In yesterday's House hearing, the Treasury Inspector-General was asked if he could list which organizations had been targeted by the IRS for delayed approval or harassing questions. He replied that he could not make that...
The Tax Policy Blog
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.
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.”
With the debate over permanent repeal of the estate tax on hold until September, it may be useful to re-examine public opinion on the federal estate tax.
According to our Tax Foundation/Harris Interactive survey of 2,013 adults in April, Americans are surprisingly united in their distaste for the federal estate tax. Respondents said that it is the most unfair of all federal taxes—even more unfair than the federal income tax.
Question 1: "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/Harris Interactive
Not only do they think the estate tax is unfair, but a majority favor outright repeal. When asked if they favor eliminating the federal estate tax, an overwhelming 68 percent favored elimination.
Question 2: "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/Harris Interactive
Support for repeal is significantly higher among middle-class Americans earning between $35,000-$75,000 (73 percent) and families with three or more children at home (76 percent). Notably, support for estate tax repeal is growing rapidly. In 2003 just 54 percent of Americans favored repeal—an increase of 14 percentage points in just two years.
You can view the full results of our 2005 "Annual Survey of U.S. Attitudes on Tax and Wealth" on our website at http://www.taxfoundation.org/legacy/show/342.html.
Many states exempt food, medicine, and medical supplies—items that are generally considered necessities—from sales tax. On the surface, this seems like a simple, straightforward policy.
However, creating numerous exemptions and taxing different items at different rates leads to increased complexity and compliance costs for businesses, as well as confusion for consumers. It’s not always clear which goods qualify for exemption, even in seemingly well defined categories like food and medicine.
Case in point: A company that sells visual aids, including Braile software and magnification devices, recently asked New York State whether the devices qualified for the state’s sales tax exemption for medical devices. The Department of Taxation and Finance issued an advisory opinion stating that the visual aids were prosthetic devices and therefore tax-exempt.
However, the exemption is somewhat complicated. Braille typewriters are tax-exempt, but calculators and books for the visually impaired are only partially exempt:
That portion of the price of braille books … which is attributable to those features of the books … that enable the affected person to use them, if separately stated on the bill, is excluded from the amount upon which the sales tax is computed. In determining the reasonableness of the amount of the exclusion, like items must be compared, such as, a comparison of the price of a hard cover braille edition of a book with the same hard cover edition of a nonbraille book. … Calculators which contain talking devices that are intended for the use of blind people are subject to tax. However, that portion of the price of the calculator attributable to the talking device is exempt from tax … .
Businesses must not only determine which items qualify, but also keep up with changing rules.
While guide dogs have always been tax-exempt in New York, in 1995 the state expanded the exemption to cover other service dogs used by the disabled, as well as items used for the care of these dogs, including food and treats, blankets, and grooming services.
While the desire to make medical devices affordable for everyone is commendable, there is an unavoidable price to pay in tax compliance costs any time a class of goods or services is exempted from taxation.
What’s the best way for a city to handle a projected $300 million budget deficit? Detroit Mayor Kwame Kilpatrick has a controversial solution to his city’s budget woes: a tax on gambling winnings at the city’s casinos.
Earlier this month, the Detroit Free Press reported that Kilpatrick, after abandoning his fast-food tax proposal, intends to ask the legislature to approve the application of Detroit’s income tax to gambling winnings, with a rate of 2.5% for residents and 1.25% for nonresidents.
Kilpatrick ‘s plan will face some hurdles. First, even though the city can tax residents’ winnings, forcing casinos to collect the tax would require changes in state law.
Second, Detroit would have a hard time justifying a gambling tax on nonresidents. Although the city taxes income earned by professional athletes and others who travel to Detroit for business, gambling is not a profession for most casino patrons. Applying local or state income taxes to nonresident workers is also poor tax policy for a number of reasons, including increased tax complexity and compliance costs.
This is not the first time Detroit and Michigan have turned to gambling to solve their budget crises. When Michigan voters approved legislation authorizing casinos, they did so in part for tax relief, hoping casinos would generate tax revenue and shift some of the burden away from individuals.
Detroit’s three casinos, which comprise the nation’s sixth-largest casino market in terms of gross revenue, collect Michigan income taxes and pay a 24-percent tax on adjusted gross receipts, which is shared by the city and state—$279.4 million in 2004. The rate was originally 18 percent, but legislators raised it last year to help balance the budget.
Using gambling taxes of any type—whether on casinos, slot machines at state racetracks, or state-run lotteries—to provide relief from other taxes or compensate for budget shortfalls is never good tax policy, but cash-strapped states and cities increasingly do so.
Singling out gambling for relatively high tax rates results in detrimental economic distortions when consumers choose to gamble in other locations or pursue other, lower-taxed types of recreation, or when gambling establishments lose investors.
