21st Century Taxation

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Tax systems can get out of date.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tax designed with a rate structure to apply to specified income levels (some type of progressivity goal), will become out of date if the tax brackets are not adjusted for inflation.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:

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

1. 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.
2. 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.

2007 was a year of examining our corporate income tax system and considering alternatives -- but only as a preliminary step to further discussions and debate.

The US combined federal and state corporate tax rate is one of the highest among industrialized countries due to reforms in those countries in the past several years. Many believe that lowering the federal income tax rate on corporations would help make U.S. companies more competitive in the global market. House Ways & Means Committee Chairman Charles Rangel included a corporate rate reduction in his "mother of all tax reform" bills (H.R. 3970) introduced in October 2007. That bill also included some base broadening to help pay for a lower tax rate.

But, there are many issues to consider:

The congressional Joint Committee on Taxation released a report with information on past efforts to provide an economic stimulus including issuing tax rebate checks (a big task!). You can find it here.

The Senate Finance Committee is holding hearings on the topic on January 22 and 24.

One of the proposals some states are pursuing to raise revenue and close perceived loopholes is to require combined reporting for businesses. California has used combined reporting for years.

In his 1/15/08 state-of-the-state address, Iowa Governor Culver proposed combined reporting for corporations. He observes that it would "level the playing field for Iowa small businesses" and "close a tax loophole [that allows] multi-billion dollar corporations that do tens of millions of dollars of business in Iowa avoid paying Iowa income taxes."