Last week, the Tax Policy Center held an event called “Measuring the Distribution of Federal Spending and Taxes.” At this event, Gerald Prante presented his findings from the Tax Foundation study called “A Distributional...
The Tax Policy Blog
In 2005 the cost of complying with the individual income tax—the cost of filling out paperwork, hiring accountants, and gathering documentation—rose to over $265 billion. And that's just at the federal level; state income taxes add a significant compliance cost of their own.
California, in an attempt to make paying state income taxes easier for residents, has launched a pilot program called ReadyReturn, in which the California Franchise Tax Board prepared 50,000 of the simplest tax returns—for single, childless, low-income taxpayers with no special deductions or credits—and mailed them to the taxpayers, giving them the option of signing the returns or redoing them.
As we’ve written before, the ReadyReturn plan would not accomplish its goal (most of the 50,000 prepared returns were thrown away), and the costs—financial and otherwise—would be high. Now, a coalition of concerned citizens and groups, including the California Chamber of Commerce, has launched a web site to stop ReadyReturn and ask the legislature not to approve an extension of the program, which is scheduled to expire after this tax season.
The Small Business & Entrepreneurship Council, a member of the coalition, stated in its Weekly Briefing (not available online):
"ReadyReturn" is risky and represents an inherent conflict of interest with tax collector also acting as tax preparer. … In addition to the concern over conflict of interest, there are serious concerns regarding taxpayer privacy. Identity theft is the fastest growing crime in America and a software glitch or bureaucratic error involving "ReadyReturn" could be catastrophic for taxpayers. With the added substantial technology infrastructure and government bureaucracy needed to run "ReadyReturn," the program will end up costing taxpayers untold amounts as well.
The best way to reduce the staggering costs of tax compliance—at the state or federal level—is to simplify the income tax code to the point where taxpayers can easily and quickly calculate their own tax liabilities. Fundamental tax reform in the form of a consumption or flat tax could also dramatically reduce tax complexity and compliance costs.
Click here for more on tax compliance costs.
One of the problems with any income tax is that it entices individuals to accept compensation through non-taxed means, some of which are referred to as “fringe benefits.” But England is taking aim at employers who compensate their employees indirectly by throwing office World Cup parties. From Financial Director:
Workers enjoying World Cup parties put on by their employer could be hit with a nasty tax bill, according to Blick Rothenberg, a tax specialist firm based in London.
Under income tax rules, employers who invite staff to social functions have to declare the hospitality to HM Customs & Revenue if the cost per worker amounts to more than £150 over the course of a year.
While Christmas parties are generally exempt because it is unusual for employers to spend that much per head, Blick Rothenberg said the extra expense of World Cup hospitality could take some workers over the limit.
If the hospitality for the year exceeds £150 staff would then [be] charged income tax at their highest marginal rate on the whole value, not just the excess.
Employers have the option to take on the expense, but the firm said many may choose not to.
While this may raise individuals’ tax burdens, this policy is consistent with the theme of neutrality in an income tax system. Neutrality means that all sources of compensation should be treated equally by the tax code. But what constitutes income is truly a question that is difficult to answer, and even if it is answered, the amount of income may still be difficult to measure. This is one major reason that many economists have looked for other tax bases, like consumption.
Under the existing income tax system in most countries, including the United States, there are a myriad of ways in which employers compensate their employees so as to avoid income taxation. These benefits are often difficult to measure (and enforcing taxation of them is also difficult, even if they could be measured) and can range from plush offices with a great window view to the privelege of sitting in the company’s luxury box at local sporting events.
For more on issues concerning the federal income tax, check out our section devoted to the topic.
In the debate over state-run lotteries, a common question is whether lotteries are a regressive tax—that is, whether they place a heavier tax burden on the poor than on the wealthy. Many studies have attempted to prove or disprove this, and the majority of experts believe lotteries are regressive.
One tool used to analyze lottery data is sales records in various zip codes. If there is a strong enough correlation between high sales and low per capita income in a certain zip code, the lottery is said to be regressive in that area.
