One point of contention in the North Carolina tax reform debate has been the fate of one particular tax expenditure—the uncapped sales tax refund for nonprofits. The refund applies to "sales of taxable tangible personal...
The Tax Policy Blog
Tomorrow, the full Ways and Means Committee will meet to discuss “Tax Havens, Base Erosion, and Profit-Shifting”
From the website:
“The hearing will examine different tax planning strategies used by multinational corporations to shift income out of the United States and into low-tax jurisdictions. The hearing also will consider when profit shifting truly is eroding the U.S. tax base and when companies are shifting profits amongst different foreign jurisdictions without affecting U.S. tax collections.”
Politicians have the tendency to over-simplify the issue of the taxation of multinational corporations and miss key facts.
Here is a list of things you should know before the hearing:
At 39.1 percent (federal plus state), the United States levies the highest corporate income tax rate in the world. This is 14 percentage points higher than the OECD average. And even though our tax system is cited as having many loopholes and deductions that lower the tax burden of corporations, we also have one of the highest effective tax rates at about 27 percent.
Although both politicians and the press continually repeat the myth that corporations hide their income overseas to avoid taxation, in reality corporations pay a substantial amount of taxes to foreign governments. Plans to increase the taxes on this income further risks double-taxing these overseas profits.
3. Corporations not only pay taxes once, but twice on their foreign income
Corporations first pay income taxes to the countries in which their profits were earned. Then when they repatriate their income to the United States, they are taxed again at the U.S. corporate income tax rate (minus the foreign tax credit). For example, if a subsidiary of a U.S. firm earns $100 in profits in England, it pays the British income tax rate of 23 percent (or $23) on those profits. Then when the profits are brought back to the U.S., the firm is required to pay the difference between the U.S. rate of 35 percent and the British rate of 23 percent—$12. Between the two nations, the U.S. firm will have paid a total of 35 percent in taxes on those foreign profits.
The U.S. is one of the only countries left that taxes income on a world-wide basis. For the past couple of decades, realizing the economic benefits, countries throughout the world have been moving to a “territorial” tax system. A system that only taxes the income of corporations in the country they earned those profits.
5. The United States’ world-wide tax system traps an estimated $2 trillion in corporate income overseas
When corporations want to repatriate their income earned overseas, they have to pay the difference between the taxes paid in the foreign country and the taxes owed in the United States. This “toll charge” makes bringing profits back to the United States much more expensive than it otherwise would be, trapping capital overseas and preventing the free-flow of capital back to the U.S.
Yesterday afternoon we reported on the introduction of a new Senate tax reform proposal in North Carolina. Today, the Senate Finance committee will hear debate on the proposed legislation at 1:00pm EST. A live audio feed can be found here. We'll be covering the committee hearing here on the blog. Updates will be posted below.
Update (1:17pm EST): Senator Berger (R) introduced the legislation again, noting that the bill would "bring North Carolina into the 21st century in terms of tax policy" and will thus bring the state to the forefront for jobs and economic expansion among the states. An amendment was proposed which would add a year and another tier for the phase-in of the sales tax exemption for nonprofits. It would give larger nonprofits (hospitals were specifically mentioned) more time to acclimate to the change. The amendment was adopted.
Update (1:25pm EST): A question was raised regarding local government funding--will this bill cause a revenue decrease for local governments? Senator Berger discussed the local food tax. The legislation would repeal the food tax that is given to local governments, but allows counties to levy their own food tax in order to raise revenue.
A second concern regarding the sales tax increase on mobile and modular homes and its effect on low-income taxpayers. According to the discussion, under the legislation, the sales tax on mobile homes would increase 300 percent; the sales tax on modular homes would increase by 95 percent.
Currently, Social Security benefits are not taxed at all at the state level. This bill will impose a tax on Social Security income to the extent that it is taxed at the federal level.
