21st Century Taxation

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:

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:

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.

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?

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.

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:

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:

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:

As promised, on 10/25/07, Congressman and Chair of the House Ways & Means Committee Rangel introduced the "mother of all tax reforms." Major provisions of the bill include repeal of the alternative minimum tax (AMT) for individuals after 2007. The cost of the repeal is about $800 billion over 10 years. His bill, H.R. 3970 (text, summary), pays for AMT repeal and some expansions of provisions benefiting low to middle-income taxpayers with a 4% surtax on individuals with income over $100,000 ($200,000 if married) and 4.6% for income over $250,000 ($500,000 if married).

The proposal also lowers the top corporate tax rate from 35% to 30.5% and cuts back on some preferences such as:

Michigan enacted changes to its sales tax that expands it to cover 23 additional services starting 12/1/07 (HB 5198 signed 10/2/07). The services now subject to sales tax include: