Washington to Remove Exemptions for Candy and Bottled Water

SB 6143 signed into law by Governor Gregoire on April 23, 2010 includes several provisions that will generate additional revenue for the state including an economic nexus standard for income taxes. [See Washington Legislature site on SB 6143 and Deloitte summary for more information on the entire bill.]

SB 6143 also removes the sales tax exemption for candy and bottled water. Washington, like most states, does not apply sales tax to most food items. Generally, this is done so that the tax doesn't apply to "necessities of life." However, as noted in this blog and 21st Century Taxation reports, this is a poorly targeted exemption because high income individuals spend a lot more on food than do lower income individuals so the exemption provides a greater tax break to higher income individuals. Also, any exemption from the general rule complicates a law because definitions are needed to distinguish between taxable and non-taxable items.

SB 6143 and its change in exemptions is a good example of the complexity of exemptions. Here are some excerpts from this new law:

"Until July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, bottled water, candy, or dietary supplements. Beginning July 1, 2013, the exemption of "food and food ingredients" provided for in subsection (1) of this section does not apply to prepared food, soft drinks, candy, or dietary supplements."

""Candy" means a preparation of sugar, honey, or other natural or artificial sweeteners in combination with chocolate, fruits, nuts, or other ingredients or flavorings in the form of bars, drops, or pieces. "Candy" does not include any preparation containing flour and does not require refrigeration."

""Bottled water" means water that is placed in a sealed container or package for human consumption. Bottled water is calorie free and does not contain sweeteners or other additives except that it may contain: (i) Antimicrobial agents; (ii) fluoride; (iii) carbonation; (iv) vitamins, minerals, and electrolytes; (v) oxygen;(vi) preservatives; and (vii) only those flavors, extracts, or essences derived from a spice or fruit. "Bottled water" includes water that is delivered to the buyer in a reusable container that is not sold with the water." Tax won't apply though to "sales of bottled water for human use dispensed or to be dispensed to patients, pursuant to a prescription for use in the cure, mitigation, treatment, or prevention of disease or other medical condition."

So, cookies are not taxable, but candy is. A bottle of plain water is taxable, but not one with enough sweet flavoring to add a few calories. This illustrates another issue with exemptions, they can violate the neutrality and equity principles. The law change may lead buyers to prefer sweetened bottled water over plain bottled water. This is also odd because how is sweetened bottled water a necessity of life?

The simplest, more efficient way to go would be to tax all food and provide relief to low-income taxpayers via a refundable income tax credit. This would also raise more revenue than the current system and that revenue could be used to either lower the sales tax rate a bit.

What do you think?

VAT Mania

I think it is fascinating to hear so much discussion today about the need for a VAT in the US. All other industrialized countries have a VAT. In fact a VAT is used in over 140 countries today. So, there is a lot of data out there on its effect on the economy, administration, etc.

I don't see that a VAT could replace any federal tax as some propose. But, perhaps as an additional tax that would allow for reduction in the income tax or payroll tax, it could help reduce the deficit (along with spending reforms!).

I have a short article in the AICPA Corporate Taxation Insider today - VAT Mania, with some background and links to additional information, including a website I've maintained for some time that explains how a VAT works and compares it to a sales tax (here).

While the Senate recently passed a resolution opposing a VAT (see link in article), I think that is unfortunate. We should not dismiss something so widely used in the world AND that is already on the table in the US in other forms. Did you know that the "flat tax" is a modified subtraction method VAT? Did you know that the national sales tax is not as efficient in operation as a VAT, but both can raise the same amount of revenue? See links above for details.

What do you think of a US VAT?

Can IRS Prepare Returns for Many Individuals?

This is a longstanding question. In several countries, the tax agency or employers handle income tax filing for many individuals. In 1996, the GAO issued a report on alternative filing systems explaining the possibilities and how systems and rules could be changed to enable the IRS to file returns for a large number of individuals.

The issue was debated a bit before President Bush's Advisory Panel on Federal Tax Reform with those opposing mainly concerned about privacy matters and errors and those favoring noting the efficiencies that could be had and the benefits to individuals. Click here to get testimony from the Panel's 5/17/05 hearing on return-free filing.

