America Speaks - Our Budget, Our Economy

I had the opportunity to participate in the Silicon Valley session of the America Speaks "town hall" meeting. This was one of 19 connected meetings held throughout the US with over 3,500 people participating together. The Silicon Valley session was supported by Joint Venture: Silicon Valley Network and the Silicon Valley Community Foundation.

I was very impressed with the logistics. We all heard the organizers speaking from Philadelphia. The answers to questions we discussed at table groups were immediately input to the "theme team" in Philadelphia so that common answers could be shared. In addition, we used clickers to record answers to many questions throughout the day.

There must have been at least 100 people at the Silicon Valley location. Everyone was respectful and civil and we all seemed to have a good time - it was a well run event.

I think it was a good opportunity for people to learn about the basics of the federal budget - revenues and spending elements and the existing and upcoming shortfalls. Various options were given. While these were scripted, that was necessary if we were to get through a tough exercise in a short amount of time. But we were able to give comments on the scripted budget choices. For example, it seemed that a majority (or at least a very vocal minority) contributed that the best solution to health care would be a single-payor system (or some called it Medicare for everyone).

I think a few people were concerned that Social Security changes, such as increasing the retirement age and reducing the inflation adjustment for current payouts, were on the list of budget options. However, the reality is that when some of the largest expenditures in the budget are mandatory ones (Social Security and Medicare primarily), they can't be ignored in looking for over a trillion dollars to balance the budget. One person shared that Social Security didn't cause the problem so should not be changed. I think that is interesting (and wrong). The failure to update the Social Security rules for changes in how we live and our demographics IS a problem. When Social Security was created, life expectancy was below age 65 (see SSA page). It hasn't been that way in decades.

Addressing the problems that cause our current finances to be unsustainable are difficult. Despite having to simplify many issues, I think it was a good educational experience for everyone in terms of learning more about the budget and that we can all learn something from civil discussions.

There were two, concise and helpful documents prepared for participants:

• Budget 101
• Options Workbook

America Speaks will present the results to President Obama's Deficit Commission at their June 30 meeting. I heard a few people express concerns that that would be misleading. I think the Commission is smart enough to take it for what it is - an assemblage of over 3,000 voices with scripted options, but also written suggestions. Commission member Dr. Alice Rivlin was at the Philadelphia session and even spoke to everyone near the end. So she knows how the input was assembled.

If you participated in any of the 19 sessions and want to share a comment - please do, and note the city - thanks.

States Examining Business Tax Incentives

Budget challenges in almost all states can lead to changes to postpone or suspend the use of tax credits and carryovers. Budget challenges along with poor press on the use of some business tax preferences can lead to a reduction in incentives and the addition of accountability measures. Accountability measures, such as collecting data to see if incentives are having an incentivizing effect are good things.

I've got a short article in today's AICPA Corporate Taxation Insider on some recent actions by some states to examine various tax preferences for businesses - here.

Need to Examine Self-Employment Tax Policy

I think that recent changes to impose Medicare and surtax on high income individuals and the "loophole" closer proposal to tax some S corporation shareholders more broadly for employment tax purposes, call for a review of self-employment taxes. The review should also consider how to reduce the self-employment tax gap. Today, the IRS estimates that about 11% of the annual $345 billion tax gap represents SE tax. Also, some new ways of generating revenue, such as having ads on a personal website, call for updated guidance on what types of modern revenues are subject to SE tax.

A benefit of a review would hopefully be to avoid piecemeal changes, particularly ones geared more towards generating revenue to pay for a tax cut elsewhere than to improving the design of our tax system and to help it meet the principles of good tax policy.

I've got a short article on this topic in this week's AICPA Tax Insider. I hope you'll take a look and post comments here on how you think SE taxes should (or should not) be reformed.

Balancing Compliance and Collection - The Expanded 1099 Filing Requirement

One of my favorite statements about reducing the tax gap is from a 1995 GAO report. The statement is a good reminder regarding ideal tax system design. Here it is (GAO/GGD-95-157, page 13):

any change that would extend the reach of the tax system also would increase the extent to which the tax system would intrude into the public’s affairs and would need to be carefully considered. Thus, the bottom-line decision on whether to broaden the reach of the tax system to recover additional revenues due the government under current law would involve determining the right balance between (1) the acceptable level of compliance for each type of taxpayer and (2) the acceptable level of tax system intrusiveness to promote compliance."