While zip-code studies are useful to a certain extent, there are limitations. First, lottery players often purchase tickets in zip codes in which they do not reside, e.g. many people purchase tickets near their workplaces.
Second, sales/zip-code data are sometimes interpreted incorrectly. The misinterpretation hinges on a misuse of the word “regressive.” A regressive tax is one that falls disproportionately on low-income individuals and takes a larger percentage of income from low-income taxpayers than from upper-income taxpayers. Regressivity measures the percentage of income spent on taxes, not the dollar amount.
If a person who makes $15,000 a year purchases $3,000 worth of lottery tickets, she will spend 20 percent of her income on the lottery—quite a large portion (about one-third of that amount will be in the form of implicit lottery taxes). However, if an individual who earns $1,500,000 a year spends the same amount, it will be a drop in the bucket—a mere .2 percent of her income. Taking into account only the dollar amount spent misses the point.
Our current federal income tax is progressive, meaning rates rise as income rises—the opposite of regressive. Many experts have argued for a flat tax, with one rate for all, but virtually no one would argue for a regressive income tax, where rates rise as income falls; such a tax would be seen as unfair and unduly burdensome to the poor.
Some people mistakenly believe a tax must impose a higher dollar amount on the poor in order to be regressive. For example, a recent Lottery Post article states:
National studies frequently show ... that the dollar amount spent on lotteries generally does not fluctuate much over income brackets.
However, the article is titled, “Study proves lottery not 'regressive tax'.” If people in different income brackets spend the same amount on the lottery, then the implicit lottery tax (the portion of proceeds kept by the state) is regressive. Therefore, this study actually shows that the lottery is regressive.
For more information on lottery taxes, click here.
An editorial appearing in the most recent Forbes magazine advocates the implementation of taxes on carbon emissions in an effort to combat global warming while at the same time trying to keep our lives simple. From Forbes (free registration required):
An inconvenient truth, not adequately addressed by Al Gore in his movie, is that environmentalism makes life complicated. If SUVs are bad and wind power is good, then we must levy a tax on gas-guzzlers and hand out tax credits for windmills. Those in the business of selling windmills are very happy with this arrangement (see story by Naazneen Karmali), but in no time our fears of global warming have caused our economy to become littered with subsidies, credits, deductions, tax surcharges, earmarks and research boondoggles. Here's a way to make life simpler: Chuck out all energy legislation, replacing it with a one-sentence statute that levies a tax on carbon emissions. Let's do it big--30 cents a pound. So that people can adjust, start it at 1 cent and increment the tax by a penny a year from now to 2036. (Full Story)
If the goal of a carbon tax is to combat global warming, there exists one major problem: enforcement. In the global marketplace, a healthy climate would be a public good where all countries benefit. Therefore, even if the entire world may benefit on net from a global carbon tax, without a proper enforcement mechanism, each autonomous country may have an individual incentive to not sign onto the tax given that everyone else has signed on. This tragedy of the commons is solved only by an allocation of property rights or via government enforcement. But who owns the rights to the global climate? And would some governments have authority over other governments, and if so, how? Would this enforcement be via military force, trade sanctions, or merely diplomacy?
All of these questions need to be addressed before any serious attempt at combating global warming through tax policy, or even through a cap and trade system, is made at the individual country level.
An article yesterday from Smartmoney.com offers what it calls, "10 Things Your Rental Car Company Won't Tell You." Not surprisingly, the growing tax burden imposed on rental car companies by state and local governments made number one on the list.
From the article:
1. "We're a tax magnet." As with the rest of the travel industry, business is up for car rentals and expected to climb even higher after having remained fairly flat for several years. But customers are already paying more, due to an unprecedented slew of taxes and fees.
However, that extra money doesn't go to the rental car companies but into city and state coffers, where it's used to fund municipal projects. For example, in 2005, car rentals in Arlington, Texas, were hit with a 5% tax to help pay for the new Dallas Cowboys stadium. Car rentals get tapped as fundraisers because local politicians won't feel the repercussions at the voting booth. "They're taxing people who are flying in from someplace else," says Hertz spokesperson Richard Broome. "These people can't and don't vote locally, so there's no harm for them."
