Tax Policy

A Level Playing Field

Terry Tamminen — Wed, 04 Jun 2008 14:02:00 -0400

Everyone hates their taxes being spent on subsidies -- unless it's to subsidize their own industry. It's time for an honest debate about the role of subsidies in a 21^st Century economy and, at least, a restructuring to a more level playing field.

Examples? When I served in California state government, the Schwarzenegger administration tried for three years to push through a solar incentive package. Ultra-conservative State Senator Tom McClintock rose during the debate in red-faced indignation and bitterly opposed any subsidy of an industry that couldn't stand on its own two feet. I've heard that argument repeatedly, often by the same politicians who support massive subsidies to the oil and coal incumbents, despite the fact such "incentives" are hardly needed to get fossil fuels out of the ground.

The latest salvo comes from President Bush, who yesterday said it was time to end subsidies to "multimillionaire farmers." He was addressing a point about sharp increases in food prices, making wealthy agribusinesses even wealthier, partially the result of rising fuel costs and ill-conceived government mandates/incentives to produce ethanol. Ironically, the President told Congress he would veto any bill than shifts even a small portion of the $100 billion/year subsidies given to oil companies towards alternative energy sources.

Given that oil companies are recording profits that are the highest in the history of commerce - - not just in the oil business, in the history of ALL commerce -- it is hard to fathom. Moreover, some say the incentives are still needed to keep oil companies investing in new oil exploration and to build more refinery capacity. But few new discoveries are being made or exploited and refinery expansion lags demand by an increasing and exponential pace. So much for performance-based subsidies.

The role of subsidies should not be annuities for wealthy campaign contributors, but should be used as a way to level the playing field when incumbents have been given a similar (or far greater) head start. They should be strategically used to jumpstart businesses that will provide multiple benefits to the people -- in the case of incentives for renewable fuels or clean energy technology, the benefits are domestic jobs, reduced dependence on a shrinking fuel source, exports, improved public health by reducing pollution, and a planet that is less at risk of biting us in the backside with ever more drastic climate change impacts.

Those multiple benefits are something the incumbents can't provide -- and it's time to tilt the playing field in the direction of positive outcomes and end the fossil-fueled, taxpayer-funded boondoggles to the rich.

The President's Tax Fix for Health Insurance - Improved Tax Policy

Annette Nellen — Tue, 05 Feb 2008 00:00:00 -0500

President Bush has mentioned providing a tax deduction for health insurance. His 2009 budget proposal has more of the details:

Employees would be required to include in income the amount their employer pays to provide health care coverage for them. This amount would be reported on the employee's W-2 so they wuold know how much it is.
Employees (and others) could deduct what they spend on health insurance (or what their employer spends on them and they have to report as income). The deduction is limited to $15,000 ($7,500 for single coverage) and appears to be allowed as a deduction even if the individual does not itemize their deductions. It is also called a "standard deduction" and it appears you get that much even if you don't spend that much on your "qualified coverage."

Basically, the rationale is that this change should bring the insured - the patient, back into the health care COST decisions. Today, most employees with employer-provided health benefits probably cannot tell you how much their employer pays and how much they pay. They are also likely not aware that the government is giving them a tax break by not requiring them to pay income or payroll taxes on the benefit they get when their employer pays for their health insurance. And, most states match the tax break. It is very generous.

For example, Gina's employer provides her health insurance coverage and it costs the employer $10,000 each year. Gina contributes $3,000 towards the coverage which comes out of her payroll deductions. The total cost of the coverage is $13,000. The employer gets to deduct $10,000 on its tax return and Gina does NOT have to report the $10,000 benefit on her tax return (it is an "exclusion"). It is a great recruitment and pay strategy. An employee is much better off earning $10,000 less in taxable pay and instead having their employer use that money to buy them health insurance.

