Report Released by the California Commission on the 21st Century Economy

A few days after the extended due date for their recommendations, the California Commission on the 21st Century Economy issued a 400+ page report with a few major recommendations to change the California tax system along with the text of the proposed legislative changes.

The recommendations were endorsed by 9 of the 14 commissioners.

The recommendations include moving from a 6 rate to a 2-rate personal income tax and per the commission, yielding a tax cut for everyone. The only deductions allowed would be a large standard deduction and for itemizers, charitable contributions, mortgage interest and property taxes. The state level sales tax would also be phased out (leaving the local sales tax) and the corporate income tax would be eliminated. A new tax - a low-rate business net receipts tax owed by all businesses (other than "small" businesses) would be created. On page 41 of the final report, the Commission suggests that the new tax would replace the revenue from the repealed taxes (and apparently the reduced personal income tax as well). The Commission suggests that the BNRT rate not exceed 4% (while that seems low compared to current tax rates, the BNRT is a form of subtraction method VAT so there is no reduction in the tax base for wages and related expenses, thus leaving a large tax base. The Commission also suggests keeping a research tax credit (which is mainly based on R&D wages - an approach contrary to a consumption tax, such as the VAT). The changes would start in 2012 to give time for the legislature to act.

The Commission also calls for a rainy day fund and creation of an independent tax forum for resolving disputes between taxpayers and tax agencies.

These are some major changes. They will be difficult to understand. Just before posting this, I heard a brief TV news report that noted that the BNRT is comparable to what is used in Europe. That is a stretch. Europe and most of the rest of the world uses a credit invoice VAT, not a subtraction method one. While in theory, they should raise the same amount of revenue, one important difference given that the BNRT is replacing the state-level sales tax is that the sales tax shows up on sales receipts - it is transparent. That is not true for a subtraction method VAT - it will not be clear who ultimately pays that tax, but will likely be some combination of customers, investors and employees.

While the corporate income tax has a lot of complexities for multistate businesses, such as determining how much income to allocate to each state, those complexities will not go away, but will also exist with the BNRT.

It will also be important to carefully look at the distribution of the tax change among income groups. Dropping the top personal income tax rate from 9.3% to 6.5% (with little change in deductions for high income individuals), there will be a significant tax drop for high income individuals. While that can reduce volatility of that tax, does it change the distribution of the tax among income groups more than most people desire?

So, the Commission has given legislators and others a lot to think about. While the proposals may never be enacted, hopefully they will at least lead to thoughtful discussion of what is wrong with our system (and there is plenty - click here) and how it can be fixed.

I've got a short article at the California Progress Report with suggestions on how to evaluate the Commission proposals. And, I'll post more on the particular changes and possible recommendations not made.

What do you think of the proposals?

State Taxes and the Mobile Workforce

In today's information age, there are many knowledge workers who don't necessarily need to be at the corporate headquarters to get their work done. Both employers and employees may desire to have an employee work from a remote location. It might be a recruitment approach - finding the very best person for the job even if they don't live nearby. Also, employers may want employees available 24/7 and so have to be flexible when the employee asks if they can work remotely.

Also, some employees may be assigned to meet with clients or corporate offices in various states as part of their work assignment.

The tax issue is how to effectively assign the employee's wages to the different states in which they work. The rules are not consistent from state to state and some of the rules come as a surprise to workers. For example, a few years ago, a worker in Tennessee who occasionally travelled to corporate headquarters in New York, but did most of the work remotely from his home office, found that New York taxed 100% of his wages, rather than only the wages attributable to the days worked in New York. The reason - New York's rule that if the work outside of NY was not for the convenience of the employer, the work was attributable to the employer's location in NY.

For the past few years, bills have been introduced in Congress to simplify and make uniform, the state rules on when they can tax wages of non-resident employees. But, nothing has happened.

I've got a short article on the issues and legislation proposals - State Taxation and the Modern Workforce, AICPA Corporate Taxation Insider, 7/24/09.

What do you think Congress should do?

CA Commission on 21st Century Economy Report and Vote Due 9-20-09

The California Commission on the 21st Century Economy had its first public meeting in January 2009 and is to issue its report, which should indicate how the 14 commissioners voted on the proposal, on 9/20/09 (the original deadline of 4/15/09 was extended twice).