Most recently, the bi-partisan tax reform proposal of Senators Wyden and Gregg includes enabling many individuals to request that the IRS file their return (S. 3018 and the sponsors' website).

As one approach to tax simplification, in a tax day op ed (here), I suggested further exploration of return-free filing. That caught the attention of Mary O'Keeffe of Union College who posted a comment on this blog and explains her concerns on her blog - Bed Buffaloes in Your Tax Code (great title! and if it were just bed buffaloes in the Code, we'd be in better shape!).

She raises some good concerns that can be addressed, such as requiring employers to send the W-2s to the IRS sooner (closer in time to when they are required to send them to the employees). If the IRS were not behind on having the best technology possible (something it has identified in its strategic plan as a priority), we'd be closer. But, I think changes can be made to help more to enabling many taxpayers to have the IRS file the return for them. Perhaps Senators Greeg and Wyden can start there with their tax reform proposal.

What do you think?

President’s Bipartisan Fiscal Commission - First Meeting

The President's Bipartisan Fiscal Commission meets for the first time today (April 27, 2010) with President Obama joining them at the start. For a photo and various links see this post from the White House blog. President Obama noted the growing deficit and some measures taken to address it so far such as reinstatement of pay-as-you-go and spending freezes.

But, these are part of the problem in that they are a lot of window dressing and buzz words that won't improve our tax systems or fiscal situation. The PAYGO rule doesn't require everything to be paid for, such as an AMT patch for 2010. The spending freeze only covers a tiny amount of spending and totally ignores the billions of spending that is buried in our tax system and growing.

I think budget reform will only happen when lawmakers and the Administration are more honest about what the situation is and what it will take to reduce the deficit. Most of the public won't want to hear it - that a larger child credit might mean they owe AMT, that allowing larger than necessary home mortgage deductions costs all taxpayers and increases the deficit and debt, and that an exclusion for employer-provided health insurance drives up health care costs and "spending" and should be curtailed. And we shouldn't tolerate politicians bragging about large tax cuts unless they can show they were needed and how their effect on increasing the deficit and debt are going to be addressed so we aren't just spending at the harm of future generations and our economy.

I hope the Commission will be bold and honest with the public and that the public won't dismiss them for saying things we might not want to hear or deal with. We need some "tough love"!

What do you think?

Cap and Trade versus Carbon Tax - CBO Letter

on April 20, the CBO issued a letter to Congressman Christopher Smith on the costs to households of H.R. 2454, the American Clean Energy and Security Act of 2009 (+ see CBO Director's blog post). H.R. 2454 passed in the House in June 2009. This is a complicated bill that creates a cap and trade for carbon emissions, allows for use of carbon offsets and has a few tax provisions in it. I wrote an short article on this in August 2009 in the AICPA Tax Insider (Tax Aspects of Greenhouse Gas Legislation).

CBO estimates: "Measured in terms of the 2010 economy, the average loss per household would be $90 for 2012, $550 for 2030, and $930 for 2050; it would average about $460 per year over the 2012–2050 period."

I'm guessing these costs will be viewed as a bad thing which is somewhat unfortunate. Reducing greenhouse gas emissions and global warming is going to cost us. But that is a good thing as opposed to suffering the costs to the economy and life of climate change. We created an economy dependent on many things that produce GHG emissions and to change course now will entail costs. These costs are also there to help encourage people to change behavior. After all, if gasoline continues to cost the same, where is the incentive to use less of it?

I hope any discussion of the information in the CBO letter will also lead to evaluation cap and trade versus a carbon tax. A carbon tax should be far more transparent as to the cost. For example, you'd see if listed on your utility bill. Gas stations could post the details of the price you pay at the pump that notes the carbon tax. It will be more difficult and less accurate to try to estimate the cost of cap and trade embedded in the cost of any goods or services.

But we definitely have to get to the point of accepting that it is going to cost us. The sooner we make changes, the lower the cost will likely be. Also, shifting from fossil fuels to renewable energy sources should also create jobs as we develop and improve upon the necessary technology.

