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
This morning, Reuters reports that California’s Proposition 82 was defeated in yesterday’s statewide election.
"California voters appeared to have rejected ballot measures to authorize the state to sell $600 million in bonds for libraries and raise taxes to fund free preschool for 4-year-old children, according to election results early on Wednesday.
With 43.9 percent of precincts reporting, 53.4 percent of votes had been cast against Proposition 81 and 46.6 percent of votes had been cast in favor of the measure, which proposed the general obligation debt sale to finance building and renovating libraries.
The state's Legislative Analyst's Office had estimated it would have cost California $1.2 billion from its general fund over 30 years to pay off the $600 million in principal and $570 million in interest expenses from the debt." [Full Story]
Tax Foundation President Scott Hodge recently published a commentary on California’s Proposition 82 in the Orange County Register, pointing out some of the problems currently faced by California’s tax system—many of which would have been exacerbated by the bill.
To read more about California’s tax system, click here.
Connecticut taxpayers may spend a little less time waiting in line to pay their local taxes this July. About two dozen Connecticut towns will join neighboring Massachusetts in allowing taxpayers to use electronic checks drawn directly from bank accounts to pay local taxes.
The town of Pomfret offered this payment option last July, although few taxpayers chose it. Now, as other towns follow suit and word spreads, local officials across the state expect more taxpayers to use electronic checks. Many Connecticut towns already give taxpayers the option of paying online with a credit card, but the transaction fees charged by collection firms can make this an expensive payment method.
The cost of paying with an electronic check is 25 cents—for the taxpayer, that is; it costs the town nothing. This is less than the cost of a stamp, and for many taxpayers it may be less than the opportunity cost of standing in line waiting to pay in person.
From the Hartford Courant:
“Some people actually look forward to waiting in line at town hall because it is their chance to chat with their neighbors," said Mary Nork, the tax collector of Haddam. "But for others, that's not their cup of tea. Some people prefer being online to in line."
Paying taxes online is the "next big thing" in municipal tax collection, said Stan Gorzelaney, the president of the Connecticut Tax Collectors Association and tax collector of Greenwich. Town leaders think it will cut down on paperwork, while taxpayers like the convenience, he said.
For taxpayers with the necessary computer technology, this new option may indeed decrease compliance costs, although for those lacking the necessary technology or know-how, this option would likely increase the time it takes to pay taxes. Offering taxpayers a choice of payment method allows each taxpayer to choose the method that will most effectively lower her compliance costs.
However, the high cost of tax compliance stems mainly from calculating the taxes owed rather than from paying those taxes; the length and complexity of tax codes—federal, state and local—are the main reasons taxpayers expend so much time, energy and money paying taxes. Legislators and tax collectors should keep this in mind when attempting to lower compliance costs.
For more on tax compliance costs, click here.
With a tip from the Tax Foundation’s new summary of estate taxation, New York Times reporter David Cay Johnston forced Brookings economist Henry Aaron to recant his previous work on estate taxation, as reported in today’s paper.
A renowned public finance economist, Aaron and co-author Alicia Munnell had written that the estate tax was so complex and riddled with avoidance schemes that the cost of complying with the tax was as high as the revenue that the tax brings in.
From the conclusion of their study Reassessing the Role for Wealth Transfer Taxes:
“In the United States, resources spent on avoiding wealth transfer taxes are of the same general magnitude as the yield, suggesting that the ratio of excess burden to revenue of wealth transfer taxes is among the highest of all taxes.”
This dollar-for-dollar estimate of estate tax compliance costs is now inconvenient for Aaron, who regrets that it provides ammunition for advocates of repeal because he has always supported estate taxation despite the administrative nightmare it causes.
The Energy Bill of 2005 passed last summer now has the IRS in the business of monitoring hybrid car sales due to the special provision that the tax credit available to consumers for purchasing certain types of automobiles (like hybrids) only applies to a limited amount of automobiles sold. Here is the message from the IRS; and hurry, this offer is only good while supplies (of tax credits) last:
WASHINGTON — The Internal Revenue Service announced that purchasers of Ford Motor Company qualified vehicles may continue to claim the Alternative Motor Vehicle Credit. The announcement comes after the IRS concluded its quarterly review of the number of hybrid vehicles sold.