I included this GAO observation when explaining the tax principle of "minimum tax gap" in the AICPA's Tax Policy Concept Statement on Guiding Principles of Good Tax Policy (2001).

I'm reminded of the GAO statement because of a recently released survey from the National Association for the Self-Employed. The survey looks at the increased compliance effort and cost for self-employed individuals due to the newly expanded information reporting rule requiring that 1099s be issued to corporations starting in 2012.

NASE reports that small business owners expect a 1250% increase in compliance work moving from about 2 filed 1099s to about 27. NASE also notes the costs from collecting the corporation's tax id number and if it is not provided, withholding taxes from payments. NASE observes that the new measure will require some small businesses to have to hire someone to handle the work for them.

NASE also points out that a bill has been introduced to repeal the expanded reporting - H.R. 5141 - Small Business Paperwork Mandate Elimination Act. This bill includes no revenue offsets so is unlikely to pass. The Joint Committee on Taxation estimated that the expanded 1099 filing requirement would generate about $17 billion over 10 years (JCX-17-10). I'm not surprised to see a bill to repeal the provision (and it has 87 co-sponsors as of June 21, 2010). With some of the health care provisions coming into effect in later years, there is plenty of time to call for repeal of some, but under PAYGO, that shouldn't happen unless the sponsor finds some way to replace the lost revenue.

Well, back to the compliance perspective of this post ... Will $17 billion really be raised by issuing 1099s to corporations? Are they really that non-compliant? Is there another way? What are the compliance costs of issuing the 1099s and the IRS processing them? Also, the bigger part of the tax gap stems from non-reporting of sole proprietors? Why is Congress ignoring this group? While it will be more difficult to reduce this tax gap, that doesn't mean Congress should not try. I refer to this as the "slow pace" of closing the tax gap (see August 2008 article).

So, does the expanded 1099 reporting requirement meet the proper balance of (1) improved compliance and (2) intrusiveness and cost of compliance? I think more information is needed. For example, which corporations will generate the $17 billion of revenue expected from this change? I doubt it is coming from publicly traded corporations or perhaps even those with audited financial statements. So, why not reduce the reporting?

What do you think?

Film Production Credits Go Too Far

There has been a fair amount of attention in the press on the variety of film production credits and grants that the majority of states offer to entice such work in their states. The attention hasn't all been positive though. In late 2009, the Wall Street Journal and others reported problems in Iowa where the incentives were used to purchase personal and lavish items - see "Build It With Tax Incentives and Hollywood Will Come" (10/19/09). The Governor temporarily stopped the program and in January 2010, the Governor's Tax Credit Review Panel recommended repeal of the state's two film project credits.

The National Conference on State Legislatures reports that 45 states offer some types of film production incentives (see list, 4/19/10). I encourage you to take a look at the list. Most of the incentives are quite generous. Michigan offers a refundable tax credit for up to 42% of the production costs!

Well, when states are contributing so much to the production of a film or commercial or other production, they just might also want to have a say in what is produced. This happened recently in Michigan. The New York Times reports that a movie was turned down as too horrific - "State Backing Films Says Cannibal Is Deal-Breaker" (6/14/10). Of course, it is really taxpayers funding these projects so perhaps film producers should be seeking public input in the states, or at least offering lots of bit parts or perhaps just free tickets (after all, the public shouldn't have to pay twice!)

These incentives violate several principles of good tax policy - simplicity, transparency, neutrality and economic efficiency. It seems like an odd thing for a state to incentive because the work is likely to be one-time. Why not reward businesses that are permanently setting up shop and creating a 21st century industry in the state? Or why not just offer a low tax rate and an incentive for hiring workers who live in the state?

What do you think?

Highway Trust Fund Problems Continue

I was quoted in a MinnPost article today about a long-standing problem that I've blogged on before (see 9/5/08 post). With people driving more fuel efficient cars, less gasoline excise tax is collected, yet the roads still require the same amount of maintenance.

