s President Scott Hodge that the state and local tax deduction gives the largest subsidy to the riches states, he argued that since New York contributes a disproportionately large amount of income tax revenue to the federal government, the citizens of New York should be able to benefit the most from these special deductions.

This is a bizarre comment coming from a man who lambasted Mitt Romney and other wealthy people for not paying their fair share in taxes due to special tax provisions that benefit the wealthy more than anyone else.

The state and local deduction is exactly one of those tax provisions that allows wealthy individuals to reduce their federal tax liability.

The state and local tax deduction is essentially a subsidy from the federal government to high-income local and state governments. You can see this in the following chart from Scott Hodge’s testimony that shows that states with higher income per capita have a larger percent of individuals claiming the deduction.

 

States like New Jersey, D.C., New York and Connecticut, all with relatively high incomes, enjoy a larger number of state and local deductions.

Even more, if you look at distribution by tax payer, the benefits are mostly enjoyed by the rich. 55 percent of the benefits go to those making $200,000 dollars or more a year.

March 19, 2013
By 

In 2009, the state of Delaware passed a series of “temporary” tax increases in order to fill a state budget gap. These changes included an increase in the top individual income tax rate from 5.95 to 6.95 percent, in addition to higher gross receipts, franchise, and estate taxes. Though these measure are scheduled to sunset in the coming year, the state again finds itself in the face of a budget shortfall and must do something to balance their budget.

The state’s Governor, Jack Markell (D), has proposed keeping some of these temporary changes permanent. We’ve quipped in the past that there’s nothing so permanent as a temporary tax increase, and the situation in Delaware is a perfect example of this. In the face of year-to-year revenue fluctuations and spending obligations, states have few options to address budget gaps. Most are subject to balanced budget obligations, so if a state doesn’t have adequate savings in rainy day funds, it must turn to spending cuts or tax increases to meet short-run budget requirements.

The Governor’s tax package contains the following:

  • Instead of allowing the current top individual income tax rate drop from its current level of 6.75 percent to the scheduled 5.95 percent, lowering it to only 6.6 percent;
  • A 1.0 percent rate decrease in gross receipts tax, rather than allowing for the 2009 8 percent increase to fully sunset (as well as granting additional cuts to manufacturers);
  • Fully lifting the sunset on corporate franchise and estate taxes (excluding certain farms).

House Republicans argue that the 2009 increases were only agreed upon because of the “understanding that the taxes would begin to go away this year.” Unfortunately, their solution is to again dub this year’s increase as “temporary.” Stability is crucial in a sound tax system. When tax laws fluctuate from year to year (or lawmakers have the reputation of changing laws frequently), it is difficult for taxpayers to engage in confident long-term financial planning.

Stability isn’t my only concern with the Governor’s plan. He proposes the state maintain reliance on gross receipts tax revenues. Gross receipts taxes are arguably one of the worst ways to raise revenue because of their lack of neutrality and simplicity. They lead to inefficient economic distortions. Further, the state is using higher-income taxpayers as a means to close a budget hole. This is problematic due to the volatile nature of these revenues. Individual income tax revenues are one of the most unstable sources of tax revenue.  

Delaware currently has the 15th highest top individual income tax rate in the country. Though lowering the rate to 6.6 percent is a move in the right direction, reducing it to pre-2009 levels would be more conducive to economic growth. The state would also do well to move away from taxes on gross receipts, as these are an inefficient, non-neutral, and overly-complicated way to raise revenue. Finally, enacting “temporary” tax measures makes it difficult for taxpayers to plan financially and gives them the impression that the state will raise taxes every time there is a budget crisis—not exactly the best way to foster confidence in the government’s ability to weather the business cycle. Instead, Delaware should design a tax system that is able generate adequate revenue regardless of the state of the overall economy and does so in an efficient, simple, and neutral way.

UPDATE: The Governor's tax package was approved as detailed above.

More on Delaware here.

Follow Liz on Twitter @elizabeth_malm.

March 19, 2013

I hope you've checked out our new 2013 Facts & Figures booklet, our pocket- and purse-sized guide ranking all fifty states on forty different measures of tax and fiscal policy. Topics include income tax rates, business tax climates, and excise taxes.

Even though it only came out yesterday, this year's Facts & Figures has already received two impressive citations. This morning, Rep. Dave Camp, the Chairman of the U.S. House Ways & Means Committee, cited 2013 Facts & Figures for income tax rates in his opening statement at a key tax reform hearing. And state sales tax rate information from Facts & Figures made its way into a background report prepared by the Joint Committee on Taxation for members of Congress at that same hearing.

Congress can turn to any number of options for information. It's certainly praiseworthy of our efforts and your support that they turn to the Tax Foundation for reliable, accurate, timely information. I thank you for enabling our success!

Tax Foundation donors should see their copy of Facts & Figures arriving in mailboxes in about ten days or so. Additional copies can be ordered online; that link will be live later this month.

March 19, 2013

Last week the Senate Democrats released their 2014 fiscal year budget titled Foundation for Growth: Restoring the Promise of American Opportunity. This 100-plus page document outlines a proposal to raise taxes by $975 billion dollars and replace the sequester with slightly smaller budget cuts, a $240 billion increase in spending over the next ten years over the CBO baseline.

This budget is essentially a continuation of the status quo. It simultaneously ignores America’s future fiscal problems, especially with regard to Social Security and Medicare, while promising “tax reform” that amounts to adding complexity to the system and more aggressively going after corporate foreign-earned income. Those of us looking for meaningful tax reform will be disappointed by the direction of this budget proposal.

On the spending side, the replacement of approximately $1.2 trillion dollars in sequester cuts with $960 billion in other cuts prevents meaningful efforts to cut government spending. These cuts include reductions in Pentagon spending, more Medicare price controls, and an assumed reduction in interest payments. Looking at the budget side-by-side with the CBO’s baseline for this year, spending as a percent of GDP is essentially unchanged (it actually goes up!).

 

After outlining proposed spending shifts, the budget also outlines its principles for tax reform. These principles include: ensuring the tax system stays at least as progressive as it is, eliminating tax breaks for the wealthy, decreasing complexity, and improving competitiveness of U.S. companies.

Unfortunately, if you look deeper into what the Senate Democrats are proposing, there is no real reform; this is simply the preservation and expansion of the problematic system we already have.

First, the Senate Democrats’ plan will eliminate or modify credits and deductions for the wealthiest Americans, while keeping or expanding them for everyone else:

“Tax reform should eliminate or modify tax breaks that disproportionately benefit the wealthiest Americans, aggressively address the tax gap and offshore tax abuse, and eliminate unfair and inefficient business tax loopholes.”

I am all for closing tax loopholes, but what the Democrats are proposing will add more complexity to the tax system by creating more rules and exceptions to credits and deductions. Real tax reform would get rid of all loopholes that both add complexity and favor certain activities over others. Eliminating the education tax credit for the top 1 percent while leaving or expanding it for everyone else may raise more money, but it doesn’t deal with its inherent complexity or the inefficiencies that make it bad tax policy.

Next, the Democrats want to tackle corporate taxation. Although they acknowledge the need for reform, especially with regard to loopholes, they are focused in the wrong place. Democrats are actually going in the opposite direction on corporate tax reform. Instead of tackling the problem head-on by lowering rates, simplifying the code, and moving to a territorial system, they will instead further cripple U.S. corporations by more aggressively pursuing foreign-earned income.

Real reform involves doing what most of the world has done by lowering our highest-in-the-world corporate income tax rate and moving to a territorial system. This will not only increase the competitiveness of U.S. corporations but would also increase economic growth and boost total government revenue.

Even more disheartening, there is no mention in the budget proposal that America already has the most progressive tax system in the world and its high tax burden on investment income. These issues need to be tackled if the government wants to establish a tax regime that fosters economic growth.

Essentially, the principle underlying the Democrats’ budget proposal is this: set a revenue goal and find a way to raise it with little regard to how it is raised. Although it mentions some things that are wrong with our tax system, it makes no real attempt to fix them; it instead makes America’s tax system more complex by adding more rules and exceptions for deductions and credits, and harms America’s competitiveness by taxing corporations even more just to reach its goal of $975 billion dollars.

Real tax reform should consider the fact that not all taxes or tax systems can be treated equally. Just because it raises revenue does not mean it is a good reform. Instead of increasing the tax burden and adding complexity, we should establish a system operates on sound tax policy and fosters economic growth.

March 19, 2013

Chris Sanchirico, a law professor and visiting scholar at the Tax Policy Center, continues to promote a view of capital income taxation that is contrary to what most economists think:

Long term capital gains are taxed only when the asset is sold and at roughly half the rate on wages and salaries. Dare to suggest that the rate on investment profits could be raised a bit—so that perhaps the rate on labor income could lowered—and you’re liable to be reprimanded for failing to understand something as plain as the nose on your face: To tax capital income is to tax the reward for saving and thus to discourage saving. Less saving means less investment and less investment means slower growth, fewer jobs, and lower wages.

Everyone knows that.