The tax credit for hybrid vehicles applies to vehicles purchased on or after January 1, 2006, and it may be as much as $3,400 for those who purchase the most fuel-efficient vehicles.
The Quarterly Report of Qualified Vehicles for the Alternative Motor Vehicle Credit for the quarter ending March 31, 2006, shows that Ford (which owns Mercury) sold 6,192 qualifying vehicles to retail dealers.
The make, model year and the corresponding allowable credit for qualified vehicles sold in the quarter are:
· Ford Escape 2WD Hybrid, 2006 — $2,600
· Ford Escape 4WD Hybrid, 2006 — $1,950
· Mercury Mariner 4WD Hybrid, 2006 — $1,950
Consumers seeking the credit may want to buy early because the full credit is only available for a limited time. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50 percent of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25 percent of the credit. No credit is allowed after the fifth quarter.
More information on hybrid vehicles and other alternative motor vehicles can be found at: IRS.gov.
Note: Here is the same news release for Toyota and Lexus hybrids (link). For more on how last year's energy bill was poor tax policy, check out this previous blog post detailing the "Tax Pork" in the bill.
For more information on tax compliance, check out our section on the topic.
The Internal Revenue Service (IRS) recently unveiled new rules designed to combat corporate inversions that are designed to reduce U.S. corporate tax payments. The rules are explanations of IRS code section 7874, which was enacted as part of the American Jobs Creation Act of 2004.
The new rules take a “bright-line” approach by saying that a U.S. corporation has to have more than 10 percent of its employees, assets and sales in a foreign country in order to avoid further scrutiny by the IRS. If this test is not met, then the IRS will proceed to use a “facts and circumstances” test to determine whether the corporation is engaged in tax avoidance. This test will consider the number of employees in the country, their payroll, and past presence in the country.
Most interestingly, the IRS will not allow a corporation to include intangible assets when determining the bright-line threshold. This is undoubtedly because many corporations will place intangible assets—and sometimes, only intangible assets—in foreign jurisdictions in order to reduce their U.S. tax.
Of course, it is difficult to draw the line between legitimate tax competition, legitimate tax avoidance, and illegitimate tax evasion. With the second-highest corporate income tax rate in the OECD and a worldwide system of taxation, the U.S. is not exactly hospitable to corporate investment.
One of the only defensible deductions from income are expenses that are directly related to the production of income, therefore legitimate business expenses are a justifiable deduction in tax policy terms.
With this in mind, an interesting story from England details how soccer superstar David Beckham expenses lucrative purchases that enhance his rock star image:
Any purchases which contribute to a footballer's public image can potentially be written off as a legitimate business expense. It means that Beckham, who brings in more than £17m a year by trading on his status as a global style icon, does not necessarily have to dip into his £70m personal fortune for his diamond ear studs, designer wardrobe and frequent trips to the hairdressers.
While it may appear outrageous that Beckham can get a tax break for these items it is defensible and in accordance with the principles of sounds taxation. A good tax system is fair and treats everyone equally. Moreover, all legitimate business expenses are treated the same. So if a businessperson can write off the cost of posh dinners with clients, it stands to reason Beckham deserves his write-offs as well. Besides, if Australian prostitutes can deduct their expenses, why can’t Beckham?
That was the subject of our most recent appearance on CNBC's "Power Lunch" last week. The full video of the segment is now available, in which Tax Foundation communications director William Ahern discusses the latest trend in environmental tax policy—"carbon taxes" on companies emitting greenhouse gasses.
Click the links below to watch the clip:
The U.S. Senate will most likely debate the federal estate tax this week, but lawmakers on Capitol Hill aren’t the only ones dealing with estate taxes. Kansas Governor Kathleen Sebelius recently signed legislation to separate Kansas’ estate tax from the federal estate tax. The legislation creates a “stand alone” estate tax for Kansas, but also mandates that it be phased out by January 1, 2010. From State Tax Today (subscription required):
“SB 365, signed May 22, is effective for the estates of decedents dying on and after January 1, 2007, but it also provides for the ultimate sunset of the estate tax, which Kansas has imposed in one form or another since 1909. A set of brackets designed to be revenue-neutral is provided for tax years 2007 to 2009, with estates valued at $1 million and below exempt from the tax. Rates for those tax years will range as follows:
2007 -- from 3 percent to 10 percent;
2008 -- from 1 percent to 7 percent; and
2009 -- from 0.5 percent to 3 percent.