In today's Minn Post article ("Oberstar points to road problem: a shortage of federal gas-tax revenue"), Derek Wallbank explains why there will be about a $140 billion deficiency in the highway trust fund (HTF) due to a decline in gas tax revenues. He also notes that the gas tax has not been increased since 1993.

"Because it is not adjusted for inflation, the federal gas tax has experienced a cumulative loss in purchasing power of 33 percent since 1993 — the last time the federal gas tax was increased."

Possible short-term solutions - other than continuing the new practice of shifting large amounts of money from the already trouble General Fund to the Highway Trust Fund ($8 billion was transferred in 9/08):

• Increases to the gasoline excise tax should be phased in over a period of years starting January 1, 2011 (delayed until at least then to help the struggling economy).
• When CAFE standards are increased or dates for meeting them moved up, there should be an accompanying increase in the gasoline excise tax. [info from DOT]
• Review the work undertaken by Oregon a while back to get ready for this new issue of more fuel efficient cars. Many people don't like the VMT approach - where you pay based on miles driven, because then we need some way to track our miles (which our odometer already does, but doesn't record it anywhere) and it would not necessarily encourage more fuel-efficient vehicle purchases. The National Surface Transportation Infrastructure Financing Commission also has studied alternatives. They issued a comprehensive report in February 2009, but it doesn't seem to have received a lot of attention. The GAO also issued a report (shorter) in June 2009. There was a hearing in the House Budget Committee on 3/17/09.
• Look into value pricing. Some people are willing to pay more than they currently do and we should take advantage of that. For example, allow people to pay a premium to drive in the carpool lane during certain times of the day. [info from DOT]

What do you think?

Oklahoma follows Colorado Approach to Increase Use Tax Compliance

On June 9, 2010, Oklahoma, following the lead of Colorado, enacted HB 2359 to require vendors that sell tangible personal property to Oklahomans and do not collect the Oklahoma sales tax to notify the customers that they may owe use tax. This new rule generally applies to vendors with total sales over a threshold amount to be set by the Oklahoma Tax Commission.

Links:

• State Legislature - search for HB 2359 to get text
• Colorado law - HB 10-1193
• Colorado Emergency Regulation 39-21-112.3.5
• Colorado Department of Revenue information

The Oklahoma Tax Commission is to create a Retailer Compliance Initiative to encourage non-present vendors to register to collect sales/use tax in Oklahoma.

The bill also provides: "D. When assisting taxpayers in preparing an individual income tax return, tax preparers shall advise their clients of their responsibility to remit use taxes through the use tax remittance line on the individual income tax return or by filing a consumer use tax return."

HB 2359 also creates an affiliate nexus provision.

California has a similar proposal - AB 2078. (Click here to search for this bill to obtain its status and analysis.)

Some question whether the Colorado requirement for non-present vendors to provide information to Colorado customers on invoices and to file an annual report with the customers and state are constitutional given that the vendors have no physical presence in Colorado. Physical presence is the nexus standard for sales tax per the 1992 US Supreme Court decision in Quill Corp. v. North Dakota, 504 U.S. 298. Is the standard less if there is no tax required to be collected? Under the Due Process clause, just making a market in Colorado may be enough for the state to be able to make a person subject to their laws. but, does the quantity of sales in the state matter? Perhaps. Here is language from Quill:

"here is no question that Quill has purposefully directed its activities at North Dakota residents, that the magnitude of those contacts are more than sufficient for due process purposes, and that the use tax is related to the benefits Quill receives from access to the State. We therefore agree with the North Dakota Supreme Court's conclusion that the Due Process Clause does not bar enforcement of that State's use tax against Quill."

How significant is "magnitude of those contacts?" What if a vendor with $100,000 or more of total sales, only has 3 out of 100 sales in Colorado and they are not large in dollar amount relative to other sales?

Perhaps in personam jurisdiction cases not involving tax issues are relevant. A 2008 9th Circuit case - Boschetto v. Hansing, found that a Californian who purchased a car on eBay from an individual in Wisconsin could not require the Wisconsin person to come to California for a lawsuit. The court did not find that a single transaction in the state does not mean that the defendant "purposefully availed themselves of the privilege of doing business in California."

Is that relevant to an information reporting requirement that invovles no tax and no travel (although it does potentially involve significant fines)? A court case on this would be helpful.

