In an effort to curb illegal cigarette sales, New York Attorney General Eliot Spitzer has compelled UPS to stop shipping smokes to U.S. consumers. From Reuters:
United Parcel Service Inc. on Monday said it will stop delivering cigarettes to consumers in the United States in an agreement aimed at reducing Internet access to cigarettes by underage smokers…
Law enforcement officials argue that selling cigarettes over the Internet leads to violations of state laws involving age-verification of buyers and also avoids the payment of taxes.
While this agreement may have been motivated partly by concern for kids’ access to cigarettes, it is clearly also motivated by tax. States have been rapidly losing cigarette tax revenue in recent years as the Internet has reduced the cost of smuggling and tax evasion.
Unfortunately, it’s unlikely that this arrangement will do much to cut cigarette smuggling. Why? It doesn’t address the root cause, which is high excise taxes. Today, New York has a cigarette tax rate of $1.50 per pack. Even without UPS, it’s likely that the chronic cigarette smuggling that plagues America’s big cities will continue.
As yet another hurricane hammers the Gulf Coast region today, we've just released a new analysis of how the state of Mississippi can clear the decks for economic redevelopment by cleaning the weeds out of its state and local tax codes. An excerpt:
As the nation prepares for a massive rebuilding effort in the Gulf Coast region, policymakers in Mississippi should also consider rebuilding their tax system. While federal incentives may encourage companies to invest in the region in the short term, Mississippi’s state and local business climates will be considerably more important for economic development in the long term.
Congress has already passed an aid package worth over $60 billion for the afflicted areas, in addition to $6.1 billion in federal tax incentives for the disaster zone. Ideally, reforms should focus on creating an environment where capital formation is encouraged and entrepreneurship is allowed to flourish. Mississippi should focus on encouraging companies to invest in the state for the long-term, not just during the immediate aftermath and rebuilding period.
The logic of the piece extends beyond Mississippi, and applies equally to the entire Gulf Coast region. Be sure to see the laundry list of suggested repeals from Mississippi's tax code at the end.
Tax Analyst's David Brunori has an excellent analysis of the Tax Reform Panel's proposal to cut the home mortgage interest deduction in this morning's Washington Post. An excerpt:
You would think from listening to the folks in the real estate, mortgage banking and home construction industries that the world will end if home mortgage interest deductions are reduced... But in any case, the roof will not fall in if the home mortgage interest deduction is changed in the manner suggested by the president's panel.
The fact is that only one-third of taxpayers (46 million out of 130 million) itemize their returns. And only a tiny percentage of those deduct interest on mortgages of $300,000 or more. Earlier this year the Congressional Budget Office estimated that limiting the tax break to mortgages up to $500,000 would affect only 1 percent of all homeowners...
There is simply no tax policy justification for allowing large home mortgage interest deductions. Both conservative and liberal public finance experts have long criticized the home mortgage interest deduction because it shrinks the tax base, thus requiring higher tax rates. That's right, you are paying higher tax rates because of the home mortgage interest deduction.
The mortgage deduction also distorts economic decision-making, effectively subsidizing ever-larger home purchases by making it cheaper to borrow money. (And at the moment, borrowing is already pretty cheap.) That, in turn, has fueled the out-of-control real estate market. People have been buying houses that they might not otherwise have been able to afford. Yet, really smart people since the time of Adam Smith have warned against using the tax laws to distort markets. Perhaps it is time we listened. (Full piece here.)
As we've written before, the home mortgage interest deduction is terrible tax policy, forcing up income tax rates and dragging down economic growth. Unfortunately, thanks to its political popularity, the smart money is likely on modest reforms if any.
The President's Tax Reform Panel held its final public meeting yesterday and has hinted at what reform proposals it may endorse when it releases its final recommendations on November 1. These include measures aimed at shifting from a tax code filled with distortions and complexities to one that promotes simplicity and economic growth. From the Financial Times (via Yahoo News):
With his second-term domestic agenda stalled, President George W. Bush has been casting about for new initiatives. The panel he appointed to recommend simplifying the labyrinthine US tax code handed him a huge one on Tuesday, recommending sweeping changes to the US taxation system.
The panel intends to call for the capping of tax deductions on interest for home mortgages and employer-sponsored healthcare, eliminating the deduction for state and local taxes, and overhauling tax reductions for popular retirement savings schemes. In exchange, it will recommend abolishing taxation of dividends, cutting personal and corporate income tax rates, and ending the worldwide taxation of US corporate earnings.
The most controversial of its recommendations is likely to be reducing the mortgage interest tax deduction, which allows taxpayers to write off their annual interest payments on home loans of up to $1m.
Even before the panel's final report has been published,the powerful home-building industry has been lobbying to kill the proposal.
