As debate rages over a possible reform of the home mortgage interest deduction, members of Congress continue to defend the subsidy and ignore the economic benefits of reforming it. From Reuters:
Republican members of the U.S. House of Representatives tax panel urged Treasury Secretary John Snow to ignore proposals to eliminate the mortgage interest rate deduction, in a letter released on Friday.
Snow is studying plans to overhaul the U.S. tax system. A panel of experts and former politicians proposed streamlining the U.S. tax code, eliminating some taxes and cutting tax rates, but canceling popular current tax deductions.
Eight GOP members of the House Ways and Means Committee said proposed cuts to the mortgage interest benefit and the deduction for state and local income taxes would remove incentives for homeownership.
"While many investment opportunities exist today, perhaps none provides more return for individuals, families and communities than homeownership," the lawmakers wrote. (Full Story)
Clearly the deduction for home mortgage interest injects money into the housing market. But what are the consequences of that? While it may help some afford larger houses (especially those who itemize on their 1040), it also artificially inflates real estate and housing prices, which pushes others out of the home market entirely.
Also, when money articificially flows into housing thanks to state subsidies, it takes money away from other forms of investment like plant and equipment, creating costly economic distortions. When thinking about the home mortgage interest deduction, lawmakers should look beyond the first order benefits and consider the secondary negative impacts as well.
We've just released a new study on corporate taxation around the globe. Bottom line: the U.S. is a global leader in yet another area—high corporate tax rates. Here's a taste of the report by Staff Attorney Chris Atkins and President Scott A. Hodge, which you can download in PDF format here:
The United States has the highest overall corporate income tax rate (39.3 percent combined federal and sub-federal) among all countries in the Organization for Economic Cooperation and Development (OECD) (see table below). Japan (39.0 percent) and Germany (38.9 percent) have the second and third highest corporate income tax rates. The nation with the lowest corporate income tax rate in the OECD is Ireland (12.5 percent).
A little-publicized accounting rule change in the recent tax proposal by the Senate Finance Committee could pave the way for President Bush’s first veto. From the Houston Chronicle:
“Just days after a joint Senate panel quizzed oil industry executives about those lofty earnings, the Senate approved a provision that would prevent major integrated oil companies from using an accounting method known as last-in, first-out, better known as LIFO, when calculating the value of their oil inventories.
The measure would essentially force companies with revenue topping $1 billion a year and production of at least 500,000 barrels a day this tax year to tack on an additional $18.75 a barrel when calculating the value of their oil stockpiles, which in turn increases their taxable income.”
This legislation is estimated to cost the industry at least $4 billion. As our recent study highlighted, America’s oil companies are already heavily taxed. Over the past 25 years large U.S. oil companies have paid or remitted over $2.2 trillion, adjusted for inflation, in taxes to state and federal governments — three times what they collectively earned in profits over the same time period.
Changes in tax policy should avoid retroactivity and strive for neutrality. This legislation violates both of these fundamental principles of tax policy. The energy industry should not be forced to play by a different set of rules than any other industry. By changing a generally accepted accounting principle like LIFO, the Senate Finance Committee threatens to impose both retroactivity and violate neutrality at the same time.
If the legislation comes out of conference with this short-sighted and damaging tax policy intact, President Bush’s veto pen may finally see the light of day.
(Click image to enlarge.)
Source: Bureau of Economic Analysis, U.S. Energy Information Administration.
Anyone who doubts the federal income tax deduction for charitable gifts needs reform need look no further than yesterday's Washington Post, which details a truly bizarre tax deduction for the cost of big-game hunting trips if the mounted heads of the kill are donated to qualified charitable organizations:
Big-game hunters will find it far more difficult and less lucrative to donate their extra trophy mounts and claim charitable tax deductions under new tax rules being debated this week on the Senate floor...
The loophole Grassley said he is seeking to close allows big-game hunters to deduct some or all of the cost of their safaris if they later donate to a museum some of the trophy animals they kill and have mounted...
The Wyobraska Wildlife Museum in Gering, Neb., for instance, received hundreds of donated trophy mounts in recent years and kept most of them in trailers behind its modest facility before selling them at a taxidermy auction for a small percentage of the value claimed by donors...
The practice of donating hunting trophies has been broadly advertised within the big-game hunting community, with one appraiser from Chicago sending out brochures promoting ways to "Hunt for Free." Hunters have also been encouraged to set up "museums" in their homes that would allow for large tax write-offs.