But there's a way for consumers to dodge some of these fees: Pick up your car in town, not at the airport... (Full piece here.)
Of course there's a better way to avoid these rising rental car taxes than to "dodge" them as the article suggests—encourage state and local lawmakers not to levy unjustified excise taxes on car rentals to begin with.
As we've written before, many of the rental car excise taxes that have been imposed around the nation in recent years are impossible to justify on any economic grounds. Most of them suffer serious design flaws, and fail to satisfy basic, widely-agreed-upon principles of sound tax policy.
Probably the most important flaw in most rental car excise taxes is that they don't closely link taxes paid with government services provided, violating what economists call the "benefit principle" of taxation.
In recent years, special rental car taxes have been levied to supplement teacher's salaries, build sports stadiums, and to fund other general government services that bear no relationship at all to the rental car industry. That's just poorly designed tax policy.
Government programs like roads, sports stadiums and theater arts centers that lawmakers argue will benefit all residents equally should be funded through broadly-based taxes. They should not be funded through high-rate, non-transparent, and politically expedient excise taxes on one particular industry.
Apropos yesterday's post on the economics of "soda tax" proposals aimed at trimming America's waistline, the Cato Institute's Radly Balko makes the case against soda tax proposals in their latest daily podcast.
The issue of line-item veto is on the table again, and the bill before Congress right now would include line-item authority for the president on both spending and tax matters.
From Tax Analysts:
As the House Budget Committee plans to mark up line-item veto legislation on June 14, the Senate will opt to move the line-item veto the following week as part of a budget process reform package, Senate Budget Committee Chair Judd Gregg, R-N.H., told reporters on June 13.
“Tomorrow we’ll be introducing a very extensive bill to help control spending and to help stop overspending,” Gregg said. Gregg and Senate Majority Leader William H. Frist, R-Tenn., are scheduled to unveil the proposal on June 14, although action on the bill likely would not come until the week of June 19, Gregg said. President Bush’s proposed expedited rescission authority would be included among the bill’s many money-saving elements, he added.
The line-item veto legislation would allow the president to send specific provisions from spending and tax bills to Congress for reconsideration. Congress then would have to vote on the proposed rescissions within 10 days without filibuster or amendment. (Full Story)
If Congress is going to give the president the line item veto authority, it should definitely include matters of tax law. One of the goals of those who champion the line item veto is to allow the president to rein in unnecessary spending. But “spending” also takes place on the tax side through the provision of special tax provisions for certain industries, companies, or geographies.
What is the difference between a direct subsidy on the spending side to a company that is poor spending policy and an equal tax deduction that is poor tax policy? Nothing, except that going through the tax code is often less transparent, and therefore easier for tax lobbyists to get inserted into law.
What happens when the expanded use of fuel efficient vehicles leads to a reduction in the usage of gasoline? Some in Oregon are not pleased with the outlook of this scenario, because it would lead to a reduction of government revenue through various forms of gasoline taxes.
Oregon was the first state to adopt a tax on gasoline in 1919 and may just be leading the way again. Oregon is set to experiment with a “mileage tax” and if successful, it could pave the way for new forms of transportation taxes nationwide. From the AP:
"If a test drive of mileage-based fees for drivers pans out during the next 10 months, it could replace Oregon's gas tax and serve as a national model for road funding in the future.Oregon's 24 cents-a-gallon gas tax, which is used to fund roads, has not increased since 1993. Some at the state Department of Transportation say the money could dry up in future years as hybrids and other fuel-efficient cars become more popular. So the state is investigating other alternatives to pay for roads.The mileage-fee project was designed by engineers at Oregon State University. The system works by using a global positioning system in a car to determine the number of miles traveled inside and outside of Oregon and at what times, which could lead to peak driving-time fees. When the car pulls into a service station, a radio transmitter sends the data to a reader in a gas pump. The mileage fee is added to the bill, and the gas tax is subtracted." [Full Story]
This story from Oregon is a perfect example of how technological developments in the 21st Century are making various forms of taxation obsolete in today’s marketplace. Professor Richard Wagner wrote an excellent Tax Foundation study on this subject, which can be read here.