The tax expires entirely for the estates of decedents dying on and after January 1, 2010. The legislation was introduced and studied by a Senate tax subcommittee after discussion of the need to eliminate the increasing administrative and compliance complexities of the state's current estate tax.”
The U.S. Senate will soon decide the fate of the federal estate tax. Regardless of their verdict, Kansas’ estate tax will soon whither on the vine.
For a recent report we published on the economic problems with the federal estate tax, click here.
This past saturday, the Oklahoma State Cowboys mens' golf team secured the NCAA Division I team golf title, winning by three strokes over the second place Florida Gators. But that's not all the Oklahoma State golf team won this past school year. Thanks to the very generous charitable provision inserted in the tax code following Hurricane Katrina that allowed one's charitable contributions to be deducted for up to 100 percent of AGI for any donation, Texas businessman Boone Pickens decided to use the opportunity to make a huge contribution to a charity entitled "O.S.U. Cowboy Golf Inc." The story from CNN Money back on February 24th of this year:
Boone Pickens got a special tax break when he donated $165 million to the sports program at Oklahoma State University, his alma mater, last year, and the school then turned around and invested the money with Pickens' own hedge fund, according to a published report.
The New York Times reported Friday that records show that Pickens' donation spent less than an hour on Dec. 30 in the account of the university's charity, O.S.U. Cowboy Golf Inc., before it was invested in BP Capital Management, a hedge fund controlled by Pickens.
Pickens, whose name graces the school's football stadium, is one of the board members of Cowboy Golf, according to the Times, which said the charity is now being turned into a charity to benefit the school's athletics at large.
The newspaper also reports that Pickens also benefited from a provision in Hurricane Katrina relief legislation that allowed him a deduction for a charitable gifts made in 2005 equal to 100 percent of his adjusted gross income, double the normal limit of 50 percent.
If he does not have that much income in 2005, he can carry the deduction into future years, according to the paper, which added the size of the donation propelled Pickens into the ranks of the nation's top philanthropists last year.
Mike Holder, the university's athletic director, who is also on the board, defended giving Pickens continued control over the donation through the investment with BP Capital.
"If a person's making a gift of that size, he can stipulate what he wants it invested in," Holder told the paper. He said that previous investment of Cowboy Golf assets with Pickens have more than quadrupled in value. (Full Story)
There are many problems with the broad extent to which the charitable deduction can apply to donations throughout the country that many would be skeptical of labeling "charity." That's in addition to the added layers of complexity that come about from legal issues of donations, which includes tax fraud and therefore the need for additional costly fraud enforcement for this issue alone.
For more on the economic problems associated with the charitable deduction, check out this Tax Foundation piece from last November on the topic.
With the Senate preparing to vote on estate tax changes, there's been renewed interest in our estate-tax-related poll questions from our 2006 Annual Survey of U.S. Attitudes on Taxes and Wealth.
In an op-ed in this morning's Washington Post, Sen. Jeff Sessions cites our survey responses about whether U.S. adults favor repeal, and their views on the fairness of the estate tax:
Sixty-eight percent of those surveyed in a recent poll commissioned by the Tax Foundation supported repeal of the estate tax. Moreover, the death tax was rated by Americans in the same survey as the least fair tax .
Also, a new FactCheck.org article on the estate tax notes our 2006 survey:
The Tax Foundation poll, published in March 2006 asked respondents... "Of the following federal taxes, which do you think is the worst tax — that is, the least fair?" The estate tax led the way with 31 per cent of respondents ranking it first.
For the record, here are the two actual estate-tax questions from our 2006 survey:
Q670. Some taxes are paid to the federal government in Washington and some are paid to state and local governments. Of the following federal taxes, which do you think is the worst tax -- that is, the least fair?
The federal estate tax
Federal income tax
Social Security payroll tax
Federal corporate income tax
Source: Tax Foundation
Q715. Do you personally favor or oppose completely eliminating the estate tax – that is, the tax on property left by people who die?
