Tax Reform

Ordinary Americans may not realize how closely linked their health care is to the U.S. tax code, but a bevy of analysts and economists could give them an earful. The major health reform plans on the table involve changes—in some cases pretty significant changes to tax treatment of health insurance, particularly the tax breaks for insurance we get through our jobs. Over at the Taxvox blog, sponsored by a joint program of the Urban Institute and the Brookings Institution, Howard Gleckman explains some of the options in a post nicely titled, "Forget Death and Taxes, How About Health and Taxes?"

Gleckman focuses on proposals for a Value Added Tax or VAT, a model seen in several European countries. VAT scenarios are circulating more in the academic/think tank world right now than in the political discourse about health care, but as Gleckman points out:

"The expiration of the Bush tax cuts and the ongoing Alternative Minimum Tax mess will surely drive big tax changes in 2009 or 2010. Health reform is also on the table, although short-term odds for reform may be longer. The question is: How will these two mega-issues fit together?"

A few days ago, the GAO released a report - Value-Added Taxes: Lessons Learned from Other Countries on Compliance Risks, Administrative Costs, Compliance Burden, and Transition.

Why? Doesn't the GAO know that the US doesn't like the VAT?

In the report, the GAO notes that tax reform includes discussion of a VAT and that it was asked to do this report by Congressmen Jim McCrery and Jim Ramstad of the House Ways & Means Committee. The countries reviewed by the GAO in this report are Australia, Canada, France, New Zealand and the UK.

The tax code is a mess. Even those pointy-headed economists that can bicker about anything (except the gas tax) agree that it is too complicated. They cry in virtual unison that the growth of tax deductions, credits, and deferrals leads to inefficiencies and market distortions (yikes!).

To confirm these fears, we need look no further than the education arena. Do you know how many tax provisions there are designed to support post secondary education and workforce training? It's a long list.

There are tax breaks for contributions to specific accounts and savings plans such as Coverdell education savings accounts, section 529 college savings plans, pre-paid tuition plans, and penalty-free withdrawals from IRAs. Further, there are other tax breaks that cover the treatment of educational expenses. These include the Hope Credit, Lifetime Learning Credit, deduction for tuition and fees, and the deduction for interest on student loans. So, that's a count of at least 8.

Many of these overlap and as such they cause a great deal confusion among consumers. Last week the House Ways and Means Commitee held a hearing on this topic and I sent in some testimony that offered by take on the matter.

BASS EXPANDS ON TAX REVIEW: The incoming California Assembly Speaker Karen Bass explains her plans for a tax reform commission in an interview with the Associated Press. Aaron McLear, a spokesman for the governor, is quoted as saying that the governor is interested in tax reform but it's "not a substitute for reforming our broken budget system." Yes, and no. Clearly, the state budget process needs procedural changes, and there are strong arguments for establishing a real reserve and an ability to respond more effectively to changes in revenue. But the main failed attempts at spending-side budget reform suggests that budget reform may not be possible without tax reform.

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.

UTAH FIGHT OVER POWER OF REFERENDUM, INITIATIVVE: A new Utah law, which goes into effect next month, would prevent local voters from making land-use decisions at the ballot. But a group in Sevier County, Utah is attempting to challenge the law -- and plans to build a coal-fired electricity plant in their community.

MORE FIXED THAN PUTIN: At an event on budget reform in Garden Grove Monday, gov. Schwarzenegger -- in answer to a question on his redistricting initiative -- talked about the lack of political compeititon. He repeated the statistic that out of 496 seats up for grabs in the last three election cycles in California, only four changed party hands. "Think about that," he said. "That's a fixed system. We always laugh at Putin in Russia when he has his elections. We say, 'This is ridiculous, it's fixed.' Ours is more fixed, I can guarantee you that. It is crazy." More fixed than Putin? Hard to judge. But on turnover, the governor has got a point, as seats in the Duma have changed party hands -- in large part because of Putin's strong-arming -- more often than California legislative and Congressional seats.

In testimony before the Senate Finance Committee ten days ago, tax expert Daniel Shaviro described the current taxation situation in the United States as a "perfect storm" for tax reform. He's right, and it's about time. Our last major tax reform came in 1986, when Congress set out to accomplish the most vaunted goal of any tax reform attempt: broadening the tax base while lowering tax rates in an attempt to improve the system yet maintain revenue collection. They broadened the base by eliminating a number of "tax expenditures," loopholes in the tax code that the tax literate jump through to lower their tax burden relative to their less savvy peers.

But since 1986, the number of tax expenditures has slowly crept back up, and now stands at 172 according to the Joint Committee on Taxation. By adding up JCT's revenue loss estimates for all of them, one arrives at a total of $1 trillion a year in forgone revenue (though it is imprecise to add the numbers.) Not only is that an awful lot of money, tax expenditures have many shortcomings--they are distortive, regressive and receive too little oversight.

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.