The Tax Policy Blog

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.

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.

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.

Read the full piece here.

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.

For more information on cigarette taxes, see our data on state cigarette tax rates and collections, and our work on the detrimental effects of excise taxes here and here.

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.

As Curtis Dubay has written, sales tax holidays are poor tax policy because they distort consumer spending, decrease stability in the tax code, and increase retailers’ compliance costs.

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.

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.