"The equivalent for non-hunters would be if someone bought a sweater in Paris, donated it to Goodwill, and took a tax deduction for the entire trip to Paris," he said. (Full story here.)
If a tax deduction for the cost of hunting trips in exchange for the transfer of preserved animal heads to charities—who then auction them for cash—isn't impossible to defend, I'm not sure what is. Unfortunately, the new rules proposed by Sen. Grassley would simply limit the deduction, not eliminate it altogether.
Upon closer examination, there are many other bizarre and indefensible provisions in the federal tax code subsidizing 501(c)(3) organizations that are questionably charitable. It's unfortunate they're receiving little attention in the current tax reform debate.
A new BEA release shows state and local government revenues skyrocketing thus far in 2005. As USA Today reports:
Soaring state tax collections have created momentum for tax cuts in 2006, when most governors and legislators will face voters.
State and local revenue rose 7.2% in the first nine months of this year, the biggest jump since 1990, according to the U.S. Bureau of Economic Analysis. Spending is up 6%, the most since 2001.
Three years of strong revenue growth have left many states with large surpluses. New Mexico is looking at a $1 billion surplus. Florida expects more than $3 billion.
Even financially troubled California took in $3.4 billion more than it spent in the budget year that ended June 30 - the state's first surplus since 2000. California's deficit was erased by a 13.2% revenue increase. (Full Story)
Tax revenues at all levels are pro-cyclical—meaning they rise and fall with the state of the economy—since the bases of both income and sales taxes rise and fall with the economy. Since the U.S. economy has boomed over the past year, governments are seeing their coffers grow dramatically.
As numerous studies have shown, it's common for politicians to cut taxes during election years regardless of whether revenues are rising or falling. But since the state of the economy can be volatile, budget policymakers should pay careful attention to the risks associated with setting budget policy based on uncertain projections of future growth.
While tax reduction is economically almost always good news, it's also important for lawmakers to stay focused on long-term sound tax policy that's not constantly changing based on economic forecast from quarter to quarter, or the latest advice from political advisors.
With talk of scaling back deductions for home mortgage interest and state and local taxes in the headlines, there's one hard-to-justify tax preference that's being mostly ignored—the federal income tax deduction for charitable gifts.
Today's New York Times has an excellent piece exploring a question that's the subject of a forthcoming Tax Foundation report—is there any justification for subsidizing non-charitable non-profits at taxpayer expense?
Bottom line: not really. From the NYT piece:
Last year, the share of giving going to organizations most directly related to helping the poor hit a record low, accounting for less than 10 percent of the $248 billion donated by Americans and their philanthropic institutions.
Adjusted for inflation, gifts to health groups have almost tripled over the last four decades, and those to educational institutions have risen almost fourfold, while donations to human services groups are up only 28 percent...
Other statistics also suggest that the nonprofit sector has drifted from core notions of charity. Nonprofit hospitals provide no more charity care than taxpaying counterparts do. While university assets soar, tuition continues to outpace inflation. Only a sliver of giving to churches is spent on social services...
Has its definition been stretched so broadly that it no longer has meaning? If so, are the tax breaks that propel our philanthropy justified? (Full piece here.)
While subsidizing charities with tax preferences might make sense in theory, in practice the charitable deduction does of terrible job of it.
For one, its benefits are shockingly regressive. More than 75 percent of tax benefits from the charitable deduction went to the 12 percent of taxpayers with incomes over $100,000 on 2004. Taxpayers would never stand for that distribution of burdens for a direct spending program.
Second, many charities subsidized by the deduction are charitable in name only. Many look a lot like for-profit firms. Ms. magazine, Harper’s, Mother Jones and many other publications are subsidized as "charitable providers of educational materials.” The National Geographic Society sells videos and maps in direct competition with for-profit companies. The YMCA operates fee-for-service gyms. It's hard to see how these groups deserve a subsidy at taxpayer expense.
Finally, by shifting part of the cost of private giving onto others, it forces some to subsidize gifts to nonprofits with goals opposite their deeply held beliefs—for example, gifts to pro-choice groups end up being subsidized by taxpayers with pro-life views, and vice versa. How is that good policy in a free society?
For more on the case for reforming the charitable deduction, check out the House Ways and Means Committee's hearings from April 2005. And our new "Special Report" on the topic.
