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Monday, May 18, 2020

Shifting tax base to consumption tax is bad idea

In January 2020, a Nebraska legislator introduced LR300CA, to amend the state constitution to prohibit all forms of taxation other than a consumption tax. The proposal states that the tax is to be at a single-digit rate. Presumably, both the state and local governments could have a single-rate tax. It would apply to all new goods and services, but does not define this term. It sounds like it means tangible personal property and services, possibly also travel and entertainment, but not clear.

It is unlikely that such as tax can raise as much revenue as an income tax, even with no exemptions to the sales tax. High income taxpayers don't spend all of their income, they save it and invest it. So that drops the tax base compared to an income tax.  Consider these two formulas and you'll see the base for an income tax is broader.

   Income = consumption + savings

   Consumption = Income less savings

And, with an income tax it is easier to have a progressive rate structure to increase vertical equity in the system.

One new category that would become taxable and affect higher income individuals more than lower-income is to tax food. Currently, Nebraska doesn't impose sales tax on food.  According to data from the Bureau of Labor Statistics, the top 20% of income earners buy 1/3 of total food purchases. They also buy 41% of all entertainment spending. Hopefully the Nebraska proposal  intends to apply sales tax to entertainment.

The proposal is likely to be a tax increase for low-income individuals as there is no exemption for low-income as there easily can be for an income tax.  With removal of income and property taxes and only a single-digit sales tax, it is likely that government would have to cut services which would also disadvantage lower income individuals.

What about alternatives?  Here are a few ideas:
  • Repeal income tax preferences such as the mortgage interest deduction.
  • Impose sales tax on food but provide an income tax credit to low-income individuals to reduce the impact to them of the tax.
  • Expand the sales tax base to include high-end consumption such as entertainment, travel, and household help.
Also in 2020, a California legislator introduced AB 2712. This calls for a universal basic income amount of $1000 per month to be paid to individuals age 18 or older with income below 200% of the median per capita income for the person's county of residence (measured by the BLS). This amount would not be subject to tax in California or affect income based tax and other benefits. AB 2712 defines "universal basic income to mean unconditional cash payments of equal amounts issued monthly to individual residents of California with the intention of ensuring the economic security of recipients." The payments would be handled by the FTB.

To pay for this, the bill calls for that "on or before July 1, 2024, the California Department of Tax and Fee Administration shall submit a report to the Legislature on the feasibility of establishing a new state tax to finance the California Universal Basic Income (CalUBI) Program. The report shall consider the feasibility of establishing a value-added tax on goods and services in the state, an analysis of the feasibility of taxing the sale of services offered in the state, and an analysis of the feasibility of raising the corporate tax. The report shall also include projections of expected tax revenue."

Adding a VAT on goods and services to fund the UBI would impose a burden on those receiving the UBI. Aside from rent, much of what is left over each month is spend on goods and services with most of the goods (other than food) subject to sales tax. Adding a VAT on top of the sales tax would also add complexity. Consideration should instead go to replacing the sales/use tax with a VAT with a broad base and low rate.

A higher corporate rate will be borne by employees, owners and customers and so can also hurt low-income individuals.

Why not remove tax breaks that primarily benefit high income individuals such as the mortgage interest deduction, sales tax exemptions for household utilities, personal service, entertainment and food? And consider if the EITC should be increased in place of a UBI although the EITC is only for workers.

Two of my colleagues and I wrote a paper in 2017 on a proposal for a different type of consumption tax that could be paid along with one's state income tax, but exempt low-income individuals. And businesses would not be subject to it (similar to how a VAT work and how a consumption tax should work to avoid pyramiding). Please check it out. I think it would be groundbreaking for the first state to adopt it in terms of removing regressivity of this consumption tax and making the state very attractive for businesses.

A UBI should be discussed as a way to help low-income individuals to know if it will help more than other programs such as greater education opportunities and medical care for all. 