Economist Milton Friedman famously argued that government programs suffer from a "tyranny of the status quo". When new programs are first proposed, there is vigorous debate about their costs and benefits. But once they are enacted, debate largely ceases, and programs develop constituencies that fight to maintain and expand them.
Over time the federal budget ends up cluttered with dead wood—and tax burdens continually ratchet upward.
However, a new White House effort to create a "sunset commission" charged with examining and eliminating wasteful and outmoded federal programs may go a long way toward slowing the process. From Wednesday's Baltimore Sun:
Government programs are the only sign of eternal life on Earth. Once they are created, they often attract large constituencies that are ready to complain loudly about their "essential" services should anyone try to reduce their funding or, worse, end them altogether...
The Bush administration is asking Congress to pass the Government Reorganization and Program Performance Improvement Act of 2005. If approved, the legislation would create two agencies that would place the interest of taxpayers before those of the politicians.
The Sunset Commission would review the effectiveness of each federal program. Programs and agencies would automatically cease unless Congress took specific action to continue them. The Results Commission would work to uncover duplication of services in government programs, of which there are many.
The need for these commissions should be evident when one considers that about one-third of the fiscal 2005 discretionary budget is unauthorized. Comprehensive reviews of federal spending might save taxpayers hundreds of billions of dollars.
Federal spending is out of control. It must be properly monitored by an entity that places the interests of those who earn the money over those who didn't earn it and can spend it with little accountability.
If taxpayers want to keep more of the money they earn, they must also work to become less dependent on a government check. We look to government too often and to ourselves not enough. When that dynamic reverses, our need of government will be reflected in less government. That will benefit the economy and the government more than additional revenue. (Full op-ed here.)
The idea of creating a "predatory bureau" to correct biases toward inefficiency in democratic political systems isn't a new idea. Economists John Baden and Rodney Fort proposed the idea decades ago. (For their original article, see "The Federal Treasury as a Common-Pool Resource: The Predatory Bureaucracy as a Management Tool," in Managing the Commons).
Read the full text of the White House proposed bill here (PDF). Read another useful summary of the proposal here.
It is back to school time, which means among other things, it's sales tax holiday season. From CNN money:
While many students shudder at the onset of the back-to-school season, parents have reason to smile, as it signals the start of the tax holidays.
In the coming weeks, 11 states and the District of Columbia will offer periods of sales tax exemptions. Those few days of tax freedom mean consumers can save a few bucks on everything from clothing and footwear to school supplies and computers.
The following states (and the District of Columbia) are granting sales tax holidays this year: Connecticut, Florida, Georgia, Iowa, Massachusetts, Missouri, New Mexico, New York, North Carolina, South Carolina and Texas. Other states plan to follow suit as well in coming years.
Is it possible that a gimmick which lowers taxes is actually poor tax policy? Economically speaking sales tax holidays are poor tax policy for two main reasons.
First, sales tax holidays are distortionary because they are non-neutral across products. This means that consumers have an incentive to buy products which fall under the sales tax holiday as opposed to goods that are not covered in the holiday.
Second, sales tax holidays are non-neutral over time, which means that they create incentives for consumers to purchase items during the sales tax holiday that they otherwise would have purchased at another time.
Additionally, sales tax holidays add to retailers' compliance costs and make the tax code less stable. Although sales tax holidays are good for certain consumers of certain products, they are poor tax policy overall.
It appears that House and Senate negotiators last night ironed out a final energy bill chock-full of complicating tax preferences. The final tally? $14.6 billion in tax subsidies for oil, natural gas, and alternative energy production.
As we've written before, the "The Energy Policy Tax Incentives Act of 2005" ought to be renamed "The Skyrocketing Tax Complexity Bill of 2005". It threatens to dramatically complicate the federal tax code at precisely the time when the President's Advisory Panel on Federal Tax Reform is set to recommend ways to simplify the code.
One Member of Congress defended the tax-complicating bill saying, "This is a darned good bill and this is going to help this country... The sooner we get it implemented, the better." Yet on his very own website he simultaneously advocates for tax simplification:
Ninety years have passed since the ratification of the Sixteenth Amendment, and during this time, the tax code has undergone significant change and become increasingly complicated...
[E]ach tax cut or adjustment signed into law also creates more chaos within the code and makes compliance more burdensome.
I think an appropriate solution would be to abolish our current code and adopt a straight-forward, simple system of taxation.
From an economist's standpoint, the bill is a disappointing abandonment of any attempt at economically sound tax policy. It's hard to see how Members of Congress can support tax simplification while simultaneously signing onto a bill that seems designed to complicate the tax code in the name of tax subsidies for politically favored activities.