Update (1:40pm EST): Concerns were raised by Senator Stein regarding the lost tax revenue and the accrual of tax cut benefits to higher-income North Carolinians. Senator Rucho expressed concerns that HB 998 was not comprehensive tax reform (Senator Rucho's tax reform proposal can be found here). Senator Rucho's plan (SB 677) contained a very comprehensive sales tax base broadening to services and explicitly exempted business inputs from the sales tax. The current Senate legislation removes the sales tax exemption on a number of business inputs. Sales tax should not be applied to business inputs because it leads to tax pyramiding (see page 6 of this for more info on this topic).
Update (1:52pm EST): Discussion is now open to members of the public. Points raised include:
The President and CEO of the North Carolina Chamber of Commerce noted that "tax policy is de facto economic development policy." Further, he said, "we are pleased that Senator Berger has brought this forward" and says the legislation sends the signal that NC is competitive for jobs and business.
Herman Stone, a small business owner in Mecklenburg County, expressed concern that this legislation "targets a specific industry." Namely, this raises taxes on movie theatres. This legislation would apply the general sales tax to movies, amusements, and live entertainment, which are currently subject to a special gross receipts tax (that is lower than the general sales tax rate). Mr. Stone said this will increase the price of admission. There are merits to simplifying the tax code so that all transactions are subject to the same sales tax rate. Namely, it increases simplicity and neutrality.
A representative from the North Carolina Budget and Tax Center argued that this legislation will lead to a local revenue loss and thus higher local taxes later, will lead to cuts in state services provided, and that the benefits of income tax cuts will accrue to higher-income taxpayers. She argued that the corporate income tax cuts will only benefit 10 percent of state residents.
A representative of AARP expressed concern that Social Security benefits are taxed under this plan, though applauded the dedication to tax reform. Most states currently do not tax Social Security (see here for more info on states that tax SS benefits). They also worried that this proposal would not generate enough revenue to provide government services and that the legislation would lead to later property tax increases.
Update (2:01pm EST): The discussion moved from long-term vs. short-term benefits of tax reform. One Senator argued: "I can tell you this, doing nothing...is no answer" and that "the status quo is not working in North Carolina." Senator Berger provided closing remarks prior to the vote, urging Senators to support the legislation.
Update (2:05pm EST): The Senate Finance committee passed the proposed committee substitute to HB998.
Yesterday, in a late afternoon Senate Finance committee meeting, North Carolina legislators introduced yet another tax reform proposal--a proposed committee substitute to House Bill 998, which was passed by the House of Representatives late last week.
Here are some helpful documents, in addition to the actual bill text, that outline the plan’s details:
- Chart comparing the House legislation and the new plan;
- Fiscal note summarizing fiscal impact of each of the plan’s components in addition to state and local impact; and
- Summary chart with effective dates.
Senate Finance will hear discussion on the new plan today at 1:00pm EST. You can listen to a live audio stream here. If you missed the meeting yesterday, check out our live blog coverage or our Economist Scott Drenkard's comments on the legislation. We’ll be following the meeting today and providing updates on the blog and via Twitter. We also have plenty of previous work on North Carolina here.
Follow Liz on Twitter @elizabeth_malm.
Previously, we’ve written about Virginia’s law (effective July 1) to lower the gas tax and change its structure, replacing it with higher sales taxes in Northern Virginia and Hampton Roads (where, presumably, infrastructure investments are most in demand) and increases in auto registration and licensing fees. At the time, we focused on the shift away from user-fees on the whole.
However, one indirect form of user-fee did increase: registration and licensing. While it’s debatable whether these fees are generally considered “transportation funding” (because they have primarily financed safety, the DMV, and policing) some states, like Virginia, Washington, Oregon, and North Carolina, have proposed using them to finance road maintenance and construction.
And even as we cover North Carolina’s other tax reform proposals, the Tar Heel State is also considering a proposal in its budget to create an additional fee on hybrid and electric cars, with proceeds being used for road maintenance. This new fee is based on the premise that such high-mileage cars, by reducing their gas consumption and thus gas tax liability, aren’t paying their fair share of just as much use of infrastructure, or miles driven. This policy, and others like it, is becoming increasingly common as states grapple with more and more high-mileage vehicles and major infrastructure costs.