Everyone, that is, except the people who study the issue.

He references his Wharton policy brief in which he lays out a strange theory of saving behavior, and then for evidence points to this figure:

As he explains:

Figure 1 shows the sixty-year time pattern of the personal savings rate (the fraction of after-tax personal income not consumed) and the highest marginal effective tax rate on capital gains (accounting for deduction phase-outs, etc.). The graph reveals little discernible relationship between such tax rates and savings. Notice in particular that the personal savings rate appears to move with, not against, the capital gains rate until the mid 1980’s and from the mid-1990’s until the mid-2000’s.

But what Sanchirico has labeled as the maximum effective rate on capital gains is in fact the maximum statutory rate, as per Treasury data.  Here is the corrected figure:

The corrected figure gives no indication that lower capital gains rates led to lower savings.  In fact, there is an obvious decline in savings following the 1986 increase in the capital gains rate.  Certainly, many other factors are in play, and a proper analysis should take these into account.  Instead, Sanchirico gives us a hodgepodge of reasons to raise taxes on investors:

But even if one could support the claim that capital income taxes—considered in isolation—hinder growth, that would not be enough. Capital income taxes aren’t set in a vacuum. Lower capital income taxes mean higher labor income taxes or additional government borrowing. (Yes, capital income tax reductions could be offset with spending cuts. But that just begs the question of why such cuts aren’t instead being used to reduce labor income taxes or borrowing .) Thus, to make the case against capital income taxes, one has to argue not just that such taxes hinder growth, but that they hinder growth more than labor income taxes and government borrowing.

That’s not an easy task.

I wouldn’t say it is easy, but it does involve a balanced review of the academic literature, which I did here and here.  The preponderance of evidence points to corporate taxes being the most harmful to economic growth, followed by personal income taxes, consumption taxes, and property taxes.  Notice a pattern?  The corporate tax is the largest tax on capital income in most countries, while the personal income tax is the largest tax on labor although it also taxes capital.  Taxes on pure labor, like the payroll tax, do not have as big an impact as taxes on capital.  The studies typically are not able to measure the effects of shareholder taxes, which are also taxes on capital, precisely because these are minor or nonexistent taxes in most countries and the data is lacking.  Further, the studies indicate that taxes on income and profit are worse for growth than deficits.

This and other evidence, as well as standard theory, points to capital income taxes being bad for growth, and this is why it is the consensus view among economists.  For example, a recent survey by the Booth School at the University of Chicago asked 40 prominent economists for responses to this statement:

Despite relabeling concerns, taxing capital income at a permanently lower rate than labor income would result in higher average long-term prosperity, relative to an alternative that generated the same amount of tax revenue by permanently taxing capital and labor income at equal rates instead.

A fair amount of economists are uncertain (31 percent), because most economists are not tax experts.  However, 36 percent agree or strongly agree, while only 13 percent disagree or strongly disagree.  In fact, only one of the 40 economists strongly disagrees, and that is Emmanuel Saez, widely known for his research into income inequality and his calls for more redistribution of income through the tax code.  Interestingly, the Booth School also asked for responses to this question:

Although they do not always agree about the precise likely effects of different tax policies, another reason why economists often give disparate advice on tax policy is because they hold differing views about choices between raising average prosperity and redistributing income.

Not a single economist surveyed disagrees with that statement.

Follow William McBride on Twitter @EconoWill 

March 18, 2013

Today's Monday Map shows the top state income tax rate in each state. California has the highest top rate at 13.3%; at the other end are seven states with no income tax - Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming.

Click on the map to enlarge it.

View previous Monday Maps here.

March 18, 2013
By 

The Cyprus government announced Saturday that in conjunction with a European Union (EU) bailout package under consideration, depositors within the country would be forced to pay taxes on accounts held in Cypriot banks. Accounts under €100,000 would be subject to a 6.75 percent levy, while accounts in excess of €100,000 would be required to forego 9.9 percent. As expected, citizens of Cyprus depleted ATM machines over the weekend in anticipation of the tax, even though “funds to pay the levy were frozen in accounts immediately” and electronic transferring abilities were halted.

The proposal has been dubbed a “stability tax” and is expected to be levied on Tuesday when banks reopen after a Monday bank holiday. The Cyprus government has yet to approve the proposal despite the fact that the vote was scheduled for Sunday; reports suggested the vote may even be cancelled altogether. Effects of failure to come to a bailout agreement may not be limited to the small country. If the bailout-tax package fails to receive parliamentary approval, there is worry that “the country of just a million people [face] bankruptcy and potentially an exit from the euro—a development that could have huge ramifications in global financial markets.” The euro and other European stocks have already fallen sharply in response to the news.

The Huffington Post reported that this “marks the first time the 17 eurozone countries and the IMF have dipped into people’s savings to finance a bailout.” Such a bold move not only threatens confidence in the banking and financial system, it discourages people from saving. According to the Boston Herald, “Now investors are worried that savers will start taking their money out of banks across Europe—just like Cyprus residents did on a weekend ATM bank run.”

Despite the fact that the Cyprus financial sector holds significant capital from Russian investors, the deposit tax will also hit ordinary citizens. The vote’s delay is thought to be in response to these concerns—the President of Cyprus has reportedly been working on a plan that would limit the impact on smaller accounts. Whether or not such a measure reaches a parliamentary vote is unimportant—the EU leadership has made it clear that they are willing let depositors, not just bondholders, bear part of the burden of a financial bailout.

Follow Liz on Twitter @elizabeth_malm.

March 18, 2013
By 

Alaska policymakers have advanced legislation that would alter the corporate income tax brackets to shift tax burdens away from smaller corporations.  Proponents argue that the bill will foster job creation, estimating lost revenue at a minor $3.8 million annually, but the proposal is a missed opportunity for a true overhaul.

The state’s current corporate income tax rate structure is highly graduated, with ten separate brackets and a top rate of 9.4 percent. The current and proposed corporate income tax bracket structures are below:

Table: Alaska Corporate Income Tax Brackets and Rates

Rate

Current Bracket Structure

Proposed Bracket Structure

1.0%

> $0

> $0

2.0%

>$10k

> $25k

3.0%

>$20k

> $49k

4.0%

>$30k

> $74k

5.0%

>$40k

>$99k

6.0%

>$50k

> $124k

7.0%

>$60k

> $148k

8.0%

>$70k

> $173k

9.0%

>$80k

> $198k

9.4%

>$90k

> $222k

One piece of news coverage described the proposed legislation as bringing the current system, which hasn’t been changed since early 1980s, in line with current price levels: “accounting for inflation the top rate of 9.4 percent should not be reached until $222,000 today.” Senate Bill 7 would do just that.

Though raising exemption levels makes the state slightly more inviting to business, the proposed system simply lowers the tax liability on smaller businesses. It doesn’t remedy the unnecessarily complicated rate structure or address the incentive concerns associated with highly-graduated rate structures.

Progressivity in a corporate tax code is unlike progressivity in personal income taxes. The reason is that the burden of personal income taxes falls entirely on the person who files the tax return and forks over the money. That's not how corporate income taxes work. Instead, the corporation (which is just a stack of legal documents) passes on the burden of the payment to three groups of people -- customers, employees and investors -- and that pass-along occurs no matter what the size of the firm.

Rather than retaining the graduated-rate structure, the state could instead reduce the number of brackets in order to move to a more simple and neutral system. “Progressive” corporate income tax structures are misleading because not all of the tax burden is borne by the owners of capital.  Raising bracket levels is a good start, but a better option would be to flatten the structure—a move that would make Alaska even more business-friendly.

More on Alaska here.

Follow Liz on Twitter @elizabeth_malm.

March 18, 2013

The federal government is considering a bill to let states expand their sales tax authority to cross-border Internet transactions. A number of states have reached agreements with large Internet retailers, imposing tax on their sales in return for new facilities and jobs. Some states have imposed "Amazon taxes," measures to defy Supreme Court rulings that have either been struck down already or are in court. States are using every revenue dip to plead poverty and demand Internet tax collection authority, and recent budget proposals (MO, MD, VA) have included tax cuts premised on new revenue from Internet taxes if Congress acts by 2015 or 2018 or so.

Central to all of this is the assumption that sales taxes on Internet transactions will be a big revenue boost to the states. The study everyone cites on this is the 2009 study State and Local Government Sales Tax Revenue Losses from Electronic Commerce by Professor Fox at the University of Tennessee, which estimated that states would lose $11 billion in 2012 if they could not tax the Internet. Some critics question whether Fox correctly accounted for the fact that tax is already paid on much Internet commerce, but for the most part Fox's state-by-state numbers are treated as the best estimate of how much money states might get.

Not anymore. Since some states began taxing the Internet in 2012, we are learning how far off Fox's estimates are. Korey Clark at State Net crunched the numbers:

Last month [California's] Board of Equalization reported that in its first full quarter of collections, which included last year's busy holiday shopping season, it took in $96.4 million, a much-needed boost to the state's bottom line to be sure, but nowhere near the $457 million quarter implied by the Tennessee study. 
 