The Senate Finance Committee voted yesterday to temporarily change for tax year 2005 the accounting methods that can be used by integrated oil companies whose gross receipts exceed $1 billion. As today’s New York Times reports:
In a telling sign of the political impact of soaring energy prices, the Republican-controlled Senate Finance Committee voted on Tuesday to impose a $5 billion tax next year on the nation's biggest oil companies.
The measure amounts to a one-year windfall profits tax, a concept that most Republicans had until recently denounced as a discredited idea from the 1970's. It was added to a larger bill that would cut taxes by about $61 billion over the next five years.
Five of the largest oil companies recently reported that their combined profits for the third quarter surged to $33 billion as a result of skyrocketing oil prices. Last week, top oil executives testified at a Congressional hearing, defending their record results in the face of mounting criticism.
Lawmakers have been prodding the oil companies to give up some of their profits and have floated the idea of a windfall profit tax. But party leaders and the White House have firmly opposed such a move. Many Senate Republicans are counting on their counterparts in the House to reverse the tax on oil companies and add back an extension of tax cuts. (Full story)
This is bad tax policy for countless reasons. First, the provision has been put in place ex post facto. This would create future uncertainty in the oil sector, along with any other industries with volatile profits from year to year.
Second, while there is a widespread belief that corporations are entities separate from individuals, in fact a tax on corporations ultimately falls on people: workers, consumers, and shareholders. Where the incidence of this special tax would fall is unclear, but there is some indication that retirees and those saving for retirement would bear a large part of it.
Finally, this special “tax” is highly non-neutral both across industries and over time. Will it only be in place this year? Will it be extended to other industries?
For details of the bill, be sure to download the full Joint Committee on Taxation report here. Senate Finance Committee Report
In addition to imposing a one-time special tax on oil companies, the Senate panel’s report that was agreed to yesterday makes you wonder what the odds are of ever getting any true tax reform out of Washington. Highlights of the proposal, courtesy of Yahoo News:
The Senate Finance Committee voted 14-6 to endorse a package that would cut taxes by $60 billion over five years but would omit a GOP priority of preserving reduced tax rates for investment income. Sen. Olympia Snowe (news, bio, voting record) of Maine, a moderate Republican holding a pivotal vote on the committee, rejected the extension.
Without a change, the maximum tax rate on capital gains will increase to 20 percent and dividends will be subject to income tax rates in 2009. Although the Senate's tax bill would not extend the capital gains and dividend tax breaks, it would extend a host of other soon-to-expire tax breaks. The list includes investment incentives for small businesses, a tuition deduction, a business research and development credit and a deduction for teachers who buy their own classroom supplies.
The tax breaks include roughly $7 billion for individuals and businesses hit by hurricanes, filling in the details of the president's proposed Gulf Opportunity Zone and increasing education tax breaks for students from the Gulf Coast. Home buyers would get a new tax deduction for private mortgage insurance premiums.
The breaks also include a new deduction for taxpayers who donate more than $210 to charity during the year, making it available to everyone whether or not they itemize their deductions. Taxpayers who itemize deductions would lose some of their current advantage and be required to exceed a new $210 floor to get a tax break. (Full story)
Every year we see these tweaks here and there with special provisions that phase-out and phase-in at some specific moment in time. It’s hard to imagine what it might take to get lasting tax reform that promotes broad economic growth, limits uncertainty in decision-making, and makes the tax implications of decisions as neutral as possible.
It turns out that our hypothesis that imposing a windfall profits tax on oil companies would hurt retirees and those saving for retirement has some empirical support. A study to be released next week conducted by Robert Shapiro and Nan Pham found that a substantial share of the burden of a windfall profits tax would be borne by retirees in the form of lower-valued pensions. From the Dow Jones Newswire:
A windfall profit tax on U.S. oil companies, advocated by some politicians who believe the industry's soaring quarterly profits have come at the expense of consumers, would have a devastating effect on the savings and pension funds of many Americans, according to a new study.
In the study, commissioned by the non-profit Investors Action Foundation, Robert Shapiro, a former trade official in the Clinton administration who heads the economic advisory company Sonecon, and economic consultant Nam Pham found that by reducing both the market value of oil company shares and the dividends they pay, a windfall profits tax would affect the value of most people's retirement savings.
