21st Century Taxation

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?

Ease of cross-border business activity has led to what Thomas Friedman describes as a flat world. However, our quagmire of state nexus rules leaves domestic commerce in a non-flat world.

States tend to take broad approaches in finding multistate sellers subject to income or gross receipts tax in the state. The 1959 federal law known as PL 86-272 provides guidance for sellers and states regarding when a state can impose income tax obligations on a seller of tangible personal property. A lot more businesses today, relative to 1959, sell something other than tangible personal property and so have no federal statute to rely on to know when they may owe income tax in a state.

Some states take the approach that an economic connection is enough - that a physical presence in the state is not needed before a seller is subject to state income tax. And, rules can vary from state to state leading to the possibility of double taxation of some income.

The 1959 law needs to be updated. It was intended to be temporary (!), but was never updated. Congress has looked at a few possibilities over the past several years, but nothing has come close to enactment.

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:

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." 

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.

Last week, the Center for Disease Control and Prevention (CDC) reported that life expectancy has gone up, hitting a "record high in 2006 of 78.1 years."

This kind of trend data is relevant to tax reform discussions, but not often highlighted. Tax reform discussions could be better focused if we spent more time looking at how the world has changed since most of our current rules were enacted and how it will likely continue to change.

Several years ago I started gathering data on trends and using it to show where our tax law was outdated or working contrary to a trend, that is - contrary to reality. A few simple examples:

1. Longevity - this is clearly relevant in considering our Social Security system. When Social Security was created in the 1930s, life expectancy was lower than retirement age. That is clearly not the case today.

2. Who lives in poverty - In 1959, 35.2% of people age 65 and older were in poverty. In 1996, that percentage had dropped to 10.8%. (Leatha Lamison-White, Poverty in the United States: 1996, U.S. Department of Commerce, Bureau of the Census, Table C-2, page C-5). The federal tax law (as well as some state income tax laws) include exemptions and credits for being old. Years ago it may have been appropriate to assume that most elderly needed a tax break, but that is not true today.

Senate debate this week on addressing climate change is raising concerns about further raising the cost of gasoline (see NY Times article and Senate Environment and Public Works Committee website for debate info).  While higher prices are hard to sell to the public, it sounds like we're missing the point.  If we want to address climate change, we need to reduce greenhouse gas emissions. The most significant greenhouse gas is carbon (CO2) from burning fossil fuels such as oil. Economics would say to reduce demand of something, raise its price.

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.]

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).

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.