And we have lessons learned from the pandemic and federal and state programs aimed at helping those with health and financial needs. This included funds for businesses of all sizes, unemployment benefits extended to self-employed individuals, economic impact payments and other provisions. Were these benefits equitably distributed? Did they help those most in need? How will the increased deficits and debt (and its interest expense) be paid?

How will these topics get attention in the public arena?

What do you think about such proposals?

Thursday, May 14, 2020

13th Anniversary of the 21st Century Taxation Blog

I started this blog 13 years ago today to help promote ideas and discussion on how to improve tax systems by moving them into the 21st century ways of living and doing business and following principles of good tax policy.

Despite being 20 years into the 21st century, these topics are still needed as tax system modernization seems to move slowly despite advanced uses of technology in other areas. For example, consider the contact tracing apps being developed by Apple, Google and others that use tech features in smartphones to keep track of who you encounter so the app can let you know if anyone later (or presently) has the virus. Consider the increasing amount of technology developed for cars and other mobility tools to provide directions, monitor traffic conditions, and send alerts. These can also be used to allow, for example, our gasoline excise tax to be based on miles traveled rather than gallons of gas purchased so that even electric vehicle owners will pay for road maintenance and building.

Here are a few ideas I'll continue to explore this year:

1. Modernizing worker classification rules to reflect use of technology to enable people to find full-time employment, as well as part-time employment when there is a need to monitize one's time to generate needed cash. This is a good use of technology. Rules that require these workers, often working less than seven hours per week to be employees means they don't get to monitize their spare time because employers logically don't to go through lots of forms and filings to hire someone to work 5 hours per week for six or fewer months.

2. Improving accountability and transparency in our tax systems so more people will ask such questions as:
  a. Why is a deduction allowed for mortgage interest on a vacation home but not for other debt?
  b. Why can someone deduct mortgage interest on up to $750,000 of debt regardless of income level but the deduction for student loan debt is limited to $2,500 and not available once income exceeds a specified amount?
  c. Why do we spend over $200 billion annually to help employees pay for health insurance but do not spend the equivalent for other employees and self-employed individuals? Why not use these funds more equitably?  And, why is health insurance tied to employment? The reason dates back to the 1940s and today results in a lot of waste because the system harms normal supply and demand (as anyone with employer-provided health care knows because doctors only ask if you have health insurance rather than discuss prices and needs with you).

3. Better use of technology for tax compliance. Filing your taxes should be as easy as ordering from Amazon or similar company, or transferring money on a banking app or making a payment with Paypal, Venmo or similar tool.

What tax policy topics are on your mind?

Thanks for reading!

Friday, May 8, 2020

Non-COVID Topic - Form 1040-SR and Data

I'll return to COVID-19 tax legislation policy topics soon, but wanted to note an item I noticed a few weeks ago in filing my own return.  In messing around with TurboTax, I discovered that it defaults to preparing a Form 1040-SR if the taxpayer or spouse is age 65 or older. I assume that likely confuses many affected people because they never heard of the form and might think it means they are paying more or paying less.

There is no difference between the 1040 and 1040-SR besides the "SR" and font size.  The SR form is not the idea of IRS who was already working to get rid of the 1040-EZ and 1040-A when Congress added 1040-SR starting for 2019 returns.  For more on that, please see my 7/29/19 blog post.

Perhaps other tax prep software is doing the same - defaulting to 1040-SR if the taxpayer is old enough, rather than giving a choice or defaulting to 1040.

I just note this because if we later see data on lots of seniors filing 1040-SR and thinking that means they like it, that data would be suspect of not really measuring liking the form.

For simplification and easing administrative burden for the IRS, it would be great to see the 1040-SR removed from the law AND to move towards filing systems using technology that makes filing so easy that it doesn't really matter what the tax form is called. It could be like online banking or ordering from Amazon in its ease and transparency (for more, see my 2019 post).

