Tax

Easy Fix to Help Federal and State Budgets (and Health Care)

Annette Nellen — Sat, 02 Aug 2008 21:31:00 -0400

I have written about this topic before - policymakers lament trying to find dollars to help get more people health care, yet millions of workers reap overly generous tax benefits when their employer pays all or part of their health care coverage. These generous tax benefits represent dollars from the federal and state budgets that could be used for other purposes. And, the problem is even worse because having so many insured employees not directly involved in how much their health care coverage costs tends to make them get too much health care at times, which drives up costs for everyone.

Here are prior posts:

On 7/31/08, the Senate Finance Committee held a hearing on Health Benefits in the Tax Code: The Right Incentives.

Each of the three witnesses commented on the exclusion for employer-provided health insurance. Joint Committee on Taxation Chief of Staff Edward Kleinbard noted:

"the current system of providing a generous tax subsidy for employer provided health care with no or little subsidy in the case of insurance purchased outside of the employer market distorts taxpayer and market behavior. The existence of the subsidy reduces the price of the consumption of health care, leading to overconsumption of health care relative to other goods and services for those taxpayers with qualifying plans, and very expensive health care for taxpayers in the individual market. Unlike most tax expenditures, the large subsidy associated with employer-provided health care is subject to few statutory limitations."

The exclusion, measured as a tax expenditure, is one of the largest in the income tax system. It is also an exclusion from Social Security and Medicare taxes. Kleinbard's testimony noted the cost of this tax break for 2007 as:

Income taxes $145.3 billion
FICA $100.1 billion

That's a lot of money!

Most, if not all states also follow the federal exclusion.

The exclusion is an even better deal than a tax deduction because the employee has not spent anything to get the break (ok - except for foregone wages). For example:

Jamie's employer pays $10,000 for Jamie's health insurance coverage. If the employer did not provide this benefit, the employer would likely increase Jamie's salary by $10,000. Under our tax system, having the employer pay for Jamie's insurance is a much better deal than getting $10K more of salary. The $10K is not taxable to Jamie, although the employer deducts it on their tax return. Also, no FICA or Medicare tax is owed by either party on the $10K. If Jamie's marginal tax rate is 25%, Jamie saves $2,500 of taxes. BUT, if Jamie had to include the $10K in income, Jamie would still have a good deal - getting $10K of insurance benefit for $2,500.

The federal government should cut back on this exclusion and better target it so more relief is given to low-income taxpayers. For example, depending on one's income level, an increasing percentage of the health insurance benefit would be included in income.

This would give the federal government funds to help move health care towards universal coverage. It would help states with their revenue problems.

AND - it would bring greater equity to the tax system. Today, it is more likely that higher income workers have health insurance from their employers. When individuals have to buy insurance on their own, there is not tax break.

Also, cutting back on this tax break would mean that employers would have to include the amount of the benefit on the employee's W-2. That would be good because today, most employees probably can't tell you how much the benefit is. This change would also be a good start in moving towards the bigger health care solutions that are needed.

What do you think?

Dealing with the Decline in Gas Tax Revenues Due to the Decline in Driving

Annette Nellen — Mon, 28 Jul 2008 19:51:00 -0400

The Department of Transportion announced today that we drove 9.6 billion fewer vehicle-miles traveled (VMT) in May 2008 compared to May 2007. While that is good for reducing carbon emissions, it is bad for the Highway Trust Fund. When we use less gasoline, less gasoline excise taxes are collected.

According to Transportation Secretary Mary E. Peters: "By driving less and using more fuel-efficient vehicles, Americans are showing us that the highways of tomorrow cannot be supported solely by the federal gas tax."

Our current federal gasoline excise tax is 18.4 cents per gallon. It is not adjusted for inflation. It has been known for some time that adjustments would eventually need to be made in the rate or HTF funding approach as MPG of cars increased. Various studies have been done to get an idea of the problem and possible solutions to provide more funds for the HTF to maintain and build roads.