Now it appears to be a wait and see of what the panel will specifically propose. Stay tuned to this blog and the Tax Foundation's Countdown to Tax Reform for the latest.
Fresh from the printers, the Fall 2005 issue of Tax Watch is now available. Highlights include: How to Expand America's Tax Base and Lower Rates, What is a Fair Tax?, and—my personal favorite—How the Home Mortgage Interest Deduction Makes Society Poorer.
Download the full issue here. And remember: Tax Foundation donors receive free hard copies of Tax Watch via mail. Why not click here and join us today?
As casino gambling made its way into St. Louis, one industry has lost business—the local horse racing track. So what do the tracks want in return? A tax on casinos that funds a subsidy to themselves. From today's St. Louis Post-Dispatch:
At Fairmount Park, the effect of a decade of casino competition is spelled out in shorter weekly horse racing schedules, and counted out in lighter purses.
Now, Fairmount and the rest of Illinois' horse racing industry want the casinos to pay for that lost business. Legislation, to be presented in Springfield next month, would require a 3 percent tax on casino revenue, to be used to fatten race purses and spur horse racing in Illinois.
State Rep. Bob Molaro, D-Chicago, next month will push for what he calls "the 3 percent solution." Under the legislation, each of the state's nine casinos, including the Casino Queen in East St. Louis and Argosy Casino in Alton, each year would have to give up 3 percent of their adjusted gross revenue (their income after paying out winnings but before any other expenses).
The money - an estimated $60 million to $100 million a year - would go into an "equity fund" to help bolster horse racing. In exchange for that cost, the legislation would offer the casino industry an increased number of allowable gambling positions to 3,000 per casino, up from the current 1,200 limit.
This is a classic case of an incumbent business seeking protection via the tax code, limiting competition at the expense of consumers.
Legalized gambling is controversial. But for one firm to argue that ensuring quality horse racing is a proper role of government—and in the process penalize competitors for doing a better job pleasing consumers—is a pretty disingenuous argument, and clearly rewards a special interest at the expense of the public interest.
If "quality" horse racing is the goal, why not extend the horse racing industry's logic (of opposing free competition) to the races themselves? That is, why not give a head start out of the gate to slower horses, and force their jockeys to carry an extra 30 pounds? Won't that ensure a quality race?
At the recent meeting of the President’s Advisory Panel on Tax Reform, members discussed the merits of capping the mortgage interest deduction. According to a story in USA Today, some special interest groups are gearing up for a fight to protect the coveted deduction.
"When this report is issued and the debate then begins ... the National Association of Home Builders is going to do its damnedest to protect the preferred treatment of housing in the tax code," says Jerry Howard, NAHB executive vice president. [Full Story]
While the mortgage interest deduction is a popular political tool, simple economics shows us why it may be time to say goodbye to the deduction in current form. As numerous economists have pointed out, the current incentive structure makes housing virtually a tax free investment. The resulting over-consumption of housing is estimated to equal 35% of net private investment since 1980. The relationship between the mortgage interest deduction and increased homeownership is not as clear as some would believe and the benefits of the deduction mostly accrue to the wealthy. Moreover, the mortgage interest deduction is one of the largest tax expenditures in the federal budget.
You can be sure that rent-seeking groups will engage in a plethora of lobbying efforts to protect their special interests. However, lawmakers should remember the public interest when deciding the future of the mortgage interest deduction.
An excellent op-ed from this Sunday's Seattle Times unleashes a terrific and well-deserved salvo against the home mortgage interest deduction. From the piece:
The mortgage-interest deduction is bad economic policy. It encourages consumption, rather than saving. People take out big mortgages to free up spending money. (A little devil tells them not to worry about all the borrowing because the interest on the loan can be tax-deductible.) An unhealthy economic incentive, the deduction is also expensive. It cost the Treasury $63 billion last year in needed revenues. The entire budget of the U.S. Department of Housing and Urban Development was $35 billion.
The deduction is bad social policy. It discriminates against renters, and even homeowners of moderate means.
"The people who have the biggest homes, who make the most money are the greatest beneficiaries of this tax subsidy," says Nicolas Retsinas, director of the Joint Center for Housing Studies at Harvard University. "If you rent, you don't get the deduction. Even if you own a home and have a modest income, you're likely to take a standard deduction, which means you don't get it."
The mortgage-interest deduction is a boulder in the stream of tax reform. A lot of people say they want a "flat tax" — a single rate for all incomes, with no deductions, exemptions or loopholes allowed. A flat tax could cure the annual migraine of filling out IRS forms. But there can be no honest flat tax that makes an exception for a break that benefits the well-to-do...
Reagan was right on this one. And so is Bush's tax advisory commission. Is there a brave political soul out there looking for a good policy?
Agreed on all counts—including the author's pessimism that lawmakers will substantially reform the home mortgage interest deduction given pressure from realtors and home builders to preserve it. Read the full piece here.
