The Tax Policy Blog

Today is the 49^th anniversary of the Revenue Act of 1964, the legislation signed into law by President Lyndon Johnson that contained the tax code changes generally referred to as the “Kennedy tax cuts.” President Kennedy had emphasized the need for tax reform in his 1963 State of the Union address:

To achieve these greater gains, one step, above all, is essential--the enactment this year of a substantial reduction and revision in Federal income taxes.

For it is increasingly clear--to those in Government, business, and labor who are responsible for our economy's success--that our obsolete tax system exerts too heavy a drag on private purchasing power, profits, and employment. Designed to check inflation in earlier years, it now checks growth instead. It discourages extra effort and risk. It distorts the use of resources. It invites recurrent recessions, depresses our Federal revenues, and causes chronic budget deficits.

Now, when the inflationary pressures of the war and the post-war years no longer threaten, and the dollar commands new respect-now, when no military crisis strains our resources--now is the time to act. We cannot afford to be timid or slow. For this is the most urgent task confronting the Congress in 1963.

After Kennedy’s death, President Johnson announced his intention to push tax reform forward in his own 1964 State of the Union address:

…every individual American taxpayer and every corporate taxpayer will benefit from the earliest possible passage of the pending tax bill from both the new investment it will bring and the new jobs that it will create.

That tax bill has been thoroughly discussed for a year. Now we need action. The new budget clearly allows it. Our taxpayers surely deserve it. Our economy strongly demands it. And every month of delay dilutes its benefits in 1964 for consumption, for investment, and for employment.

For until the bill is signed, its investment incentives cannot be deemed certain, and the withholding rate cannot be reduced-and the most damaging and devastating thing you can do to any businessman in America is to keep him in doubt and to keep him guessing on what our tax policy is.

Congress took up Johnson’s suggestion and passed what became the Revenue Act of 1964, which the President signed on February 26, 1964. The bill dropped the top marginal tax rate from 91% to 70% (and also reduced the corporate tax rate from 52% to 48%). In the wake of this reduction on high-earner households, federal revenue actually increased, rising from  $94 billion in 1961 to $153 billion in 1968, an increase of 33 percent in real terms.

For more analysis, see Tax Foundation Fiscal Fact No. 15, "Comparing the Kennedy, Reagan and Bush Tax Cuts" by William Ahern.

With the recent comments from Phil Mickelson and the emigration of French actor Gerard Depardieu and other celebrities for tax reasons, people have been abuzz about millionaires fleeing high tax states in favor of low tax states. New York Times writer James B. Stewart, however, thinks millionaire migration due to taxes is a myth. Unfortunately, he greatly simplifies the issues, while ignoring ample evidence that migration is in fact happening. While the studies and evidence Mr. Stewart cites are interesting, he ignores how high tax burdens tend to slow economic growth and immigration over the long run.

It is no coincidence that the states that are famous for their “millionaire taxes” are also famous for their overall high tax burden. These tax burdens have persisted for decades in some states.  New York, New Jersey, and California, with high personal and corporate income tax rates, have routinely been among the states with the highest overall tax burdens on businesses and individuals. Small changes to the top marginal income tax rate may not be the biggest factor in a person’s move. However, when it comes time to move for retirement, or to relocate a business, high tax states are much less desirable compared to states such as Nevada and Wyoming with no personal or corporate income tax.

IRS data indicates a migration trend from high tax states to low tax states. Between 1999 and 2010, high-tax New York, New Jersey, and California lost about 1.2 million individual taxpayers and more than $97 billion of personal income.  This does not include the corporate losses.  Meanwhile, low-tax Nevada, Wyoming, and South Dakota –not known for their magnificent climates – gained about 172 thousand individual taxpayers and $15 billion of personal income during the same period, again not including corporate losses.  People are moving to these states and their money is following. Certainly this trend is not a coincidence.

There is one point that Mr. Stewart is right about: one of the main reasons people move is because of job prospects. However this cannot be divorced from a state’s high tax burden. Most academic studies on the subject have found that high and progressive income taxes are related to slower economic growth. For instance, a forthcoming paper by Mertens and Ravn in the American Economic Review finds that a one percentage point cut in the average personal income tax rate raises real GDP by 1.4 percent in the first quarter and 1.8 percent in the next three. Higher taxes may not have a huge immediate effect on migration, but their negative effect on the economy will eventually drive the jobs and the job seekers elsewhere.