To read Tax Foundation research on gasoline taxes, click here.
Governor Bush signed into law two interesting tax bills recently. One bill repealed the despised per-alcoholic drink tax and the other provided a property tax exemption to a bible amusement park.
Governor Bush signed a bill repealing Florida's tax on alcoholic drinks. The measure does away with the last of the per-drink tax, which has long been a bane of restaurants and bars, because owners say it costs them more to collect and remit than it brings in for the state.
And the Holy Land Experience biblical theme park near Orlando won't have to pay property tax under a bill Bush signed.
Park officials describe the five year old Holy Land Experience as more of a Bible-based history museum aimed at religious education. Visitors can enter a replica of Jesus' tomb, or see Jesus heal a blind man, climb the stairs of a faux Herod's Temple and travel down a re-creation of the Via Dolorosa.
Full story here.
The drink tax was levied on each drink served at a rate of 3.34 cents for 1 ounce of spirits or 4 ounces of wine, 1.34 cents per 12 ounces of beer and 2 cents for 12 ounces of cider. The rate structure alone made the tax difficult to administer.
The property tax exemption for the biblical theme park is difficult to justify from a neutrality perspective. All amusements parks should be taxed at the same rate so as not to create distortions in the market favoring one type of park over another. Even though the park is owned by a nonprofit group and has an educational theme, it should be taxed like all other parks. See a recent paper by Andrew Chamberlain on charitable deductions to learn more.
In a story that has garnered considerable media attention, the American Medical Association is considering recommending that a special tax be imposed on soft drinks in an effort to curb obesity.
The American Medical Association, meeting in Chicago this week, will consider a controversial proposal to fight obesity by taxing soda pop.
A committee of the influential doctors' group is recommending the AMA lobby for a "small" federal tax on sugar-sweetened soft drinks, with proceeds going to anti-obesity efforts such as physical activity programs and healthier school meals.
The committee did not specify how high the tax should be. But a consumer group, Center for Science in the Public Interest, estimates that a 1 cent a can tax would raise $1.5 billion a year. That's more than the advertising budget of McDonald's. (Full story here.)
As with many attempts to achieve broader social goals through the tax system—as opposed to simply raising revenue efficiently for programs—a soda tax aimed at curbing obesity is not designed with any economic rationale in mind. Instead, it appeals to a paternalistic desire to control individual behavior in society, and treats the tax system as merely a convenient mechanism to achieve that end.
The problem with this approach to tax policy is that the possibilities for such interventions are endless. Every organization, regardless of mission or political orientation, has a set of social outcomes they’d like the tax system to encourage or discourage, ranging from smoking, gun control, illegal drugs, abortion, adult entertainment, gay marriage, drinking, immigration, gambling and more. Because the tax system can change relative prices facing individuals, it can have a powerful effect on individual behavior regarding all these issues, and across a large number of individuals.
But is there an economic rationale to these types of taxes in general? One might argue that there are what economists call “negative externalities” caused by drinking soda, and that as a result people are drinking “too much” of it in the private marketplace. But what could these externalities be?
Many have claimed that drinking soda leads to obesity, and that the health risks associated with being overweight may drive up the price of health insurance. While this nutritional linkage is scientifically far from clear, even if it were true, this is clearly not a negative externality as understood by economists. Externalities are costs imposed by some party onto another outside the normal operation of the price system. If the rising demand for health care by obese people leads to rising health care prices, that isn’t an externality. That’s just a normal price change in the marketplace like any other.
Others have claimed that obesity—again, on the unlikely assumption that soda consumption is in fact an important cause of obesity—drives up taxes because it leads to increased expenditures for government-provided healthcare. However, there are problems with this line of reasoning as well.
