The 21st Century Taxation Blog

On April 16, 2008, Maine enacted a law that doubles its beer and wine excise taxes and creates a new tax on soda syrup (LD 2247, Chapter 629). The syrup tax is $4/gallon and 42 cents/gallon of bottled soft drinks and those made from powder (see 4/17/08 article in the Portland Press Herald). The revenues will be used for the state's health insurance program called Dirigo. One estimate is that the syrup tax will mean about $28K of new taxes for an average McDonald's.

The new law defines soft drink broadly as "any nonalcoholic beverage, whether naturally or artificially flavored, whether carbonated or noncarbonated, sold for human consumption, including, but not limited to, soda water, cola and other flavored drinks, any fruit or vegetable drink containing 10% or less of natural fruit juice or natural vegetable juice and all other drinks and beverages commonly referred to as soft drinks, but not including coffee or tea unless the coffee or tea is bottled as a liquid for sale." Unflavored water and milk are exempted.

In the past year, we have seen both Michigan and Maryland enact new taxes, only to repeal them soon thereafter and before they became effective, due to complaints. That's a lot of work for no effect. What could have been done differently?

On 12/1/07, the day a use tax on specified services was to go into effect, Michigan repealed the law (see prior blog post). More recently, Maryland repealed its expansion of the sales tax to computer services. In November 2007, the legislature added computer services to a measure designed to address a budget shortfall (see Washington Post article of 12/9/07). The tax was to become effective on July 1, 2008. Fierce opposition by the business community led to its repeal in April 2008. The tax would have mostly applied to businesses since they purchase more computer services than do individual consumers.

Back in 1987, we saw Florida expand its sales tax to include specified services, only to repeal that tax 6 months later. In 1990, Massachusetts expanded its sales tax to services, but repealed it before the effective date.

On April 10, 2008, the House Small Business Committee held a hearing - “Modernizing the Tax Code: Updating the Internal Revenue Code to Help Small Businesses Stimulate the Economy." The Committee also issued its own report - “Seven Ways to Stimulate the Economy by Updating the Internal Revenue Code." In addition to having witness testimony online in written form, the Committee has videos on YouTube about the hearing. This can all be accessed at this summary of the hearing.

I think the ideas presented by witnesses and in the Committee's report fall into two categories:

1. Tweaks to the federal tax law to make compliance and doing business easier for small businesses.
2. Changes that reflect the fact that most of the federal tax law was written before we entered our global, interconnected, knowledge-based economy and society and thus is in need of modernization.

Examples of Category 1 suggestions:

In reaction to a US Supreme Court decision - Northwestern Cement v. Minn., 358 US 450 (1959), which many members of Congress thought would lead states to tax businesses beyond what they should under the commerce clause, Congress enacted Public Law 86-272 on September 14, 1959. Despite the lack of an expiration date in this legislation, it was described as a temporary measure while Congress further studied state taxation (a study established by PL 86-272). The report was completed in the mid-1960s (referred to as the Willis Commission report after the Congressman who chaired the subcommittee). However, PL 86-272 was not revised.

PL 86-272 explains when a state may impose income taxes on multistate businesses selling tangible personal property. Businesses selling services or intangibles, get no protection (or guidance) from the federal law. With more businesses selling services and intangibles today than in 1959, PL 86-272 is in need of updating.  There have been various congressional proposals in the past few years, but no changes have been enacted and there are differences of opinion between state governments and businesses on what the reforms should be. Also, recent court decisions have held that "economic presence" is sufficient for a state to be able to impose income tax obligations on a business (businesses believe that "physical presence" should be the standard). The US Supreme Court has declined to hear any of these cases. Meanwhile, the 50th anniversary of this stopgap legislation is approaching.

Ideally, tax reforms, of any size, should follow the principles of good tax policy. There are many views of exactly what these principles are, dating back to at least Adam Smith in the late 1700s (and even back to Aristotle if considering "fairness" in general - "equals should be treated equally and unequals unequally"). Most of the lists are fairly similar (see this chart for an example).

A while back I came across a 1967 report of the Ohio Tax Study Commission that included a principle to follow in its work that we don't often see. It ties well to the point of the 21st Century Taxation Blog. The extra Ohio principle was:

"Relationship to the Modern Economy

Insofar as possible, a tax or tax structure should be capable of growing with the economy of the state and should be revised from time to time so as to correspond with the true makeup of that economy as it develops and changes. Some products, habits of consumption, and classes of enterprise decline, while others rise to take their place. Ideally, a tax structure should be reviewed and revised as necessary so as to bear a relationship to the way people are doing things, regardless of whether additional revenues are needed at a given time."

In efforts to either raise new revenue or change behavior, or both, we sometimes see some unusual tax proposals from lawmakers. Here are a few recent examples, some of which were enacted:

Tax systems can get out of date. For example, an income tax designed with a rate structure to apply to specified income levels (some type of progressivity goal), will become out of date if the tax brackets are not adjusted for inflation. That is, if individuals with income between $30,000 and $40,000 are to have a 15% rate, they will start to creep into the next higher rate as their income increases with inflation (for example, a person gets a cost-of-living raise), even though their buying power has remained constant (they are really no richer). So, one way to keep the system current, is make an inflation adjustion to the income levels at which each tax rate bracket begins.

What about keeping a tax base current and relevant? That is, enabling a tax base to reflect current ways of doing business and how people live even as things change. That's harder than the rate adjustment which can just be built into the law by having a rule that tells the IRS to adjust the rate structure annually for inflation. Keeping a tax base current and relevant requires regular attention from legislators and making tough decisions. For example, perhaps decades ago it made sense to provide special tax breaks to a particular industry. Yet, if such breaks are not looked at regularly, they remain even when no longer needed. And, it is politically difficult to get a tax break removed once it has been there for a while.

This is the title for a 2/27/08 New America Foundation and UC Center Sacramento workshop in Sacramento. It will look at a variety of California tax and budget issues and possible remedies that also bring California's depression-era, industrial-based tax system into the 21st century. This blog post serves as place for further discussion on the topic and the workshop presentations.

Here is a link to my presentation topic on broadening the California sales & use tax base and lowering the rate. If other workshop materials are posted on the web, I'll add a link to them at this blog entry.

I look forward to your comments and online discussion.

In his 2/13/08 State-of-the-State address, Minnesota Governor Tim Pawlenty announced that he would create a 21st Century Tax Reform Commission to recommend tax reforms for the 21st century economy. Related to this, he also noted:

• the state has a serious deficit
• tax policies, job climate and large government have harmed economic growth
• there is a need to reduce taxes
• Minnesota should join other states and cap property taxes
• there is a need to move the tax system from the 1960s to the 21st century
• tax reforms should "encourage job growth, income generation, investment, entrepreneurial activity, research and exports"

Well, as the title of this blog would suggest, I think this is a good move for Minnesota. But, it won't be easy -- change rarely is.

The presidential candidates have mostly "tweaking" ideas for our tax system; they don't seem to be focused on the incredible budget and tax issues that will face the new president during the first term. Or, perhaps they just aren't being asked the right questions.

Pending fiscal challenges include: