Ahead of the Senate hearing on “Offshore Profit Shifting and the U.S. Tax Code,” I released a report reminding us that contrary to the perception created by these types of political spectacles, corporations pay a...
The Tax Policy Blog
Yesterday marked the 70th anniversary of President Franklin Roosevelt’s signing the Social Security Act in 1935. See more about the history of Social Security here.
Social Security was designed as a system to keep the country’s senior citizens from falling into poverty. As originally constituted, Social Security was intended to be a social safety net to catch those falling on hard times and to provide a steady base of income for the retired.
One benefit of the recent debate is a growing awareness that Social Security cannot provide all the income necessary for recipients to live more and more comfortably.
On its 70th birthday, it may be a good time to look back at the program’s roots to rediscover its original intention.
Check out the Tax Foundation’s research on Social Security to learn more.
From Yahoo news:
The federal budget-deficit picture turned brighter Monday as congressional scorekeepers released new estimates showing the level of red ink for the current fiscal year would drop to $331 billion.
The falling deficits illustrate how rising incomes increase tax revenues rapidly because of the progressive tax code. If employment and income continue growing, the deficit is likely to continue to decrease.
The deficits are still large however, which suggests that the problem isn’t caused by deficient tax revenue, but by excessive spending. Check out past blogs on income and tax collections here, here, and here.
There's a useful piece in this morning's Inside Bay Area reminding readers that income tax refunds aren't the "bonus" they're commonly thought to be:
Getting a tax refund may seem like one of the more pleasant rites of spring. It may even seem like you're taking the government for a ride, what with that pile of money you're getting.
But that's really not the case, say tax experts who advise workers to take advantage of a tax-planning strategy that will give them more take-home pay over the course of a year as opposed to a big refund once a year. The idea behind the strategy is to lower your federal income tax withholding rate, which will result in higher take-home pay. The extra money could then be invested in an interest-bearing savings account. Or you could use it to pay bills...
"The more allowances you claim, the lower your withholding, so the higher your paycheck will be," said Jackie Perlman, senior tax researcher for H&R Block.
"When you get the big refund, you've loaned the government your money all year. They are holding your money all year and paying it to you in April of the next year," said Mary Kay Foss, a partner at Danville-based accounting firm, Marzluft, Tulis & Foss CPAs. (Full piece here.)
As the authors note, the larger the refund, the larger the opportunity cost you've incurred by loaning payroll taxes to Uncle Sam at a zero interest rate all year.
In 2002, the Tax Foundation estimates the opportunity cost of federal income tax withholding was roughly $23.4 billion (for the calculation, see page 8 here).
Senators Carl Levin (D-MI) and Norm Coleman (R-MN) recently introduced the Tax Shelter and Tax Haven Reform Act of 2005 (S. 1565). The bill would make four major changes to federal law, in an effort to combat “abusive tax shelters”:
· First, those who promote abusive tax shelters and aid in understating tax liability would face financial penalties; · Second, a host of provisions would prevent abusive tax shelters through prohibiting certain fee arrangements, requiring information sharing, and denying deductions; · Third, the bill would codify the economic substance doctrine for federal court hearings on abusive tax shelters, and; · Fourth, the bill would designate certain nations as “uncooperative tax havens” and impose reporting requirements and restrict tax benefits for corporations that invest in those countries
The fourth section would require any United States person to disclose money or property transfers to uncooperative tax havens, defined as those countries that impose no or nominal taxation and that do not, in the opinion of the United States Treasury, sufficiently disclose enough information to allow the U.S. to enforce its own tax laws. The fourth section would also impose a number of penalties on investment in uncooperative tax havens, including the denial of a foreign tax credit for taxes paid to such a country.
The broadness of the fourth section could sweep in those countries that are legitimately competing with the U.S. for business investment. Ireland, for instance, maintains a very low corporate income tax rate (12.5 percent), causing numerous U.S. firms to invest there. Estonia does not tax corporate profits if those profits are reinvested domestically (a major incentive for export-intensive firms). If these countries decline to disclose information about investment from U.S. taxpayers, will the U.S. impose penalties on those taxpayers?
Administrative remedies are certainly important to combating corporate tax shelters, but Congress may also want to consider reducing the federal corporate tax rate, which is currently the third highest in the world (as reported in our report linked here). Our high rate undoubtedly leads many corporations to seek to minimize their tax payments, and lowering the rate could do more for tax administration than penalizing legitimate investments in low tax countries.
In McCullough v. Maryland, the U.S. Supreme Court ruled that the state of Maryland could not levy a direct tax on a branch of the national bank located in Maryland. Having ruled that a national bank was a reasonable exercise of the constitutional powers of Congress, the Supreme Court ruled that the Constitution restricted Maryland from taxing the bank.