Mr. Stewart is off the mark if he believes he has uncovered a myth. Besides the posturing of celebrities, no one claims that at the very moment someone whispers “tax increase” one thousand millionaires head to the border. What really happens is that these higher tax burdens cause wealth and income to flee to states and countries with lower burdens and higher economic growth over time. High-tax states such as Vermont, Michigan and Missouri have not been magnets for jobs over the long run. Look over at Europe, which is once again scaring investors. It is a continent with excellent climate, culture and an educated workforce, but its high taxes and spending have stalled population and economic growth for a decade or more. America will go that way if we continue down the same path, driving out investment, businesses, and jobs.

In case you missed the recent Cato Institute event featuring Tax Foundation chief economist William McBride, you can watch it below. The Capitol Hill briefing, "Taxes and Economic Growth: Understanding the Effects" also included Tax Foundation alumni J.D. Foster of the Heritage Foundation and Chris Edwards of Cato.

For more background, see McBride's recent study Tax Foundation Special Report No. 207, “What Is the Evidence on Taxes and Economic Growth?”

Just over a week ago, Nebraska Gov. Dave Heineman decided to withdraw his two bills that would reduce the state’s income tax rate by expanding the sales tax base to additional business-to-business transactions. His action came after a contentious legislative hearing where witnesses (particularly from agriculture) expressed strong concern.

Their concern was justified, as I testified to at that hearing. B-to-B transactions, or business inputs, should actually be exempt under a properly structured sales tax system. This is not because businesses deserve special treatment, but because not doing so leads to the “pyramiding” of hidden taxes on taxes, distorting prices between goods based entirely on how many steps in the production chain there are. Instead, sales taxes should aim to tax final retail sales once and only once. It’s a mistake nearly every state with a sales tax makes, but one that should be addressed in tax reform.

This suggestion and criticism, I must note, does not reduce my enthusiasm for the Governor’s overarching goal: a simpler, more sensible tax system for Nebraska that will mean more jobs and economic growth. His approach – reducing taxes on wages and investment and shifting to taxes on consumption – would boost economic growth and be in line with strong academic evidence for tax reform. Taxing services rather than business inputs could keep the plan revenue-neutral while ending a disparity between those who sell goods and those who sell services, which is actually just a holdover from how sales taxes were designed in the 1930s.

Legislators are now considering a bill to set up a commission to study the state’s tax code and recommend changes. If enacted, a preliminary report would be due December 15 and a final report by November 15, 2014. Nearly everyone seems supportive of this approach.

I am too and even started sketching out some back-of-the-envelope options, using the Governor’s basic approach but instead exempting business inputs and expanding the sales tax to services. Depending on how broad the sales tax expansion is, the state could get the income tax and sales tax rates both down to 5.5 percent on a revenue-neutral basis. If the sales tax rate stayed where it is, you could get the income tax down to 4 percent, lower than all neighboring states. A very aggressive sales tax base broadening could get it down even further. An 8 to 10 percent sales tax rate would be needed to completely eliminate the income tax.

There’s a lot of moving parts of course. Besides the sales tax and income tax, there’s the property tax, the inheritance tax, and other taxes. I am pleased that legislators seem to be taking this step because they want to do something and do it right. Go Big Red!

In the closing days of the session, Virginia legislators passed a transportation funding bill. The full bill text is provided by Americans for Tax Reform here (PDF). The Competitive Enterprise Institute (CEI) also has a brief summary here. The Washington Post reports that the bill is supposed to raise an additional $880 million per year.

The main takeaway is that, if approved by the Governor, Virginia will raise its sales tax from 5.0 percent to 5.3 percent statewide, and further to 6.0 percent in Northern Virginia and the Hampton Roads area. The state’s retail gasoline tax will be repealed, but replaced by an equivalent tax on wholesale gasoline. (This tax will be somewhat lower if the federal government authorizes the state to impose its sales tax on Internet purchases from out-of-state retailers.) Car taxes go up statewide, as does a license tax on electric vehicles. Northern Virginia will see higher real estate transfer and hotel taxes. The bill also prohibits new tolling on I-95 south of Fredericksburg.