Scott Hodge has an op-ed in this morning's New York Sun. The topic? The growing number of Americans being pushed out of the tax system by various credits, exemptions and deductions in recent years, and what that means for tax reform.
Hint: it's not good news for tax reformers. An excerpt:
For the first time in 20 years, Washington seems poised to overhaul the federal tax code. Americans are ready to support fundamental tax reform judging from their responses to the 2005 Tax Foundation Annual Survey of U.S. Attitudes on Taxes and Wealth conducted by Harris Interactive. A majority of American adults believe federal taxes are too high, the tax code is too complex, and the income tax system is unfair. A majority even support simplification even if it means giving up the deductions and exemptions they now enjoy.
The biggest obstacle to reform may not be the army of Washington lobbyists who will fight to protect those deductions and exemptions. The most serious obstacle to reform is the fact that America has become divided between a growing class of people who pay no income taxes and a shrinking class of people who are bearing the lion’s share of the burden.
Despite the charges of critics, the tax cuts enacted in 2001, 2003, and 2004 dramatically reduced the tax burden of low- and middle-income taxpayers and shifted the tax burden onto higher-income taxpayers. In 2004, one out of every three Americans who filed a tax return (42.5 million) had no tax liability after they took advantage of their credits and deductions, while millions more paid next to nothing. As a result, the top 20% of taxpayers — those earning more than roughly $71,000 in 2004 — now pay over 80% of all the income taxes.
The widening gulf between the “payers” and the “non-payers” poses a dilemma for tax reformers. Generally speaking, the goal of tax reform is to broaden the tax base while lowering tax rates. But how do you craft a tax reform plan that (1) doesn’t raise taxes on the 42.5 million Americans who pay nothing — and in many cases receive a refundable credit — and (2) doesn’t “cut taxes for the rich” who now pay everything? There is no easy answer.
As gas prices rise and the calls for conservation continue, many lawmakers are congratulating themselves for adding fuel tax credits to the recent energy bill. But given the staggering complexity of the various credits and bonuses, it's not clear whether the tax savings are worth the headache. From U.S. News & World Report:
If you want a nice tax break for buying a hybrid vehicle, it might be worth waiting till January. But not much longer than that.
Congress has changed the law to create a new tax credit program for "alternative motor vehicles," potentially broader and more valuable than the old tax-deduction program—but far more complicated. Each car will carry a different tax credit, depending on its fuel economy, weight, and tailpipe pollution.
Another twist: Even though the program purportedly extends to 2010, tax breaks on the most popular vehicles will run out before the end of next year. That's because Congress has limited the number of cars eligible for the tax credit by manufacturer. As soon as an automaker has sold 60,000 hybrids, the tax credit phases out.
If you can handle an even more in-depth explanation of the staggering complexity of these credits, read the full story here.
The intension may have been to boost environmental quality and lower energy demand, but the end result may be drug stores stocking up on aspirin around tax time. Further evidence of the many flaws in the recent energy bill. For more proof, see here, here, here, here, here.
What are the chances Congress will enact fundamental tax reform? Not good, according to those placing real bets in U.S. financial markets. From Forbes:
Many economists, for example, argue that the total exclusion from tax of employer-paid health insurance and the generous tax breaks for homeownership inflate demand and prices in those sectors. Yesterday, the president's panel publicly toyed with limiting both of them--perhaps capping the health insurance exclusion at $11,000 an employee and limiting the deduction for mortgage interest to as little $350,000 in home-acquisition debt, down from the current $1 million.
Stocks of home builders such as Toll Brothers, Pulte Homes and D.R. Horton, already hurt by Fed tightening, didn't react. The smart money, it seems, is still betting against tax reform.
In addition to this nugget of economic wisdom, the Forbes piece is chock-full of smart analysis of the current tax reform debate. Check out the full piece here.
A tax increase went into effect yesterday in Oklahoma, and people are celebrating. All across the state, jubilant Oklahomans are lining up to begin paying the new tax. The governor even bestowed upon Oklahoma’s Teacher of the Year the honor of paying the first few cents.
It seems odd for taxpayers to celebrate a new tax, doesn’t it? Perhaps we should mention that the new tax is actually a state-run lottery. Oklahoma has just joined the District of Columbia and 40 other states that raise implicit taxes through lotteries.
The lottery is projected to generate $219 million in sales in FY2006, 30% of which will go into state coffers (35% after the first two years). This means the lottery will raise $65 million in tax revenue for the state, although Oklahoma, like other states, will refuse to acknowledge that its lottery proceeds are actually tax revenue.
The implicit tax rate on Oklahoma’s lottery tickets is a staggering 43% and will rise to 54% after the first two years. If revenue estimates are correct, every Oklahoman will pay $18 in lottery tax in FY2006.