The proposals discussed at their final meetings on 9/10 and 9/14 are fairly bold - reducing the personal income tax for high income individuals, and replacing the corporate income tax and state level sales tax with a business net receipts tax. The big question is - are these appropriate changes to improve California's tax system to make it one appropriate for the 21st century economy.

Well, I'd say "yes and no."

Yes - 21st century improvements offered in the Commission's plan include:

• Reducing the sales tax for businesses. This will reduce (but not eliminate) a flaw with our current sales tax in that it is a pyramiding tax. We make businesses pay sales tax on equipment. That tax makes its way into the price of the goods sold by the business on which customers pay sales tax again. Most states do not make businesses pay sales tax on manufacturing equipment (or sometimes R&D equipment is also exempt). This reality makes California very uncompetitive for manufacturing - why pay an extra 9.25% on manufacturing equipment when you can avoid it in most other states? However, the proposal reduces the sales tax for all taxpayers and still makes businesses pay the local portion of the sales tax. Thus, businesses have the continued complications of sales tax and other states still look more competitive. So, while this proposal helps move us into the 21st century economy where businesses face fierce global competition, it doesn't go far enough.
• Elimination of the corporate income tax - why not? Small companies either don't owe it or owe very little. Large multitstate companies work to reduce their state income tax with the help of tax professionals and the state legislature that provides a lot of tax credits. Elimination of this tax might lead companies to want to locate more payroll and property here as doing so won't raise their CA corporate income tax (because there would not be one) and would lower their state income taxes elsewhere. However, our high sales tax would still be a deterrent. Big question - which should be eliminated for corporations - the sales tax or the income tax? Definitely the sales tax. That along with the option of a single sales factor should make California attractive to manufacturers and R&D operations - activities with high wage labor that should boost state tax collections.

No - aspects of the plan that don't move us into the 21st century:

• Flattening the personal income tax. For years, the trend has been a growing income gap between individuals with the highest incomes and those with the lowest. What is the point to reduce the top income rate and eliminate some deductions, such as the medical deduction that might benefit a middle-income taxpayers? AND, at the same time continuing to allow for deductions of interest on home equity loans (something only homeowners can get, not apartment dwellers), a vacation home (something also for higher income individuals) and on up to $1.1 million of debt! Greater equity could be achieved by eliminating inequitable deductions like the parts of the overly generous home mortgage deduction.
• I've written before about ways to reduce the volatility of the personal income tax while not necessarily giving a tax cut to high income individuals (here).
• The business net receipts tax - it is not clear if this moves us into the 21st century. I've heard a lot of misstatements about this tax which concerns me. For example, it has been likened to the European VAT. However, all of Europe and most of the rest of the world use a credit invoice VAT that appears on sales invoices (it is a transparent tax and a non-pyramiding one). The BNRT is a subtraction method VAT. Only Japan uses a version of this and Michigan. I've heard that the BNRT is better because it has a broader base. Broader than what? I'm concerned that people mean compared to the corporate income tax. That is correct - the BNRT has a broader base because wages are not deductible, BUT, we should not be comparing the bases of the BNRT and the corporate income tax because they are two different types of taxes!! The BNRT is a consumption tax while the corporate income tax is an income tax. Perhaps those saying it has a broader base mean in comparison to the sales tax. That might be, but it is not clear. Compared to the sales tax we have today in CA, the BNRT has less pryamiding, so represents a narrower base, rather than a broader one. Of course, in that it applies to all businesses, not just those that sell tangible personal property, the base is broader. But, how does the narrowing and broadening aspects of the BNRT compare to our current sales tax?
• Where is a polluter pays tax? CA has ambitious greenhouse gas emission reduction targets. One way to help us reach them would be to increase the cost of carbon-based fuels, such as gasoline. So, why not increase the gasoline tax? That would help our tax structure tie to our state strategic goals and raise some revenue. Some of that revenue could be used to provide a rebate to low-income taxpayers.

That's just a few comments. I hope the final report will have a longer narrative on the personal income and sales tax changes (there is only a detailed explanation for the BNRT). While statutory language has been provided, it is hard to know if the changes are the correct ones if we don't have detailed explanatory text to go along with it.

For more information:

• Commission's 2-page explanation of the plan
• Commission's Powerpoint presentation on the plan
• Proposed statutory language from the Commission

Questions for you:

1. How many commissioners do you think will vote for the plan?
2. Would you vote for the Commission's plan? Why or why not?