Full details:

Sales & Use Tax

• Raises the state sales and use tax from 5.0 percent to 5.3 percent, effective July 1, 2013. Of this increase, 0.175 percent goes to highway maintenance and operations, 0.050 percent goes to intercity rail, and 0.075 percent goes to mass transit.
• An existing sales tax exemption for out-of-state mail order catalog items under $100 is removed.
• Imposes an additional 0.7 percent sales tax in the counties and cities of the Northern Virginia Transportation Authority and the Hampton Roads Region (the tax will thus total 6 percent in those areas). The additional sales tax will not apply to purchases of groceries but will otherwise have the same tax base as the state tax, and will be collected by the state on one consolidated return.
• Requires the tax commissioner to give sellers at least 30 days’ notice of local sales tax changes, and that changes can only become effective on the first day of a calendar quarter. Holds sellers harmless for sales tax collection errors caused by erroneous state information.
• Caps state use tax on equipment brought into the state for performing contracts at 5 percent. Sales of aircraft are also taxed at 2 percent and watercraft at 2 percent with a maximum tax of $1,000.

Gasoline Taxes

• Repeals the 17.5 cent gasoline tax effective July 1, 2013, replacing it with a 3.5 percent wholesale gasoline tax. The tax will be computed and modified twice each year based on the average wholesale price, on January 1 and July 1. The average wholesale price calculation cannot be less than the actual wholesale price of self-serve gasoline on February 20, 2013 (which news reports say equals $3.50 per gallon). At that $3.50 per gallon rate, what was a 17.5 cent tax will now be at minimum a 12.25 cent tax ($3.50 X 3.5 percent).
• A similar formula is used for taxing diesel, which presently pays a 17.5 cent tax and after July 1, 2013, will pay a 6 percent wholesale tax.
• If Congress does not enact legislation by January 1, 2015 giving Virginia the authority to collect sales tax from remote sellers with no physical presence in the state, the 3.5 percent tax will instead become a 5.1 percent tax, effective January 1, 2015. Again, the average wholesale price calculation cannot be less than the actual wholesale price of self-serve gasoline on February 20, 2013; at that $3.50 per gallon rate, what was a 17.5 cent tax will now be at minimum a 17.85 cent tax ($3.50 X 5.1 percent). The tax can now go up with any rise in gasoline prices, although in a manner now less transparent to consumers.
• Expands the existing 2.1 percent gasoline wholesaler tax in the Northern Virginia Transportation Authority region to the Hampton Roads region.

Car Taxes

• Tax on the sale of a car, presently 3 percent, will rise to 4 percent (July 1, 2013), then to 4.1 percent (July 1, 2014), then to 4.2 percent (July 1, 2015), then to 4.3 percent (July 1, 2016). The minimum tax is raised from $35 to $75.
• Raises the statewide $50 license tax for electric vehicles to $100.
• Changes license tax due date for all vehicles from the last day of December to the date of registration and each subsequent renewal.

Other Taxes

• Imposes a real estate transfer tax of 0.25 percent, termed a “regional congestion relief fee,” for land or property transfers in the Northern Virginia Transportation Authority area.
• Imposes a 3 percent hotel tax, on top of existing hotel taxes, in the Northern Virginia Transportation Authority area.

Miscellaneous

• Dedicates $300 million of the new revenue to the Metrorail silver line extension to Dulles International Airport.
• Prohibits tolls on Interstate 95 south of Fredericksburg without further approval by the Legislature. Virginia had applied for a waiver from the federal government to do so in a limited fashion, so this kills that.
• Northern Virginia Transportation Authority consists of the Counties of Arlington, Fairfax, Loudoun, and Prince William, and the Cities of Alexandria, Fairfax, Falls Church, Manassas, and Manassas Park.
• Hampton Roads region consists of Counties of Gloucester, Isle of Wight, James City, and York, and the cities of Chesapeake, Hampton, Newport News, Norfolk, Poquoson, Portsmouth, Suffolk, Virginia Beach, and Williamsburg.