Uses of special fees for electric or hybrid cars could partially compensate for lost gas-tax revenue (and thus lost transportation funding) insofar as they are earmarked for infrastructure, like many gas taxes are. Such fees or taxes could also serve to place at least some of the burden of funding transportation infrastructure on its users, which is fair and efficient.
But blunt fees on arbitrary types of vehicles are a poor substitute for simpler user fees like tolls, or possible experimental new “vehicle-mile taxes,” both of which can more directly target infrastructure use without creating rigid new technology standards and extra taxes: taxes which actually discourage consumers from purchasing high-mileage vehicles. Furthermore, hybrid and electric cars are not alone in having low gas-tax “incidence” relative to miles driven. Conventional high mileage vehicles pose the same problem. A choice to place fees, not based on a car’s gas-tax-paid-to-miles-driven-ratio, but based on the general technological category of its motor, is unnecessary, inefficient, and distorts the decisions facing both investors in new auto technologies and the consumers buying new vehicles.
If states need to close revenue gaps for infrastructure (as they undoubtedly do), there are better tools available than blunt fees on whole categories of cars. Tolls and per-mile taxes are two such tools, and both could be less distortionary.
Commentary from The Hill reminds us that the time for corporate tax reform is now. The U.S. needs to modernize its code to keep American companies competitive and productive at home and abroad.
States that miss out on the revenue from the gas tax for hybrid cars hope to recoup that cost by taxing hybrid and electric cars. Generally, gas taxes provide a rough estimate of miles driven and, subsequently, wear and tear on the road. But for obvious reason that doesn’t work for hybrid and electric cars. Perhaps using tolls instead of taxes to finance roads is worth further study.
A Russian plan to create a tax haven zone within the country has cooled lately. Russian officials face a July 1st deadline to return all their money invested in offshore accounts to Russia or lose their official posts. The proposal, first suggested by the Prime and Deputy Ministers, would give the officials in country option to receive similar tax treatment as they would in Cyprus.
Relatedly, Switzerland’s upper-house in parliament will vote tomorrow on a measure to allow U.S. authorities access to banking information regarding Americans holding their money in Swiss bank accounts.
The Senate voted today to take the next steps in a rewrite of the immigration laws. The process will most likely play out over the next month as senators debate the legislation and offer potential amendments, some of which have already received some coverage.
In my last post, I was somewhat critical of Proposition 13, but I still acknowledged that it contained positive attributes. One of the best parts of Prop 13 is that it prohibits split roll property taxation. This means that California cannot charge different rates for homestead and commercial properties, and instead must tax all property at the same rate.
On cue, the California Taxpayers Association has published a new report that analyzes the effects of the split roll prohibition. Prop 13 restricts the rate of growth of assessments to 2 percent per year, but if a property is sold to new owners, or if there’s new construction on a property, then the property is reassessed at its market value. It’s not uncommon for a person to pay much less in property taxes than his next-door neighbors, who just bought their house. Since residential properties are bought and sold more frequently than are commercial properties, they are also reassessed more frequently. This fact caused some people to warn that Prop 13 would shift the property tax burden to homeowners and away from businesses.
The California Taxpayers Association has found that this fear never came to fruition. “Business property owners pay a greater share of the property tax under Proposition 13,” the report states, and “the assessed value of homeowner-occupied property . . . has declined since passage of Proposition 13.” There are several reasons for this outcome: “Court decisions have clarified when reassessments should occur. . . . large mergers and acquisitions have resulted in valuation increases on the local property tax rolls that are equal to the turnover of thousands of homeowner-occupied properties. New construction also contributes to the rise of property tax assessments on businesses.”
Interestingly, the California Taxpayers Association also found that “California’s property tax is the most stable source of revenue in the state,” and this stability ensures “that local governments are shielded from booms and busts of the economy.” It’s very important for governments to have stable streams of revenue, because there is usually a higher demand for government services during recessions.