In December 2007, the National Surface Transportation Policy and Revenue Study Commission released its study of transportation funding issues and possible solutions. This lengthy report provides background on transportion and highway funding challenges and the results: roads in disrepair, increased congestion, economic losses due to problems of moving goods, and increased safety concerns. The report also looks at existing programs, funding problems and makes recommendations for preventing negative balances in the HTF. The Commission ended in July 2008.

Chapter 5 of the report lays out various recommendations. Some interesting ones include:

Have the revenues from the gas guzzler tax be directed to transportation projects.
Have any gas tax exemptions funded by the General Fund.
Have custom fees related to transportation go to HTF

A few observations:

Carrots versus sticks: It is interesting that higher gas prices led to a drop in consumption. Several state governments have greenhouse gas emission reduction goals, why didn't they just raise their gasoline excise taxes and generate some needed funds while also helping their state to meet GHG emission reduction targets as a way to help meet their goal?
1. How should governments determine when a carrot - such as an income tax credit for purchase of a hybrid fuel car is warranted rather than incentivizing behavior with an added cost, such as a higher gasoline excise tax? Couldn't the federal government have encouraged people to buy hybrids by raising the gasoline excise tax rather than giving away tax credits - and done some good for the federal budget? Of course, there are other costs of higher gas taxes.
2. A problem with incentives is that they can sometimes fund activity that would have occurred anyway. For example, today most hybrid cars have waiting lists - even those without a tax credit.
3. Sticks, such as higher taxes, are hard to implement as evidenced by some policymakers wanting to provide some type of relief for today's high gas prices. There are alternatives to high gas prices - driving less, using public transportation, making sure cars are in good operating condition and not carrying "stuff" that doesn't need to be transported around continually.
Several states have suggested or studied an alternative to tax per gallon - tax per mile traveled. Of course, that is much harder to measure and collect relative to paying per gallon at the pump, but not impossible.
1. Research Triangle
2. Oregon Mileage Fee Concept (2007 final report)
3. California DMV Director (2004)
The gas guzzler tax could be expanded so that it also covers SUVs and the mileage rates modified to cover more "low" MPG cars.

Given tight budgets and plenty of other needs for general fund revenues, other options will need to be found for funding transportation and transit projects, particularly in light of declining gasoline excise tax collections.

What do you think?

The Pressing Need to Rethink Our Existing Tax Rules for Retirement Savings

Annette Nellen — Sun, 20 Jul 2008 18:00:00 -0400

On 6/26/08, the House Ways & Means Committee held a hearing on Individual Retirement Accounts (IRA) due to concern over underutilization and reasons why many small businesses did not offer some type of IRA plan for workers. The GAO report on the topic was highlighted. Subsequent to this hearing, a few other committees held hearing on retirement savings and a report was released by Ernst & Young on people not having enough to live on in retirement.

There are some troubling data and realities about IRA participation and inadequate retirement savings. For example:

For 2004, 79% of all taxpayers were eligible to make an IRA contribution (about 145 million taxpayers). Just 14.7 million taxpayers made a contribution though (about 10%). Participation was highest for taxpayers with $200,000 or more of AGI and that group also made the largest average contribution. For eligible taxpayers with positive AGI, participation was greater among higher income taxpayers. [Bryant, Accumulation and Distribution of IRAs, IRS, 2004]
In 2001, 60% of taxpayers either had assets in or income from an IRA or employer-sponsored plan. Thus, 40% of taxpayers have no retirement accounts although they may have other assets for retirement. (Sailer & Holden, IRS, 2004)

I have more information in a short article - Rethinking IRAs.

On 7/10/08, the Joint Economic Committee held a hearing on the shift from defined benefit plans to defined contribution plans, the greater risk upon workers under DC plans, and the greater return DB plans produced. A representative of the venture capital industry noted the importance of DB plans to providing funds for investment.