Because Gina isn't involved in much of the health insurance decision, she doesn't negotiate whether she is getting a good deal (as someone may likely do in getting car insurance). Also, the health plan may be quite generous and Gina just pays $10 every time she visits a doctor and doesn't know (or care) what the doctor is charging the insurance plan. Gina has no incentive to even ask about costs or whether all of the medical procedures she gets are crucial because it costs her so little.

All of this leads to increased medical care and health insurance costs for everyone.

Also, the current system provides a greater benefit to higher income individuals because they are in a higher tax rate. For example, if Gina has a marginal tax rate of 30%, the tax break saves her $3,000 in taxes each year. If she were instead in a 10% tax bracket, her savings would be $1,000.

Another rationale for the President's proposal is that employees with employer-provided health care get a better tax break then people who have to purchase their own insurance. While the tax law does include a medical deduction, it is only for those who itemize deductions and you can only deduct the excess of medical expenses over 7.5% of your adjusted gross income.

Back to Gina - President Bush is proposing that she include the $10,000 in her taxable income, but she would also get a deduction of $15,000 (apparently whether or not she itemizes her deductions). If her employer were instead paying over $15,000 for her health coverage, Gina would be limited to a $15,000 deduction.

It is not clear why the proposal allows a $15,000 deduction ($7,500 if single) even if the employer and employee are not paying that much for coverage.

More information on the health insurance tax proposal can be found at pages 19 - 22, and 92 of Treasury's explanation of the budget's revenue proposals.

There are specific rules on the type of coverage and several other details (as typical for special tax rules).

Some questions:

Treasury's explanation notes that this proposal would result in a revenue loss of $23 billion in 2009 and later years, but a revenue increase for 2009 - 2018. Is that a mistake? How was this all deterimined?
How would this change affect health care and spending decisions of employees, employers and those without employer-provided health insurance?
How would this proposal workwith other proposed and needed health care changes?
Would a tax credit be better? The income inclusion and deduction should offset, but if an individual's income inclusion from employer-provided health insurance is less than $15,000, they get a tax break (deduction is greater than the income hit) that is worth more to individuals in higher tax brackets while the credit is worth the same to everyone. Similarly for someone who buys their own health insurance - the credit would be more fair. And the credit should be refundable so that individuals who owe tax less than the credit would get it refunded (which would help them pay for the insurance).

Tax policy considerations - the proposal will bring transparency and greater fairness to the tax rules on health insurance taxability and deductions.

Other policy considerations - the proposal may also help control health care costs if it does lead patients to be more involved in spending and treatment decisions.

What do you think?

Economic Stimulus and Taxes

Annette Nellen — Sat, 19 Jan 2008 00:00:00 -0500

The hot topic of the week is the call by President Bush and others for some type of federal action or actions to help stimulate the economy (AP story and White House fact sheet).

Economists debate whether or not such an action can work and timing is also a consideration - how long will it take for the government to act and for consumers to react?

Some tax considerations:

Can we afford more tax breaks? They have to be paid for some way, someday.
Not all individuals need to file a return because their income may be below the filing level. How to you get economic stimulus, such as a tax rebate, to them?
States likely won't be able to adopt any federal tax cut because they won't be able to afford it. So, if done through a tax break, can it be done in a way that won't complicate state tax return calculations?
Should all individuals and businesses get the same benefit - such as $200? Should there be a greater amount for lower income taxpayers? Should higher income taxpayers get anything? What might get them to spend money they have saved?
What about some type of hiring and/or asset investment tax credit (refundable) for businesses?
Could any rebate be structured such as to perhaps get some people to file who don't, but should? This could also help reduce our tax gap.
If people get a rebate,when will they have to pay it back and how? Would it be an early refund of next year's taxes? Paid for through a future tax increase of some type?
We still have expensive tax fixes to consider. H.R. 3996 that provided 1-year AMT relief for thousands of individuals (but not all individuals) cost about $50 billion. And lots of expiring tax breaks that would be costly to extend or make permanent. Can these fixes be incorporated into any current relief plans?