The state of Maryland had made two arguments in this case: first, that the Constitution did not give Congress the power to charter a national bank, and; second, that even if Congress did have such a power, Maryland could levy a tax on the bank. The Court rejected both of these arguments, fearful that such an interpretation would severely injure the letter and spirit of the Constitution:
“If we apply the principle for which the State of Maryland contends, to the Constitution generally, we shall find it capable of changing totally the character of that instrument. We shall find it capable of arresting all the measures of the Government, and of prostrating it at the foot of the States. The American people have declared their Constitution and the laws made in pursuance thereof to be supreme, but this principle would transfer the supremacy, in fact, to the States.”
More important, perhaps, than the ruling in this case was the principle it espoused on taxation. Chief Justice John Marshall, writing for the Court, said that the “power to tax involves the power to destroy.” Marshall understood that allowing direct state taxes on federal government operations could completely undermine the sovereignty and legitimacy of the federal government. This principle should ever be on the minds of our lawmakers.
On the occasion of his 60th birthday, economist John Llewellyn—chief economist at Lehman Brothers—recently shared ten lessons for economic policymakers, derived from his 35 years of professional experience as an economic analyst.
They're all excellent. But one in particular struck me as a guiding principle that undergirds much of what we do here at the Tax Foundation:
3) It is structural, not demand-side, policies that most influence economic performance over the long term. The experience of reforming economies as diverse as Australia, New Zealand, the Netherlands, and Poland is testimony to that. But structural policies take ages to produce effects. The initial consequence is usually a reduction in expenditure, which slows economic activity. It typically takes five years or more for positive effects to start to outweigh the negative. No surprise that politicians so seldom undertake reform. They know that the negative consequences will occur on their watch, while the benefits will accrue to their successors. Look at how Labour has benefited from the policies of Mrs Thatcher.
When thinking about tax policy, many Washington analysts take an ad hoc approach. The short-term pressures of the legislative process on Capitol Hill make it tempting to focus on the near-term effects of individual tax changes in isolation from the total tax system.
One of the goals of the Tax Foundation's scholarship is to re-orient policymakers from a short-term focus on the distributional and behavioral effects of taxes, to one that focuses on long-run structural efficiency of the entire system of tax from both an economic and political (that is, public choice) perspective.
It's easy to lose the tax system forest for the short-term-tax-change trees. But Llewellyn's advice helps remind us of an essential principle of economic policy: in the long-run, the only thing that really matters is the long-run.
As the German economy continues to lag behind its EU neighbors, political support for free-market reforms is growing. As Tax Analysts' Martin A. Sullivan reports, fundamental tax reform is likely to dominate debate leading up to the national German elections this September:
The leadership of the world’s third largest economy [Germany] is up for grabs, and the overwhelming favorite to be the next chancellor is conservative challenger Angela Merkel, a physicist from the formerly communist East...
You are likely to be told that "Angie" is Germany’s "Maggie." Like British Prime Minister Margaret Thatcher a quarter century earlier, Merkel would be her country’s first female elected leader. And like Thatcher’s, Merkel’s political philosophy is market-oriented conservatism. You are also likely to come across commentary from conservatives suggesting that Merkel’s election would be another nail in the coffin of the European-style social welfare state.
Like it or not, globalization is opening the floodgates of competition, and around the globe it is washing away all sorts of inefficient economic structures. Germany has more than its share of those. With its high taxes, overly protective labor laws, and bloated welfare, retirement, and healthcare systems, Europe’s largest country provides the prime example of what happens to an economy that inadequately responds to the challenge of mounting international competition: soaring unemployment and flagging income growth.
The lesson for the U.S.? Tax reforms are politically painful since they create short-term winners and losers during transition. As a result, the performance of our own federal tax system may have to get much worse before it gives rise to sufficient political will to make hard choices about eliminating deductions and other holes in the tax base. Read the full piece here (PDF).
[Link via Tax Prof Blog.]
The North Carolina legislature, after a month-long delay and three stopgap spending bills, has finally reached an agreement on a 2005-2007 budget. But not everyone is breathing a sigh of relief. Among the disappointed are many North Carolina smokers, who face a steep tax increase.
The legislature has decided to increase the cigarette tax—which is currently the lowest in the nation at 5 cents per pack—to 30 cents per pack on Sept. 1, then to 35 cents per pack on July 1, 2006.
Check out the Winston-Salem Journal’s cigarette tax calculator to see how much this tax increase will cost smokers over the course of a year.
Legislators hope the increase will help compensate for a projected $1.3 billion budget shortfall. Many other states are, unfortunately, trying to balance their budget the same way, not realizing—or caring—that excise taxes are regressive, distortionary, and often counterproductive.