First, as with other health-influencing behaviors like smoking, if rising health expenditures due to obesity are counted as “negative externalities,” then for the calculation to be honest it must also include “positive externalities” associated with decreased life expectancy, such as reduced government expenditures on old-age related programs such as Social Security. Any legitimate measurement of the tax-related “externalities” from obesity must account for both taxpayer losses and gains, and cannot simply total-up the costs alone.
Second, not everyone who drinks soda, and thus who would pay a soda tax, ends up obese, making a broad excise tax on soda a blunt and inefficient mechanism for curbing obesity. As we’ve written before, if the true goal is weight reduction, there are more direct means of achieving that than a poorly targeted excise tax on certain politically unpopular products or industries.
Of course, the core problem that obesity taxes are an attempt to solve is that some users of government-funded health care inevitably make risky health choices that others end up subsidizing through the tax code.
But the simplest solution is not an additional tax on risky health choices, and the products that supposedly lead to them. It is to create a health care system in which individuals who demand healthcare bear the costs of their own individual behaviors, as they are expected to do in most other areas of the marketplace.
We've posted a new "Fiscal Fact" to the website explaining the difference between Census Bureau state and local tax collections figures, and Tax Foundation tax burdens.
They key difference lies in the treatment of "tax incidence." Census figures measure who is legally required to make tax payments—what economists call the "legal incidence" of a tax—while Tax Foundation tax burdens attempt to measure who actually bears the economic burden, or the "economic incidence," of taxes.
This distinction is an old one, dating back at least to the 19th Century French Physiocrats. Yet it is surprising how often it is ignored in modern tax policy debates.
In the wake of a defeat of California's Proposition 82—which would have increased California's top income tax rate to fund a preschool education program—there's an interesting article in yesterday's Los Angeles Times examining how California's rising state and local tax burdens may be approaching a "tipping point," encouraging wealthy residents to relocate to nearby lower-tax states. From the article:
To live in California is to pay the highest state income tax rate in the nation, if you're wealthy enough.
Last week, voters had a chance to raise that tax rate to new heights by approving Proposition 82. They declined.
Did they figure that the Golden State's rich were already thoroughly soaked — or did 82, which would have funded universal preschool for 4-year-olds, just not present a convincing enough case?
The question is important to Bob Rodriguez, a principal at money management firm First Pacific Advisors Inc. and someone who is in Proposition 82's target demographic.
He fears that the electorate may yet be willing to embrace more tax-the-rich propositions. He sees these ideas as fiscally calamitous in the long run because they may induce high-income people to move out of state to avoid the tax hit. Drive out enough of the rich, Rodriguez says, and the state will have no choice but to demand more tax revenue from people much further down the income scale.
The 57-year-old Rodriguez says he would, in fact, have been driven out of his native state if Proposition 82 had passed. For months before the primary election, he told anyone who would listen that he would leave California if 82 were approved.
Nevada is right next door, after all, and it has no income tax, period. Proposition 82 would have raised California's top tax to 12% from 10.3%.
"I will not allow my assets to be expropriated," Rodriguez says.
The rant of a greedy millionaire who doesn't want to pay his fair share of taxes? Rodriguez knows that some will say so. But he comes to the discussion with a different perspective from that of many millionaires. His grandparents on his father's side had their wealth seized in the Mexican revolution of 1910, he says. They came here to start over.
Looking through that prism, Rodriguez sees a tax imposed on a minority by the majority as grossly discriminatory.
"If these services in society are needed, then everyone in society should pay for them," he says of the preschool program.
Two weeks ago, we blogged about changes made to New York’s regulations on the taxation of telecommuters. Relying on a Wall Street Journal story, we said that the new rules appeared to make more sense from an economic perspective, with the caveat that much depended on how New York defined the terms of the new rules.
After a careful evaluation of the definitions, it turns out that not much has changed. The new rules say that New York no longer taxes income earned by an employee working out of state in a “bona fide employer office.” New York’s definition of that term, however, is so restrictive that normal telecommuters will still face double taxation in New York.