The Congressional Budget Office (CBO) has a report on ways to respond to short term economic weakness and some factors to consider in the design of any remedy.

The Joint Economic Committee held a hearing on 1/16/08 on how to avoid a recession. It includes testimony from former Treasury Secretary Summers. Links to a variety of data, such as on unemployment and oil prices is also at this link.

Would some type of benefit truly help the economy?

What do you think?

This post was originally published at http://21stcenturytaxation.blogspot.com.

Business Tax Reform -- New Reports

Annette Nellen — Tue, 25 Dec 2007 00:00:00 -0500

In the past few months, at least 3 reports on corporate tax reform have been issued:

1. Congressional Research Service (CRS), Corporate Tax Reform: Issues for Congress (10/31/07), 39 pages
This report focuses on calls for lowering the corporate income tax rate, which some label as the 2nd highest rate (combined federal and state) among industrialized countries. It also analyzes Congressman Rangel's "mother of all reforms" (H.R. 3970) which proposes to broaden the corporate base and lower the tax rate to 30.5%.

2. U.S. Department of Treasury, Approaches to Improve the Competitiveness of the U.S. Business Tax System for the 21st Century (12/20/07), 121 pages.
This report provides some background on U.S. business taxation and compares it to other countries. It then lays out three possibiltiies for reform: (a) a business activity tax (BAT) which is a type of consumption tax, (b) a broadened income tax base and a lower tax rate including contrasting a lower rate with faster asset writeoffs and moving to a territorial system, and (c) reforming various aspects of the current system such as its preference for debt over equity.

See:

Asst Secretary Eric Solomon's statement about the report.
Treasury summary of the report.

3. OECD, Fundamental Reform of Corporate Income Tax (11/16/07), 131 pages

This report covers trends in corporate income tax, the reasons for a corporate income tax, types of corporate taxes, why countries are considering reforms, and types of reforms.

OECD's Executive Summary

Additional corporate tax reform reports and proposals related to the above:

Rangel's H.R. 3970 - summary, text, prior blog post
Treasury's report and forum on Business Taxation and Global Competitiveness
The Future of the Corporate Income Tax, by Nellen, 10/07
Many links (and reports) on fundamental tax reform (web)

More later (I'm still reading the reports!)

This post was originally published at http://21stcenturytaxation.blogspot.com.

How We Make Budget Problems Worse

Annette Nellen — Sat, 15 Dec 2007 00:00:00 -0500

In my 11/22/07 post on ideas for addressing California's $10 billion budget shortfall, I included reinstating the vehicle license fee (VLF). Apparently I'm not alone on that suggestion. But as Dan Walters recently reported, when the VLF was cut a few years ago, it was done in a way that prevents it from being restored. See his 12/11/07 article in the Sacramento Bee.

Lots of restrictions on budget options is a poor way to run a government. California has too many restrictions that tie the legislators' and governor's hands. These restrictions include Prop 98 that mandates that a certain percentage of the budget go to K-14. Of course, funding education is an extremely important role of government (and should include beyond grade 14!), but the restriction ignores that every year is different and ignores the role of lawmakers. Other restrictions include Prop 13 and 218 among others.

I was once on a panel that included a former California legislator. When I noted that these laws are too restrictive and prevent legislators from doing their job, this person noted something along the lines of "but we have to do that because you can't trust legislators to do the right thing." I about fell off of my seat that such a comment would be made publicly or even believed by someone who had served in the legislature. Apparently, we need to have better civics education.

Well, the VLF restriction can probably be undone, but would not be easy or politically wise so soon after going into the law. But, the state definitely needs revenue and should never have removed a tax that was working and was even progressive in that higher income people are the ones who tend to have higher value cars. We could increase the state gasoline excise tax with the additional funds going into the general fund. Unfortunately, that tax is regressive and some relief for lower income taxpayers would be needed. Or perhaps a state version of the federal gas guzzler tax could be enacted as that would primarily affect higher income taxpayers.