Despite its well-documented tax problems, California does demonstrate that it is possible to have a flat and neutral tax that falls on taxpayers in an equitable manner, while still providing a stable revenue source. California’s property tax, with its prohibition on split roll taxation, is neutral, which is one of the principles of sound tax policy. This means that there are no advantages to owning one kind of property, so Californians will make decisions that make the most economic sense, not the decisions that politicians want them to make. And since Prop 13 was intended to protect homeowners first and foremost, the fact that the tax burden hasn’t shifted to homeowners is an encouraging sign.
We've been following the recent tax reform debate in North Carolina. At 4:00 pm EST, the Senate Finance Committee will hear more tax reform legislation. You can listen to a live audio stream here, or follow our live updates here.
Update (4:23pm EST): The Senate Finance Committee is currently hearing discussion of a Senate substitute for HB 998 that passed the House of Representatives yesterday. After distributing legislation, Senator Berger noted:
"What you have before you is a tax reform bill that does not tax food, does not tax prescription drugs, and does not tax services that are not taxed. It does simplify our 1930s era tax code, it provides...relief to working families, it makes North Carolina...more attractive for job creation and it cuts taxes by more than $1 billion in the first three years alone."
- Reduce individual income tax to 5.25 by 2015; create new zero bracket for first $15,000 of income (for married filing jointly);
- Retain the child tax credit ($100, but this is the only one retained);
- Eliminate corporate income tax by 2017;
- Phase out franchise tax by 2018;
- Create flat rate tax on all limited liability companies tax in place of franchise tax (this would eventually be expanded to corporations, too);
- Eliminate local business privilege taxes in 2018;
- Remove local food tax by 2016; and
- Repeal estate tax.
The bill would not expand the sales tax to services, does not change corporate income tax apportionment (since tax will be repealed), and retains scheduled sunsets of various tax expenditures.
Update (4:30pm EST): Meeting documents can be found here.
Update (4:40pm EST): The state impact is $173.8 million in FY 2013-14 and $510.2 million in FY 2014-2015. This would not cut spending, but would slow the rate of growth of revenue that is projected. The rate of growth would "cover around 3 percent," according to the discussion.
Update (4:43pm EST): I'm interested in the reform of the franchise tax. This tax would now be flat (read: capped, which is good) and apply to more companies (including LLCs now, unlike the current tax structure). It would be renamed the "privilege tax."
Update (4:47pm EST): Like the House debate, electricity taxes have come up. According to Senator Berger, taxpayers currently pay a utility franchise tax plus a sales tax of around 3 percent on electricity. The plan would eliminate utility franchise tax and put full sales tax rate on sale of electricity.
Senate Finance committee will hear this bill tomorrow for a vote.
Update (4:55pm EST): Our economist Scott Drenkard is testifying on some of the economic implications of portions of this bill. Some of his main arguments on the corporate income tax:
- Taxes and growth are related, and that relationship is negative. Corporate income taxes are the most destructive to growth.
- The corporate income tax doesn't raise a large portion of revenue--only 4 percent of state and local tax revenues in North Carolina, so repeal is doable.
- Corporate income taxes aren't fully borne by corporations. A portion of these are passed on to consumers in the form of higher prices and workers in the form of lower wages.
Update (4:57pm EST): On estate taxation:
- Estate taxes decrease capital stock because they discourage savings. Capital accumulation is a driver of growth.
- Estate taxes are complex and require significant planning. This planning requires the use of economic resources (time and money) that could be used more effectively elsewhere.
Update (5:00pm EST): We'll have a more detailed analysis of the new legislation soon. Stay tuned for live coverage of continued discussion tomorrow at 1:00pm EST in the Senate Finance Committee.
This week's Monday Map takes a look at the total property tax collections per capita at the state and local levels. Coming in with the highest per capita collection rate is New Jersey at $2,819, and Alabama comes in at the other end of the spectrum with a per capita collection rate of $539.