In New York, another affiliate-nexus state, online retailers had remitted $360 million in sales taxes on over $4 billion in taxable online sales as of February 2012, according to the state's Department of Taxation and Finance. While that figure represents about 90 percent of all taxable online sales in the state, it is also well below the $2.5 billion the Tennessee study predicted. 

"To the extent the estimates being used are overstating reality, and I think they are, it is not solving anyone's deficit problem," said Navigant Economics Managing Director and Principal Jeff Eisenach, who co-authored a study that pegged the national online sales tax potential at $3.9 billion, about a third of the Tennessee study's estimate. 

Fox, reached for comment by State Net, pointed to small retailers not paying tax, although it's hard to believe that's why the numbers are off by 75 to 80 percent. NCSL, another Internet sales tax booster, blamed Amazon terminating agreements with its affiliates, but as this did not occur in either California or New York it's not an explanation.

The real explanation is that Fox's numbers are probably overstated by four- or five-fold. Before states start writing revenue expectations into their budget plans, they ought to be aware of this fact.

March 18, 2013
By 

Last month, we analyzed the disappointing tax plan suggested by Minnesota Governor Mark Dayton (D). The proposal would have added a new top income tax bracket and sharply hiked cigarette taxes, and included a poorly-designed revamp of the state’s sales tax system, a sharply-criticized property tax rebate program, and a welcomed corporate income tax rate reduction.

In theory, promising sales tax reform includes base broadening and rate reduction. By including more transactions in the base, a state can reduce the overall rate without any negative revenue implications. Unfortunately, this reform is both politically difficult and tough to get right.

Governor Dayton’s first budget attempt would have expanded the sales tax to services, but many of these services would have been classified business inputs. Taxing business inputs is problematic because it causes tax pyramiding and leads to associated economic distortions.  Although expanding the sales tax to services is generally a good way to broaden the tax base, care has to be taken to ensure inputs are excluded. Further, service providers don’t often take too kindly to such a measure.

As expected, many service businesses within the state voiced opposition to the proposal. After the Minnesota Management and Budget Office announced that the state’s projected deficit wouldn’t be as high as has been originally predicted, the Governor was able to scrap the unpopular sales tax scheme. He also withdrew his suggestion to lower the corporate income tax rate.

The Governor’s revised plan includes the following (see page 15 of this document for specific tax-related revisions):

Governor Dayton removed all of the promising parts of his original plans—such as the corporate income tax reduction and the sales tax base expansion. The sales tax portion, though not without serious issues, could have been fixed by exempting business inputs. Instead of using the state’s more promising revenue projections to push for positive tax reform, the Governor instead proposed an easy-sell tax plan that does little to improve the business and tax climate within the state.

More on Minnesota here.

Follow Liz on twitter @elizabeth_malm.

March 15, 2013

Most economists will describe a good tax system as one with broad bases and low rates. Such a tax system is neutral, simple, and transparent by design, and is able to provide adequate and stable revenues from year to year. By not favoring certain industries, groups, or activities with targeted carve-outs, tax rates can be kept low for taxpayers of all types. Any tax reform measure that moves in this direction is on the right track. Rate cuts coupled with spending reductions make sense in states where there is a desire to reduce the tax burden and the scope of government. Less defensible are rate reductions that lose revenue without cutting spending, as that just causes budget problems.

That’s what Kansas is doing. Last year, Governor Sam Brownback (R) proposed a comprehensive tax reform plan that would have moved Kansas toward a simpler and more neutral tax code. His plan offered lower individual income tax rates and the closing of numerous carve-outs (such as most itemized deductions). A modified version of this plan eventually passed in the House. Less-costly compromise legislation in the form of a House-Senate Conference Committee was intended to replace the House bill, but that ultimately did not occur. According to the Wall Street Journal, “in an attempt to embarrass the Governor and House Republicans, the Senate passed a giant income tax cut that it believed the House would reject because of its price tag. The ploy backfired when the House approved the Senate plan.”  Other versions of the story argue (Tax Analysts, subscription required) that the Senate passed the tax cut bill under the assumption that the House would choose the compromise version, but the House instead sent the larger plan straight to the Governor’s desk for approval.

Regardless of why, the final tax plan kept the income tax cuts (dropping the top rate from 6.45 percent to 4.9 percent, effective this year) but dropped the income tax base broadening that would have made the budget impact manageable. Additionally, it problematically exempted certain non-wage business income from the income tax, increased the standard deduction for certain individual taxpayers, and halted the suspension of a sales tax rate drop that was set to occur mid-year. The fiscal note estimated that the plan would cost $231 million in 2013 and $803 million in 2014. Spending was not cut, so a hole developed in future years—a hole that cannot be closed by any reasonable expectation of economic growth, and one that threatens to discredit other tax reform efforts.

One year later, the Governor again proposed some base-broadening to close this budget hole. The bill would have further reduce income taxes rates over the next few years (reducing it down to 3.5 percent by 2017), phased out most itemized deductions, and frozen the sales tax rate at its current level. Once again, legislators stripped out the base broadening and kept the tax cuts. Some conservatives openly spoke of “starving the beast”—the notion that spending cuts will have to happen once the state is deprived of extra revenue. However, the spending cuts have not yet been identified, let alone implemented. According to the Houston Chronicle, even Governor Brownback “acknowledge[s] that last year's aggressive cuts created budget problems.”

The eventual goal for Gov. Brownback and for many legislators is to completely phase-out the individual income tax. I’d feel a lot more comfortable if there was a good game plan on how to do it—whether that involves spending cuts or replacement revenue. The Senate has rejected the Governor’s proposals for replacement revenue, preferring to just promise the current level of services and hoping that enough time passes before it all comes to a head. Kansas can do better than that: that’s what the federal government is doing, after all. Kansas also has to do it, as they have a balanced budget mandate. (The Kansas Policy Institute has offered some suggestions.)

Base-broadening, in addition to offsetting revenue losses from decreasing rates, eliminates distortionary tax preferences and can create a neutral and simple tax code. Kansas can provide a valuable lesson to all states—tax reform is a tough process that requires politically difficult decisions. I bet they’re up to the task. 

March 15, 2013

From the IRS:

Refunds totaling just over $917 million may be waiting for an estimated 984,400 taxpayers who did not file a federal income tax return for 2009, the Internal Revenue Service announced today. However, to collect the money, a return for 2009 must be filed with the IRS no later than Monday, April 15, 2013.

Individuals Who Did Not File a 2009 Return with a Potential Refund

State or District

Individuals

Median

Potential

Refund

Total

Potential Refunds* ($000)

Alabama

16,000

$565

$13,317

Alaska

5,000

$658

$6,107

Arizona

24,800

$509

$20,742

Arkansas

8,600

$560

$7,289

California

100,700

$518

$92,590

Colorado

17,900

$556

$16,860

Connecticut

12,100

$638

$13,031

Delaware

4,000

$561

$3,405

District of Columbia

4,200

$595

$4,151

Florida

62,700

$577

$60,746

Georgia

31,300

$538

$27,409

Hawaii

7,200

$599

$7,448

Idaho

3,800

$511

$2,984

Illinois

39,500

$626

$39,613

Indiana

20,300

$592

$17,547

Iowa

9,800

$581

$7,893

Kansas

9,900

$509

$7,774

Kentucky

11,300

$578

$9,552

Louisiana

18,700

$592

$17,843

Maine

3,700

$505

$2,771

Maryland

23,100

$564

$22,780

Massachusetts

23,300

$572

$22,756

Michigan

30,000

$600

$28,019

Minnesota

13,600

$528

$11,480

Mississippi

8,700

$529

$7,144

Missouri

18,700

$500

$14,674

Montana

3,100

$511

$2,529

Nebraska

4,600

$543

$3,808

Nevada

12,600

$559

$11,058

New Hampshire

4,200

$615

$3,891

New Jersey

31,600

$642

$33,192

New Mexico

7,100

$567

$6,450

New York

62,700

$620

$65,277

North Carolina

26,200

$503

$21,337

North Dakota

1,900

$524

$1,682

Ohio

32,100

$561

$26,714

Oklahoma

15,200

$573

$13,442

Oregon

15,200

$516

$12,253

Pennsylvania

38,200

$619

$34,505

Rhode Island

3,300

$612

$3,148

South Carolina

10,800

$530

$9,347

South Dakota

2,100

$546

$1,728

Tennessee

16,400

$550

$14,513

Texas

86,000

$578

$86,136

Utah

6,500

$503

$5,397

Vermont

1,700

$551

$1,397

Virginia

28,800

$559

$28,027

Washington

27,200

$644

$29,807

West Virginia

4,100

$598

$3,894

Wisconsin

11,500

$505

$9,430

Wyoming

2,400

$657

$2,539

Totals

984,400

$569

$917,426

* Excluding the Earned Income Tax Credit and other credits.

March 15, 2013

Illinois has agreed to settle, without admitting wrongdoing, charges by the Securities and Exchange Commission (SEC) that the state misrepresented the financial health of the public employee pension system and what the impact of chronic underfunding would be. The system is now at least $96.7 billion short of what it has promised retirees—barely 40 percent funded.