Proceeds will allegedly benefit public education. However, other states have found that lotteries for education often do not live up to their promises; legislators can shuffle funds, knowing that lottery money will fill in any gaps in the education budget. Oklahoma has created a “lockbox” to prevent misallocation, but there is no practical way to safeguard the revenue.
Not everyone is celebrating—not the 35% of voters who rejected the lottery referendum last November, nor the public policy groups who vehemently oppose it. They worry that the lottery will take advantage of the poor, and they may have a point: the Lottery Commission planned to allow pawn shops, check-cashing businesses, and payday loan companies to sell tickets, until a groundswell of opposition forced them to reconsider-–the day before ticket sales began.
Many Oklahomans envision pots of gold for the schools--or for themselves if they beat the odds--but all a lottery really does is undermine the principles of sound tax policy. It makes taxes more complex, more regressive, less transparent, and less neutral.
Is that really worth celebrating?
Read more on state-run lotteries here.
Tax Foundation President Scott A. Hodge recently appeared on Marketwatch Weekend. The topic? High property tax bills and booming housing prices, and the impact a collapse in housing values might have on state and local tax revenues.
Governments tend to not let any new technology go too long without trying to get its hands on the money it generates. Such is the case in Japan where the government is considering a tax on the popular iPod. From ABC News:
A Japanese government committee is mulling a copyright law revision to charge royalties on digital music players, but the opinion is so divided on the so-called "iPod tax" that it isn't likely to be imposed, officials said Wednesday.
Japan already levies an extra fee for copyrights on gadgets sold in stores such as mini disk recorders that consumers can use for home copying of music. That charge, generally 3 percent of the product's wholesale price, is included in the price tag so most shoppers aren't even aware they're paying it.
Since last year, recording companies and other lobbies here have been grumbling that the same system should be applied to recording devices with hard-drives, including MP3 players like Apple Computer Inc.'s iPods as well as possibly flash-memory players.
As the article further explains, this tax tends to violate many of the core principles of sound tax policy, especially the likelihood that fair enforcement would be difficult and the fact that this tax is highly discriminatory against a specific industry. Taxing a specific industry like portable recording devices merely because taxes are already in place for its “old” competition and thus to make the market “fair” leads to a continual game of catch-up for tax policy makers as new technologies constantly emerge.
The best policy would be for governments to not impose special taxes on certain industries, but rather a broad based tax that all industries pay, where “specific” taxes would only be imposed in those cases where special government services disproportionately benefit that narrow group of producers.
The most striking trend in tax policy in recent years has been the rapid rise of flat tax systems in country after country (see previous posts here, here, here and here).
Since 1994, Estonia, Georgia, Latvia, Lithuania, Romania, Russia, Serbia, Slovakia and Ukraine have all adopted single-rate income taxes ranging from 12 percent to 19 percent. Poland is set to replace its progressive system with a flat rate of 18 percent, and Greece and Italy are both considering single-rate taxes in the range of 25-30 percent.
Tax Analysts' Martin A. Sullivan has an excellent analysis of the recent trend toward flat taxes in the October 10, 2005 Tax Notes (via TaxProf Blog). An excerpt:
Governments -- especially those in developing economies with massive compliance problems -- are going to lower rates and broaden their tax bases no matter how many books Americans write on tax reform. It is just icing on the cake for those governments, hungry for foreign investment, that they can call their modified systems "flat taxes." Not only is it free advertising but it's also advertising targeted to the investor class.
What better way for former communist countries to signal their capitalist renaissance than by appearing to embrace the fiscal ideas of U.S. conservatives? What better way for the American flat tax movement to claim continuing success than to go beyond textbook presentations and point to tangible progress in other countries? But to force that square peg into a round hole, the "receiving" governments and the "donating" conservatives have let the definition of the flat tax slip. That hasn't caused much fuss because it is to the mutual advantage of both parties.
It is to our advantage, however, to look beyond the slogans and see the flat tax "revolution" for what it really is. The world is becoming more global. Capital and even labor are more mobile. Out of necessity, governments around the world are responding with lower rates and broader tax bases. That is the good side of tax competition. International forces are bursting the political coalitions that have kept high-rate, loophole-ridden tax systems viable.
What is called the flat tax revolution is only a small part of a worldwide transformation in taxation. The flat tax is a neat idea, but it has political limitations. It certainly is not the driving force behind tax reforms around the world. It is just along for the ride.
Join the Tax Foundation's fight for sound tax policy Go
The Tax Policy Blog is the official weblog of the Tax Foundation, a non-partisan, non-profit research organization that has monitored tax policy at the federal, state and local levels since 1937. Our economists welcome your feedback. If you would like to send an e-mail to the author of a blog post, please click on that person's name to locate his or her e-mail address or visit our staff page here.