In the meantime, we need to stop putting "shackles" into the law so that elected officials can have more options for solving budget problems.

Your thoughts?

This post was originally published at http://21stcenturytaxation.blogspot.com.

Michigan Changes Course -- Repeals Sales Tax on Services

Annette Nellen — Sat, 08 Dec 2007 00:00:00 -0500

Recently, to address budget problems, Michigan lawmakers agreed to expand the sales tax base to include many more types of services (see prior post). Big surprise - taxpayers and service providers did not like the change - a $725 million tax increase (see story in The Detroit News, 11/1/07)

On 12/1/07, the effective date of the expanded tax, Governor Granholm signed HB 5408 (PA 145) to repeal the tax on services. That expected sales tax revenue will be replaced with a business tax surcharge.

There are many good reasons for having a sales tax cover all types of personal consumption rather than just tangible personal property (see prior post). However, change is difficult. Expanding the sales tax base to include more types of services means that businesses, such as nail salons and child care facilities, who have not collected sales tax before and not had to file returns, now have to.

How might the Michigan sales tax expansion to services have been done in a way that might have reduced the desire to immediately repeal it?

Transition in the expansion. This gives the tax agency more time to help businesses that must now collect and remit the tax.
Do not tax services primarily used by businesses. Businesses should not pay sales tax, only final consumers. This prevents pyramiding of the tax where businesses add it to their costs and consumers pay tax on that amount. (see prior post)
Start with education efforts to help consumers better understand the sales tax and why some types of consumption should not be exempt.
Expand the base along with a rate reduction !!!!!

This post was originally published at http://21stcenturytaxation.blogspot.com.

Bottled Water Tax in Chicago

Annette Nellen — Tue, 27 Nov 2007 00:00:00 -0500

The Chicago City Council passed a 2008 revenue ordinance that in addition to some increases to existing taxes, adds a new "bottled water tax." This 5 cents per bottle tax applies to retail buyers and is collected by dealers and wholesalers starting January 1, 2008.

The tax is expected to raise $10.5 million (Sun Times, 11/14/07).

The tax was originally proposed at 25 cents per watter bottle by Alderman George Cardenes. The revenue was intended to address a shortfall in water and sewer funds believed to be partially due to people drinking less tap water. (CBS2, 8/14/07)

Is a bottled water tax a good idea?

If there are costs of using bottled water that are not included in the price that society ends up paying (negative externalities), then a tax helps to make the price of the item reflect the truer cost. There are costs to Chicago of bottled water. These apparently include a drop in funds for the tap water they produce. Undoubtedly, there are also disposal and recycling costs. Beyond Chicago, there are costs of the materials used to produce the bottles (including petroleum) and pollution costs involved with delivery.

If the concern is with disposal of plastic bottles, the tax is too narrow as other products are packaged in plastic bottles, such as soda. However, it appears that some of the rationale for focusing on water is that the City Council knows its tap water is fine to drink, making the bottled water an unneeded item.

Is the tax well designed?

If bottled water is creating costs for Chicago, then a tax or fee to address it make senses. However, before creating a new tax that will create new compliance and administrative costs for taxpayers and tax collectors, alternatives should be explored. For example, could the city just produce less tap water to meet reduced demand, thereby reducing its costs? Given the likely high fixed costs of producing clean water, this may not have been an option. Also, while the city might be able to increase the cost of tap water, that would put the cost on those who did not cause the problem and perhaps make the problem worse (more people may start buying bottled water).
If disposal of plastic is the problem, then the tax - as a "polluter pays" tax, is too narrow.
While 5 cents per bottle is simple, it may lead to larger water bottles being sold in Chicago.
While Chicago is a big city, people may still find it relatively easy to buy their water bottles outside of the city limits.
Could the tax be construed as an additional sales tax on bottled water? If yes, is that allowed under state and city law?
Could the tax be viewed as creating unfair competition for city water? A tough question, perhaps. The tax is likely within the city's taxing powers, and it is trying to cover costs it has under its obligation to provide water. A correlation between the drop in water funds and increase in bottled water sales with the new tax covering that shortfall and no alternatives to the city, likely brings it within their operating powers and responsibilities.
The tax seems to have been designed to be simple. All bottles are taxed the same and the collection chain seems straightforward.