What about the US Commerce Clause? Will the Colorado requirement impede interstate commerce? There are significant penalties for failure to comply and there are costs to comply. Is it enough to reasonably lead some Internet vendors (including eBay sellers with $100,000 or more of annual sales) to say they will no longer sell to Colorado customers? Probably not, but I could be wrong.

Also, if copycat states enact the exact language of Colorado and work together to have the same reporting forms and due dates and perhaps even a third party vendor arrangement to assist sellers, the Commerce Clause issue seems to be diminished. But, I expect that someone will challenge the constitutionality of the provision - we'll see what happens and how many states follow the Colorado model, which should increase use tax compliance and certainly makes it easier for the state to know who has not complied with the obligation to self-report and pay use tax.

What do you think?

Creative Pennsylvania Tax Amnesty Ad

I accidentally came across this website today and it caught my attention:

http://www.pataxpayup.com/portal/server.pt/community/tax_amnesty_home/18967

In case the website is no longer live when you read this page ... The ad lets people know of a temporary amnesty period and has the catch phrase - "If you owe PA back taxes - we know who you are." A picture of some residential rooftops shows one with a message bubble - "Tim's Co. owes $3,211 in back taxes."

Well, that seems like an interesting use of technology for tax compliance. I wonder though how many people will see it. Hopefully the PA Department of Revenue also placed ads on popular websites as well.

Rhode Island Tax Reform

On June 9, 2010, Governor Carcieri signed a tax reform bill - H8196 Sub A & S2921. The governor described this as "legislation that overhauls the state’s personal income tax system, reduces taxes for most Rhode Islanders, simplifies the current tax system, and makes Rhode Island a more attractive state in which to live and do business."

The legislation reduced individual tax brackets from five to three and increases the standard deduction. The top rate goes from almost 10% to almost 6%. The goal seems to be simplification and making the state more attractive for business. The governor's press release includes a chart comparing the new RI system to what taxpayers would pay in nearby Massachusetts and Connecticut.

It seems that the genesis for the proposal was work of the governor's tax reform study group which issued a report in 2009 (see The Providence Journal, "R.I. tax-reform panel issues final report," 3/12/09. And various reasons for tax reform are laid out by the RI Department of Revenue in this presentation file - here.

So, reform is possible. It does not sound like a lot of simplification though because while many Rhode Islanders will claim the larger standard deduction rather than itemize, they are likely still itemizing for federal income tax purposes. Also, the number of tax brackets doesn't tie to simplification (unless is it just one bracket) because people use tax tables and tax preparation software to apply the tax brackets.

Hopefully, the state will track changes in business activity and start-ups in the state to see if the rate reduction did indeed encourage existing businesses to stay and expand and for new businesses to locate in Rhode Island.

The Tax Foundation states that it views the reform as moving Rhode Island's business climate from 7th worst state to 10th worst! (see 6/2/10 News Release).

Bernanke Reminds Us of Need for Fiscal Responsibility

In testimony before the House Committee on the Budget on June 9. 2010, Federal Reserve Chairman Ben Bernanke spoke about the state of the economy. Towards the end of his testimony, he stated:

"history makes clear that failure to achieve fiscal sustainability will, over time, sap the nation's economic vitality, reduce our living standards, and greatly increase the risk of economic and financial instability."

While he blamed the current economic crisis for reducing revenues and costs of economic stimulus for much of our current situation, he also noted that other factors are at play and will continue to keep our economy on an "unsustainable path."

"Among the primary forces putting upward pressure on the deficit is the aging of the U.S. population, as the number of persons expected to be working and paying taxes into various programs is rising more slowly than the number of persons projected to receive benefits. Notably, this year about 5 individuals are between the ages of 20 and 64 for each person aged 65 or older. By the time most of the baby boomers have retired in 2030, this ratio is projected to have declined to around 3. In addition, government expenditures on health care for both retirees and non-retirees have continued to rise rapidly as increases in the costs of care have exceeded increases in incomes. To avoid sharp, disruptive shifts in spending programs and tax policies in the future, and to retain the confidence of the public and the markets, we should be planning now how we will meet these looming budgetary challenges."

"Achieving long-term fiscal sustainability will be difficult. But unless we as a nation make a strong commitment to fiscal responsibility, in the longer run, we will have neither financial stability nor healthy economic growth."