To an economist, the true cost of government to a society isn't the level of taxes. It's the level of spending. Every dollar spent by the state draws resources away from alternative uses in the private sector. Economists call this the opportunity cost of government, and it represents the true value of what we sacrifice as a society in exchange for the benefits of spending programs.
The Christian Science Monitor reports that legislation to curb state spending—as opposed to taxation—is now on the rise in some 20 states as various groups work to scale back the cost of government:
The idea: keep state governments from spending more than they take in. Known as TEL (tax and expenditure limitation), it has moved front and center in California, which will vote on the measure this fall, and in Ohio, which is considering doing so. Maine and Oregon are preparing initiatives for 2006. Conservative groups are poised to follow suit in 20 other states.
Some national observers see this as the beginning of a grass-roots rebellion remarkably similar to the tax-revolt brushfire that swept through California, Massachusetts, and other states 20 years ago. That movement limited how much states could tax. This one aims to curb how much they spend...
The new impetus comes more from citizens than legislatures. Although Georgia, Missouri, Tennessee, and Wisconsin have seen significant lawmaker support for such measures, 23 other state legislatures have raised the issue, and then done nothing.
"Citizens want to figure out how better to find ways that government can function without ... locking into programs that are suddenly too expensive when revenues all off," Mr. Waisanen says.
Throughout August, Massachusetts parents and children will stock up on notebooks, clothes, and backpacks in preparation for a new school year. Many of them will confine their back-to-school shopping to August 13 and 14, since those days are “tax holidays” in Massachusetts, which means all purchases under $2,500 are exempt from the state's 5 percent sales tax.
This year Massachusetts joins ten other states and the District of Columbia in providing sales tax holidays (click here for a chart of each state’s exempt items and other details).
But now it seems Massachusetts might be upstaged by its neighbor to the north. According to the New Hampshire Union Leader, New Hampshire Governor John Lynch has announced a new advertising campaign targeted at Massachusetts residents. New Hampshire will spend approximately $40,000 to run an ad in the Boston Globe on August 7, 10, and 11, proclaiming, “365 vs. 002 . . . Tax-Free Shopping Days (for those of you keeping score)."
New Hampshire is one of only five states without a sales tax and is therefore a popular destination for shoppers from neighboring states, especially those living near the border. Gov. Lynch is keenly aware of the lure of tax-free shopping:
"There is no need for shoppers to pack all of their shopping into two days during a beautiful summer weekend, when every day is a sales tax holiday in New Hampshire," Lynch said.
Alice DeSouza, director of the state's Division of Travel and Tourism Development, told onlookers the state annually welcomes about 27 million visitors. The link between the Granite State's permanent tax holiday and tourism is "significant," she said.
Tax holidays are popular with consumers, but if a state wants to bring in more non-resident shoppers, improve its economy, or give taxpayers a break, a better solution is a consistently low sales tax rate–-or none at all—rather than a one- or two-day tax holiday.
Estate taxes are a hot topic on Capitol Hill currently, in part because they are viewed as the most unfair federal tax by the American public, as a recent Tax Foundation survey illustrates. The following chart shows federal estate tax revenue by state and per capita. For more data on state and federal estate taxes, check out our new estate tax data section.
|Federal Estate and Gift Tax Collections, by State and Per Capita|
|State||Total Collections||Collections Per Capita||Rank Per Capita||Collections Per $1,000 of Income||Rank Per $1,000|
|Source: Internal Revenue Service, Tax Foundation calculations.|
Eight senators proposed a tax on internet pornography recently, from the Washington Post:
A group of Democratic senators last week introduced a bill that would slap a 25 percent tax on Internet pornography sites to pay for a trust fund to "protect" children online.
Senators Thomas Carper (DE), Mark Pryor (AR), Mary Landrieu (LA), Joseph Lieberman (CT), Blanche Lincoln (AR), Ken Salazar (CO), Debbie Stabenow (MI), Evan Bayh (IN) & Kent Conrad (ND) proposed the legislation.
We have blogged on porn taxes previously here. The proposed tax is poor economically because it is non-neutral since it singles out a particular industry for heavier taxation.
Furthermore, the administration of such a tax would be extremely cumbersome and may lead to flight from the tax by the purveyors of internet porn. This also leads to questions of what defines internet porn versus content with artistic merit, but that is a separate legal topic.
Lastly, this is yet another example of social policy being implemented through the tax code, which is generally bad tax policy. Social policy is best left out of the tax code as it is less transparent to taxpayers than spending programs and leads to more tax complexity and less neutrality.