All maps and other graphics may be published and re-posted with credit to the Tax Foundation.
Click on the map to enlarge it.
View previous maps here.
To see how property tax bills in your area stack up against other areas across the United States, please visit our property tax calculator.
Corporate tax reform gets most of the attention in Washington these days, and rightfully so (the corporate tax code is a giant mess and the studies show that it is the most harmful tax to economic growth). But what about small businesses?
In the United States, small businesses, or pass-throughs, earn 61 percent of all business income and make up 30 million businesses across the country. Small businesses – companies organized as s-corps, partnerships, and sole proprietorships – pass their business income through the company to the owner’s individual income tax return. Because they pay income tax on the individual returns, they often face the high tax rate of 39.6 percent. Such a high rate, like with the corporate tax, damages economic growth.
But Rep. Devin Nunes (R-CA) has a pretty good idea on how to fix that: something he calls the American Business Competitiveness tax reform.
The plan, which he rolled out last fall in an op-ed, would treat all businesses the same, and at an equal and lower rate of 25 percent. Perhaps the most important aspect of the congressman’s plan, though, is how it treats income.
His plan is a cash flow business tax that allows companies to fully expense all costs immediately. Rep. Nunes says this will spur investment and economic growth, and there’s reason he’s right to believe so. Tax Foundation analysis shows that under the current tax code, 100 percent expensing option would boost GDP by 2.28 percent over the long run - and this is under the current tax code. If you rewrite the code as the plan suggests and cut the tax rate for all businesses as well, you could expect to see a couple additional points added to long term GDP.
A big reason for the economic growth from Rep. Nunes’s cash flow tax is because the plan properly defines the income tax base. Current law requires depreciation schedules that understate costs and overstate income, treating cost recovery as tax expenditures. This plan would completely rewrite those rules.
The correct treatment of income is crucial to investment and growth for so many small businesses, and gives them the freedom to invest when it makes business sense, instead of investing for tax reasons.
But with the discussion so fixated on revenue neutrality, people might be wary of the revenue a new system would bring in on a static bases. Fortunately, Rep. Nunes says he’s flexible on the 25 percent rate, because he says he’s confident the reform would bring in more revenue through economic growth, whether the rate needs to be 20 percent or 30 percent.
“You’re going to bring so much money off the sidelines and plow it into the economy,” he’s quoted saying in a Post article. “You’ll have really strong economic growth.”
After an whirlwind couple of weeks in which the mortgage interest deduction nearly derailed North Carolina tax reform efforts, House Bill 998 passed the House of Representatives early Friday afternoon. For more information on the legislation, you can view the plan’s summary and fiscal note, or check out the analysis we released this morning.
Though the floor debate was short, it was heated. Multiple amendments were offered (but all ultimately tabled). Those offered included various combinations of the following:
- Keeping the individual income tax structure graduated to some degree by retaining an additional higher bracket on higher-income earners,
- Extending or expanding the state’s Earned Income Tax Credit (which is set to expire soon), and
- Lowering taxes on electricity.
Critics of the bill argued that it disproportionally helps millionaires. This point of contention was passionately debated, but ultimately one thing needs to be kept in mind. When you compare an income tax cut of a given percentage on someone who pays a lot in incomes taxes to someone who pays less in income taxes, simple math tells you that the former will be higher. That’s not an argument against cutting income taxes on everyone.
Opponents also asserted that the proposal would increase sales taxes on low-income earners due to its expansion of the sales tax base to certain services. Like I’ve noted before, sales tax regressivity can be easily fixed and this shouldn’t be a reason to write off an otherwise positive tax reform proposal. Further, the sales tax base expansion is very moderate.
The bill will now be heard for its third reading on Monday. Don’t forget that the Senate has been discussing tax reform plans of their own, which are on the table for discussion in Senate Finance early next week.
Follow Liz on Twitter @elizabeth_malm.