On 7/16/08, the Senate Special Committee on Aging held a hearing on people not saving enough for retirement, the recent increase in hardship withdrawals from 401(k) plans and the possibility of "automatic IRAs" that allow for payroll contributions to IRAs. Click here for more information on this topic from Chairman Kohl.

The EY report (July 2008) - Retirement vulnerability of new retirees, found that "almost three out of five middle-class new retirees can expect to outlive their financial assets if they attempt to maintain their current pre-retirement standard of living. To avoid outliving their financial assets, middle-class retirees will have to reduce their standard of living, on average, by 24 percent." The report was prepared for Americans for Secure Retirement.

Living longer, inadequate participation in retirement savings, financial illiteracy, greater personal responsibility for managing retirement savings (DC versus DBs), frequent job changes, and retirement tax rules that are skewed to benefit higher income individuals all point towards a retirement savings crisis that will cause people to work longer, put pressure on social programs and children of retirees, and lower our standard of living.

The reality of greater personal responsibility for retirement will require greater financial education in schools, easier options for retirement savings (such as automatic payroll contributions) and modification of existing tax rules to bring greater equity to the system.

What do you think?

Proposed Tax Increases in California: Overlooking the 21st Century

Annette Nellen — Sat, 12 Jul 2008 02:36:00 -0400

California legislators continue to struggle with how to close the $15 billion budget gap even as the year has begun and the budget deadline has passed. On July 8, the Budget Conference Committee developed a plan that restores some proposed cuts and proposed a package of six tax increases. Five of the increases involve the individual income tax and corporate franchise tax while the sixth calls for efforts to collect some of the state's uncollected taxes (reduce the tax gap).

A problem with aiming to close a specified budget shortfall is that it is too easy to look at the amounts various changes could raise and massage it until you hit your needed number. Math wins out over strategy. while the committee has reasons for each of the five tax increases, they are fairly weak, such as - we had these high rates in the past. Why does that mean they make sense for California's economy and society now? What about cutting back on tax deductions, exclusions and credits that are too generous or poorly targeted such that they benefit taxpayers who don't need a benefit? What about shaping our tax laws to support our economic, societal and environmental goals? For example, policymakers are working to find ways to get California to reduce its GHG emissions. So, why not enact a carbon tax?

While a primary purpose of this tax increase package is to help get a discussion going and to push Republicans to come up with an alternative plan, some of these tax proposals could remain. We'll have to see. Here's my thoughts on each of the proposals and if they are moving California's tax system into the 21st century.

Proposal 1: Add two new tax brackets to the individual income tax. The 10% rate would apply to joint returns with income above $321,000 and the 11% rate would apply to joint returns with over $642,000 of income. We have had these high rates before. Without the change, this income would be taxed at 9.3% and 10% if over $1 million.

Comments: California is already a high income tax rate state. Our income tax is very volatile because the bulk of it is collected from a small number of high income individuals. When their income goes down, in essence, the entire state feels it. This is also because the personal income tax is about 50% of our general fund revenues. California law is designed such that, for example, a family of 4, no income tax would be owed until their income was over $44,000. I've got more information on this volatility in a 2007 report.

There are flaws with many of the tax deductions, credit and exclusions in the personal income tax. For example, CA follows federal law in allowing mortgage interest to be deducted on a primary and second residence and on up to $1.1 million of debt. This tax break is worth more to high income individuals. Why is the state subsidizing home purchases beyond the median home price and on a second home as well? This rule is provides too generous of a benefit to high income/wealthy individuals. It should be cut back and perhaps even converted to a tax credit to eliminate its skew to higher income individuals.

Raising the rate rather than fixing the base just leaves Califorrnia labeled as a high tax state, gives high income individuals pause to question if they should live elsewhere, makes tax planning more attractive and continues to leave the base problems for another day.