Since 41% of oil company stocks are currently held in various forms of pension plans and retirement accounts, retirees and those currently saving for retirement would bear much of the burden of the foregone gains, the economists said in the study to be released on Tuesday and acquired by Dow Jones Newswires. (Full Story)
Unfortunately, despite the warnings brought forth by this study, momentum to impose special taxes on “big oil” continues to build as is evidenced by yesterday’s agreement by the Senate Finance Committee to impose special accounting rules on oil firms, which amounts to $5 billion in additional taxes. See previous blog post.
Not to anyone's surprise, the realty industry has come out against the tax reform panel's attempt to limit the federal government's subsidization of their industry. From the Charlotte Observer:
The National Association of Realtors is "extremely upset" at a federal panel's proposal to reduce the home mortgage interest deduction, its chief economist said recently at the group's annual convention.
"We're in shock," said David Lereah, who said the Realtors had been promised that housing and charitable deductions would be protected. "Now this Bush commission has put all the housing subsidies on the table."
The proposal, by the President's Advisory Panel on Federal Tax Reform, "is not a trial balloon," Lereah said. It's not something the panel floats, fully expecting to trade it away later in exchange for something it really wants from the real estate industry. (Full story.)
Ask any economist that does not speak for the homebuilding or real estate industry and he or she will tell you that the home mortgage interest deduction has little economic justification.
Unfortunately, much of the backlash against proposed reforms has been within an income-class-distributional framework. Many of the defenders claim that limiting the deduction would hurt middle-class homeowners. However, they seem to ignore a simple fact: in order to take the deduction, you must itemize when filing taxes. And who tends to itemize rather than take the standard deduction? High-income earners.
Over 90 percent of householders making over $200,000 in 2003 itemized, while less than 40 percent of households making under $50,000 in 2003 itemized. (See IRS Filing Statistics (Excel)).
Also, the Panel's recommendations do not eliminate the deduction. They merely scale it down, especially at the top end (i.e., high property values). The proposal actually expands the deduction for lower and middle income homeowners who do not itemize. If anything, the Panel's proposals would help the middle class.
Given the fallacy of the "middle-class homeowners will be hurt" defense of the mortgage interest deduction, it's our hope that all parties can look beyond the game of short-term winners and losers and support policies that improve the economic well-being of society as a whole.
The Congressional Budget Office released a new study of marginal effective tax rates on labor income yesterday (PDF here). Why should we care about marginal tax rates? Here's one answer from their executive summary:
Higher marginal rates tend to cause more behavioral changes than lower rates do, leading to larger inefficiencies. Taxes on activities about which people are very flexible in how much of them to pursue will tend to create greater distortions than taxes on activities about which people have less discretion. And taxes that affect broad aspects of the economy—such as how much work is done—can have the greatest distortionary impact...
One interesting section of the paper explores what will happen to marginal tax rates if the 2001, 2002 and 2003 Bush tax cuts are allowed to expire in coming years. From the perspective of economic efficiency, it's not good news:
If tax provisions enacted in 2001, 2003, and 2004 expire as scheduled over the next five years, marginal rates will increase across most of the income distribution. Compared with a fully phased-in version of existing law, expiration would raise effective marginal tax rates by an average of almost 3 percentage points. Roughly half of taxpayers would face higher marginal rates...
Here's a chart of effective marginal tax rates on labor, by income percentile, under current law and after the expiration of the Bush tax cuts (click to enlarge).
Read the full study here (PDF).
At the beginning of 2004, just three local governments had rental-car taxes on the books. Today, there are some 44 rental-car tax proposals pending or approved nationwide. Why the sudden increase?
Sadly, it has nothing to do with good tax policy, and everything to do with politics.
Apparently the car-rental industry recently lost its lobbying group, making it easy prey for lawmakers. And since most rental-car customers are from out-of-state, local lawmakers can easily nail them with new taxes and face little political opposition at home. Here's the complete story, via the Wall Street Journal:
As of this August, there were 44 rental-car tax proposals pending or approved by local governments, up from just three on the books in the beginning of 2004, according to Enterprise Rent-A-Car Co.
At Chicago's Midway Airport, for example, a new charge of $3.75 per day went into effect on Sept. 1. Overall, the taxes range from 0.8% of the bill to $10 per rental. That might not sound like much, but an extra $10 per day charge can almost double the cost of renting an economy car in some cases, because base prices are near historic lows and some companies have been running aggressive weekend specials.
The flurry of taxation is partly due to the fact that the rental-car industry's trade association was dissolved in June, leaving it with no effective lobby. The industry is notoriously fractious, making it harder for companies to jointly combat tax increases.