For example, New York defines “bona fide employer office” as a place that has or is close to “specialized” equipment that cannot be set up at the employer’s office. Most telecommuters, however, utilize the same equipment (i.e. a desk, personal computer, phone and Internet connection) at home that they do in the office.
Other factors required to meet the “bona fide employer office” definition include separate phone lines, exclusive use of part of the home for business purposes, and a home office as a condition of employment (i.e. part of a written employment contract).
One can see that most telecommuters will not benefit from New York’s revision of its tax regulations, leaving them exposed to double taxation. This means that federal legislation is still necessary to protect telecommuters from unfair and inefficient tax treatment.
Without ceremony, Governor Rick Perry of Texas recently signed legislation to increase the cigarette tax in the Lone Star State.
From State Tax Today: (subscription required)
“Texas Gov. Rick Perry (R) has signed legislation to increase the state's cigarette tax by $1 per pack effective January 1, 2007. The tax is currently 41 cents per pack.
HB 5, sponsored by Rep. Peggy Hamric (R), was signed as the last part of a five-bill package approved by Texas lawmakers in a special session in May to reduce local school property taxes and overhaul the state's public school finance plan to comply with a Texas Supreme Court mandate.
Perry held public ceremonial signings for several bills in the package and other measures approved during the special session, but not for HB 5, a spokeswoman said.”
As stated above, Texas’ cigarette tax is currently 41 cents per pack. That rate is among the lowest in the nation, but after the $1.00 per pack tax increase, Texas will rank 10th highest nationally – just behind New York and Massachusetts. Our own Patrick Fleenor wrote a recent commentary that shows Texas’ cigarette tax increase will lead to additional cigarette smuggling and tax evasion.
To read additional Tax Foundation commentary that provides an analysis of Texas’ cigarette tax increase, property tax reform and new business tax, click here.
One of the leading public finance economists, Princeton Professor Harvey Rosen, has a commentary today on Marketwatch.com regarding the estate tax. He addresses an issue that has is often overlooked in tax policy debates: who bears the economic incidence of the estate tax?
Here's an excerpt in which he explains three key economic arguments on the negative impacts of the estate tax:
First, a high estate tax rate has a detrimental effect on the behavior of individuals in their roles as entrepreneurs. People with large estates are disproportionately owners of small businesses -- Douglas Holtz-Eakin, former director of the Congressional Budget Office and Donald Marples (GAO) estimate that entrepreneurs are three times more likely to be subject to the estate tax than portfolio investors. The estate tax in effect reduces the returns to entrepreneurs' investments. Thus, the estate tax increases the "user cost of capital" -- the rate of return that an investment must make in order to be profitable. The higher the user cost of capital, the lower the number of profitable investments available to the entrepreneur...
Second, an increase in the estate tax rate would have a negative effect on individual saving rates and wealth accumulation. Research by academic economists suggests that an increase in the estate tax rate of 10% leads to a roughly 14% decrease in net worth. Other serious studies conclude that there would be a substantial increase in saving if the estate tax were eliminated altogether...
Third, arguments that high estate tax rates make the U.S. tax code more progressive are problematic. The basic assumption is that the burden of the estate tax falls entirely on the decedent -- the rich dead guy takes the entire tax hit. This assumption is natural because, by law, the decedent's estate is responsible for paying the tax. However, it reflects an approach that the economics profession has rejected for at least a century. Who bears the burden of a tax depends on the underlying economic fundamentals, not on who writes the check to the IRS. When the government levied a special tax on yachts, for example, the burden fell not only on the owners of yachts, but also on the individuals who produced and serviced them. Applying the same kind of logic in this case, the most likely scenario is that the decedent will not bear the burden of the tax. Rather, he or she will simply leave a smaller bequest, because the estate tax makes wealth accumulation (saving) less attractive. (Full Story)
For more on the estate tax, have a look at our most recent Special Report on the topic.