That is all good advice, but what does it mean to make a "strong commitment to fiscal responsibility?"

My reading of the news and the reality of members of Congress bragging about the tremendous tax cuts they have enacted (without also reminding us of the negative effect on the deficit and debt) leads me to think that it will be hard for anyone in office to have a strong commitment to fiscal responsibility. People expect more and continued tax cuts - even of temporary tax cuts. And I don't read about anyone saying they want less government services or a smaller Social Security check or Medicare benefits.

People want tax cuts and continuation of temporary tax breaks AND it looks like the President and Congress want to provide them.

A Tax Notes article of May 3, 2010 (Letter to the Editor from two CPAs - Mary Anne Reilly and Martin B. Solomon) notes that more people seem to be paying less in taxes. They note an example of a hypothetical family of 5 in 2009 with earnings of $100,000 and tax deductions and credits that result in $0 income tax! This is a sign that something is wrong. A family with $100K of wages and no enormous casualty loss or medical expense, should pay something in income tax.

I'd like to see Congress enact a law that each federal government website must have financial data on it regarding revenues, expenses (in various categories) and the size of the debt. We should have better Paygo that really requires all tax cuts to be paid for. Congress should enact tax gap measures that help reduce the largest contributors to the tax gap. Congress should phase out unnecessary tax breaks such as interest deduction on a second home and on home equity debt, tax-free rental income on short-term residence rentals, reduce the exclusion for employer-provided health care and continue to look at others.

As I've noted before - we'll need some "tough love" from elected officials to help them enact the measures needed to exercise a strong commitment to fiscal responsibility.

What do you suggest?

Georgia Tax Reform Committee - HB 1405 enacted

Georgia lawmakers have created the 2010 Special Council on Tax Reform and Fairness. HB 1405 calls upon this special committee to study the state's tax laws and issue a report of its findings and recommendations by January 10, 2011. The legislation also creates the Special Joint Committee on Georgia Revenue Structure that will work in 2011 to introduce legislation comprised of the Council's recommendations.

The Special Council is comprised of these 11 members:

• 4 named economists from 4 universities
• Governor Sonny Perdue
• 2010 chairperson of the Georgia Chamber of Commerce
• 2010 Georgia chairperson of the National Federation of Independent Business
• 2 members appointed by the Lieutenant Governor
• 2 members appointed by the Speaker of the House

Per an article in the Atlanta Business Chronicle - "Tax reform will impact many Ga. businesses" (6/11/10), tax issues in Georgia include lack of accountability measures for various tax breaks, an out-dated tax base and volatility. According to HB 1405, it has been "many years" since there was a "systematic" review of Georgia's tax system.

Well, it can't hurt to find some way to review a tax system and find ways to improve it. The downside is that like so many tax study commissions, a report will be prepared that then sits on the shelf. It is good that HB 1405 includes a mechanism to be sure the recommendations get to the legislature in legislative format for discussion.

In 2008 when Governor Schwarzenegger and Assembly Speaker Bass announced a tax reform commission (the Commission on the 21st Century Economy), I wrote an op ed describing six factors that would likely increase the effectiveness of a tax study commission and its findings. I've listed them below and ranked the Georgia approach against them.