Also, rental cars are considered ripe for taxation because more than half of customers rent at the airport, so lawmakers assume they don't live in the town and can't vote down the proposed fee.
Here's a table of some of the big cities with travel taxes, along with suggested ways to dodge the fees, courtesy of the WSJ.
Oil company executives went before Congress yesterday in a hearing designed to give the American people an explanation for the recent run-up in energy prices. From Reuters:
Big oil companies defended their combined quarterly profits of more than $30 billion at a Senate hearing on Wednesday, warning lawmakers that proposals for a windfall profit tax could discourage investments and lead to higher prices.
It was unclear whether the hearing would lead to any new energy legislation, or simply be a vehicle for Republicans and Democrats to assure voters of their concern about high prices.
Lee Raymond, the gruff chief executive who is about to retire from Exxon Mobil Corp., told the Senate's energy and commerce committees that proposals for a windfall profit tax on oil could hurt investment in domestic oil production. Exxon earned its biggest-ever profit, $9.9 billion, on revenue of more than $100 billion in the third quarter. (Full Story.)
It’s true that the oil industry is earning record profits thanks to higher oil and gas prices. But most causes of higher prices are beyond the control of oil companies, including increased energy demand from China and India, supply shocks from Hurricane Katrina, and falling output in Russia due to the Yukos scandal and in Venezuela and Iraq because of political uncertainty.
Unfortunately, even though these events are beyond the control of oil companies, the answer to rising prices from many in Washington has been a proposed windfall profits tax. Not only would such a tax create uncertainty that’s likely to reduce future output, it also would unfairly strip away profits from shareholders in an ex post facto manner.
A large portion of the shares of companies like Shell and Exxon Mobile are owned by mutual funds. Who owns mutual funds? Anyone with a well-diversified retirement portfolio. As a result, imposing a windfall profits tax may end up harming many Americans on the verge of retirement, without doing much to lower gas prices.
Just in time for Senate hearings grilling oil companies for their strong profit reports in recent months, here's a provocative data set to keep in mind.
The chart below shows the projected and actual revenues from America's last windfall profits tax passed during the Carter administration. The tax went into effect in early 1980, and was phased-out in 1988.
Not exactly a stable revenue source. For that chart and more, be sure to check out our latest "Fiscal Fact" here.
Around the globe, tax systems vary dramatically. But the most striking difference is between rich and poor countries. Rich countries tend to rely on broadly based tax systems that tax income or consumption, while poor countries rely more on tariffs, seignorage, and other non-tax revenue sources.
This is puzzling. Economists widely agree that broadly based tax systems are superior, and over time we’d expect all countries to converge on the “best” tax systems thanks to global competitive pressure. But poor countries aren’t moving in that direction.
Why not? There are two theories. One says that poor countries don’t have broadly based taxes because they have corrupt and unresponsive political systems, and bad policymakers make bad tax policy. However, the other theory says that poor countries don’t tax broadly because it’s harder for them to monitor taxable activity—think of trying to monitor the income of street vendors in a village market. That means relying on easy-to-monitor taxes might make economic sense for them.
Which theory is right? According to a new NBER paper by Roger Gordon and Wei Li, the latter explanation—that poor countries’ can’t easily monitor taxable activity—does a much better job explaining the data. From the abstract:
Observed economic policies in developing countries differ sharply both from those observed among developed countries and from those forecast by existing models of optimal policies. For example, developing countries rely little on broad-based taxes, and make substantial use of tariffs and seignorage as nontax sources of revenue.
The objective of this paper is to contrast the implications of two models designed to explain such anomalous policies. One approach, by Gordon-Li (2005), focuses on the greater difficulties faced in poor countries in monitoring taxable activity, and explores the best available policies given such difficulties. The other, building on Grossman-Helpman (1994), presumes that political-economy problems in developing countries are worse, leading to worse policy choices.
The paper compares the contrasting theoretical implications of the two models with the data, and finds that the political-economy approach does poorly in reconciling many aspects of the data with the theory. In contrast, the forecasts from Gordon-Li model are largely consistent with the data currently available.
Interesting paper—though it may be bad news for the world's poor. It's hard to see how poor countries can get growth while relying on tax systems that raise most revenue through trade barriers (tariffs) and printing money (seignorage).
Read the full paper here (PDF).
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