Source: Tax Foundation
In anticipation of the Senate vote next week on whether to repeal or reform the federal estate tax, we've released a new "Special Report" examining the economics of the estate tax, as well as an overview of its 90-year history. From the executive summary:
The federal government taxes transfers of wealth in three ways: through the estate tax, the gift tax and the generation-skipping transfer tax. Together these taxes make up the federal transfer tax system. The modern estate tax was enacted in 1916, just three years after the federal income tax. Congress supplemented it with the gift tax in 1924 and again in 1932, and in 1976 enacted a generation-skipping transfer tax to curb tax avoidance through the use of trusts. Since 1976, the three-legged framework of the modern transfer tax system has remained essentially unchanged.
This report examines two common arguments in favor of estate taxation. First, estate taxes are commonly assumed to be borne by wealthy taxpayers. As a result, it is argued that they are an efficient mechanism to redistribute income within society. Second, it is commonly argued that estate taxes are an important federal revenue source, which should be maintained. However, both arguments rely on questionable assumptions. First, once the tax-shifting behavior of estate holders is taken into account, the economic incidence of the estate tax may be much less progressive than is commonly assumed, making it a blunt instrument for income and wealth redistribution. Second, the history of the federal estate tax makes clear that the tax has never been an important federal revenue source, typically accounting for 1 to 2 percent of federal collections. A growing body of economic research suggests the tax may raise zero or even negative net tax revenue once widespread estate-tax avoidance is accounted for.
This report provides an overview of two other well-researched aspects of the estate tax as well: its effect on entrepreneurship, and its high costs of compliance. Previous Tax Foundation research has found the estate tax acts a strong disincentive toward entrepreneurship. A 1994 study found that the estate tax’s 55 percent rate at the time had roughly the same disincentive effect as doubling an entrepreneur’s top effective marginal income tax rate. The estate tax has also been found to impose a large compliance burden on the U.S. economy. Economic studies estimate the compliance costs of the federal estate tax to be roughly $1 for every dollar of revenue raised—nearly five times more costly per dollar of revenue than the federal income tax—making it one of the nation’s most inefficient revenue sources.
From this morning's Wall Street Journal, Nobel Laureate Edward Prescott makes the case for repeal of the federal estate tax:
From what I can tell, there are two main arguments in favor of an estate tax: the increased revenue that government receives to go about the people's business; and the desire to somehow balance life's unfairness by limiting the amount of capital assets that "the rich" can leave their kids.
On the second point, there is little to say except that what's fair for one is often penalty for another. What is fair, for example, about telling someone that he will be unable to distribute his hard-earned money, which has already been taxed once, to his heirs as he sees fit? Such a person has zero incentive to accept an estate tax for which he sees no justification. He will do his best to try to avoid this tax through every legal means necessary, after which he may be inclined to consume more than he otherwise would, or just quit working sooner than otherwise. And while there's nothing wrong with consuming one's assets, if such consumption comes at the expense of capital that would otherwise be put to better use, such consumption is suboptimal. Recent empirical work on the disincentive effects of estate taxes has proven these phenomena true.
And that gets to our first point about the supposed budgetary benefits of such a tax. Since an estate tax is really just another name for a tax on capital income, then there is certainly no justification for such a tax. I, and others, have written before in these pages about the inefficiency of capital income taxes, and there's no need to revive those arguments here, except to say that we can only grip the neck of our vibrant economic goose so tightly before it eventually dies and quits laying those golden eggs. And many of those golden eggs come in the form of capital that allows descendents to keep family businesses intact, or to begin new businesses that fuel our economy.
Besides, even if estate taxes were not inefficient and could be construed as fair, they would still do little to address the budget deficit. In 2003, net estate taxes accounted for $20.7 billion, a drop in the bucket of an $11 trillion economy. Clearly, we are not going to balance the budget by grave robbing. (Read the full piece here.)
Aside from its indirect effects on charitable giving—which in our view isn't a compelling justification for policy—the estate tax is typically defended in two ways.
First, because estate taxes are assumed to be borne by wealthy taxpayers, it is argued that they are an efficient mechanism to redistribute income within society. Second, it is commonly argued that estate taxes are an important federal revenue source.
However, once the tax-shifting behavior of estate holders is taken into account, the economic incidence of the estate tax may be much less progressive than is commonly assumed, making it a blunt instrument for income and wealth redistribution.
Also, the history of the federal estate tax makes clear that the tax has never been an important federal revenue source, typically accounting for 1 to 2 percent of federal collections. A growing body of economic research suggests the tax may raise zero or even negative net tax revenue once widespread estate-tax avoidance is accounted for.