From the SEC order:

The statutory plan structurally underfunded the state’s pension obligations and backloaded the majority of pension contributions far into the future. This structure imposed significant stress on the pension systems and the state’s ability to meet its competing obligations – a condition that worsened over time.

The SEC’s order finds that Illinois misled investors about the effect of changes to its funding plan, particularly pension holidays enacted in 2005. Although the state disclosed the pension holidays and other legislative amendments to the plan, Illinois did not disclose the effect of those changes on the contribution schedule and its ability to meet its pension obligations. The state’s misleading disclosures resulted from various institutional failures.[…]

This enforcement action marks the second time that the SEC has charged a state with violating federal securities laws in their public pension disclosures. The SEC charged New Jersey in 2010 with misleading municipal bond investors about its underfunding of the state’s two largest pension plans. 

In related news, the Illinois Policy Institute’s project NoPensionBailout.com is seeking signatures to oppose any effort by the federal government to bail out the Illinois pension system. They include a map of which states would win and lose in such a massive bailout.

March 14, 2013

Ways and Means Committee Chairman Dave Camp released this week a new discussion draft aimed at simplifying the tax rules regarding pass-through businesses, i.e. those businesses that file under the individual income tax code, such as partnerships, S-corporations, and sole proprietors:

With about half of the private sector workforce employed by a small business – a total of nearly 60 million Americans –  every dollar spent on complying with an overly complex, burdensome and broken tax code is a dollar that cannot be used for investment, hiring and higher wages for American workers.  The discussion draft contains several core components that simplify tax compliance for small businesses and provide certainty with respect to the ability of small businesses to recover certain costs immediately.  These include widely supported reforms such as permanent section 179 expensing and expansion of the “cash accounting” method, amongst other provisions.  The discussion draft also includes two separate options designed to achieve greater uniformity between S corporations and partnerships – one that revises current rules and a second that replaces current tax rules with a new unified pass-through regime.

Compliance with the income tax is a serious problem, and especially difficult for small businesses.  Dave Camp deserves much credit for shining a light on this problem, which disproportionately affects those taxpayers least likely to have much of a voice in Washington, i.e. entrepreneurs and other upstart businesses.  Most of us do not run businesses or file business tax returns, so it would surprise most Americans to know the ridiculous time-wasting hurdles the tax code forces upon business.  Strangest of all is the requirement that legitimate business expenses be written off over a period of years or even decades.  This is what passes for “normal” cost recovery, only because we have been stuck with it for so long.  Various reforms over the years have exempted certain businesses from these rules, such as section 179 that exempts small businesses.  But it begs the question: why do we continue to mistreat medium and large businesses this way?

For a taste of just how silly the tax code is in this regard, here is Forbes writer Tony Nitti on section 263A:

There’s nary a tax advisor alive who wouldn’t like to see Section 263A – which requires a producer or reseller to capitalize a portion of their G&A costs into their ending inventory – struck from the Code.  The regulations are exceedingly complicated and impractical to implement, and rarely will a client be willing to pay an advisor the amount it would actually cost the advisor to compute the capitalized costs correctly.

While Camp’s proposal doesn’t go as far as to remove Section 263A from the law, it does greatly expand the universe of taxpayers who will be exempt from the provision.

Under current law, resellers with less than $10,000,000 of average gross receipts are exempt from Section 263A; producers, however, are subject to the capitalization requirement regardless of their level of receipts. The proposed legislation would expand the $10,000,000 exclusion to cover producers as well, relieving a great many small businesses from the need to undergo this time-intensive computation.

Again, why do we do this to any business?  Dave Camp rightly wants to simplify the code and treat businesses more equally, but the first step in that process should be to abandon the distinction between small and big business, which is never well defined anyway.  Ultimately, all businesses should be taxed under the same simple rules.  The biggest impediment to that in the code is the treatment of cost recovery, which depends not only on the size of the business, but the industry.  It may be hard to believe, but the same machine used by the transportation industry is treated differently for tax purposes when used by the retail industry.  The tax code contains some 4000 different classifications of business assets, depending on how they are used and by whom.  This is ridiculous.

The end result is that businesses are reluctant to invest, since they are allowed to deduct only a portion of their investments immediately and the rest over a period of years or decades, depending on rules that never made sense.

Let’s hope the next discussion draft acknowledges that a) all American businesses should operate under the same rules, including tax rules, and b) if we intend to tax business income it should be defined as simply as possible and neutrally for all businesses.  The logical way to get there is to first let all businesses use cash accounting and to deduct immediately all investment expenses, i.e. the same way labor expenses are treated now.  Such a move would not only make life simpler for millions of small and large businesses, but it would boost investment dramatically, leading to more productivity, higher wages, and more jobs.

Follow William McBride on Twitter @EconoWill

March 14, 2013

Louisiana Gov. Bobby Jindal (R) today released details about his tax reform proposal, which we first discussed in January here. We’ve been communicating extensively with the Governor’s staff in recent months about ideas and the pros and cons of various possibilities, but it should be said that the Governor and his staff ultimately decided what mix of policies they considered best for Louisiana (as it should be). As much as I wish sometimes that I had the power to rewrite state tax systems, we stick to the role we’re best at: describing what policies can best create a simple, sensible tax system in line with good public finance principles that are supported by research and evidence.

The plan, as a whole, is a major step toward creating a pro-growth tax system that can work for Louisiana. Corporate and individual income taxes are generally considered the most destructive taxes to economic growth, and both have a great deal of complexity and compliance costs associated with them. I’m no fan of the cigarette tax increase portion and despite being a lawyer I’m all for lawyers having to pay sales tax, but overall it’s a plan for a simple, stable, and modern tax system.

The highlights:

  • Revenue neutral. Designed to raise as much revenue as the state does now, but through taxes that are less harmful to job creation and economic growth.
  • Eliminates the state income tax. Despite a 6% rate on income over $50,000, Louisiana's state and local governments get just 14 percent of their revenue from the tax—the third lowest reliance among the states with an income tax. It’s a change that Louisiana can achieve.
  • Eliminates the corporate income tax and the franchise tax. The state gets only about 2 percent of its revenue from the corporate income tax, so again not much reliance there. Franchise taxes are taxes on investment and capital accumulation and are widely recognized as destructive to economic growth.
  • Broadens the sales tax base and raises the state tax rate from 4.0 percent to 5.88 percent. (Including local sales tax; for example, the New Orleans sales tax will be about 10.9 percent, up from the current 9 percent.) The sales tax base would be expanded to many personal and professional services. Among the items remaining exempt are food for home consumption, utilities, prescription drugs, fuel, manufacturing machinery and equipment, farm and agricultural inputs, leases and rentals, trade-in value for new vehicle purchases, historical structure rehabilitation, non-profit organizations, government purchases, healthcare, education, construction, real estate, financial services, legal services, oil and gas services, funerals, and advertising. Additionally, any service providers with revenue under $10,000 per year are exempt.
  • The cigarette tax, currently 40 cents per pack, would rise to $1.41 per pack (matching the Texas rate).
  • Low-income families and retirees will receive a rebate to offset some of the impact of the higher sales tax. (Note: an earlier version of this post mentioned a $60,000 cut off - this is for retirees only).
  • State and local sales tax bases will be made uniform, and all collection and administration across the state will be done by a new state entity. Retailers will thus face a streamlined sales tax payment process.
  • An independent tax tribunal would be set up. Presently, taxpayers challenging the Department of Revenue must file lawsuits against the state in trial court. Instead, there will be a single Tax Court to hear all tax-related disputes.
  • Maintains many targeted economic development programs. Louisiana spends hundreds of millions of tax dollars on things like film and television production incentives, which are poor policy.
  • The plan would take effect January 1, 2014.

Jindal summarized his plan as six main points:

First, eliminating income taxes will give more control to the taxpayer. Taxing what people spend instead of what they earn gives taxpayers more control over their own money.

Second, eliminating income taxes will make Louisiana the best place to start a business. This is the best way to grow our economy and create good-paying jobs throughout the state.

Third, in our plan, everyone will pay their fair share, but no more than that.

Fourth, our plan will close special interest loopholes. Powerful special interest groups will no longer be able to rig the system. For far too long average Louisiana citizens have felt the state’s tax code works for the rich and powerful, but not for them. By closing special interest loopholes, we level the playing field for everyone.

Fifth, we are going to protect food, prescription drugs and utilities from increased sales taxes.

Sixth, and finally, by switching to a state sales tax base, there will be more stability in funding for government services. Stability breeds confidence. Switching to a more stable tax base can smooth out many of the rough edges and stabilize state budgeting, and stability in government attracts businesses and creates good jobs.

The plan is particularly responsive to key possible objections. One objection would naturally be from the services industry, which would want to keep its existing sales tax carveouts. I’m hopeful that the elimination of the income, corporate, and franchise taxes makes it a worthwhile tradeoff, but one never knows. In any event, it’s just not fair that retailers have to collect tax when they sell goods, while service providers don’t. This plan corrects much (but not all) of that inequity.