Will other cities or states follow Chicago's lead? Some are focusing on the "luxury" nature of bottled water and the message sent when government funds are used to buy bottled water for employees when the local water is perfectly fine to drink. In fact, on Nov. 16, 2007, Illinois started a policy that state agencies may not purchase bottled water with state funds. In February 2006, San Francisco Mayor Gavin Newsome expressed concern over the $500,000 of city funds going to bottled water when the local drinking water is fine. One solution he had was for the city to bottle its own water. Since then, he decided to just forbid the use of city funds to buy bottled water. The Executive Order the mayor signed in June 2007 includes some interesting data about the usage and cost of bottled water.

Does a bottled water tax help move Chicago's tax system into the 21st century? I don't think so. This sounds like a seized opportunity without consideration of what overall reforms would be best. While polluter pays taxes can help promote economic efficiency by taxing activities that result in costs to society and to governments, and freeing up other tax dollars to be kept by taxpayers, the bottled water tax is too narrow. Many products are packaged in plastic bottles and other materials that are harmful to the environment. More work is needed.

This post was originally published at http://21stcenturytaxation.blogspot.com.

California Budget Woes + Possible Solutions

Annette Nellen — Thu, 22 Nov 2007 00:00:00 -0500

California continues to have budget deficiencies. The Legislative Analyst's Office (LAO) projects a $1.9 billion deficit for the current year if no actions are taken to bring the budget into balance. And, it gets worse. The LAO projects a shortfall of $8 billion for 08/09 and another $8 billion for 09/10. Thereafter, with debt to fund prior deficits paid off, the annual shortfall is projected to be a mere $3 billion per year.

Wow!

Here are some ideas to address the shortfall:

Get serious about collecting much of the $1 billion of use tax that goes uncollected annually. (more info)
Bring our sales tax into the 21st century by including today's consumption - digital items and services, and eliminating some exemptions. There are billions of dollars here. For example, we could bring in about $1 billion of revenues just from imposing the sales tax on admissions, amusements and personal storage. Of course, ANY expansion of the sales tax should be accompanied by a rate reduction. But, there is still revenue to be obtained here very legitimately. After all, there is no reason for taxing a lawn mower, but not what a household consumes in the form of gardening services. Also, digital goods and services tend to be a type of consumption of higher income folks and not taxing these items, but instead taxing clothes and CDs, is not fair. The sales tax should be better distributed among rich and poor. (more info)
There is more than one way for the government to spend money. The most obvious way is for the government to write someone a check. The less obvious way is for the tax law to allow a special deduction, income exclusion or tax credit for some activity. For example, if your employer provides health insurance for employees, the employer takes an income tax deduction for the cost, but the employee does not need to include the benefit in income. That is equivalent to the government writing a check to these employees. This spending is hidden though and does not need to be evaluated annually in the budget process. So, governments must decide each year how much to spend on higher education, for example, while employees continue to get unchecked government assistance for health insurance. And this is just one example, another costly one is the home mortgage interest deduction. The health insurance tax break costs California about $4 billion annually and the home mortgage interest deduction costs about $4.5 billion annually. And, that home mortgage deduction is for 2 homes and up to $1.1 million of debt. Why should the state be subsidizing so much? These and other tax breaks should be reviewed for appropriateness and logic and a goal of generating at least $3 billion from changes. (The list of tax breaks (hidden government spending) - referred to as "tax expenditures" can be found here.)
Let's bring back the higher vehicle license fee, or at least for high value cars. When the VLF was cut a few years ago, the average savings for a car owner was $138 annually. That's not much per car owner, but adds up to a lot for the state. Legislators should aim to generate at least $2 billion from a higher VLF.
If we really want to reduce carbon emissions, as we must by law, let's get serious about it and institute a carbon tax. It should be added to the carbon content of fossil fuels (oil, coal and natural gas) and in a transparent way so users see the tax and can be motivated to reduce their use of fossil fuels. The tax could be used to generate at least $2 billion annually with $1 billion returned to taxpayers for alternative energy incentives.
Hire auditors to examine where spending can be reduced, purchasing efficiencies created, and technology used to reduce costs.