The California Budget Project notes that in an economic downturn, tax increases are better than spending cuts. But I don't see any reason to get that tax revenue in such a way that increases the volatility of tax collections and doesn't help California's economy. I think we need to replace part of the PIT with an environmental (polluter pays) tax and broaden the sales tax base to bring in the items higher income individuals tend to be the buyers of (personal services, entertainment, digital downloads). A polluter pays tax could be a carbon tax, it could be a utility tax on bills above what the average would be for a family of four living in a 1200 square foot house.

This is a poor proposal.

Proposal 2: Suspend use of corporate NOLs for 3 years.

Comment: The committee's write-up describes this as closing a "tax loophole for large corporations." But, corporations of all sizes are allowed to carryonver NOLs and there is no information provided to say that corporations have used the carryover provision in any way other than how intended. Thus, it this is not a loophole.

[Two of the proposals were described as closing loopholes and neither one is a loophole. For more on this - see my op ed in the San Diego Union Tribune (7/11/08)]

Instead of completely denying corporations use of their NOLs for 3 years, it should be more helpful to the business (and the state) to instead provide that in any year, an NOL carryover cannot reduce taxable income by more than 70% (or some other percentage). This means that when a corporation has positive income, it will pay some level of tax even though it has an NOL carryover. It still gets full use of its NOL, it will just take longer to use it.

This proposal could be improved.

Proposal 3: Suspend the indexing of the individual income tax brackets, apparently, just for one year.

Comment: This is a disguised tax rate increase. For example, if an individual's 2008 income goes up due to a cost-of-living raise, they may end up in a higher tax bracket. Even if this is for just one year, it is a disguised tax rate increase. Also, even if the suspension of indexing is just for one year, the effect will last forever because higher rates will kick in at lower income levels and those are the brackets that will be indexed going forward.

This is a poor proposal. There are more transparent ways to generate additional tax revenues.

Proposal 4: Reduce the dependent credit for individuals with AGI above $150,000. A few years ago, to benefit families, the credit amount for dependents was raised to $294 while the personal credit is $94. A key purpose of these credits is to help measure ability to pay.

Comment: This changes was also described as closing a tax loophole for upper-income income. However, it is not a loophole (see article). There isn't really any strong reason why the dollar amounts of these credits should be different. Also, for high income individuals, the amount of the credits is phased out. However, these are high income levels, such as about $150,000 for single taxpayers.

Proposal 5: Increase the corporate franchise tax rate from 8.6% to 9.3%. This rate had been in place a few years ago and so is described as restoring the franchise tax.

Comment: California already has high tax rates. Rather than making them higher, consideration should be given to broadening the tax base and perhaps lowering the rate.

Proposal 6: Increase tax enforcement efforts to help generate about 1.5 billion.

Comment: This is great. It is always good to be sure the tax gap (amount of tax owed, but not collected) be kept to a minimum. Rather than increasing a tax or creating a new tax, see about collecting more of the taxes already on the books.

Given the push to make changes that lead to closing the $15 billion shortfall, math won out over making tax reforms that would help our economic, societal and environmental goals. But, it is likely just a start to further budget debates. We'll see what other tax increases are proposed and which, if any, of the ones from July 8 are continued.

What do you think?

Taxing Digital Products - Let's Also Use the Technology to Modernize Collection

Annette Nellen — Mon, 23 Jun 2008 12:47:00 -0400

When today's forms of taxes were created decades ago, there wasn't any technology to consider in making computations and collection easy. But that is not true today. While some states are slowly modernizing their laws to address new ways of living an doing business that are partly due to changes in technology, the technology as a tool of tax compliance and administration is often overlooked.

Tennessee enacted various tax law changes which the governor signed on June 5, 2008, including expanding its sales tax to include most digital goods provided the tangible equivalent is something already subject to sales tax. [SB 4173 enacted as Public Chapter Number 1006]

"The retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state shall be subject to the tax levied by this chapter on the sales price or purchase price thereof at a rate equal to the rate of tax levied on the sale of tangible personal property at retail by the provisions of § 67-6-202."