Another objection would be on equity grounds—that relying more on the sales tax and less on the income tax is a regressive move. The Governor’s proposed rebate program would remove the negative impact to low-income individuals and households. The sales tax base expansion applies mostly to services purchased by higher-income households, not low-income households. Finally, it must be said that Louisiana’s tax system ought to focus on creating the best environment for jobs and opportunity for everyone in the state, because what the distributional tables say doesn’t really matter if the economy isn’t growing and people aren’t working.

A final objection I hear sometimes is that states need a balance of revenue sources—I sometimes hear this described as the “three-legged stool.” This is the weakest argument because there is no evidence that having three types of taxes instead of two or one or four leads to revenue stability. In fact, California has the fifth most volatile revenue system despite having every major tax, and the state with the most stable revenue (South Dakota) has only a broadened sales tax (no individual or corporate income tax). What matters is how your tax system is designed, not how many taxes you have. California has a lot of taxes but they’re all badly structured with high rates and narrow bases. Louisiana aims to mimic South Dakota, with a better-structured and stable sales tax that grows with the economy.

We previously estimated that a plan roughly in line with what Jindal has proposed would have made Louisiana 4th best on our 2013 State Business Tax Climate Index, instead of 32nd. (Now that we have the details, we’ll put out an update soon.) This would primarily be because of the elimination of significant complexity, compliance burdens, and tax obstacles to long-term economic growth.

My colleague Scott Drenkard discussed the plan earlier on our podcast program here.

March 14, 2013

I’ve never filled out an Iowa income tax form but it looks like one of the harder state tax returns. Iowa allows you to deduct what you pay in federal income tax, which is nice but is that much more calculation work (and probably drives up tax rates). There are lines for the lump-sum tax, the minimum tax, the K-12 textbook credit, the school district surtax, the motor fuel tax credit, and the earned income tax credit. I’m sure each one of these has their explanations of necessity but together it sounds like a lot of paperwork, record-keeping, and Tax Filing Day frustration.

Finally, the Iowa tax table is nine tax brackets, the first seven of which are below $30,000. Of course, the state provides a booklet to ease tax calculation but it still seems needlessly complicated.

Hence, I’m impressed by a bill passed yesterday (House File 478) by the Iowa House which would offer an alternative to all Iowa taxpayers: a 4.5 percent tax on all income above about $15,000, which no further deductions or exemptions. It’s not perfect: our friend Joe Kristan pointed out that a credit for taxes paid to another state and a deduction for federal interest are probably constitutionally required, and offsetting deductions to certain kinds of income (allowing gambling losses if you tax gambling winnings) is good policy. But as Joe said, the bill “is a welcome step towards improving Iowa’s income tax.”

The Legislative Services Agency estimates that taxpayers who earn between $30,000 and $40,000 would see the most benefit, although 492,000 taxpayers would see a reduction. Iowa’s top income tax rate of 8.98 percent is among the highest in the country and higher than all neighboring states (see table below).

The bill reportedly will have a tough time in the Senate.

Top State Income Tax Rates, 2013

State

Tax Rate

Applicable Income Bracket (Single Filer)

Applicable Income Bracket (Joint Filer)

Rank

California (top rate)

13.3%

>$1,000,000

>$1,000,000

1

New York City (top rate*)

12.696%

>$1,000,000

>$2,000,000

 

California (second rate)

12.3%

>$500,000

N/A

 

California (third rate)

11.3%

>$300,000

>$600,000

 

Hawaii (top rate)

11.0%

>$200,000

>$400,000

2

New York City (second rate*)

10.726%

>$500,000

>$500,000

 

New York City (third rate*)

10.498%

>$200,000

>$300,000

 

California (fourth rate)

10.3%

>$250,000

>$500,000

 

New York City (fourth rate*)

10.298%

>$75,000

>$150,000

 

New York City (fifth rate*)

10.098%

>$50,000

>$90,000

 

New York City (sixth rate*)

10.041%

>$25,000

>$45,000

 

Hawaii (second rate)

10.0%

>$175,000

>$350,000

 

New York City (seventh rate*)

9.984%

>$20,000

>$40,000

 

Oregon (top rate)

9.9%

>$125,000

>$250,000

3

New York City (eighth rate*)

9.434%

>$13,000

>$26,000

 

California (fifth rate)

9.3%

>$48,942

>$97,884

 

Hawaii (third rate)

9.0%

>$150,000

>$300,000

 

Oregon (second rate)

9.0%

>$8,150

>$16,300

 

Iowa (top rate)

8.98%

>$66,105

>$66,105

4

New Jersey (top rate)

8.97%

>$500,000

>$500,000

5

 

*-New York refers to non-New York City tax rates. New York City refers to the combined state and city income taxes. New York and New York City tax brackets are 2012 figures, as 2013 inflation-adjusted figures have not yet been released. New York also has a benefit recapture provision, meaning that higher tax rates apply to all income of some taxpayers, not just income above the bracket threshold.

Tax Topic 
March 14, 2013

There’s been lots of coverage of the dueling House and Senate budgets that were released this week and how they represent such contrasting views of the proper size and role of the federal government, particularly in regard to taxes.  House Republicans propose to keep total taxes as a share of GDP about where they are projected to be under current law (19 percent of GDP), but lower the top rate to 25 percent and broaden the base by closing “loopholes”.  Senate Democrats propose to just broaden the base, raising taxes by $1 trillion or more over 10 years, by closing “loopholes” benefitting the rich and corporations.  Neither budget is very specific beyond that, but these are very clear statements of philosophy, with Democrats arguing their budget is more fair, and Republicans arguing their budget is more conducive to economic growth.

But New York Times reporter Eduardo Porter doubts the premise that lower taxes grow the economy:

Problem is, there is little evidence that tax cutting has worked as advertised.

Thomas L. Hungerford, an economist with the Congressional Research Service, got into trouble with Republicans last year when he published a study suggesting that the sharp drop in top tax rates since 1945 did little to lift economic growth but probably did contribute to soaring income inequality.

And there’s no clear evidence that lower tax burdens have helped the United States grow faster than other advanced industrial nations with higher tax rates and much heavier tax burdens. Economic growth per person in the United States was a little faster than in France or Australia over the last 40 years. But it was a little slower than in Austria, Germany and the Netherlands, according to data from the Organization for Economic Cooperation and Development, a research organization for the world’s richest countries.

While high taxes do have an effect on variables that affect growth, many other factors are much more significant and overshadow whatever taxes do.

First, we debunked the CRS study on numerous occasions. There is no peer-reviewed academic journal in the world that would accept such a sloppy analysis.

Second, casual correlations can be dangerously misleading when it comes to the complexity of economic growth.  This is why I reviewed all the major studies on the subject from the last 30 years, and 90 percent of them indicate high taxes hurt economic growth, particularly taxes on profit and income. 

Third, the studies show taxes on profit and income have bigger effects on the economy than government spending.  Yes, these studies find other factors matter as well, such as inflation and demographics, but these factors do not “overshadow whatever taxes do.”

This is a very misleading article because it has the patina of science, quoting Nobel laureates and expert economists:

 “It’s hard to say for sure what our economic trajectory would have looked like with higher taxes,” said Alan Auerbach, an expert on the economics of taxation at the University of California, Berkeley. “Some of the disappointment that our low taxes haven’t had a more obvious impact comes from overblown claims of tax cut supporters.”

Yes, of course it is impossible to predict the future with 100 percent certainty.  But the preponderance of evidence gives us a clear sense of the most likely effects of taxes.  Ignoring and obscuring this evidence is the opposite of science. 

Such reporting makes it even less likely there will ever be broad agreement on the federal budget.

Follow William McBride on Twitter @EconoWill

Tax Topic 
March 14, 2013

I often note that people move for all sorts of reasons, including weather, housing prices, job and education opportunities, and family. One of those reasons – and one that legislators can do something about immediately – is tax policy. There are people out there who say that no one moves for tax policy and people who say that every move is because of tax policy, but the real answer is in the middle.

States certainly understand that taxes induce people to move, as their auditors are cracking down on the practice. A Bloomberg News article today reports the following:

  • Massachusetts tax authorities are conducting “domicile audits,” seeing whether taxpayers live where they say they live. A Boston litigator has nine cases in litigation and five in the audit process, which he compared to an “exit tax.” Audits in the state have doubled to 45,887 in 2012, totaling $79 million.
  • Minnesota’s Governor has proposed requiring tax returns from those who live in the state just 60 days out of the year, down from 183 days.
  • An asset manager working for Wells Fargo says families are especially considering moving out of New York and California due to high income tax rates.
  • Hedge fund manager John Paulson of New York is considering moving to Puerto Rico for tax reasons.
  • Revenue departments are using IRS databases, E-Z pass records, credit reports, and automated programs to hunt down former residents.

Want to see where people have moved over time? Visit our migration data lookup tool.