What do you think?

Saturday, April 18, 2020

Business Loss Change by CARES Act - Track Changes and Policy

The CARES Act (P.L. 116-136; 3/27/20) or Phase 3 of COVID-19 relief includes several tax law changes for individuals and businesses. Most notable for many (but not all) individuals is the recovery rebate or what the IRS calls the economic impact payment. Generally, this provides many adults with an advance, refundable credit for 2020 - today, of $1,200 +$500 if they have a child under age 17.

A few notable ones for businesses include the ability to carryback net operating losses (NOLs) for 2018, 2019 and 2020 for 5 years even though the TCJA ended this for tax years beginning after 2017 and even though the carryback can go to years when tax rates were higher than today. Employers also have some payroll credits and deferrals that should help with cash flow and some financial relief.

In addition to a temporary NOL change, the CARES Act also temporary changes another TCJA item. The limitation on losses for non-corporate taxpayers (IRC Section 461(l)) is changed to go into effect for tax years beginning after 12/31/20 rather than after 12/31/17. The TCJA's expiration date of tax years beginning before 1/1/26 remains.

There are a few other changes to Section 461(l) including making the technical corrections from the TCJA that are needed. To help see what is changed, please see the track changes version of Section 461(l) I have posted here.

This loss limitation only applies to non-corporate taxpayers with income above $250,000 ($500,000 if married filing jointly). Thus, this is relevant to less than 5% of non-corporate taxpayers. It causes them to not be able to currently use a specified loss above these amounts; the excess is not lost, it carries forward. One of the technical corrections made is that in measuring the income the loss can offset, wages are not included. This means it is more likely for some individuals to have a loss and for others who already have a loss and wages, the amount to carryforward will be higher. But, this loss limitation rule now doesn't go into effect until tax years beginning after 12/31.20.  Those who applied it on 2018 returns will need to amend.

So, what this an appropriate change to provide financial relief for COVID-19 economic problems? I don't think so as the small group that benefits are already high income taxpayers (in the top 5%) and there were other business relief measures provided that benefit employees and self-employed that could have been larger without the Section 461(l) change.

It's a costly change: The Joint Committee on Taxation estimates that the 461(l) change will cost $170 billion over 10 years. In contrast, the NOL change will cost $26 billion. The employer retention credit will cost $55 billion. The recovery payments for individuals will cost $292 billion. Given how few benefit from the 461(l) change and that they are individuals who are well off, seems like an odd use of limited funds and poorly targeted. Senators Whitehouse and Doggett use JCT data to state that 4 our of 5 filers that benefit from the change make $1 million or more per year and for a few, the average benefit is $1.6 million.

The change also creates some complexity due to the need to amend 2018 returns for affected taxpayers. Also, some states might not conform to this CARES Act change.

This change is not a complete giveaway though because most of these taxpayer would most likely eventually be able to use the carried forward loss. This just delays the impact of this TCJA temporary provision and provides a refund opportunity for 2018 and the ability to use more losses for 2019 and 2020. There are other changes that would have benefited far more taxpayers. I have several in prior blog posts (3/13/20 + 4/4/20) although most of them have already been enacted.

When the TCJA was enacted and when California conformed to Section 461(l), I was surprised to see that the revenue raised was so large (such as the $170 billion cited above just for removing the limitation for 2018, 2019 and 2020).  It's a reminder that some taxpayers have large business losses. Many are likely in the real estate industry where depreciation and interest expense can easily create large losses. But, if they have income high enough to be subject to this loss limitation, they are in the top 3 - 5% of individuals and arguably not suffering or wondering how they will pay rent or mortgage payments and utility bills during the pandemic shutdown.

Why did Congress make the change? Did they not have the data on how few would benefit and that they are high income taxpayers? Too rushed? Something else?

What do you think?