7 in 10 Americans say that the high price of gasoline causes financial hardship for their family. The painful routine of filling up the gas tank is often all too familiar for many Americans. It is becoming more apparent as prices top $4 a gallon that the pain at the pump will only get worse. As the reality of climbing gas prices sinks in, we pause to recognize the birthday of the federal gasoline tax.
The gasoline tax was first signed into law 81 years ago today by President Herbert Hoover on June 6, 1932. It was designed to combat growing budget deficits. The economic turmoil brought on by the Great Depression had sharply reduced federal revenue while spending on relief and public works programs dramatically increased. The 72nd Congress examined many options for revenue-generation and ultimately passed legislation creating a federal gasoline excise tax at a rate of 1 cent per gallon (the equivalent of about 17 cents per gallon today).
The gas tax has significantly changed over the past 81 years. One year after its creation the IRS reported that it generated $125 million tax dollars, nearly 8 percent of all federal revenue. Since then, the gasoline tax has increased ten times (most recently in 1993) to its current rate of 18.4 cents per gallon. Federal gasoline and diesel taxes generate about $30 billion per year.
Some have called for an increase in the gas tax both to curb the deficit and to deter people from using gasoline for environmental reasons. The impact of any increase in the gas tax will be directly passed to the consumers at the pump. The average burden of federal gasoline taxes is already $150 per licensed driver. Will Americans support paying more than that? Research conducted by the Pew Research Center answers that question with a resounding no. Pew conducted a survey where they questioned people regarding twelve different options for deficit reduction. Gasoline tax increases, a national sales tax, a tax on employer-provided health insurance, and the elimination of the home mortgage interest deduction were several of the options mentioned. The proposal to raise the gasoline tax garnered the highest disapproval rating at 74 percent. Only 22 percent of people surveyed support raising the federal gasoline tax.
How much the gasoline tax affects the price of gasoline is debatable, but one thing is for certain: the birthday of the gas tax is one thing many Americans wished never happened.
Nestled in the heart of the Pyrenees mountain range, between France and Spain, rests the small nation of Andorra. Known primarily for its tourism industry, Andorra faces threats from the European Union and OECD. Unless they act to comply with international tax standards, the EU warned, they would be placed on a blacklist.
What has Andorra, with a population of 85,000 people, done to raise the ire of the EU? They are one of the few nations in the world that has maintained bank secrecy laws and not levied income taxes on residents. Andorra has previously relied on registration fees, property transaction taxes, and minor sales taxes to generate revenue. This tax climate has drawn investment into the Andorran economy which the EU cannot reliably track because of Andorra’s bank secrecy policies. These policies have caused Andorra to be labelled as a tax haven. The EU, which loses $1.3 trillion a year in tax evasion, intends to bring tax havens into compliance with international standards by requiring them to levy income taxes and share banking data. This will decrease both the incentive and the ability for people to move their money into Andorran banks.
Refusal to comply with EU pressure would be economically and politically costly. The French budget minister, Eric Woerth, declared that noncompliance would result in placement on the OECD’s blacklist of uncooperative tax havens. Blacklisted nations face being ostracized by the EU, as well as higher international dividends and capital gains taxes.
Andorran prime minister Antoni Martí met with the President of France in response to the threat. Their discussion culminated in Martí’s promise to introduce an income tax on residents before June 30th in order to avoid blacklisting. Although a tax rate has not been decided, officials have agreed that both a personal and a corporate income tax will be enacted.
This news comes as a blow to the Andorran economy, as it will add additional burdens to the already struggling tourism industry. Tourism represents nearly 80 percent of the economy and has seen significant turmoil over the past several years. The financial crisis of 2008 directly impacted Andorra as people cut back on vacationing to save money. As a result, the tourism industry has shrunk by 25 percent over the past decade. This trend can be expected to continue as tourists see higher prices as a result of the taxes.