A carbon tax - a polluter pays tax, makes sense. While it is regressive, relief can be provided via the income tax, but everyone needs to pay something to be better incentivized to change our behavior to help save the planet.

What do you think?

Earth Day and Taxes

Today is Earth Day! There is a significant connection to San Jose State University where I teach because the co-founder of Earth Day - Gaylord Nelson, is an alum.

Back to taxes - the Treasury Department announced its green initiative earlier this week (TG-644; 4/19/10). It will be moving more paper transactions to electronic ones. Treasury expects that this will save both money and trees. Specifically, they estimate their new initiatives will reduce costs by over $400 million in five years and save 12 million pounds of paper.

Some details from Treasury:

1. "First, Treasury will require individuals receiving Social Security, Supplemental Security Income, Veterans, Railroad Retirement and Office of Personnel Management benefits to receive payments electronically. Individuals will be able to receive benefits either through direct deposit into a bank account or Treasury's Direct Express debit card."
2. "Second, businesses currently permitted to use paper Federal Tax Deposit coupons will have to make those deposits electronically beginning in 2011 with a few exceptions, primarily businesses with $2,500 or less in quarterly tax liabilities that pay when filing their returns."
3. "Treasury will eliminate the option to purchase paper savings bonds through payroll deductions for federal employees on September 30, 2010 and for the private sector by January 1, 2011. This policy covers only paper savings bonds purchased through payroll sales; individuals will still be able to purchase paper savings bonds at financial institutions for themselves and as gifts. Payroll savers will be encouraged to continue their purchases through Treasury Direct, a web-based system that allows investors to buy and hold electronic savings bonds. Transitioning employees to electronic payroll purchases saves employers administrative costs and allows employees to manage their own bond accounts. This is estimated to save nearly $50 million in the first five years."

Moving tax systems into the 21st century involves both structural changes as well as administrative ones. I think this move by Treasury is a good one as these transactions should be done electronically to make good and appropriate use of today's technology, save money (which should also help reduce the deficit), and electronic can be done more securely than paper transactions. It also helps the growing number of people who keep all of their financial statements electronically.

What do you think?

More Stimulus - Payroll Tax Exemption

In March, enactment of two health care reform laws overshadowed signing of another economic stimulus bill. On March 18, 2010, President Obama signed the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147). The stimulus highlight is a payroll tax exemption (Social Security only) for employers who hire a new worker this year. This is an interesting policy approach for a few reasons. For example, a payroll tax credit benefits more employers that would an income tax credit. The payroll tax credit will benefit employers with a taxable loss and non-profits.

There is more in this stimulus bill, namely some significant new foreign reporting and withholding rules. So, all in all, more to keep tax advisers well-employed.

I've got a short article in this week's AICPA Tax Insider on the employer benefits in HIRE and some policy considerations of the approach and the Act - here.

Signs of Tax System Problems - Serious Ones!

Today - tax day - among the emails I received are two that I think are good illustrations of how troubled our federal tax system has become. The system needs to be improved and updated to reflect 21st century ways of living and doing business today. Unfortunately, I see very little proposed by lawmakers that will make any of this happen.

Here are the 2 emails:

1. The Treasury Inspector General for Tax Administration (TIGTA) released a report, Interim Results of the 2010 Filing Season (4/14/10). Highlighted in the email:

"TIGTA auditors analyzed 2010 filing season results as of the first week of March, 2010. As of that time, the IRS had paid some $24.2 million in erroneous Making Work Pay and Government Retiree Credits and improperly awarded some $4.7 million in erroneous Plug-in Vehicle Credits. The IRS estimates that 50 percent of the individuals claiming the First-Time Homebuyer Credit will not attach the required documentation this year." ...

"As of March 5, 2010, the IRS had identified 119,484 tax returns with $733 million in fraudulent refunds and prevented the issuance of some 98 percent ($721 million) of those refunds."

