The Tax Policy Blog

Just in time for the tax-filing deadline, we'll be releasing our much-anticipated Tax Freedom Day calculation for 2006 tomorrow.

The full study will be posted at http://www.taxfoundation.org/taxfreedomday/ at 9:00am EST tomorrow, April 12. Be sure to check back then.

In the meantime, we've also released a thorough rebuttal of several Tax Freedom Day criticisms made by the Center on Budget and Policy Priorities. Here's the bottom line:

Each year, the Center on Budget and Policy Priorities (CBPP) releases a criticism of the Tax Foundation’s annual calculation of Tax Freedom Day. Their criticism relies on three main arguments, none of which stand up to close scrutiny.

First, they assert that Tax Freedom Day should focus only on tax burdens of the middle one-fifth of earners, and ignore the taxes paid by the remaining four-fifths of Americans. Second, they assert that the Tax Foundation should employ the CBPP’s unofficial preferred definitions of “income” and “tax” rather than the official definitions used by U.S. government statistical agencies. Finally, they assert that the Tax Foundation’s state and local tax burden estimates are unreliable because—like all statistical estimates based on official government data—initial estimates are revised when improved data become available.

All three criticisms rely on either factual errors, unsupportable value judgments or misleading interpretations of the Tax Foundation’s tax burden estimates. For these reasons, the CBPP’s criticisms do not constitute a serious critique of the Tax Foundation’s established methodology for estimating the nation’s average annual tax burden.

Read the full rebuttal here.

The recent debate on the issue of illegal immigration has led some to question whether or not undocumented immigrants pay taxes, and if so, how much. A story from KRQE in Albequerque combines this hot-button issue with another current top story – income tax filing -- and sheds some light on the growing number of undocumented immigrants filing a return with the IRS. From KRQE:

The IRS has seen an increase in the number of tax returns filed using an Individual Tax Identification Number.

The system originally was designed for people living abroad who had investments in the US.

But it quickly is becoming used by undocumented workers who aren't eligible for Social Security numbers.

Last year, 1.4 million people filed tax returns using the numbers. That's an increase of 40 percent over the previous year.

In 2003, 7,600 people in New Mexico requested the numbers.

For opponents of illegal immigration, the system shows the federal government's fractured approach to the country's undocumented work force.

Immigrant-rights groups say paying taxes is one way immigrants show they want to comply with US laws.

The question of how much illegal immigrants pay in taxes is not always clear cut because attempts to answer it suffer from the same common problems that persists when trying to allocate the incidence of any tax – who the law says must pay (statutory incidence) and who actually pays (economic incidence). In addition, like most estimates pertaining to undocumented immigrants, the numbers are all over the map.

It is true that many undocumented immigrants pay payroll taxes (i.e. FICA and Medicare) using either an invalid Social Security number or a Tax Identification Number (TIN), and empirical evidence tends to show that a large fraction of the economic incidence of these taxes falls on workers.

Some of these same individuals also pay income taxes, assuming their reported adjusted gross incomes are high enough to where they actually have a positive liability. Certain legal questions such as the proper filing status most likely exists as well, and mixing a complicated tax system with the complicated issue of undocumented workers can cause nightmares for willing accountants and law enforcement.

But even if one is paid “under the table” where neither the employer nor employee report the income to the IRS, other taxes are paid by illegal immigrants. This would include mainly sales taxes on items purchased in most states and localities. Only states with most likely few undocumented individuals -- Alaska, Montana, Oregon, New Hampshire, and Delaware -- do not have a statewide sales tax. The incidence of sales taxes varies by product, but in terms of essential products that low-income immigrants are most likely to purchase (i.e. food, clothing, etc.), they tend to be highly inelastic, meaning the burden mostly falls on the them as the consumer.

Corporate income taxes could also be paid in part by illegal immigrants. The burden of any corporate tax will fall on a combination of three parties: workers, consumers, and/or shareholders. While illegal immigrants tend to not be active investors, they are often workers and consumers, so they do bear a fraction of that burden.

Overall, while some illegal immigrants may work in the black market, avoiding taxes entirely is not practically possible. Even those illegal immigrants who may be involved in other illegal activities like drug smuggling/dealing ultimately pay some tax when they use that income to purchase goods.