What are your ideas to balance California's budget?

This post was originally published at http://21stcenturytaxation.blogspot.com.

Enacting the 'Mother of All Tax Reforms'

Annette Nellen — Fri, 09 Nov 2007 00:00:00 -0500

Congressman Rangel's "mother of all tax reform" bills - H.R. 3970, is an interesting mix of items. It includes repeal of the individual AMT, an increase in the standard deduction, a new individual surtax, a lower corporate tax rate and a 1-year extension of 32 temporary provisions.

What would it take to get major tax reform enacted? I think at least the following:

Cooperation: Both the administrative and legislative branches must agree that existing tax law problems can only be remedied through major reform that will likely affect many parts of the existing tax law and most taxpayers. Both branches must be willing to work together to craft and support reform.
Purpose: In order to convince policymakers and taxpayers that reform is the right direction, the purpose of the effort must be clear. Leaders of the effort should be able to articulate the reasons why change is needed. Knowing the purpose enables legislators to identify appropriate changes and to verify if they address the problems. The purpose for making major changes must be perceived as meaningful to taxpayers.
Resoluteness: Every tax preference has a group that supports it. Thus, every change will have opposition. But, if the change is appropriate given the purpose of reform, legislators must be resolute in pursuing the change; otherwise, the goals for reform will not be achieved.
Transition: Taxpayers have made long-term decisions based on existing tax rules. The pain of new rules that alter past plans can be eased by transitioning in new rules if feasible.
Making everyone a winner: Taxpayers are more likely to accept the loss of favorable provisions if they see that there are also benefits for them, such as lower tax rates.

How does H.R. 3970 measure up against these elements? How does it measure up against the last real "mother of all tax reforms" - the Tax Reform Act of 1986? For a brief overview, see my article (11/08/07):

Strategy for Major Tax Reform in the AICPA Tax Insider.

What do you think will happen with H.R. 3970?

This post was originally published at http://21stcenturytaxation.blogspot.com.

Internet Tax Freedom Act - Missed Opportunity to Help Internet Grow

Annette Nellen — Thu, 01 Nov 2007 01:00:00 -0400

On 10/31, President Bush signed a bill to extend the Internet tax moratorium for 7 more years (H.R. 3678). Without the extension, the ban would have expired on 11/1/07. The ban is on state and local taxes on Internet access and multiple or discriminatory taxes on e-commerce. It has been around since 1998, originally designed to help the Internet grow.

While lawmakers and the President seem unable to say enough wonderful things about the ban, it has problems. Here are a few:

It represents the federal government using the state and local tax base to do something. The federal government could provide incentives to promote broader use of the Internet with its own dollars and should do so. The federal government could provide tax credits to low-income individuals and Internet service providers who offer discounts to low-income customers, and subsidies to libraries and senior centers to improve Internet access.
It hurts federal and state/local relations because the federal government is imposing itself on the subnational governments thereby preventing them from being able to fully make their own decisions in crafting their tax systems.
It misses opportunities to really help the Internet grow. The ban is very broad even though data exists to show which groups in the population have low Internet usage. A better approach would be to use a TARGETED approach to address the problem. Research shows that broadband use is lowest for people in four groups: low income, age 65 or older, no college education, and rural community dwellers. The extended ban does nothing to help promote Internet use among these groups. If it did, businesses that offer new usages of the Internet would prosper.

This post was originally published at http://21stcenturytaxation.blogspot.com.