More importantly, new taxes will place additional financial strain on local and international businesses. Research has shown that corporate taxes have a negative impact on investment and productivity. The elimination of an income tax free zone and introduction of a permanent corporate tax will diminish the incentive for international corporations to invest in Andorra. Perhaps the most significant impact, however, will be on local businesses who face permanent corporate taxation for the first time in the nation’s history.
Andorra’s economy will likely continue to struggle in the upcoming years as a result of the EU-induced policy changes. The toll of slower tourism, the housing crisis, and increased taxation has already caused the economy to contract by roughly 12 percent. Piling taxes on individuals and businesses will only exacerbate the problem by causing higher unemployment, higher prices, and diminished productive activity.
On June 6, 1978, thirty-five years ago today, California voters passed Proposition 13, which cut property taxes down to 1 percent (for both homestead and commercial property) and limited the growth rate of future assessments to 2 percent. Once properties are sold, though, new assessments are conducted to value the properties at their market value. In addition, Prop 13 “requires taxes raised by local governments for a designated or special purpose to be approved by two-thirds of the voters,” and all tax increases to be passed by two-thirds of both houses of the California legislature.
Some Californians worried that capping property tax rates at such a low level would result in devastating cuts to government spending. According to Bruce Bartlett, UCLA economists predicted at the time that Prop 13 would cause California’s unemployment rate to increase by .8 percent, from 5.9 percent to 6.7 percent.
On the other hand, many prominent free-market thinkers, including Milton Friedman, William F. Buckley Jr., and Jack Kemp, advocated for Prop 13’s passage. Donald Hagman, writing in the September, 1978 issue of the Tax Foundation’s Tax Review, warned that these thinkers were mistaken. The property tax, Hagman argued, is one of the best types of taxes, since it’s efficient, equitable, and taxpayers come face to face with their tax burden. Hagman asserted that the lost revenue would be “replaced by revenue generated primarily by sales and income taxes.”
This prediction has proven correct. While California’s property taxes are lower than New Jersey, New York, and even Texas, it remains a high tax state. It has the third worst business climate in the country, the highest top marginal income tax rate in the country at 13.3 percent, a corporate income tax of 8.84 percent, and the highest statewide sales tax in the country at 7.5 percent. But in 1978, California had the fourth highest overall tax burden, and today the state still has the fourth highest burden. Although one cannot say for certain that Prop 13 caused the other taxes to increase, Prop 13 at the very least failed to prevent high taxes and an expansive public sector.
The property tax cap portion of Prop 13 is what is known as a tax and expenditure limit, sometimes abbreviated TEL. Since 1978, many other states have enacted tax and expenditure limits, with Colorado’s “Taxpayer's Bill of Rights” being the most famous (or infamous, depending on whom you ask). Although these limits come in many different shapes and sizes, they all basically try to rein in government spending or tax collection.
Some new empirical evidence suggests that tax and expenditure limits do not work. Benjamin Zycher, a visiting scholar at the American Enterprise Institute, recently produced a study that finds that the provisions are ineffective. As Zycher explains:
The ineffectiveness of TELs is unambiguous in terms of summary statistics, case-study examination of the records of several individual states, and estimation of an econometric model. . . . In part, it is likely that the limits themselves are the products of the same political pressures and election dynamics that yield fiscal outcomes. Moreover, the competition among political interests that results in budget outcomes also is likely to weaken or circumvent limits that otherwise would be effective.
Matthew Mitchell of the Mercatus Center found somewhat contradictory evidence, however. The results of his study show tax and expenditure limits have at least a small effect on reducing state expenditures as a share of income.
Specific tax and expenditure limits have been successful in limiting government revenue. In a 2010 report for the Manhattan Institute, Josh Barro analyzed the effects of Massachusetts’ 2.5 percent cap on municipal property tax revenues. Barro found that this tax and expenditure limit “succeeded in restraining growth of property-tax collections, total tax collections, and per-pupil education spending in Massachusetts.”