The problem as I see it: too many law changes including ones that involve millions of taxpayers and thus lots of IRS time. And these are temporary provisions which seem to cause extra confusion and the time spend figuring them out is lost when the item expires. A tax rate decrease for low bracket taxpayers and an increase in the Earned Income Tax Credit would probably have been adequate stimulus techniques.

2. An email from Congresswoman Lofgren stating "As we mark the passage of another Tax Day, we should recap tax cuts enacted by this Congress. All totaled, more than $800 billion in tax cuts." She is my representative and I admire her work. I don't agree with the message she is sending, but I think it just illustrates that the majority of politicians and the public have come to think that the job of elected officials is to cut taxes when in fact it is to oversee budgets with appropriate spending and revenues. I don't think anyone should be bragging about $800 billion in tax cuts when our deficit is ballooning into the trillions of dollars.

The email has a link to more details from Speaker Pelosi which also brags about the tax cuts - here. Who is going to talk about the growing, staggering deficits and the increased interest expense they are causing us to pay?

AND - who is going to talk about the intersection of these two email messages? The tax cuts were not well designed and there were too many for the public and the IRS to handle which has led to an increase in the tax gap.

A better approach?
(1) Ask - do we really need tax cuts?
(2) If yes, how can they most simply and effectively be drafted? Typically, a rate decrease would be the answer or an increase in the standard deduction. Use tax rules that already exist and that people understand rather than create new complex rules that require guidance from the IRS and new tax forms.
(3) Talk more about our staggering debt and deficits. There are many tax preferences that make no sense and should be phased out as a start (such as interest expense on a second home and on up to $1.1 million of debt). Also, we should not stand by quietly while Congress and the Administration talk about re-instating the 2001/2003 tax cuts. Some lawmakers say these cuts helped create the deficits (or eliminated the budget surpluses that existed for a very short time). Why would they now want to keep some of them rather than let them expire at the end of 2010.

What do you think?

Time to Demand a Simpler Income Tax System

As we complete our income tax returns this week (unless you got it done earlier), we are reminded of the complexity of the process. This year, some people claiming a standard deduction have a new form because of the additional deductions Congress has added to the standard deduction (see Schedule L) - the standard deduction is not supposed to require a form! And millions have a new Schedule M to fill out to reconcile their Making Work Pay Credit and/or Government Retiree Payment (Schedule M + instructions).

I've got an op ed in The Press-Enterprise today (April 14) on the reality that the federal income tax will only get simpler if we honestly demand it of lawmakers. They have no incentive to do it on their own. I think the public has come to expect and perhaps admire politicians with campaign promises of new tax breaks. Such breaks just complicate the system and usually are not needed. A lower rate without the special tax breaks would be a lot easier and save us a lot of time and money preparing returns and keeping records.

It's a short op ed - "Demand a simpler income-tax process" - I hope you'll read it and leave a comment here. Thanks.

California AB 2148 - Poor Tax Policy

On Monday April 12, 2010, the California Assembly Revenue & Taxation Committee is scheduled to discuss 18 bills. Among them is AB 2148 which "would allow a deduction for the value of medical services contributed free of charge by a physician to a local community clinic, not to exceed specified amounts."

The deduction would be limited to the lesser of: "(A) The value of any contribution that exceeds a rate of fifty dollars ($50) per hour for any medical services rendered. (B) One thousand five hundred dollars ($1,500) per taxable year."

Problems:

• Design of an income tax. Federal income tax law, which California mostly copies, denies a deduction for the value of donated services (per Treasury Regulation §1.170A-1(g)). Federal law does allow the donor to deduct costs of expenses incurred, such as mileage and supplies, but not the value of the services. The likely reason is that the donor has no basis in the services. That is, he has not included the value of the work in his income. If someone were allowed to deduct the value of donated services, they should also include that value in their income. It would mostly be a wash (except that payroll or self-employment taxes would be owed on the labor income). The current system is simpler in that there is no need to have to value the donated services.
• Potential for abuse: While AB 2148 calls for a maximum deduction, it is still too easy to just claim the maximum. That is sort of the hidden message in that maximum. Also, what hours count? What about the time getting ready? Travel time?
• Complexity: Franchise Tax Board guidance would likely call for some type of documentation or reporting for the hours donated. This requires special recordkeeping by the doctor which would only be needed for tax purposes.
• Where would it end? AB 2148 would open the door for others asking for similar treatment. For example, many accountants donate time to help people prepare tax returns and to help non-profit organizations. Many attorneys do a lot of pro bono work. Many people donate time to many causes which could otherwise have been used to generate income. The law is better left as it is and it has been working well for decades.
• Non-conformity: The federal government is unlikely to ever adopt such a rule so the doctors would have an adjustment to their California return.