In Kelo v. New London, the U.S. Supreme Court ruled that that Takings Clause of the U.S. Constitution did not bar the city of New London, CT, from using its eminent domain power to transfer ownership of land from homeowners to economic developers so long as the transfer furthered a valid “public purpose.” The Court accepted the argument of New London that transferring the property from the current homeowners to private developers would increase the number of jobs in New London and increase the tax revenues available to the city. This, in the Court’s mind, was enough to satisfy the “Public Use” requirement of the Takings Clause.
The Kelo ruling adds an interesting twist to the concept of tax neutrality. Public finance theory (as well as our own principles of tax policy) dictates that taxes should be neutral to investment decisions. Thus, taxes on property should only seek to raise revenue and not distort the way in which the property is used. The Kelo decision, however, gives carte blanche to government redistribution of land to those taxpayers that will generate the most tax revenues.
The Kelo decision also creates an interesting, if not ironic, twist on the Sixth Circuit’s ruling in Cuno v. DaimlerChrysler. In that case, the Sixth Circuit ruled that Ohio’s investment tax credit, taken by DaimlerChrysler for building a plant in Ohio, discriminated against interstate commerce because other Ohio corporations that invested outside Ohio were not eligible for the credit. In the decision, though, the Sixth Circuit gave its blessing to the use of property tax abatements, finding no constitutional infirmity.
Thus, reading Kelo and Cuno together, the Constitution is no bar to transferring property from one private owner to another, so long as the subsequent owner generates higher tax revenues from investment on the property, but giving the new owner a corporate tax credit for investment on the seized property is unconstitutional because it discriminates against interstate commerce.
As Justice Thomas said in his Kelo dissent, “[s]omething has gone seriously awry with” our “…interpretation of the Constitution.” Were Cuno to become the law of the land, expect more states and localities to seek to attract new investment through the use of eminent domain instead of tax credits. Thus, we would trade a system where corporations are allowed to keep more of their tax dollars for a system where they are given other people’s property. Both systems are imperfect but the tax credit system is far preferable in a society that values freedom and democracy.
Between 1970 and 2002, the percentage of Americans who smoke fell from 37 percent to 22.5 percent. Over the same period, the number of obese Americans rose from about 14 percent to 30 percent. Coincidence?
According to a growing number of economists and health care experts, probably not. Daniel Gross explains why in a recent New York Times column:
Nicotine is a stimulant, which means that smokers burn calories faster. And it's an appetite suppressant, which means that smokers eat less. Consider "French Women Don't Get Fat," the best selling book. Some critics said that the real reason chic Parisian women stayed trim while gorging themselves on croissants was that they smoked more than their American counterparts.
Indeed, conventional wisdom ... has long held that short-term weight gain is the price to be paid for quitting smoking. But economists are increasingly applying their tools to measure the way monetary incentives, or disincentives, affect all sorts of human behavior - and hence the ability of government policy to alter it.
And they've been wondering whether high cigarette taxes, which are intended to encourage people to quit smoking, may have the unintended effect of redirecting them from one form of unhealthy behavior to another. (Full piece here.)
The old Pigovian logic of using simple excise taxes to "correct" externalities from things like smoking and over-eating—an idea subjected to a thorough refutation more than 40 years ago by economist Ronald Coase—has probably led to more bad policy than any other single idea in economics.
Once we accept the logic that the tax code can legitimately be used to tax and subsidize any behavior in society that emits externalities—however small or speculative in nature—we've given license to tax and subsidize essentially every action in the social world.
Once we've done that, we risk transforming the whole field of tax policy into a simple political power game about whose preferences ought to be imposed on whom, rather than a principled discussion about how to raise revenue for programs in the least economically harmful way.
Some interesting tax factoids from the 1700s (courtesy of Prof. Jim Mahar of FinanceProfessor.com):
In 1733 Britain passed the Molasses Act. It raised taxes on molasses from Non-British West Indies. Liike most taxes, this tax resulted in changes in behavior. By 1763 approximately 80% of molasses was smuggled into the colonies.
In 1765, the Stamp Act is enacted. It sets off protests centered in Boston. Most likely not coincidentally, Boston is suffering through a serious economic downturn.
In 1773 Britain lowered taxes on tea shipped into Britain but not on that shipped into the colonies. This gave British tea exporters a virtual monopoly but angered colonialists. The Act ended up sparking the most famous tax revolt of all time: the Boston Tea Party. At the Tea Party, an estimated £9,650 (or roughly equivalent of the annual income of 200 common laborers) was destroyed.
In 1789 Benjamin Franklin writes “Nothing is certain but death and taxes.” Incidentally, Franklin dies in 1790.
In 1799 Britain imposed its first income tax. The tax was remarkable similar to current income taxes. It was for 10% for incomes over £200 but allowed deductions for “children, insurance, repairs to property, and tithes.”