The law defines various types of digital goods and notes a few exemptions. To determine where the buyer resides, the new law provides:

"(g) The tax imposed by this section shall apply to retail sales in this state, indicated by the residential street address or the primary business street address of the subscriber or consumer."

Thus, Tennessee joins New Jersey, Nebraska and a few other states that have modernized their sales taxes to include today's forms of consumption, although they don't also address using the technology for collection ease. For equity reasons and continuation of the tax base, as forms of consumption progress beyond what yesterday's legislators ever envisioned, such as the digital equivalent of tangible goods, including software and music downloads, a state needs to update its laws.

First - why include digital downloads in the sales tax base? As a consumption tax, there is no reason to tax a song sold on a CD that you'll play in your CD player, but not one downloaded online onto your MP3 player or computer to listen to. The result in both situations is the same - you enjoy the music. And both forms are consumption which is what a sales tax is designed to tax.

One argument sometimes voiced about including digital downloads in the sales tax base is that you may not know the location of the buyer. But, unless the song is free (in which case it is unlikely to be taxed unless it was bundled with something else that is taxable), the consumer is using a credit card which includes their address. While the credit card user could have the card registered in a different state, it is unlikely and there are ways to still require the user to let the credit card company know where the cardholder is located.

Another argument against taxing digital goods is that it will hurt Internet companies. This is a distractor argument. The sales tax is paid by the consumer, although collected by the seller if the seller has a physical presence in the state (if not, the buyer pays use tax on their own). Will people stop buying digital downloads because of sales tax? It seems unlikely because if they really want the product, their alternative is to buy the taxable tangible equivalent. Also, retailers of tangible personal property have been collecting sales tax for decades and they seem to be able to remain in business. Certainly, moving something from being non-taxable to taxable is shocking at first, but people will get used to it. If the states that are modernizing their laws to comport with today's ways of consuming and doing business help explain why the change is needed - equity, fairness, neutrality, to keep state tax bases from eroding, consumers are more likely to understand. And, the sooner the states update their laws, the better because the longer the delay, they are really indirectly educating consumers that digital consumption is not subject to sales tax.

Many states with sales tax, added it in the 1930s when digital goods were not in existence. So, most laws were written to apply to the key type of consumption - tangible personal property. If states had originally written their laws to apply to consumption of goods without using the word "tangible", digital downloads would have been taxable from the start and I don't think consumers would have questioned it. After all, if you pay sales tax on your music CD, why wouldn't you also pay it when you download the music onto your MP3 player to enjoy.

Another issue sometimes raised is the cost to vendors of collecting the tax on digital items. This is also a distractor in that other vendors have been incurring costs for decades to collect sales tax on the tangible items they sell. I do think though that vendors should recieve some relief for these costs, something very few states do today. I also think this is an area where technology could be better used to collect the tax. Again, when sales taxes were enacted decades ago, the use of technology to collect the tax was primarily paper and pencil.

Better Use of Technology:

Today, the sales tax could be collected by the state tax agency at the same time the buyer's credit card is billed for the item. This would enable the state tax agency to get the money sooner, there would be no need for the vendor to file any reports and it would still be transparent in that the buyer would see the sales tax charge when they buy the item. Checks and balances could still be in place in that in auditing a vendor, the state agency would primarily review the system for charging to see that it works as intended and check a sample of transactions to be sure the collected tax was charged by the correct state tax agency.

This sales tax billing system could also be used for tangible goods. Whenever the credit card is charged, the sales tax portion gets charged by the state tax agency. The credit card or other payment card would just need to have the customer's state noted or they could be asked at the register (already, many stores ask for a zip code - apparently for marketing purposes).