Looking forward to the feast of tax subsidies in the new energy bill, QWQC-TV Iowa glowingly congratulates House Speaker Dennis Hastert for his efforts to funnel taxpayer dollars into the pockets of rent-seeking Iowa ethanol producers:
House Speaker Dennis Hastert has inserted a special tax credit in a wide-ranging energy bill that is intended to help Illinois' ethanol industry and those who buy the fuel additive when they fill their car up at the gas pump.
Under the provision, gas stations will get a tax credit to install equipment accommodating E-85 -- an ethanol-based fuel alternative that its promoters say is up to 50 cents cheaper per gallon than unleaded gasoline.
Hastert says the tax credit will not only help consumers save money, but it will also benefit the environment, reduce the nation's dependency on foreign oil and help farmers.
Sadly, "further complicates the federal tax code at a time when tax simplification is a domestic priority of the President" didn't make the list of the credit's likely effects.
The drive to repeal the estate tax is close to success in the U.S. Congress, but it still may fall short. The two best arguments for repeal hinge on fairness and economic growth.
• For the sake of fairness, it should be repealed because its monstrous complexity favors vast family fortunes whose tax lawyers and accountants plan for decades to shield money from estate taxation. The losers in this game are small businesses and farmers whom death often catches legally unprepared.
• For the sake of economic growth, it should be repealed because it penalizes saving, and many economists believe it discourages new wealth creation by America's most innovative, productive entrepreneurs.
On the other hand, there have always been two arguments in favor of the estate tax that have prevailed. One of them is obsolete.
For the sake of fairness, the estate tax was thought to prevent wealth from remaining concentrated in the hands of the same few families. Fortunately, the newly globalized economy generates vast amounts of new wealth and large numbers of newly rich people each year, solving the concentration-of-wealth problem more effectively than the estate tax ever could.
With all this against it, the estate tax has one last remaining ally, and that is the belief, supported by official estimates, that it brings a lot of money into the U.S. Treasury. In fact, it certainly does not raise nearly the money that the official estimates show. There are many complex tax-planning reasons why. Here are the three simplest:
1. Tax-exempt organizations have grown like weeds, crowding out taxable income. Most charities believe the estate tax boosts gift-giving as taxpayers try to avoid paying up to 55 percent of their accumulated savings to the federal government. These donations end up producing capital income for tax-exempt charities instead of taxable earnings for the donor.
For example, consider a $1 million charitable gift made to avoid estate tax. If the charity invests the gift and earns 8 percent annually, then it will earn $80,000 annually, tax free. If the estate tax were repealed, the donor would keep the million dollars or give it to a taxpaying heir. Either way, Uncle Sam would get between $12,000 and $28,000 in tax the first year, depending on how he invests. If the earnings are reinvested each year, then within 20 years the government would be out over a half million dollars in income tax revenue.
2. Estate planning is phenomenally expensive – and tax deductible. Official revenue estimates take no account of the enormous tax-deductible expenses incurred during estate planning. Absent the estate tax, these individuals would likely shift their estate planning money to non-deductible expenses, or they would save them. Either way, current or future income tax receipts would be higher.
3. Compliance costs for taxpayers and the IRS. Finally, if the estimators produced a truly comprehensive estimate for estate tax repeal, they would also account for the savings to the IRS which spends millions of dollars each year attempting to collect estate tax revenue. The resources devoted to estate tax compliance would likely be redirected into other areas of tax collection, areas which the estimators have historically scored as increasing collections significantly.
The estate tax is a levy without a mission. Its ill effects are legion, its social policy motivation obsolete, and even its revenue is an illusion. It should be repealed.
Economists assume people are mostly motivated by self-interest. The theory of public choice just extends that analysis to government, taking the same principles economists use to analyze people's decisions in markets and applying them to political actors.
Not surprisingly, the key result is that politicians mostly work to maximize net benefits to themselves, not benefits to the public at large—what Nobel Laureate James Buchanan has called "politics without romance."
One more confirmation of the soundness of the public choice approach comes from the excellent cover story of the July 2005 Harper's magazine, "The Great American Pork Barrel" by Ken Silverstein:
"Pork-barreling" as a legislative epithet is a pre-Civil War coinage that referred to the custom of handing out salt pork to slaves, who would crowd around the barrels that held it; and indeed, members of Congress have raided the federal treasury for home-district boondoggles ever since the earliest days of the republic...
The pork barrel was to become as central to our national political culture as the gerrymander or the filibuster; it has long been a foregone conclusion that whenever the federal government builds a road, or erects a dam, or constructs a power plant, members of Congress will artfully pad the bill with hometown "pork."
In the past two decades, though, the pastime has become breathtaking in its profligacy. Even as the federal deficit soars to record heights, the sums of money being diverted from the treasury have grown ever larger. Last year, 15,584 separate earmarks worth a combined $32.7 billion were attached to appropriations bills—more than twice the dollar amount in 2001, when 7,803 earmarks accounted for $15 billion; and more than three times the amount in 1998, when roughly 2,000 earmarks totaled $10.6 billion...