Saturday, April 4, 2020

Observations on recent pandemic tax changes and a few more needed

I think the administrative and legislative changes to address health and financial problems of the global coronavirus pandemic has led tax practitioners to spend more time figuring it all out than was needed for tax reform change of the Tax Cuts and Jobs Act!  Of course, the timing of dealing with this right now is more significant than with the TCJA.

I won't go through all of the changes since there are many other sources, such as the following:
A few observations:
  • What will people do with their 2020 recovery rebates (referred to as economic impact payment by the IRS)? Most individuals will get $1,200 tax free. A married couple will get $2,400. Parents with children under age 17 will get $500 per child. There are phase-outs based on income (using either 2018 or 2019 tax return info generally). The Washington Post has a nice online calculator to help you determine your rebate amount.
    • The folks at Money Done Right estimate that 43% of recipients will use their check to pay debt. See their website for the details.
      • Recipients should also check if lenders will give them extensions without extra fees or interest expense if they have other needs as well, such as rent.
  • Federal and most state income tax returns for 2019 that are normally due on April 15 have been extended to July 15.  Be sure to check for your state as a few are using a different date.
    • Individual expecting a refund should file soon if they need the funds.
    • Money Done Right also has data showing that less than 20% of individual expect to wait until July 15 to file for 2019. That makes sense since many individuals get a refund due to overwithholding during the year (often purposefully done as a savings plan).
    • States use a fiscal year ending June 30. They will face challenges of having payments normally due April 15 and June 15 due July 15, yet, most, including California have done this.
      • Recommendation: States should put out a plea to high-income individuals to make their payments for any tax due for 2019, as well as first quarter and second estimated tax payments for 2020 by June 15 or earlier. I think this will help states with their increased spending due to the pandemic and will reduce the need to borrow as much.

  • Practitioners:
    • Find some way to stay sane despite the overwhelming amount of changes particularly for practitioners helping small business clients.
    • When relying on any FAQ, print it off because these are not binding but hopefully the IRS will follow them in the future, such as during an audit of a 2019 or 2020 return.
    • A lot of the changes, such as for paid leave and SBA loans are not tax provisions so tread carefully in offering any interpretations. A challenge is that clients often don't have anyone else to turn to for financial assistance. Also, some of these items tie to tax rules. For example, HR 6201 (P.L. 116-127) and the required paid leave matches the amount of payroll credits employers get. So, an understanding of the leave rules coordinated by the Dept. of Labor is needed to help a client figure out their payroll tax obligations and timing. And of course, many practitioners have employees so need to know how these rules - tax and non-tax, apply to their own firm.
    • Documentation: Remind clients (and yourselves) to get documentation now, such as why HR 6201 sick or family/medical leave was given to an employee for which payroll credits were claimed.  Likely better to get it now than later.

  • More Ideas for Tax Law Changes to Help in Dealing with the Pandemic
    • I offered several in a March 13 blog post (most of where were enacted).
    • Relax the home office rules under Section 280A now that so many are working from home:
      • Modify the requirement that the office has to be used exclusively for work. This also needs to be done to modernize this rule to reflect today's ways of working and living (as suggested last year by the AICPA).
      • Relax the principal place of business rule for 2019 since many business owners are working at home.
      • Make it clear that if employers reimburse employees for use of their home office, it is allowed without the need to prove that it was for the convenience of the employer.
    • The TCJA disallows a deduction for parking and transit passes provided to employees. With employees working at home, employers are still paying these expenses, particularly the parking. Repeal this rule at Section 274(a)(4) at least for 2019 to help employers.
    • Push the federal income tax estimated tax payment due June 15 (still) to July 15 or later. It is too confusing for the second payment to be due before the first payment. Also, June 15 is likely to early. For example, Virginia has a shelter-in-place order through June 10 and perhaps other states will as well.
    • Additional filing and payment is needed. See the AICPA's April 2 letter to IRS and Treasury on this.
What do you think? What additional suggestions do you have?

Stay safe please.