March 14, 2013

On Tuesday, the Missouri Senate approved SB 26 by a 23-11 vote. The bill would phase in reductions of the state’s income and corporate taxes while raising the sales tax by half a point:

Income Bracket

Current Tax System (2013)

Proposed (2014)

Proposed (2015)

Proposed (2016)

Proposed (2017)

Proposed (2018)

>$0

1.5%

1.5%

1.5%

1.5%

1.5%

1.5%

>$1,000

2.0%

2.0%

2.0%

2.0%

2.0%

2.0%

>$2,000

2.5%

2.5%

2.5%

2.5%

2.5%

2.5%

>$3,000

3.0%

3.0%

3.0%

3.0%

3.0%

3.0%

>$4,000

3.5%

3.5%

3.5%

3.5%

3.5%

3.5%

>$5,000

4.0%

4.0%

4.0%

4.0%

4.0%

4.0%

>$6,000

4.5%

4.5%

4.5%

4.5%

4.5%

4.5%

>$7,000

5.0%

5.0%

5.0%

5.0%

5.0%

5.0%

>$8,000

5.5%

5.5%

5.5%

5.5%

See below

See below

Top Bracket

6.0%
>$9,000

5.85%

>$8,700

5.7%

>$8,400

5.55%

>$8,100

5.4%

>$7,900

5.25%

>$7,600

 

Income Bracket

Current Tax System (2013)

Proposed (2014)

Proposed (2015)

Proposed (2016)

Proposed (2017)

Proposed (2018)

Sales Tax Rate

4.225%

4.325%

4.425%

4.525%

4.625%

4.725%

Corporate Income Tax Rate

6.25%

6.1%

5.95%

5.8%

5.65%

5.5%

 

If the Marketplace Fairness Act or similar legislation becomes federal law, the top income tax rate and the corporate tax rate will both fall a further 0.25 percentage points.

Missouri’s rather absurd income tax brackets – stepping up in $1,000 increments to top out at $9,000 – are a relic of 1931, when $9,000 was a lot of money (equivalent to around $136,000 today). Missouri might be better off junking everything but that top rate, since most taxpayers are probably in the top bracket anyway. The bill instead creates a new 50 percent income tax deduction for business income, a problematic trend started in neighboring Kansas.

The state’s sales tax rate is currently 4.225 percent, comprised of 3 percent for the general fund, 1 percent for education, 0.125 percent for conservation, and 0.1 percent for parks and soils. Local sales taxes average an additional 3.23 percent for a combined average of 7.46 percent. The 8.925 percent combined sales tax rate in St. Louis would rise to 9.425 percent in 2018 under this bill.

The legislation also centralizes sales tax administration, collection, enforcement, and operation with the state – a key reform for Missouri, where many of those functions currently rest with local sales tax authorities. The state’s list of local sales tax rates runs 53 pages, so there’s a lot of them.

Altogether, the Joint Legislative Research Committee estimates the bill would reduce revenue by about $477 million annually when fully implemented. Governor Jay Nixon (D) has criticized the bill but has not yet threatened a veto.

March 13, 2013

Rep. Luke Messer’s bill, H.R. 668, that would require the president’s annual budget to include the projected cost of deficits per taxpayer passed the house last week. The bill would require a dollar cost per taxpayer, using individuals who file tax returns as the measure. For fun, we’ll look at the cost per person (every man, woman and child), per tax return, and per taxable tax return.

Using historical data and the most recent CBO Budget and Economic Outlook, we’ll take a look what that number would look like in future years, the additional amount Americans would have had to pay in taxes to cover the deficit at current spending levels, and how the deficit has changed over time.

First, a little history: as a percentage of GDP, the graph below shows that with the exception of World War I and II and the Great Depression, the United States’ deficit hovered around 0%, switching between surplus and deficit, until about 1970. From 1971 on, the U.S. experienced an average deficit as a percentage of GDP of 3.1%. Since 2001, our last year of surplus, our average deficit as a percentage of GDP has been 4.7%, with an average of 8.7% over the last four years.

In 2009, the United States’ deficit was 10.1% of GDP. In other words, this means that every American would have had to pay an additional 10.1% of their salary to cover the cost of government - the highest percentage of the average salary in America since 1945 when the deficit was 21.5% of GDP. Over the CBO’s current budget window (2013-2023), we see that ratio drop down to 2.4% in 2017 before it increases each year from 2018 to 2022.

In dollar terms – which the bill uses – the picture looks similar. From 1998 to 2001, the federal government experienced four years of surplus, but from 2002 through the end of the 2023, every year is projected to be in the red (as shown in the Deficit/Surplus Per Person graph below).

When we break this down by cost per person, the greatest the deficit reached was $4,605 per person in 2009. Over the CBO’s current budget window, the deficit would be cut to $1,338 per person in 2015 before increases every year until it reaches $2,864 per person in 2023. 

This means to cover the deficit for 2013, every person counted (projected) in the census would need to pay an additional $2,670 a year. If we only consider those who are liable to pay taxes (i.e. exclude nonpayers), every person with a taxable income tax return would need to pay an addition $8,748.03 in federal income taxes to cover the deficit.

By 2023, the tax increase needed to cover the projected levels of spending is projected as $2,864.37 per person, $5,904.43 per tax return, or $9112.17 per taxable tax return. All three comparisons, over the budget window, are shown in the graph below.

Notes: Population projections taken from U.S. Census. Budget and GDP projections taken from CBO and the Office of Budget and Management. Tax Return data taken from IRS. Methodology on tax returns and taxable tax return projections: For total tax return, the projections are a linear extrapolation based available data of total tax returns (1995-2010). For taxable tax return projection, the percent of taxable tax returns compared to total tax returns was taken from 2003 to 2010. The year 2003 is chosen as start year to reflect tax changes beginning in 2003, the majority of which remain in place through the present day. 

Tax Topic 
March 12, 2013

Every speech I give, every panel I’m on, every trends piece I write nowadays includes my prediction that federal aid to the states will drop in future decades. Many people—including many state legislators—are astonished to learn that states rely on federal aid for about one-third of their budgets. (See state-by-state here.) As the feds start looking around for deficit reduction opportunities, I see aid to the states as easily on the chopping block. I try not to run from my past failed predictions, so we’ll all see if I’m right or wrong in a few years.

However, this remains a prediction about the future, as evidenced by new information put out (PDF) by Federal Funds Information for States (FFIS) and forwarded by the National Conference of State Legislatures (NCSL).

FFIS estimates that pre-sequester, federal aid to states in Fiscal Year 2013 would have totaled $607.2 billion, a 2.5 percent increase over the $592.3 billion in 2012. The March sequester “cuts,” fully in effect, would pare that back to $601.2 billion, a 1.5 percent increase over 2012. So it’s not so much “cuts” as a less generous increase.*

Table: Federal Aid to States

Year

Amount

Change from 2012

FY 2012 Actual

$592,306,548,000

 

FY 2013 Estimated (pre-sequester)

$607,252,257,000

+2.5%

FY 2013 Estimated (post-sequester)

$601,166,608,000

+1.5%

Note: Includes both March 1 sequester (reductions due to the “Supercommittee’s” failure to achieve $1.2 trillion in deficit reduction) and the March 27 sequester (reductions due to Congress exceeding FY 2013 spending caps).

Source: FFIS; NCSL.

Apparently NCSL’s executive director didn’t get the memo, as he penned an op-ed today decrying the sequester cuts and calling for higher state taxes “to help ease the burden.” I'm not sure whose burden he's talking about.

*Note: Nine states actually will see a drop in federal aid due to the sequester, primarily because their increase over 2012 had been planned to be so low and the sequester pushes it negative: Illinois, Kentucky, Minnesota, New Mexico, North Dakota, South Carolina, South Dakota, Washington, and Wyoming, as well as the District of Columbia, Guam, the Northern Mariana Islands, and the Virgin Islands. Six states were seeing a cut in federal funds anyway: Connecticut, Indiana, Louisiana, Maine, Massachusetts, and Missouri, as well as American Samoa.

March 12, 2013
By 

While Nevada legislators consider mimicking the Texas margin tax, no less than 99 bills are under consideration in Texas to modify or repeal the tax. Most relate to credits, exemptions, and other carve-outs, but others permanently increase the exemption level or alter the constitutional requirements for raising rates. Five bills call for the phase-out or direct repeal of the tax. Because of the way tax overhaul’s design shifted the burden of the tax from certain entities to others, the tax has mixed reviews among the business community. A few companies have attempted to challenge the constitutionality of the tax, and there’s even a petition for its repeal.

We’ve criticized this particular Texas tax a few times (here and here), despite the state’s merits in other areas of taxation. There are two compelling economic reasons why this is a poorly-designed tax. First, it’s complicated to calculate and drains economic resources due to high compliance and administrative costs. Second, it isn’t neutral, treating certain business types, industries, and operations differently. Both of these lead to economic distortions that would not be present in the absence of such a tax.