While some argue that illegal immigrants do not pay their fair share of taxes compared to the value of government services they receive, this is partially a normative question that needs to be accompanied by more empirical evidence to support or refute. But to answer the question, "Do illegal immigrants pay any taxes?" the answer is clearly yes.

Here's some basic federal spending data I ran into today and thought I'd share on the blog: where we send each penny of a federal spending dollar.

When you think about tax policy as much as we do, it's easy to forget that in the long run, spending pulls the tax policy cart. So here's a list of the ten biggest draws of federal dollars. Personally, I'm always surprised by the size of "net interest on debt," which devours 8-cents of every federal spending dollar.

Pennies of Each Federal Dollar Spent on Various Programs, 2006 Estimate

Yesterday on Capitol Hill, a hearing was held by the Senate Finance Committee looking into the problem of fraud and confusion among taxpayers and tax professionals. The solution from members of Congress? Federal licensing requirements for paid tax preparers. From the Minneapolis Star-Tribune (AP):

Tax laws should require paid return preparers to meet minimal standards for training and competency, senators said after hearing that congressional investigators uncovered errors in virtually every tax return prepared for auditors masquerading as taxpayers.

If barbers need a license to cut hair, there's no reason the government cannot set requirements for tax preparation, said Senate Finance Committee Chairman Charles Grassley, R-Iowa.

"The worst that can happen when you get a lousy barber is you have a bad hair day,'' he said. "But if you get an unqualified tax preparer who gives you bad advice, you may be audited, owe thousands of dollars and even face jail time.''

Grassley and Sen. Max Baucus, the top Democrat on the panel, said laws may be needed to impose a training requirement on tax professionals.

The article further describes the government report detailing the problem:

The senators heard from investigators at the Government Accountability Office, who found mistakes in virtually every tax return filled out by commercial chain preparers. The investigators said they looked at a tiny number of tax returns, and that their conclusions could not be generalized to the rest of the tax preparation industry.

The auditors, posing as taxpayers from two hypothetical families, got the correct refund amount in only two of 19 tax returns prepared. Both of those returns, nevertheless, showed errors.

Incorrect refunds on the other tax returns delivered as much as $2,000 extra to some taxpayers but took more than $1,500 from others. (Full Story)

Too often the easy answer for members of Congress is additional federal regulation, without regard to the benefits and costs of doing so.

Given the problem of a confusing tax code, requiring that tax professionals be licensed is clearly the wrong policy response. For one, it will result in a restricted supply of preparers, likely driving up tax preparation fees and causing more taxpayers to prepare their own taxes—likely leading to more mistakes on tax returns, not less.

The most effective action Sens. Grassley and Baucus could take to remedy the problem of erroneous tax returns is to move the Senate Finance Committee toward fundamental tax reform.

The fundamental cause of erroneous tax returns is the complexity of the federal income tax code, not the lack of government oversight of paid preparers. Rather than attempting to regulate an entire industry of tax preperers, why not focus on the tax complexity that gives rise to the fraud, confusion, and abuse that’s rampant in federal tax filing?

On March 30, North Carolina launched a state lottery, joining 41 other states and the District of Columbia. Lottery supporters fought for two decades to bring the lottery to North Carolina, and finally forced a lottery bill through the legislature last August. However, several clouds hang over their celebration, even amid the new lottery’s jubilant customers and employees.

First, there are accusations that the bill was passed as a result of underhanded maneuvering. Then there are the suspicions that funds raised by the North Carolina Education Lottery will partially supplant rather than supplement the education budget.

Finally, there is the lawsuit. A group represented by the North Carolina Institute for Constitutional Law filed suit against the state in December, arguing that the lottery is a tax, and the legislature breached the state’s constitutional requirement that revenue bills be passed in both houses on three separate days. On Match 21, a judge ruled that the lottery is not a tax, and therefore the bill was passed constitutionally, and the lottery can proceed with ticket sales. The judge wrote, "A tax is a forced contribution to government which has no necessary immediate relationship to a benefit conferred."

As a matter of tax policy and common sense, the judge's reasoning is badly flawed. The purchase of any product—such as a lottery ticket—is voluntary, but the tax portion of the ticket price is not, just as a sales or excise tax is compulsory on a voluntary purchase of alcohol, clothing or books. Even income taxes would be "voluntary" by the judge's reasoning; no one forces the taxpayer to take a job and earn income.