1. Serious commitment - MET - It is a good sign that the commission was created by the governor and legislature. Also, including a mechanism in the bill to require legislative attention to the recommendations is good. One missing element is a requirement for the legislature and governor to specifically state why they will not enact any particular recommendation offered by the commission (so the public knows and to ensure that there was discussion)
2. Able, willing and non-partisan commissioners - MOSTLY MET - It is good that there are four economics faculty participating. There are also two business leaders. Missing from the group and hopefully the remaining four appointees could include tax practitioners. Tax advisers know best where there are complications and oddities in the law and where taxpayers struggle, where they make decisions not to do business in Georgia (perhaps) due to tax issues, etc. Adding at least one tax professor from a graduate tax program or a law school would also be a good idea.
3. Principles and goals - NOT MET - HB 1405 is very general in what the commission is to do and how its work is to be accomplished. A reminder that they should be guided by the principles of good tax policy would be helpful. Also, what are the goals for the state? Are they aiming to attract high tech businesses? have a highly educated workforce? reduce poverty levels? what?
4. Reality - TO BE DETERMINED - Taxes must make sense for the system to be respected such that compliance is high. An approach that might make great economic sense but is too difficult to comply with won’t be a lasting change. Also, change can’t happen overnight so transition rules must be considered. The commission needs to consider how ways of doing business and how we live have changed since many of Georgia's tax laws were put in place. The laws of other states should also be considered given the mobility of capital and labor today and the reality that some business can be conducted remotely and virtually.
5. Time-saving background work - TO BE DETERMINED - There are numerous reports from other states, think tanks, business and government organizations, and academics that can help the commission with its work. Also look at the recent tax commission work in Minnesota and California and what happened and why to see where lessons can be learned.
6. Public education - NOT ADDRESSED - Concurrent work is needed by the legislature and tax agencies to help the public understand current tax problems and their direct and indirect effects on their lives and the state. This will help ensure that the commission’s recommendations get the careful consideration they’ll need in order for tax system modernization to become a reality.

Full text of my article: "A Tax Commission for California? How It Can Be Made to Work," California Progress Report, 7/27/08.

We'll see what happens.

Plastic or Canvas? Tax Or Ban? California AB 1998

AB 1998 would, with some exceptions, prohibit certain stores from providing single-use bags to customers, after 2011. The goal is to reduce both paper and plastic bag usage and get people using reusable bags.

Erik Assadourian of The Worldwatch Institute has an op-ed which raises a good question - "To Ban or to Tax: That is the Only Question" (6/9/10).

I think it would be better to impose a tax on disposable bags. The benefits of that approach include:

• California needs the money.
• Consumers can decide if they want to pay for a bag or use a reusable one.
• An enforcement mechanism is not needed because the bag tax could be collected along with sales tax and bottle/can deposits that these sellers already collect.
• It would mean fewer plastic bags many of which become litter. In addition they do use up natural resources to produce.

The op ed notes that DC's 5 cent per bag tax which started in 2010 has reduced the use of plastic bags from 22.5 million/month to 3 million/month. That is impressive.

While some might argue that it is not the role of the government to address how customers haul their goods home, that is not true. The government incurs a great deal of the cost of cleaning up plastic bags and disposing of them in landfills. Also, because they do use up natural resources to produce, we all should have a say in protecting these resources.

A polluter pays tax is an appropriate solution. And, the revenue can be used not only to help reduce the state's budget deficit, but to reduce some other tax, such as the sales tax.

But, a structural problem in California is likely what is preventing AB 1998 from taking the better approach of imposing a tax on disposable bags. That challenge is the 2/3 vote requirement to create or increase a tax. So, the best solution is ignored - too bad for the state budget and consumers.

What do you think?

Call for Papers on Pennsylvania Tax Reform

The Fall 2010 issue of the Pittsburgh Tax Review will be a special symposium issue on Pennsylvania tax reform. The Review is currently soliciting papers for the issue.

Details:

• They invite submissions from faculty, judges, and practitioners.
• "Papers should explore aspects of the Pennsylvania state and/or local tax systems and suggest potential reforms or improvements."
• "Submissions should be typed and double-spaced (except for indented quotations). All citations should conform to The Bluebook: A Uniform System of Citation (18th ed.2005)."
• "Though manuscripts of all lengths will be considered, the suggested length for submissions is 15-25 pages, and all manuscripts should be accompanied by a 200-word abstract."
• "Authors must also submit a resume or curriculum vitae that includes their contact information.
• Deadline is August 27, 2010.
• Papers maybe submitted electronically to taxrev@pitt.edu or through the Expresso online submission service (http.lllaw.bepress.com/expresso). Papers may also be submitted in hard copy to:
  Editor-in-Chief
  Pittsburgh Tax Review
  University of Pittsburgh School of Law
  Barco Law Building
  3900 Forbes Avenue
  Pittsburgh, PA 15260

Maine voters reject tax change enacted by legislators

The June 8 ballot in Maine included this question: "Do you want to reject the new law that lowers Maine's income tax and replaces that revenue by making changes to the sales tax?" The majority of voters said "yes" so the new law will not go into effect.