Let's truly act like we're in the 21st century and not only modernize sales tax to apply to the digital equivalent of tangible consumption, but use technology to make it easier and more cost effective for vendors, consumers and state tax agencies.

[For further information, see my 21st Century Taxation website.]

Health Care Spending versus Extending 2001/2003 Tax Cuts - Tough Issues

Annette Nellen — Fri, 20 Jun 2008 21:00:00 -0400

On June 16, the Senate Finance Committee sponsored a Health Reform Summit. The presentations focused on costs and possible improvements to the delivery and insurance system.

CBO Director Peter Orszag's first part of his testimony helps put the immense financial problems facing us in the next few years in perspective. He says:

"The single most important factor influencing the federal government’s long-term fiscal balance is the rate of growth in health care costs. The Congressional Budget Office (CBO) projects that, without any changes in federal law, total spending on health care will rise from 16 percent of the gross domestic product (GDP) in 2007 to 25 percent in 2025 and 49 percent in 2082, and net federal spending on Medicare and Medicaid will rise from 4 percent of GDP to almost 20 percent over the same period.1 Many of the other factors that will play a key role in determining future fiscal conditions— including the actuarial deficit in Social Security and a decision about extending the 2001 and 2003 tax legislation past its scheduled expiration in 2010—pale by comparison over the long term with the impact and challenges of containing growth in the cost of federal health insurance programs."

And he didn't mention the cost of AMT reform. As noted in my last blog entry - the dollars involved in both tax and health care reform are so immense that the discussions need to be better merged in some way. Otherwise, it might be a race to see which issue gets solved first - finding a way to extend all or part of the 2001-2003 tax cuts or finding ways to address health care spending. Also, there are a lot of health care dollars in the tax law that could be used for either tax reform or health care reform. It seems that the Senate Finance Committee may be going in that direction given that they have held information hearings on both topics to help get ready for work needed in the 111th Congress.

Another link between tax and health care reform is that the increaing cost is hurting the ability of US employers to compete due to the decades old (and odd) linkage of health insurance and employment. One reason cited for business tax reform is to help companies to be more competitive in the global market place. But it isn't just a high tax rate that is a problem, it is health care spending (and for some companies today with an effective tax rate well below 35%, exploding health care costs might be a bigger concern). Craig Barrett, Chairman of Intel, also testified at the Health Reform Summit. He stated:

"Without providing some major fixes, US business will continue to export jobs directly as a result of healthcare costs. I conclude that healthcare is pricing itself out of business, and in the process is just going to drive CEOs to make decisions to put resources elsewhere where the healthcare cost is much more affordable."

That will certainly make our problems even worse if we lose jobs.

Mr. Barrett also expressed concern that the health care debate wasn't focused sufficiently on how to control escalating costs, but instead tended to look at who should pay. He said:

"Sadly, the current debate typically centers on “who pays”? This leads to endless discussion on which financing mechanism to utilize to increase the funds deemed necessary to change our healthcare system. While entertaining, it does not address the inherent problem in the current model; namely the excessive costs."

These two reform efforts are extremely challenging due to their magnitude, but also very crucial. Even if the 2001-2003 tax cuts expire, there is still the AMT problem to fix which is also costly. How to approach solving these difficult issues are good questions to ask of candidates for Congress and President this year. I proposed a few questions on these budget matters a few months ago.

What would you want to ask the candidates?

What do you think can be done to address the enormous fiscal challenges that lie ahead?

Tax Reform and Health Care Reform

Annette Nellen — Wed, 18 Jun 2008 17:06:00 -0400

We hear lots of talk about tax reform and lots about health care reform, but rarely hear about the two together. While there are proposals to change the exclusion for employer-provided health care, such as President Bush's proposal to remove it and provide a standard deduction for health insurance, they typically don't consider either the entire health care or tax reform picture.