California has many tax problems. Decades of not allowing people who donate their services to get a deduction for it (or have to report their value as income) has worked well and time should not be spent to start changing this rule. Time would be better spent on:

• Broadening the sales tax base to bring it into the 21st century and lower the rate.
• Starting to reduce the pyramiding in the sales tax (AB 1812 and AB 2280 also on the agenda for April 12 would be a good start, but needs to be phased in along with base broadening). The analysis accompanying AB 2280 notes that only California, South Dakota and Wyoming require businesses to pay tax on manufacturing equipment. This means: Why would any manufacturer locate in California and pay an almost 10% surcharge on its equipment (the sales tax) when it won't be subject to that extra cost in almost every other state?!
• Phasing out and eliminating unnecessary, poorly targeted, unfair tax preferences in the personal income tax, such as the deduction for mortgage interest on a second home and on debt greater than $500,000.

For more on California tax problems and possible solutions - please see my reports on this topic - here, which cover the suggestions above and a few more.

Paul Volcker Again Mentioning a National VAT

CBSMoneyWatch.com has an article today - "VAT: New Tax Coming Soon?" by Cait Murphy (4/7/10). It states that in response to a CBS MoneyWatch.com question on April 6 in NYC, Volcker said that a VAT in the US was "not a toxic idea." The article also notes that Speaker Pelosi and Senator Conrad likely support not leaving the topic off the table. This is really important because:

• Volcker advices President Obama.
• The US is the only industrialized country without a VAT (although we have state sales tax).
• A VAT can be more efficient than a sales tax and with a federal VAT, states could adopt it (at rates lower than existing sales tax) and get rid of their troubled sales taxes.
• The current income tax is unlikely to solve our deficit problems (and yes, reduced spending should also be considered in addition to tax reform). See the Tax Foundation Fiscal Facts of 3/12/10 - Can Income Tax Hikes Close the Deficit?

I've discussed this before a few times (for example, 2/8/10 post which also notes Volcker's interest in a VAT).

I think a VAT is something that should definitely be discussed at the federal level with the states participating. I'll be writing more on the issues and opportunities of this (including using materials I wrote back in the mid-1990s when major federal tax reform was a very hot topic). I do have a brief overview to how the VAT works if you are interested - here. Here is a longer paper presentation from 1999 on major federal tax reform - much of it is still relevant today although the need for reform is likely greater today than ten years ago.

What do you think?

Ohio Tax Reform - Success or Not?

In 2005, Ohio made significant changes in its tax law. It added a gross receipts tax called the Commercial Activity Tax (CAT) and phased out its corporate income tax and personal property tax; reduced the individual income and sales tax; and increased the cigarette excise tax. The CAT used a factor presence nexus standard and sourcing rules designed to tax companies with sales into Ohio and not those located in Ohio that make sales out-of-state.

With the 5 year anniversary of the changes approaching, I've seen a few stories telling of the success of the changes. For example, today's (April 5) Akron Beacon Journal had an article - "Tax reform brings kudos to Ohio - Analysis finds burden improves in last 5 years; changes are positive draw for business, leaders say" by Paula Schleis. It refers to a Federation of Tax Administrators (FTA) survey ranking Ohio as having the 16th lowest tax burden. Per the author, that ranking is 9 places better than in 2005.