But the fact remains that Prop 13 has failed to rein in California’s public sector. Moreover, as Hagman rightly observed at the time, property taxes fit many of the characteristics of a good tax: they are relatively simple, transparent, neutral, stable, and have a broad base. So while there are some good elements of Prop 13 (especially the prohibition of split roll), we’d rather see caps on other taxes.
State income tax revenues in the first quarter of 2013 soared 17 percent over 2012, according to a new collection of data released yesterday by the Rockefeller Institute. While about half of that increase is due to California's hefty income tax hike, excluding California still means an average 9 percent growth in state income taxes. By contrast, sales taxes grew 6 percent and corporate taxes 3.5 percent.
Why the spring "surge" in state income tax revenue? Part of it is the improving economy, but a big culprit is the increase in federal capital gains taxes. In late 2012, it became clear that capital gains taxes would go up for 2013, as indeed they did (from 15 percent to 20 or 23.8 percent). Lots of people "accelerated" their capital gains realizations -- sold stuff in 2012 -- to make sure that they paid 2012 tax rates rather than future, higher tax rates. Taxpayers paid those taxes this spring, leading to a huge revenue boost for the federal government (knocking hundreds of billions of dollars of the 2013 budget deficit), and flowing through to the states.
All good news, right? So long as we understand that if accelerate is indeed the cause, much of the boost is temporary. One-time sales of capital gains are exactly that: one-time. The CBO report I just linked to unnerved me a bit because they show this spring's tax revenues as a upward trend rather than a spike. States should be careful not to make that same assumption.
Here's state-by-state data. Some stories from 2012 jump out in the numbers: California's income and sales tax increases, Michigan's economic recovery and corporate tax reform, North Dakota's continued oil boom, the wild oscillation in state corporate income taxes, and income tax cuts in Oklahoma and Kansas.
Table: Percent Change in State Tax Revenues, First Quarter 2013 vs. First Quarter 2012
Source: Rockefeller Institute. NA=No Tax; ND=No Data; *=Insignificant Change.
A widgets corporation has two shareholders: Tobias and Lindsey. Every year, the corporation pays out all its profits to its two shareholders who each own equal shares (maybe not a great business decision, but works for this example). Tobias and Lindsey live in a country with no dividend or corporate tax.
In year one, the corporation earns $100 in profits, which is divided between the two shareholders with each Tobias and Lindsey earning $50. Both Tobias and Lindsey are happy and they use their money to throw a fundraiser for charity.
At the end of year one, the country decides it will institute a dividend tax of 23.8 percent for all years going forward. Again, the corporation earns $100 in profits, which is divided equally between Tobias and Lindsey. Tobias and Lindsey take their $50 and pay the 23.8 percent tax, giving their country $11.90 and leaving each of them with $38.10. Both Tobias and Lindsey are a little less happy because they have to throw a slightly smaller fundraiser than in year one.
At the end of year two, the country decides that the dividend tax is not enough, so in addition they institute a corporate tax of 35 percent for all years going forward. The corporation, consistent as always, earns $100 in profits. But this time, before it pays its two shareholders, the corporation pays its 35 percent tax of $35 to the country, leaving the widget company with $65 to pay its shareholders. The corporation pays Tobias and Lindsey the after tax profit of $65 with each receiving $32.50. They take their $32.50 and pay the 23.8 percent dividend tax rate, or $7.74, leaving both parties with $24.76 each. Tobias and Lindsey as much less happy and no longer have the money to throw a fundraiser.
So, who pays the dividend and corporate taxes?
Each year Tobias and Lindsey faced a different tax regime. In year one, the effective tax rate for both Tobias and Lindsey was 0 percent, because they faced no taxes.
In year two, the addition of the 23.8 percent dividend tax decreased their income by $11.90 for an effective tax rate of 23.8 percent.
In year three, despite the 35 percent tax being levied on the corporation, Tobias and Lindsey’s effective tax rate goes up to 50.1 percent, with $13.34 of the total tax burden due to the corporate tax and $11.90 due to the dividend tax.