April 16, 2012

Taxmageddon Looms, Potentially Pushing Tax Freedom Day Later than Ever

Download Fiscal Fact No. 297: Taxmageddon Looms, Potentially Pushing Tax Freedom Day Later than Ever

While Tax Freedom Day[1] is just around the corner, on April 17 this year, try to enjoy it. If Congress fails to act, “Taxmageddon”—the roughly $500 billion tax increase scheduled to occur January 1, 2013—could push Tax Freedom Day to the end of April or beyond.

Taxmageddon, as Curtis Dubay[2] and others[3] have described it, is the result of a litany of expiring tax provisions, all occurring at the end of this year. The biggest expiring provisions are the Bush tax cuts, the payroll tax holiday, and the Alternative Minimum Tax (AMT) patch.

The table below shows the effect of all expiring provisions in terms of days added to America’s total tax burden. While this year it will take Americans 107 days to pay the total tax burden, these federal tax increases will add another 11 days, pushing Tax Freedom Day to the end of April. Add to this the fact that state and local tax collections are surging and it means that Tax Freedom Day next year could easily be a record breaker.[4] The all-time latest Tax Freedom Day occurred on May 1, 2000, after huge stock market gains produced huge capital gains tax collections.

The table breaks Taxmageddon down according to the major tax types. The biggest effect is on the federal individual income tax, the burden of which would increase more than 5 days unless these tax increases are halted. This is mainly the result of expiration of the Bush tax cuts and the AMT patch, which would each add more than 2 days to the burden. Another partial day would be added by the expiration of various “tax-extenders,” most of which affect businesses, and are included here to the extent that they are used by pass-through businesses, such as S-corporations, partnerships, and sole proprietorships, that file under the individual code.[5] The largest tax extender by far is bonus depreciation, which this year allows companies to write off 50 percent of the cost of investment.[6]

The corporate income tax burden would increase more than 3 days, partly as a result of these expiring tax-extenders. Besides bonus depreciation, some of the other large tax-extenders that primarily affect C-corporations include the R&D tax credit, Subpart F for active financing income, and the alcohol fuel tax credit. Additionally, corporate profits are projected to continue their recent accent as the economy recovers, adding to the tax burden.

More than 2 days would be added by expiration of the payroll tax holiday. Finally, expiration of the Bush tax cuts would increase the estate tax burden considerably, but because the estate tax is such a small part of the total burden, it would add only a partial day.

Tax Burden Due to Increase More than 11 Days if Congress Fails to Act

Individual Income Tax

5.3

Bush Tax Cuts

2.6

Alternative Minimum Tax

2.2

Tax-Extenders

0.4

Corporate Income Tax

3.4

Payroll Tax

2.5

Estate Tax

0.2

Total

11.3

Note: The methodology[7] is the same as that for Tax Freedom Day,[8] but it should be noted that these projections are less accurate since they are one more year out, into 2013, based on CBO[9] estimates of GDP and tax collections.
Totals may not sum due to rounding.

1. See William McBride, Tax Freedom Day 2012, Special Report No. 298, https://taxfoundation.org/legacy/show/28074.html.

2. See Curtis Dubay, “Taxmageddon: Massive Tax Increase Coming in 2013,” Heritage Foundation Issue Brief (Apr. 4, 2012), http://www.heritage.org/research/reports/2012/04/taxmageddon-massive-tax-increase-coming-in-2013.

3. Ezra Klein, “‘Taxmageddon’ in one table,” Washington Post (Mar. 30, 2012), http://www.washingtonpost.com/blogs/ezra-klein/post/taxmageddon-in-one-table/2012/03/30/gIQA1GkElS_blog.html.

4. State tax collections are up 9 percent in 2011 over the year before. See Joseph Henchman, State Tax Collections Rise 9 Percent, Tax Foundation Tax Policy Blog, https://taxfoundation.org/legacy/show/28125.html.

5. More than half of business income is taxed under the individual code. For a break-down of how various tax-extenders and other tax expenditures effect standard C-corporations versus pass-through entities. See Robert Carroll & Gerald Prante, The Flow-Through Business Sector and Tax Reform, Ernst & Young LLP, Apr. 2011,
http://www.s-corp.org/wp-content/uploads/2011/04/Flow-Through-Report-Final-2011-04-08.pdf.

6. Congressional Budget Office, The Budget and Economic Outlook, Jan. 31, 2012, http://cbo.gov/publication/42905. See the section on expiring tax provisions.

7. Tax Freedom Day: A Description of Its Calculation and Answers to Some Methodological Questions, Working Paper No. 3, http://www.taxfoundation.org/legacy/show/23039.html.

8. William McBride, Tax Freedom Day 2012, Special Report No. 198, https://taxfoundation.org/legacy/show/28074.html.

9. Congressional Budget Office, CBO Releases Updated Budget Projections for Fiscal Years 2012 to 2022, http://cbo.gov/publication/43079.

A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

Tax expenditures are a departure from the “normal” tax code that lower the tax burden of individuals or businesses, through an exemption, deduction, credit, or preferential rate. Expenditures can result in significant revenue losses to the government and include provisions such as the earned income tax credit, child tax credit, deduction for employer health-care contributions, and tax-advantaged savings plans.

A pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates.

A payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue.

An estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs.

An individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S.

Depreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment.

A corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax.

A capital gains tax is levied on the profit made from selling an asset and is often in addition to corporate income taxes, frequently resulting in double taxation. Capital gains taxes create a bias against saving, leading to a lower level of national income by encouraging present consumption over investment.

Bonus depreciation allows firms to deduct a larger portion of certain “short-lived” investments in new or improved technology, equipment, or buildings, in the first year. Allowing businesses to write off more investments partially alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs.

A tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly.

The Alternative Minimum Tax (AMT) is a separate tax system that requires some taxpayers to calculate their tax liability twice—first, under ordinary income tax rules, then under the AMT—and pay whichever amount is highest. The AMT has fewer preferences and different exemptions and rates than the ordinary system.