50th Anniversary of PL 86-272 - Temporary Legislation!

Today - September 14, 2009, marks the 50th anniversary of Public Law 86-272 which many of its drafters viewed as a temporary law. PL 86-272 provides guidance to businesses as to when they have income tax obligations in a state. Basically, if the only thing a business does is to take orders in the state that are approved and filled from outside of the state and the business has no property in the state, the business is not subject to income tax in that state.

PL 86-272 also called for a congressional committee to study various state income tax issues as relevant to multistate businesses. Results of that study were to enable Congress to improve or broaden PL 86-272.

Despite a 1,200+ page report released in 1964 and 1965, no changes were made to PL 86-272. That's a long time to have a temporary provision. A key lesson learned is that a termination date should have been specified in the law to make it a higher priority to get the law into a final and lasting form. One of the key defects of PL 86-272 is that it only provides guidance to multistate businesses that sell tangible personal property.

I've written on this before, asking the question over 1 year ago whether PL 86-272 would get modernized prior to its 50th anniversary. Legislative proposals to do so, remain in limbo - as they have for the past few sessions of Congress.

For more information, see a website on this topic - http://www.cob.sjsu.edu/nellen_a/TaxReform/PL86-272-50thAnniversary.htm.

What do you think?

Revenue Ideas for the Internal Revenue Code

Every 2 years, the Congressional Budget Office releases a lengthy report with a list of well explained list of possible changes to spending and to the Internal Revenue Code that Congress could consider. All of the ideas have revenue estimates too. This year, CBO released the report in 2 parts. The first part was issued in December 2008 and dealt with health care changes including changes to the tax law. Part 2 was released in August 2009.

Do any of the tax ideas in the August report move the tax system into the 21st century? Most of the proposals are changes to make the system more fair, simpler or raise taxes. For example, one suggestion is to have a flat 35% tax rate for all corporations (no more graduated rate structure). Another is to simplify the education provisions by consolidating them. An example of an equity proposal is one to reduce the mortgage interest deduction or convert it to a tax credit too.

But back to modernization, proposals here include:

• Reducing the corporate tax rate by 5% - that would reflect that in the global economy, most other countries have a lower rate structure than the US. A lower rate could improve international competitiveness - something more crucial in the 21st century.
• Eliminating the telephone excise tax - an outdated tax.
• Adding some polluter pays taxes that should help reduce GHG emissions and improve air quality, reflecting global efforts to reduce both climate change and pollution.

I have a short article on the August CBO report that includes links to the two parts of the report - here.

What proposals intrigue you?

Ideas for President Obama's Tax Reform Task Force

On 9/8/09, Tax Analysts released a set of 32 short papers (Towards Tax Reform) with suggestions for President Obama's tax reform task force (I have a prior post with info on the task force). The task force is to issue a report by 12/4/09. Its 3 key areas of focus are:

1. Simplification.
2. Closing tax loopholes and reducing tax evasion (tax gap reduction).
3. Reducing corporate welfare.

Tax Analyst's solicited the papers from a variety of folks. I was pleased and honored to have an opportunity to make a contribution. My essay is entitled Strive for a Sound and Respected Tax System.

Tax Analyst's has posted all of these papers on its website - here.

What would you tell the task force to do to improve the federal tax system?

A New Approach for a Federal Energy Credit

In the American Recovery and Reinvestment Act of 2009 (P.L. 111-5; 2/17/09), Congress tried something that a few states had already done to gain a bit more control over tax credits. The credit is at IRC section 48C and is designed to encourage investment in manufacturing facilities to produce certain green equipment.

A fixed amount of dollars were allocated for the credit - $2.3 billion. Taxpayers wanting to use the credit must have their project approved by the Departments of Treasury and Energy. Thus, one benefit to the government of this pre-approval approach is that the "cost" to the government is capped.

The window for preliminary applications is short. Guidance on how to apply was issued late August (Notice 2009-66) and the applications are due 9/16/09.

I have a short article in the 8/27/09 AICPA Corporate Taxation Insider about this type of credit approach in general and this particular credit.

While this approach does require a lot of peoplepower upfront, some of that would have been spent in future audits anyway. The approach should greatly increase accountability for both the government and taxpayers. The government can be more accountable to the public that the dollars were used properly. Taxpayers are likely to be more careful to be sure their project qualifies, making them more accountable to the system.

What do you think?