Meanwhile, the Tax Foundation notes that the poor tax climate in Ohio drives businesses out of the state. In its blog post of January 7, 2010 - "Ohio's Poor Tax Climate at the Heart of the State's Economic and Fiscal Woes," the Tax Foundation suggests Ohio undertake tax reform. Ohio tax problems noted by the Tax Foundation include the use of a gross receipts tax and its inherent pyramiding problem and imposition even when a business has a loss for the year (for more on pyramiding, see my report here and some articles on gross receipts taxes here). Additional problems noted are Ohio's complex personal income tax and imposition of an income tax by most cities and school districts, as well as a sales tax that applies to many business purchases.

So, why the discrepancy in the views on Ohio's tax reform? Some of the difference may be due to the 5-year phase-in/phase-out of the changes where two types of businesses taxes applied. Another cause is varying perspectives on gross receipts taxes. Some say they are good in that they have a broad base (very broad) and thus, a low rate. Also, they are not subject to Public Law 86-272 or the physical presence nexus standard of Quill. This gives states more leeway in stating who is subject to the tax (within Due Process and Commerce Clause restraints) and the ability to "export" the tax. Of course, that would change if Congress enacts an update to PL 86-272 that calls for some degree of physical presence for any "business activity tax" which includes a gross receipts tax.

So, different perspectives on the nature of taxes, ways to measure tax burdens among the states, and the effect of transition rules for tax changes complicates the picture as to whether the Ohio tax reform has been a success. I think it is impressive that something was actually done rather than only talked about for decades with no changes made (as happens in many states including California which has already had two tax reform commissions in the 21st century with no changes enacted). (I don't think a gross receipts tax with its inherent pyramiding is an effective way to tax.) In addition, differences in the meaning of "successful tax reform" can lead to differences in opinion as to whether tax reform in Ohio has been successful.

What is your take on whether the Ohio tax reform effort enacted in 2005 has been a success or not?

First-Time Home Buyer Credit Problems

On April 1, 2010, the Treasury Department reminded people (if they read Treasury press releases), that they have just to the end of April to buy a home so they can claim the up to $8,000 refundable first-time homebuyer credit (TG-622). The Worker, Homeownership and Business Assistance Act of 2009 (P.L. 111-92; 11/6/09), extended the credit to homes purchased before May 1, 2010 (for summary and links, see Nellen, Documenting the First-Time Homebuyer Credit, AICPA Tax Insider, 3/11/10).

When Congress extended the credit last November, they added features to reduce abuse. For example, individuals must now attach the closing statement to prove that they actually purchased a house. They must also be at least 18 years old. There have been many stories of abuse (see, for example, 2/27/10 post).

There are also stories of people who qualify for the credit being greatly delayed in receiving it because of the IRS asking for additional information (this pertains to the credit prior to the documentation change in November 2009). BNA had a story on this today (4/5/10) - "Treasury Reminds Taxpayers of April 30 Home Buyer Credit Deadline; Issues Remain." The BNA article includes stories of challenges some taxpayers have had in claiming the credit including one where someone who purchased a condo was denied because the IRS told him apartments did not qualify (the condo had a unit number). That taxpayer eventually got the credit approved after getting the IRS Taxpayer Advocate involved.

Per the BNA article, IRS Commissioner Shulman noted in his March 25 testimony before a House Ways & Means Committee that the IRS would likely open 200,000 audits in 2010 due to the homebuyer credit (here is a link to the testimony - that figure must be in his oral testimony as I don't see it in his written testimony).

This is an unfortunate use of IRS audit resources. I say this because I think this first-time homebuyer credit is an example of the need for members of Congress, the Administration and the public to stop expecting all benefit and stimulus programs to be handled via the tax law. Given the large dollars involved in the credit, its goal to stimulate home purchases (so people most benefit by getting the funds at time of purchase), it should have been administered as a grant by a unit within the US Department of Housing and Urban Development (HUD) for example. They could have verified eligibility during the loan approval or closing process and the funds could have been available at closing of the home purchase. Then IRS audit time could be used for better purposes. Today, the audit rate for individual returns is just 1% (IRS 2009 Data Book, pg 22). Now in 2010, the IRS will spend a lot of time auditing 1040s that claimed the homebuyer credit - most legitimately.