An article posted on The Maine Public Broadcasting Network website (6/9/10) includes comments from some voters on their views on the measure. One concern was whether there was really a tax reduction from the combination of income tax rate reduction and broadening of the sales tax base. That is a good question. Reducing the top income tax rate sounds like a tax reduction for high income individuals. In contrast, broadening the sales tax, without a rate reduction, sounds like a tax increase for everyone with the burden heavier for low income taxpayers as the greater sales tax represents a larger percentage of their income relative to a higher income taxpayer.

Is the Maine approach the best technique for making tax law changes? Taxes are complicated and it is not easy to get the full picture of how a broad reform plan will work. Of course, that is why we elect representatives to the legislature - so they can get the information needed and propose appropriate reforms. I think it was a difficult measure for voters to consider. Perhaps town hall meetings would have worked better where details of the state's tax and spending could be explained, where weaknesses exist in the tax system based on principles of good tax policy and how various reforms would work.

What do you think?

Increasing attention on tax exenditures (and interesting, but good, irony in HR 4213)

I've seen a few articles and reports lately on the need to examine, reduce, and bring greater attention to a form of government spending that doesn't show up in budgets - tax expenditures.

(1) A 5/25/10 article in the LA Times - "Oil companies have a rich history of U.S. subsidies" doesn't offer lots of details, but reminds readers that the government (that is - us) subsidize a lot of oil company drilling and exploration through direct spending and favorable tax breaks.

(2) The Center for American Progress issued a very good report in April - Audit the Tax Code - Doing What Works for Tax Expenditures. It points out that direct government spending which we can see as line items in some government agency's annual budget and spending hidden in the tax system (via tax deductions, credits and exemptions) achieve the same purpose. However, the tax expenditures are hidden. They do not get annual review and can easily grow and do grow. The author notes:

"The cost of tax expenditure programs has skyrocketed over the last two decades. Last year, spending through tax expenditures totaled over $1 trillion—significantly more than all nondefense discretionary spending. This year, tax expenditures will make up nearly 25 percent of total government spending."

(3) Bruce Bartlett's Forbes article (5/10) - see blog post here.

(4) On June 9, 2010, the CA Senate Revenue & Taxation Committee will consider two bills related to tax expenditures:
(a) AB 2564 - this bill just moves up the date that the California Dept. of Finance is to release its annual report on tax expenditures - from 9/15 to 2/1 and to provide it directly to any legislator who requests it. This is a great idea as it better enables the information to be useful when lawmakers are finalizing the state budget. I'd like to see the bill go further and require that the report be given to all lawmakers, issued in press releases, a YouTube video made summarizing it, and a presentation on it be made to both houses of the legislature.
(b) S.B.X.6. No. 19 - is designed to bring greater transparency to just a few tax expenditures. The bill would "require the Franchise Tax Board to annually compile specified information relating to a corporation receiving credits of $20,000 or more, allowed from corporate tax expenditures, as provided. The bill would require the board to include the information in the California Income Tax Expenditure Report and on the state transparency Internet Web site." This is a start in increasing transparency, but is too limited and may cause some people reading the information to think that only corporations get tax breaks when most are directed to individuals. It would be better to publicize all tax expenditures, breaking them down by type of taxpayer (individual or corporation) and by income category (or for corporations, asset size).

(5) H.R. 4213 - the American Jobs and Closing Tax Loopholes Act of 2010 includes a little publicized provision which states:

"Findings- Congress finds the following:
(1) Currently, the aggregate cost of Federal tax expenditures rivals, or even exceeds, the amount of total Federal discretionary spending.
(2) Given the escalating public debt, a critical examination of this use of taxpayer dollars is essential.
(3) Additionally, tax expenditures can complicate the Internal Revenue Code of 1986 for taxpayers and complicate tax administration for the Internal Revenue Service.
(4) To facilitate a better understanding of tax expenditures in the future, it is constructive for legislation extending these provisions to include a study of such provisions."

Well, good for Congress! It is about time they make such findings. Of course, it is telling and ironic that the above statement appears in a bill extending numerous tax expenditures that for the most part have not been reviewed and without discussion as to whether they are needed or whether we can afford them!

The report required would be more detailed than what the Joint Committee on Taxation is currently required to submit. I encourage you to take a look at the details in Section 272 of H.R. 4213.