As for the second part of the judge’s argument—“A tax … has no necessary immediate relationship to a benefit conferred”—the chance to win a cash prize is not a benefit conferred by the lottery; it is a good purchased by a consumer. After prizes have been distributed and administrative costs have been covered, the money that is left from ticket sales is used to confer benefits—such as aid to public education—that are unrelated to the purchase of lottery tickets.

As we have written before (here, here and here), lottery “profits” are tax revenue, and should be recognized as such.

With the April 17th tax deadline looming, Americans are feeling the weight of their annual income tax burden. But there's a quirk of the federal tax code that may actually entice taxpayers to pay a little extra to Uncle Sam this year: the ability to write a special check to help pay down U.S. public debt along with their tax return.

Each year a handful of Americans take advantage of this oddity in the tax code, voluntarily sending debt-reduction checks to the IRS along with their regular tax return. It's no surprise few taxpayers take advantage of it, since it's not well advertised by the IRS. There's no line on the 1040 form for "public debt reduction." However, the IRS website offers detailed instructions for those inclined toward charitable gifts to Uncle Sam's debt-relief fund:

How do you make a gift to reduce debt held by the public?
If you wish to do so, make a check payable to “Bureau of the Public Debt.” You can send it to: Bureau of the Public Debt, Department G, P.O. Box 2188, Parkersburg, WV 26106-2188. Or you can enclose the check with your income tax return when you file.

Tip: You may be able to deduct this gift on your 2006 tax return.

According to the most recent IRS Data Book, last year 48 taxpayers mailed in contributions to reduce the public debt, for a total of exactly $21,179. That's $441 per gift. Since 1982, there have been a total of 16,122 voluntary contributions to reduce the debt, for a grand total of $9.8 million—or about 0.00012 percent of the nation's public debt of  $8,367,661,575,868 as of March 29, 2006 according to the U.S. Treasury.

Here's a table summarizing public-debt contributions from the 2005 IRS Data Book:

Update: The data above only include gifts to reduce public debt made by those filing federal individual income tax returns. Gifts can also be made without filing returns. According to the Bureau of Public Debt, the total gifts toward public debt are much higher than the totals from the IRS Data Book above. In 2005, total gifts to reduce public debt—including donated cash, bonds and property—were $1,455,541.65, much higher than the $21,179 from individual tax returns listed above. See here for more.

Data from the final report for 2005 from the Bureau of Economic Analysis (BEA) show tax revenues rising across the board last year. The following is a brief overview of government finances for 2005 at both the federal and state/local level.

Federal Government Federal government receipts (current receipts) rose by 12 percent ($1.974 trillion to $2.225 trillion) with most of the increase coming from personal current taxes, which increased by 16.6 percent.

Federal excise taxes only rose by a mere 1.7 percent, which is largely due to the fact that high gas prices led to lower-than-average growth in gasoline consumption.

Federal tax receipts on corporate income, which is typically the most volatile variable took the biggest jump of any category as they rose by over 40 percent last year.

On the spending side, government expenditures rose by about 7.0 percent, which is less than the revenue growth rate, but because we have had a deficit last year, the fact that receipt growth exceeded expenditure growth merely implies that the deficit is lower this year than last year. We still had a deficit in 2005 of about $323 billion. (This is negative government savings, which comes from current receipts. Total receipts and total expenditures, which add in other variables like capital transfer payments/receipts, means that the federal government was forced to borrow $376.4 billion last year.)

State/Local GovernmentsAt the state and local level, overall government current receipts increased by 6.8 percent. There was an 8.7 percent increase in tax receipts, including an 11.1 percent growth in personal current tax receipts, which are predominantly state/local income taxes. Note that state/local income taxes make up a relatively small percentage of total state/local revenue (about 15 percent) compared to the federal government where income tax revenue is the main source.

Sales taxes and property taxes grew at rates of 5.9 percent and 5.8 percent, respectively.

And although they make up a relatively small fraction of state/local government revenues, corporate income tax revenue rose by 41 percent at the state/local level, which is similar to the large increase that we saw at the federal level.

Overall In summary, fueled by rising tax revenue from corporate income and personal taxes, government current revenues in the United States rose by nearly 11 percent in 2005, while government current expenditures rose by about 6.5 percent, leading to smaller deficits (yet still growing debts) in overall government finances.

(Data from BEA NIPA Tables 3.1, 3.2, and 3.3.)