Overly complicated tax calculations create compliance and administrative costs that are a loss to society. The calculation of a business’s margin tax liability is far from simple. Businesses subject to the tax must choose one of three bases. The definitions used in determining these tax bases are statutorily defined and different from definitions set by the federal government. Since calculations are so complicated, compliance and administrative costs are high. In a 2010 interim report of the House Committee on Ways and Means, one taxpayer, represented by the National Federation of Independent Business (NFIB), reported an increase from $400 to $2,500 in compliance costs after the margin tax was implemented. Economic resources wasted on complying with a complicated tax could be utilized more efficiently elsewhere in the economy. Further, when a tax treats different activities differently, it implicitly favors certain practices and operations over others. This generates economic distortions that would not be present in the absence of the tax. The less economic decisions that are created due to a tax, the better.

Taxes should be neutral, and the margin tax favors certain industries, practices, and business types by design. The margin tax isn’t neutral for a variety of reasons. First of all, there are two separate rates—0.5 percent for businesses “primarily engaged in wholesale or retail trade” and 1.0 percent for everyone else. Businesses with sufficiently low revenues have another separate rate. Second, it isn’t horizontally equitable, meaning that businesses that are similarly situated don’t face the same liability. For example, as described by the Texas Taxpayers and Research Association (TTARA):

[T]he retail outlet of a manufacturer may be taxed at one percent because the combined group of companies may be classified as a manufacturer. In contrast, an independently-owned retail store is classified as a retailer and pays a half percent tax rate…A company that hires its own employees may deduct salaries as compensation; however, a company engaged in the same line of business that chooses to use independent contractors to conduct its operations may not. Companies in the business of renting equipment may not deduct the cost of their equipment as cost of goods sold, while companies that sell that same equipment may. As a retailer, the company selling equipment will also qualify for a lower tax rate, while the rental company will not because they are considered to be engaged in providing services.            

(Note that these observations are based on the law as of October 2011.) The tax treats businesses differently based on the industry in which they operate, how they are organized, and on minute operating and organizational details. Again, this implicitly favors certain activities over others—something the tax code shouldn’t do.

Back to Square One. Unfortunately, Texas is right back where it began. Last month, the school financing system was again deemed unconstitutional by the same District Judge that ruled on the system in 2005. (This had been the impetus for enacting the tax in the first place.) The decision will likely be appealed to the Texas Supreme Court, which could result in more than a year of additional litigation time. In the meantime, perhaps this will provide the needed impetus for Texas to find a more efficient way to fund state operations, rather than relying on a tax that is complicated and confusing, generates wasteful costs, and creates economic distortions. 

March 11, 2013

Tax Foundation Vice President for Legal and State Projects Joseph Henchman returned to C-SPAN's Washington Journal on Sunday to discuss the states with the highest and lowest tax burdens.

March 08, 2013
By 

In recognition of International Women’s Day, we would like to honor the contributions that women have made to the advancement of economics and taxation theory and policy. Although many women have facilitated progress in our understanding of economics and taxation, as the first (and only) woman to receive the Nobel Prize in Economics, Elinor Ostrom’s contributions and work provides an excellent example of the critical role women have played in the field. Her work on governance issues continues to be highly relevant as these are addressed in national, state, and local debates.

Dr. Ostrom’s work on common-pool resource problems and her models on public goods and public choice have provided insight for a wide variety of topics including budget appropriations and taxation. For example, budget allocation in academic research has often been described as a budgetary commons. A discrepancy between the perceived and actual costs of a budgetary outlay occurs because participants internalize the full benefit of the outlay, but costs are dispersed through taxation to the whole public. Thus, some claim that a tragedy of a commons results. Ostrom’s work focusing on natural common-pool resources cautioned against this oversimplification because it often results in inappropriate policy enactment. Therefore, she described a variety of factors that distinguish the complex and multiple problems or dilemmas facing common-pool issues like taxation and appropriations.

Finally, her studies of self-governing common resource pools find that characteristics that foster their success include a long time horizon, a lower discount rate, a stable membership, accurate information regarding the resource’s condition, correct projections of future benefits and cost, and consideration of local conditions or norms.

Ostrom’s contributions to our understanding of common-pool resources will continue to facilitate policy making to ensure that appropriate policy prescriptions are enacted by policy makers regarding inlays and outlays of governing bodies and has laid the foundation for many more women economists to influence and change how we perceive economic problems in the future.

At the Tax Foundation, we have been grateful for the contributions of many pioneering women in the fields of economics and tax policy from under our own roof. In the early 1940s, we were joined by several women, including Jo McBay, senior researcher, Phoebe C. Main, junior researcher, and Mary Fernholz, statistician. Since that time, we have strived to ensure that women are not only adequately represented in our field, but also respected in our field. From Elsie Watters’ unparalleled study of unemployment insurance systems in the 1980s to Elizabeth Malm’s current stewardship of our Annual State-Local Tax Burden Rankings and her news-making work debunking bad state tax policy proposals, women have made an indelible mark on our work.

We are pleased on this day, and every day, to honor these path-blazing, brilliant women who continue to demonstrate to the world that, to paraphrase President Obama’s proclamation, no wall or ceiling will keep our daughters, our sisters, our mothers from their dreams.

March 08, 2013

We're honored this week to have Nina Olson, head of the IRS' Taxpayer Advocate Service, back as a guest on the Tax Policy Podcast. Ms. Olson has been generous enough to have been our guest on multiple occasions, and we greatly appreciate her taking time to talk with us again about her most recent report to Congress. As in previous years, she scores tax complexity as the number one problem affecting taxpayers at the federal level.

The existing tax code makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns, and leaving many unaware how their taxes are computed and even what rate of tax they pay. It enables sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud; and by creating an impression that many taxpayers are not compliant, it undermines trust in the system and reduces the incentive that honest taxpayers feel to comply.

Her report takes on many other problems, however, including identity theft, agency funding, and return preparer fraud. Listen in to hear which part of the tax code she considers "an abomination" that should be abolished. LISTEN HERE!

March 07, 2013

The IRS just released preliminary data on tax year 2011, showing total returns filed increased to 145.6 million from 142.9 million in 2010.  Taxable returns, those who paid taxes, increased to 91.8 million from 84.5 million in 2010.  That means in 2011 about 63.1 percent of tax filers owed federal income tax, or oppositely, 36.9 percent were nonpayers.

While these numbers are returning to historic norms, as the economy recovers, taxable returns continue to be about where they were in the late 1980s and 1990s (see the chart below).  This is mainly because of successive expansions of refundable tax credits, such as the earned income tax credit and child credit, which have knocked millions from the tax rolls.

The fact that the number of people actually paying federal income tax has been flat for about 20 years, while federal spending has skyrocketed, explains much of our current fiscal predicament.

Follow William McBride on Twitter @EconoWill 

March 06, 2013

President Obama and others have pointed to carried interest as one specific “loophole” that should be eliminated, with Lynn Forester de Rothschild calling it a “costly and unjust perk for financiers.”  Steve Judge, writing in the New York Times, disagrees:  

Carried interest, therefore, is the profits share on the sale of a capital asset and not “ordinary income” as some would have it treated. In other words, it is a capital gain within a partnership and is rightfully taxed at the long-term capital gains rate — provided that the asset, or company, is held for more than one year.

The aristocratic argument presented by Ms. de Rothschild and others that capital gains treatment should only be available to those with money to invest would advance a policy that puts a higher value on financial contributions than vision, hard work and other forms of “sweat equity.”

The underlying principle is no different than two friends who partner together to purchase a restaurant. One might bring capital and the other brings expertise. The restaurant could be in disrepair or a great concept that needs additional capital to expand. The chef identifies the restaurant to buy and possesses the skills to manage the restaurant and add value to the enterprise over time. The friend has the capital to invest, but doesn’t possess the operational or investment skills to generate a return.

When they sell the restaurant years later, both partners receive capital gains treatment on their long-term investment. A private equity partnership works in the same way. This is Partnership Law 101.

The capital gains rate exists to provide incentive for investment partnerships to take risks, invest hundreds of billions of dollars of capital into new and existing businesses and contribute operational expertise to improve these businesses over time.

The Joint Committee on Taxation, a nonpartisan committee of Congress, has pegged the additional revenue from carried interest at just $16.85 billion over 10 years. The joint committee estimate even includes the controversial enterprise value provision, which experts believe constitutes two-thirds of the total revenue assumption.

Permanent tax increases on private equity, venture capital and real estate in exchange for a short-term spending patch does not come close to solving our country’s fiscal situation. Policy makers should reject calls to eliminate this incentive for long-term economic growth in exchange for 3.1 hours of federal government operations.

Follow William McBride on Twitter @EconoWill

March 05, 2013

This week's map shows the state sales tax rate, plus the average local rate, for each state in the U.S, as of the beginning of this year.  Tennessee has the highest average combined rate at 9.44%; at the other end are states with no sales tax: Delaware, Montana, New Hampshire, and Oregon.

Click on the map to enlarge it.

View previous maps here.

March 05, 2013

The trillion dollars in tax increases from the Affordable Care Act have the potential to hinder small business and investment, and further set back a struggling economy.