Previous TF blog coverage:

• Crunch Time for Virginia Transportation Funding Plan Monday, February 11, 2013 - 13:15
• Virginia House Passes Modified Version of Governor McDonnell’s Transportation Plan Wednesday, February 6, 2013 - 17:00
• VA Democrats Don’t Like McDonnell’s Transportation Plan, Offer Something Strikingly SimilarWednesday, January 16, 2013 - 13:30
• Virginia Governor Proposes Smoke & Mirrors Transportation Financing Plan Tuesday, January 8, 2013 - 18:00
• Virginia Regional Divides Lurk Behind Transportation Financing Debate Tuesday, January 8, 2013 - 09:45
• Virginia May Consider Gasoline Tax Increase Tuesday, December 11, 2012 - 09:45

The Washington Department of Revenue released a report last month estimating that over 35 percent of total state cigarette sales illegally evaded cigarette taxes. That amounts to $376.4 million in lost revenue. To put that in perspective, that’s enough to buy nearly 42 million packs of cigarettes in Washington State.

By comparing in-state per capita cigarette sales with per capita consumption, the Department concluded that there were 147.9 million packs of untaxed cigarettes consumed during the 2012 fiscal year. Just over 46 million of those packs were legally exempted from taxation, leaving 101.4 million illegally untaxed packs sold in 2012.

Washington taxes cigarettes at $3.025 per pack—that was fifth highest in the nation in 2012. The rate exceeds all surrounding states (Oregon only taxes at $1.18 per pack and Idaho at $0.57 per pack).  The average price of cigarettes in Oregon last year was only $5.74. In Idaho it was $5.11—almost half the price of the average selling price in Washington. That price difference creates an incentive for consumers to shop for cheaper cigarettes elsewhere, reducing the revenue collected by Washington.

Lost tax revenue isn’t the only problem—the price differential across state lines creates a lucrative business opportunity for cigarette smugglers. When high-tax states are neighbored by low-tax states, smugglers can move and sell cigarettes across borders for a handsome profit. Such activity has been linked to violence, theft, and government corruption. Some states (such as Maryland and Virginia) have turned to harsher penalties for those caught engaging in these criminal activities. Instead of seeking to regulate a side-effect of high taxes, lawmakers should instead address the source of the problem. Lowering cigarette taxes will decrease the incentive to smuggle across state lines, in addition to reducing the crime associated with it.

More on Washington here.

More on cigarette taxes here, and our most recent report on cigarette smuggling here.

Follow Elizabeth on Twitter @elizabeth_malm.

Citizens for Tax Justice (CTJ) has long depicted the use of stock options as a way for corporations, such as Facebook, to avoid tax:

Earlier this month, the Facebook Inc. released its first “10-K” annual financial report since going public last year. Hidden in the report’s footnotes is an amazing admission: despite $1.1 billion in U.S. profits in 2012, Facebook did not pay even a dime in federal and state income taxes.

Instead, Facebook says it will receive net tax refunds totaling $429 million.

Facebook’s income tax refunds stem from the company’s use of a single tax break, the tax deductibility of executive stock options. That tax break reduced Facebook’s federal and state income taxes by $1,033 million in 2012, including refunds of earlier years’ taxes of $451 million.

But that’s not all of the stock-option tax breaks that Facebook generated from its initial public offering of stock (IPO). Facebook is also carrying forward another $2.17 billion in additional tax-option tax breaks for use in future years.

So in total Facebook’s current and future tax reductions from the stock options exercised in connection with its IPO will total $3.2 billion. That’s almost exactly what CTJ predicted last year, when Facebook first announced its IPO.

Here is another amazing admission: Mark Zuckerberg and other Facebook employees have to pay tax on these options.  A lot of tax.  Mark Zuckerberg alone will pay something like $2 billion in federal and California income taxes as a result of exercising $5 billion in options last year.  That’s because options are a form of compensation, much like salary, so they are taxed as ordinary income.  Like all compensation, options are deductible as a business expense.  CTJ, as well as Senator Levin, would remove this deductibility, thus double taxing this form of compensation, i.e. first by the corporate tax and then by the individual income tax. 

Double taxing is a serious no-no.  Double taxing our most successful entrepreneurs and businesses is just dislikable.

Follow William McBride on Twitter @EconoWill