The Congressional Research Service has released an interesting new report, "Flat Tax Proposals and Fundamental Tax Reform: An Overview". Here's the summary:
President George W. Bush has stated that tax reform is one of his top priorities.
He appointed a nine-member bipartisan panel to study the federal tax code, and
November 1, 2005, this panel proposed two alternatives to reform the code including simplification elements. Consequently, the concept of replacing our current income tax system with a “flat-rate tax” has received renewed congressional interest.
Although referred to as “flat-rate taxes,” many of the recent proposals go much
further than merely adopting a flat-rate tax structure. Some involve significant
income tax base broadening whereas others entail changing the tax base from income to consumption.
Proponents of these tax revisions often maintain that they would simplify the tax
system, make the government less intrusive, and create an environment more
conducive to saving. Critics express concern about the distributional consequences and transitional costs of a dramatic change in the tax system.
Most observers believe that the problems and complexities of our current tax system are not primarily related to the number of tax rates but rather stem from difficulties associated with measuring the tax base.
Read the full report here (PDF).
As we've written before, growing tax law complexity is almost entirely the result of tax base issues, not the multiple rate structure per se. For an extensive discussion of why, see our 1995 Special Brief, "The Compliance Costs and Regulatory Burden Imposed by Federal Tax Law."
The most powerful argument for fundamental tax reform is that cleaning up the tax base allows all rates to be lowered—regardless of the rate structure—cutting "deadweight costs" of the tax system for everyone.
Contrary to popular belief, favoring a progressive rate structure is not a good reason to oppose fundamental tax reform. There are consumption tax plans—such as the Bradford "X Tax"—that combine both broad bases and low rates with a progressive rate structure. Even those wedded to the idea of a progressive rate structure should favor fundamental tax reform that moves us toward a consumption base.
A Wall Street Journal article (via TaxProfBlog) says that New York is relaxing its onerous “convenience of the employer rule”. This rule originally said that workers who telecommuted from outside the state had to pay New York income tax on 100 percent of their income unless they telecommuted out of necessity. Since telecommuting is almost never done based on necessity, this rule ensnared many New York telecommuters in double taxation because they could face tax on 100 percent of their income in New York as well as their home state.
Although New York won two state court battles over this rule, federal legislation was introduced that would force New York to alter it. The federal legislation would require a worker to be physically present and performing work in New York before it could require the worker to pay income tax to New York for the days worked.
New York’s new rule does not adopt the physical presence approach of the federal bill, but it does say that telecommuters will not be treated as working in New York if their home office is a “bona fide employer office.” While it remains to be seen how New York will define this term, it appears as if it will be more telecommuter-friendly than the “convenience of the employer” rule.
We’ve written on this issue before, arguing that a physical presence approach is best in order to reduce double taxation and tax complexity. The federal legislation will still be an issue, because New York is not the only state to adopt a “convenience of the employer” rule, though it does seem to be the most aggressive in applying it.
In the larger scheme of things, this issue is just another example of the disconnect between the 21st century economy and state tax systems largely based on the 20th century economy.
We've updated several tables in our "Tax Data" section of the website this afternoon. The new tables reflect this week's latest release of state and local government figures from the U.S. Census Bureau. Enjoy:
State and Local Corporate Income Tax Collections Per Capita, 2004 http://www.taxfoundation.org/legacy/show/1390.html
State and Local Property Tax Collections Per Capita by State, 2004 http://www.taxfoundation.org/legacy/show/251.html
State and Local Individual Income Tax Collections Per Capita, 2004 http://www.taxfoundation.org/legacy/show/1389.html
State and Local Sales and Gross Receipts Tax Collections Per Capita, 2004 http://www.taxfoundation.org/legacy/show/275.html
State and Local Tax Collections Per Capita, 2004http://www.taxfoundation.org/legacy/show/279.html
Local Property Tax Collections Per Capita, 2004http://www.taxfoundation.org/legacy/show/243.html
State and Local Revenues Per Capita, 2004http://www.taxfoundation.org/legacy/show/274.html
State and Local Spending Per Capita, 2004http://www.taxfoundation.org/legacy/show/276.html
State and Local Debt Per Capita, 2004http://www.taxfoundation.org/legacy/show/272.html