I think it would be good if Congress came up with some standards for when a new spending program should be administered via the tax law and when it should be a grant program administered by an existing federal agency. For example, the higher education tax credits could be handled via the Pell grant and similar Department of Education programs. This approach would reduce fraud, would enable the funds to go to those who truly need them (such as people with income too low to owe income taxes) and the students would get the funds when needed such as at the start of a semester rather than after filing a tax return).

What do you think?

Tax Administration and Electronic Communication

Here is a proposal that certainly fits within the concept of "21st century taxation" - allowing the Franchise Tax Board (FTB) to communicate with taxpayers who request it, through a special set up on the FTB website or via email. This change would not be effective until January 1, 2013 or later pending "successful implementation of the Taxpayer Folder as a component of the Enterprise Data to Revenue project of the Franchise Tax Board."

While such a set up sounds like it will involve significant website and software changes that can be costly, we certainly need to move in the direction of electronic communication and filing of tax returns and other tax documents, such as protests.

This proposal is in AB 2177 (3/23/10 version; Beall). There is a hearing on the bill scheduled in the Assembly Revenue & Taxation Committee on April 12, 2010.

Example of Alternatives to Solving Problems with the Tax Law

With the EPA announcing on April 1 that it is increasing fuel efficiency standards and adding greenhouse gas emission standards, we are reminded that not all changes in direction need to be motivated, incentivized or forced by tax law provisions. There are many ways to help change behavior such as the following.

• “Command and Control” - Statutes and regulations that require action with some type of penalty imposed for failure to comply, such as the recent EPA change.
• Incentives - If we think of the “command and control” technique as a “stick” to make someone do something, think of incentives as the “carrot” to entice someone to do something. For example, in California, some hybrid car owners were able to get permission to drive in the carpool lanes even with a single driver.
• Market-Based Approaches - Techniques that fall into this category allow economic principles, such as supply and demand, to prevail. With respect to environmental problems, market-based approaches are typically designed to let the polluter decide the best way to meet an environmental goal. Examples include a tax on the use of plastic shopping bags, the gas guzzler tax, and a system of trading pollution rights. Market-based approaches provide incentives, but also mandates (almost always from the government). For example, while a tax on plastic shopping bags will lead to a better consideration of the true price of selling and using such bags, it is also a mandate because if the bags are used, the tax must be paid. But it allows the consumers to decide if they pay the tax or find an alternative to a plastic bag.
• Education and Information - This technique is just what it sounds like – providing more and better information to individuals and entities so that they may be more likely to do the “right thing.” For example, if people knew how much carbon emissions were produced by around town driving and the fuel costs, they might do better at consolidating trips or walking. The mpg information provided on new car stickers is an example of providing information that can influence behavior.
• Personal and Corporate Values - Individuals and businesses may decide to act and behave in ways that protect the environment because they believe it is the right thing to do. Businesses may adopt some type of code of social responsibility that affects their purchasing, hiring and other decisions. They may do this to please their customers, because shareholders demand it, and/or because it is cost effective in the long run. Similarly, individuals may decide to follow a specific course of action because of a strong belief in something or a concern over something. For example, an individual may decide that he or she does not want to contribute any more to air pollution than absolutely necessary and so does not own a car and bikes or uses public transportation.
• Development and Use of New Technologies - Sometimes, technology can fix a problem. For example, if paper waste became a significant problem, the federal government could reduce use of paper by imposing a heavy tax on it or passing a law requiring a specified usage with a penalty for breaking the law. In contrast, technology might eliminate or significantly reduce the problem through such techniques as use of other biodegradable materials for packaging and better systems of digitized information (to replace paper mail and other paper information sources). Of course, the development may be incentived by tax breaks (such as an R&D credit) or government or other types of grants - so also involving incentives and market forces.

Which technique is best to address a problem? It depends on many factors and often, more than one technique is appropriate. Factors to consider include linkage - being sure that the solution and problem are connected; considering unintended consequences such as safety issues and employment changes; and costs.