There are significant dollars in the tax code that should be on the table in reforming health care. All of the government dollars should be in the picture in looking at how to fund any change, such as universal coverage. The largest federal tax expenditure is the one where employees are not required to include in taxable income the value of the health insurance their employer provides to them. The estimated cost of this expenditure in 2007 was $134 billion. There are other health care tax breaks as well such as the itemized deduction for medical care and health savings accounts.

The employer-provided health care exclusion is a tremendous benefit to employees. For example, Susan's employer provides health insurance to employees. Susan pays about 20% of the cost and the employer pays the rest - about $10,000 per year. Susan's marginal federal and state tax rate is 30%. Thus, she saves $3,000 of taxes from the exclusion. BUT, if the exclusion were removed, she'd end up getting $10,000 of coverage for $3,000 - still a good deal!! And, she'd likely find that she really doesn't need as much insurance as she selected from her employer. She'd also know how much it costs (today, most employees don't have any idea of what their health insurance costs). And removal of the exclusion would mean that more Social Security and Medicare taxes would be collected.

For employees in a lower tax bracket, perhaps some tax relief could still be provided.

For more information on the topic of the intersection of health care and tax reform, see a recent short article of mine from the AICPA Taxation Insider - Pot of Gold in the Employer-Provided Healthcare Exclusion (6/08). It has more of the details as well as links to various proposals and reports.

New America recently released a report about the challenges businesses face with employer-provided health care particularly given increasing costs of this fringe benefit.

There is a lot of money in the employer-provided health care exclusion (a pot of gold!). It is time to make a significant modification to it in order to better target the government dollars in this tax break, remove the adverse impact it has on health care spending, recognize the changed ways of living and working such that expectations of getting health insurance from your employer rather than on your own are outdated and too costly in our global economy, and to improve the federal income tax by broadening the base and lowering the rates.

Decennial Tax System Discussions

Annette Nellen — Mon, 26 May 2008 04:45:00 -0400

At least once every decade since at least the 1960s, there has been talk of serious tax reform in Congress. I came across a 1998 quote from then chair of the Senate Finance Committee, Senator Roth announcing his desire to review the international tax provisions in light of the current state of global markets. He stated: "We need to fundamentally rethink the tax code with a view to enhancing American competitiveness in the new global economy and helping the American workforce. In order to ensure that we enact policies that will lead the United States into the 21st Century at the forefront of competition, as Chairman of the Finance Committee, I intend to hold hearings over the coming year to explore the ramifications of the changing world economy and the needed reforms in both the international tax and trade areas. The cornerstones of these hearings will be ensuring economic growth in our domestic economy and competitiveness overseas. We must determine how our existing international tax regime, which was designed to address the needs of a totally different age, can be reengineered to complement the changing international marketplace and changing business profiles. We must also strive to encourage the creation of more jobs that draw on these new opportunities." [Source: "U.S. Finance Committee Chair Roth's Address at Forum on Taxation of Multinationals," 98 TNI 192-24, October 1, 1998.]

Wow! It sounds like this could have been said in 2008. The Senate Finance Committee held a hearing on 4/15/08 to get ready for tax reform discussions. Treasury held a conference and issued a background report on reform proposals in 2007. The Joint Committee on Taxation has issued reports on international tax issues and reforms in the past few years (2007 and 2006). In 2006, the House Ways and Means Committee held a hearing on international competitiveness and tax reform.

Other than repeal of FSC rules, not much has happened for fundamental international tax reform. Discussions on worldwide versus territorial taxation will continue, along with discussions on border-adjustable taxes, tax havens and more.

What do you think we'll be talking about in 2018?

Helping the Federal Income Tax Cry Out for Reform

Annette Nellen — Mon, 19 May 2008 20:41:00 -0400

While well-intentioned and needed, a recent bill passed by a tax-writing committee also indicates the need for a serious look at our federal income tax system to see how it can be simplified, made more logical in terms of what we want it to do in addition to raising revenue, and how it can support economic growth. This bill makes it even more obvious that our federal income tax is in need of some type of reform.