The Joint Committee on Taxation recently released a 96 page report on the tax provisions associated with Affordable Care Act. The report describes the 21 tax increases included in Obamacare, totaling $1.058 trillion – a steep increase from initial assessment. The summer 2012 estimate is nearly twice the $569 billion estimate produced at the time of the passage of the law in March 2010.

Last summer, the House Ways and Means Committee detailed the breakdown of each tax provision in a chart, which we reproduced here.

 

Provision 

March 2010 Estimate, 2010-2019, $US billion

June/July 2012 Re-Estimate, 2013-2022, $US billion

Additional 0.9 percent payroll tax on wages and self-employment income and new 3.8 percent tax on dividends, capital gains, and other investment income for taxpayers earning over $200,000 (singles) / $250,000 (married)

210.2

317.7

“Cadillac tax” on high-cost plans *

32

111

Employer mandate *

52

106

Annual tax on health insurance providers *

60.1

101.7

Individual mandate *

17

55

Annual tax on drug manufacturers/importers *

27

34.2

2.3 percent excise tax on medical device manufacturers/importers* 

20

29.1

Limit FSAs in cafeteria plans *

13

24

Raise 7.5 percent AGI floor on medical expense deduction to 10 percent *

15.2

18.7

Deny eligibility of “black liquor” for cellulosic biofuel producer credit 

23.6

15.5

Codify economic substance doctrine

4.5

5.3

Increase penalty for nonqualified HSA distributions *

1.4

4.5

Impose limitations on the use of HSAs, FSAs, HRAs, and Archer MSAs to purchase over-the-counter medicines *

5.0 

4

Impose fee on insured and self-insured health plans; patient-centered outcomes research trust fund *

2.6

3.8

Eliminate deduction for expenses allocable to Medicare Part D subsidy

4.5

3.1

Impose 10 percent tax on tanning services *

2.7

1.5

Limit deduction for compensation to officers, employees, directors, and service providers of certain health insurance providers

0.6 

0.8

Modify section 833 treatment of certain health organizations

0.4

0.4

Other Revenue Effects

60.3

222**

Additional requirements for section 501(c)(3) hospitals

Negligible

Negligible

Employer W-2 reporting of value of health benefits

Negligible

Negligible

Total Gross Tax Increase:

569.2

1,058.3

* Provision targets households earning less than $250,000.

** Includes CBO’s $216.0 billion estimate for “Associated Effects of Coverage Provisions on Tax Revenues” and $6.0 billion within CBO’s “Other Revenue Provisions” category that is not otherwise accounted for in the CBO or JCT estimates.

Source: Joint Committee on Taxation Estimates, prepared by Ways and Means Committee Staff

 

These new taxes will hit small businesses hard. Owners of small businesses will face a tax increase on self-employment income and the employer mandate will pose huge challenges to many small businesses. Businesses that work with small profit margins and have workers with relatively low wages may have to close up shop. Businesses that are able to comply will be forced to reduce worker wages and raise prices on customers.

The cost of compliance is another ding on the budgets of small business, large business, medical providers and individuals. The Obamacare Burden Tracker pegs the total cost of compliance at 127.6 million hours. That’s 127.6 million hours of productive work the U.S. economy loses to complexity. 

Add the complexity and the cost to small businesses to the investment tax increase in the ACA, and the tax provisions in the law could do some real damage to economy. Following the fiscal cliff tax increases and the additional 3.8 percent investment tax from the ACA, the U.S. now has a combined state and federal capital gains rate of 28 percent, up from 19 percent in 2012. High investment tax rates discourages the free flow of capital and damages long-term economic growth.

The economic effects of the increases in investment taxes from the ACA won’t necessarily be felt immediately, but will harm future development. Less capital will lead to less future productivity, which will lead to lower future wages.

But small businesses and individuals will feel the other effects of the tax increases in the ACA much sooner, as businesses learn to comply with the law and all its provisions over the next couple years.

March 05, 2013

On February 28, South Dakota Gov. Dennis Daugaard (R) signed legislation withdrawing his state from the Multistate Tax Commission (MTC). South Dakota's move follows similar legislation signed by California Gov. Jerry Brown (D) on June 28 (S.B. 1015), and precedes a bill (S.B. 247) rapidly advancing through the Utah Legislature to do the same.

What is the MTC and why are some of their state members starting to race for the exits?

The MTC was founded in 1967 as part of the Multistate Tax Compact. It was created after Congress became irritated at the utter mess of conflicting and complex rules for interstate business taxation, and threatened to impose a modest basic framework: one standard apportionment formula that all states had to use in divvying up corporate profits for taxation. Fearful that this was the camel's nose into the tent, states set up the MTC to hammer out a self-enforcing rule on their own without Congress's interference.

But not for long: today, as the MTC itself admits, “39 of the 47 states with a corporate income tax” have abandoned this original uniform formula. States, pressured by in-state businesses, have modified their tax rules to measure taxes owed by sales in a state rather than property oremployees, as had been done in the past. Despite eager MTC efforts to draft model legislation and set up working committees on important state tax issues--controversial as the MTC's voting membership consists only of state tax officials--state tax systems have continued to move further and further away from tax base and regulatory uniformity.

That may mean the MTC isn't effective at its mission, but that isn't usually enough reason for states to start leaving. That came about after one company dusted off its copy of the MTC compact and found that it gives taxpayers in MTC member states the option to use the old uniform apportionment formula rather than whatever formula might be in state law. California is an MTC member state, and the Gillette Company says it wants to use that old uniform formula even though it’s not authorized by state law. The courts agreed with Gillette, and to prevent other companies from invoking the provision, California left.

MTC's brief in the case did a disservice to its important mission, contorting itself to downplay the importance of uniformity and the relevance of language in its own founding document. The brief dangerously argued that compacts need not be adhered to by states in full, provoking other multistate compacts to warn that states do not have the power to unilaterally change the terms of a compact. The MTC has also gotten into a war of letters with the National Conference of State Legislatures (NCSL), which is critical of the insular nature of MTC decision-making.

Whether the MTC changes itself to survive or dies out (a two-day meeting later this month will consider watering down uniformity requirements in the Compact), some effort to bring about simplification and uniformity is essential. State tax officials are unlikely to lead such an effort, because despite any lip service to the concept, they shirk from it whenever it means actual changes to how a state does things. With state tax officials clamoring for more authority to tax interstate business income and sales, Congressionally-mandated simplification efforts (and not just vague state-enforced promises of uniformity) need to be a part of the mix.

March 05, 2013

In late January, the Nevada Supreme Court ruled that a ballot initiative to implement a "margin tax" in the state could proceed to the 2014 ballot. However, the Legislature is empowered to tackle the topic in the first 40 days of its session. Three things could happen:

  • The Legislature takes no action. In this case, the initiative will then appeal on the November 2014 ballot.
  • The Legislature recommends a counterproposal. In this case, the initiative and possibly the counterproposal will appear on the November 2014 ballot.
  • The Legislature passes the initiative as received. This requires a two-thirds vote.

Today, legislators hold a hearing on the proposal, which is patterned after the "margin tax" problematically implemented in Texas. The Nevada tax would be a 2 percent rate, however, compared to the Texas 1 percent tax.

We evaluated Texas's experience with the margin tax here. Highlights:

  • The tax is structured with a fair amount of complexity:
    • Business taxpayers choose one of three tax bases: (1) total revenue minus "cost of goods sold"; (2) total revenue minus wages and benefits; or (3) 70% of total revenue
    • "Cost of Goods Sold" has been a key sticking definitional point, with the following items currently excluded: services, selling costs, distribution costs, advertising, taxes, and compensation.
    • Tax rate is 1 percent, with a special rate of 0.5 percent for wholesalers and retailers. This unequal rate has been unsuccessfully challenged in court, and previews the myriad rates that states with gross receipts taxes inevitably adopt (see reference to Washington here).
    • Businesses with less than $1 million liability are exempt. The exemption was intended to be sharply reduced but this has been postponed.
    • Taxable entities with less than $10 million can instead elect top pay 0.575% of total revenue.
    • Tax is owed on the Texas-apportioned share of combined reported profits from all related business entities.
  • Revenue has fallen far short of predictions, creating budget problems.
  • While designed to apply to more businesses than the corporate income tax, the adoption of exclusions and preferential rates has led to a very inequitable system.
  • The evolving state definition of "cost of goods sold" differs from federal rules, creating complexity, uncertainty, and confusion.
  • Designed to be a simple tax, it in fact has all of the most complex features of corporate income taxes: apportionment formulas, decoupling from federal rules, combined reporting, different rates for different businesses, and political efforts to obtain preferential tax rates.
  • There is a strong effort in Texas to modify or repeal the tax.
  • Public finance expert Professor John Mikesell has described the margin tax as a "badly designed business profits tax...combin[ing] all the problems of minimum income taxation in general—excess compliance and administrative cost, penalization of the unsuccessful business, undesirable incentive impacts, doubtful equity basis—with those of taxation according to gross receipts."

Click here to download a PDF of the 56-page Nevada proposal.

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