Work to achieve better fuel efficiency will likely involve R&D and if the research credit is extended beyond 2009, that will provide a market-based approach along with the command and control of higher mileage standards. Perhaps Congress and the Administration will leave it at that, although if they think these approaches are not enough, I'm guessing we'll see new tax incentives for manufacturers or customers to assist all parties in meeting the new EPA standards.

What do you think?

People's Tax Problems and Possible Solutions

Yesterday, a blogger sent me a post on "The Ten Most Famous Tax Evaders of All Times." It lists some very famous people with tax problems such as not paying their taxes timely or failing to report all of their income. The list includes Judy Garland and Abbott and Costello with problems in the early 1950s which I assume was partly due to the high tax rates at that time - 92% (!) which didn't leave much money for "ability to pay" even for high income earners (see IRS table with income tax rates over time). If you do a Google search, you'll find a few websites with information on famous people with tax problems.

So - what is the relevance of this to improving tax systems? Well, this is April 1st and we'll likely read a few stories in the papers in the next few weeks about taxpayers being sent to prison and/or paying large fines for not paying their taxes or omitting income or taking improper deductions. These stories at this time of the year help promote voluntary compliance. You can find press releases from the Tax Division of the US Department of Justice with stories about tax preparers shut down for illegal activity and serious troubles of some taxpayers.

My search for more stories of tax problems led me to an assortment of problems posted at numerous tax and finance related websites, including the following. I think all stem from the complexity of federal and state tax systems and the general public not understanding tax basics (a subject not taught in K-12 or tested on standardized tests).

• Questions about whether people owe taxes on eBay sales (you can find several websites with this question and some of the answers)
• A CPA noting that one tax problem observed with some new businesses and young people is not filing a return (!). (See Generation X Finance post and comment on "Don't Let Your Taxes Make You A Criminal" 3/23/10)
• Some states post lists of the names of those with the largest outstanding tax bills - an interesting and low-cost collection technique - public shame (for example, see the California FTB list here)

And, there is a great post from the Tax Policy Center - "The Other Individual Mandate: Tax Prep" by Howard Gleckman (3/30/10). (Also see the links in that post to recent posts by Lawrence Lokken.) They note that growing complexity of the tax law (made worse with recent health care legislation that includes numerous tax changes and mandates), causes more people to seek professional tax compliance assistance or buy tax prep software. And, as I've noted in a few articles reporting on GAO findings in various tax gap studies, error rates are not much different on returns completed by paid preparers versus those that are self-prepared. ("S Corps and the Tax Gap" (2/1/10), and "Complexity and the Tax Gap - We Just Can't Blame Cheaters" (1/16/09), and an article on California finding that self-prepared returns were more likely to report use tax than those by paid preparer)

Relevance to a 21st century tax system:

• Federal and state tax systems need to be simplified. A high error rate (or even a low one) on returns prepared by paid preparers indicates a system that is too complex. Yes, some of the errors by paid preparers are unscrupulous preparers ripping off taxpayers and the system, but there are also numerous errors by attorneys, CPAs and Enrolled Agents. A key simplification is eliminating deductions and credits in exchange for lowering the rate. Also, Congress needs to stop adding more special rules.
• Taxpayer education is needed. Something the IRS and others found in uncovering work of unscrupulous preparers is that some did not sign the return, claimed bogus deductions and omitted income. BUT - why didn't the taxpayers raise questions? Most likely, few taxpayers know that a paid preparer must sign the return and don't know how to verify when they hear things that sound too good to be true. High school civics classes should include lessons on our tax system, citizen's role, how to get tax information and the basics of how different types of taxes work.
• Tax agencies need to do even better in providing guidance by thinking of tax questions from the taxpayers' perspectives. Why does anyone have questions about whether eBay sales are taxable? This is not an obscure question and hundreds of thousands of people are likely to have it. So why not just lay out the answers simply in a flowchart on tax agency websites? Why not post ads with the flowcharts on popular websites?

Tax problems and the number of people with them - famous or not, will grow with increased complexity of the tax laws and new types of transactions for which clear and timely guidance is not provided by tax agencies. What is preventing this all from happening? Probably that not enough people are demanding it.

What do you think?