On May 15, 2008, the House Ways & Means Committee passed HR 6049 which makes many changes to our federal income tax. Many of these changes are 1 year extenders of provisions that expired at 12/31/07, such as the itemized alternative deduction for sales tax, the deduction for qualified tuition and expenses, and some energy incentives. In total, 33 expired provisions were extended for one more year! That avoids the issue of having to determine if they should be made permanent or if they have served their purpose and are no longer needed. These temporary provisions make tax planning difficult (for example, will the benefit be renewed or should alternatives be pursued by taxpayers).

HR 6049 also includes a few new provisions, such as a temporary above-the-line deduction for real property taxes, limited to $350 ($700 for a joint return). Why? What is the rationale for allowing a deduction for state and local taxes? [For more on this topic, see a short article - Goodbye State Tax Deduction (5/08); perhaps I should have called it "Hello new state tax deductions."]

Some of the funding for HR 6049 comes from a temporary modification in corporate estimated tax payments (a non-permanent source of funding).

These elements of HR 6049 are an indication that it is time for some type of tax reform. Isolated changes, such as the temporary deduction for real property taxes by non-itemizers, should instead be done in the larger context of what type of income tax do we want/need and how do we get there. For example, do we want an income tax wtih a broader base and lower rates? Do we want an income tax with lots of temporary provisions? The presence of so many temporary provisions in the tax system add to its complexity, hinders effective tax planning, and takes time away from serious tax reform discussions. It also perhaps helps those wanting reform to point to a tax law in even greater need of reform!

Desperate for Tax Revenues

Annette Nellen — Sat, 03 May 2008 14:59:00 -0400

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.

"Syrup" means "the liquid mixture of basic ingredients used in making, mixing or compounding soft drinks by mixing the syrup with water, simple syrup, ice, fruits, vegetables, fruit juice, vegetable juice or any other product suitable to make a soft drink."

Was this a good idea? The legislators and governor appear to have needed funds for the health insurance plan. Despite wide consumption, alcohol and soft drinks are not viewed as necessities of life so taxing them migh be justified in the public's eye. But what about other things people consume that also are not necessities of life, such as bottled water, soft drinks with less than 100% natural juice, candy, pastries, and more?

Unfortunately, despwrate needs for revenue usually don't lead to the best tax system modifications. The new law in Maine also earmarks the new tax revenue rather than having it go to the general fund. Earmarking is not a good idea when there is no connection between the taxed item or activity and where the revenue goes. Also, should sales of beer, wine and soft drinks decline, the health plan will suffer.

There may be some tax gap issues with the tax as well because it will be easy for Maine residents living close to New Hampshire to purchase wine, beer and soft drinks in that state. Legal issues can also arise with new narrow taxes. For example, if a state prohibits taxation of food, an excise tax on soda might not be permited (depending on definitions and the nature of the tax).

What would be a better approach? When revenues are not sufficient to match state spending, spending should be reviewed to see if it can be reduced. If that doesn't work, the state should review its overall tax system to see if there has been erosion in any tax base. For example, perhaps its sales tax only applies to tangible personal property. If so, it has eroded because today, consumption of services and intangibles (such as digital goods) has increased while consumption of tangible personal property has declined. Adjustments to existing taxes tend to keep the overall system simpler by not creating new taxes to comply with.

Maine is not alone in being desperate for revenues. California has tried to impose a higher income tax on oil companies and increase the tax on beer to help address its significant budget shortfalls. Time spent on these endeavors would be better spent on looking for appropriate and feasible spending reductions and improvements to a state's overall tax structure. Singling out one industry or one product that might be viewed as sinful or bad as a way to solve budget problems is ill-advised as it can complicate the tax law, make the tax system inequitable, and most importantly, ignores the structural problems that are more difficult to solve, but need to be solved, rather than left for another day.