Although there are a number of legislative instruments that moneyed interests can use to raid the federal treasury, appropriations bills have become the vehicle of choice, both because they are regularly scheduled—they must be passed, or else the government shuts down—and because their staggering size and scope deter public scrutiny of individual line items. Unsurprisingly, seats on the appropriations committees are among the most desirable sinecures in Congress.
It's hard to imagine a more absolute and total confirmation of the methodological soundness of the public choice approach to public spending and taxation.
Unfortunately, the full piece isn't available online. For a useful summary from the Washington Post, see here.
Andrew’s post on pork spending reminds me of a story about the Father of the Constitution. President James Madison, in his last act before leaving office, vetoed a bill for “internal improvements,” including roads, bridges, canals, etc. These kinds of programs are ripe for the pork-barrel treatment today.
In his veto message to Congress, he said:
“Having considered the bill…I am constrained by the insuperable difficulty I feel in reconciling this bill with the Constitution of the United States…The legislative powers vested in Congress are specified...in the…Constitution, and it does not appear that the power proposed to be exercised by the bill is among the enumerated powers…”
Congress had tried to justify the bill by using the General Welfare Clause, to which President Madison responded:
“Such a view of the Constitution would have the effect of giving to Congress a general power of legislation instead of the defined and limited one hitherto understood to belong to them, the terms ‘common defense and general welfare’ embracing every object and act within the purview of a legislative trust.”
Finally, Madison sympathized with congressional efforts to improve commerce, but reminded Congress that:
“But seeing that such a power is not expressly given by the Constitution, and believing that it can not be deduced from any part of it…I have no option but to withhold my signature from it….”
This angered many in Congress, but it was a great last stand for the Father of the Constitution.
Quotes are from JAMES MADISON: WRITINGS (1999).
Here's our motivational quotation for the day:
If, as I am inclined to believe, economists cannot usually affect the main course of economic policy, their views may make themselves felt in small ways. An economist who, by his efforts, is able to postpone by a week a government program which wastes $100 million a year (what I consider a modest success) has, by his action, earned his salary for the whole of his life.
Indeed, if we compute the total annual salaries of all economists engaged in research on public policy issues (or questions related to this), which might amount to $20 million (or some similar figure) it is clear that this expenditure (of one much larger) would be justified if it led to a miniscule increase in the gross national product.
It is not necessary to change the world to justify our salaries.
Source: Ronald H. Coase, "Economists and Public Policy," Essays on Economics and Economists (Chicago, 1994)
One of our talented summer analysts—Eric A. Miller of the University of Rochester landed a piece in Sunday's Washington Post laying out the case against a taxpayer-funded stadium in our nation's capital. Here's an excerpt:
In its quest to bring professional baseball back to Washington, the D.C. Council agreed to build a new stadium for the Washington Nationals that is to be largely financed by taxpayer dollars. This is a sweetheart deal that will allow Major League Baseball to sell the team at a price that virtually guarantees it a profit while likely creating a burden for D.C. taxpayers...
Economists seldom agree, but the many studies done over the past decade all arrived at the same conclusion: Publicly funded stadiums do not deliver the benefits they promise...
The D.C. Council estimates that a new stadium will create 380 direct and indirect jobs for D.C. residents, but most of these jobs will be day-of-game positions for food vendors, parking lot attendants and other unskilled workers.
Local taxpayers will be forking over more than $1 million a job for such part-time, low-wage positions that won't even pay enough to support a family.
According to Senator Blanche Lincoln (D-Ark) the answer is yes -- at least if your internet business happens to provide adult content.
The Los Angeles Times reports that Sen. Lincoln will "propose a new 25 percent federal tax on Internet pornography and new requirements for adult Web sites to help prevent children from looking at them."
The bill is expected to be introduced this week and would affect all for-profit adult websites operating in the United States. The money collected would be used for the Internet Safety and Children Protection Act of 2005, which would help prevent minors' access to pornographic websites.
Contrary to popular belief, the Federal Internet Tax Freedom Act of 1998 doesn't totally exempt on-line businesses from tax. It applies to the application of state telecommunications taxes on internet access. Lincoln's internet porn excise tax, however, would be the first federal internet excise tax on the books.
Lincoln's proposal, though well-intentioned, may only cause a mass-exodus of adult websites off-shore, raising little tax revenue in the short run and possibly giving rise to increased tax disputes internationally as domestic companies move websites to offshore servers.
There is also a neutrality issue with Lincoln’s proposal, as the 25 percent excise tax may in fact shift the sale of pornography back toward brink-and-mortar stores as an unintended consequence.