As I've noted a few times in articles and this blog, additional problems with tax expenditures:

• When lawmakers look for spending cuts to address budget shortfalls, tax expenditures are typically ignored despite their significant size and the reality that many are not needed (such as deductions for interest on a debt on a second home or a home equity debt).
• When elected officials, impose spending freezes, they don't apply to tax expenditures, which makes the freeze somewhat pointless, as noted in the quote above from the Center for American Progress.

Let's see if anything comes of the new attention and even legislative effort to more closely examine tax expenditures. They are growing out of control and state and federal budget sanity depends on bringing them into a bright spotlight and under control. And public education is needed so that taxpayers see and understand the government spending directed to them via tax breaks (i.e., subsidies).

Comments?

Exemptions that are too broad

An article in The Atlanta Journal-Constitution on June 2 - "Tax breaks for seniors: Can counties afford them?" caught my attention. The tax break at issue is not uncommon and exists in California. The exemption is for property taxes and is available to seniors. In California and other states, the assessment that seniors are able to avoid are extra property tax assessments to help fund local schools. One way these voter approved assessments can garner more votes is by including an exemption which allows seniors to apply for an exemption from the new tax so they don't have to pay it (even if they voted for the new tax). A property owner only needs to be a certain age and file the paperwork to get the exemption. Even if the senior is wealthy, he gets the exemption. (Another example in California of an exemption that is too broad is the senior exemption for state income taxes which is based on age rather than income level.)

The Atlanta article notes the high cost to the government of such exemptions: "In Cobb County, where the school system faces a $126.7 million deficit, there have been rumblings of re-evaluating the county’s lenient school tax exemption, which provides a full exemption for all homeowners age 62 and above and costs the county more than $50 million a year. "

Wow! That's a lot of money that would certainly benefit the schools. And, if all taxpayers were subject to the tax equally, the tax could be lower.

Exemptions based solely on age are the wrong way to go. Decades ago, many seniors were in poverty status, but that is not true for most today. So, broadly assuming that all seniors need a tax break is just wrong, and a foolish way to design a tax system.

When exemptions are too broad, several principles of good tax policy are violated, most notably - equity and fairness.

Another issue with the property tax exemption for seniors, when the tax comes into existence via voter approval: Is it right to treat a tax as enacted if some of the people voting for it then file forms to waive application of the tax to themselves? Seems like filing of the application could be viewed as, in effect, really being a "no" vote. In California, that question requires a review of "Prop 218."

Comments?

California Reconsidering Optional Single Sales Factor

On May 26, 2010, the Legislative Analyst's Office released, Reconsidering the Optional Single Sales Factor. It describes the February 2009 legislative change included as part of the budget agreement to allow multistate businesses to decide between (1) the current apportionment factors (double weighted sales and single weighted property and payroll) and (2) sales only apportionment starting in 2011. Some legislators are not pleased with the 2009 change finding it gives too much leeway to businesses in choosing and is too costly.

The LAO report concludes that apportionment formulas with greater weight on sales "promotes job growth to some extent." It also points out that with other states also placing more weight on the sales factor, California is almost forced to have to do the same to be competitive. Finally, the LAO states that "allowing firms to choose their formula every year arbitrarily favors some firms over others." The LAO recommends that any apportionment change be delayed for two years due to the current $20 billion budget shortfall (page 12).

This short report is also interesting in these aspects:

1. Its definition of income tax nexus - on page 6 - ""Nexus" (Basically, physical presence) in the state." This is the nexus definition for sales tax, not income tax. Public Law 86-272 governs income tax nexus for sales of tangible personal property. Under this law, a physical location in a state will create nexus, but a physical presence of sales staff who have no corporate office in the state and only solicit sales for orders that are approved and filled from outside of the state, does not create nexus. Many states today apply an economic nexus standard when PL 86-272 does not apply (such as for sales of intangibles or services). Even California has adopted a factor presence standard where starting in 2011, a non-present company with over $500,000 of sales in California will be considered to be "doing business" for income tax purposes (R&T Section 23101).
2. There is no mention of Public Law 86-272 in the report. An entity only needs to apply a state's apportionment factors if it has nexus in the state (is doing business in the state). This seems important in understanding who is subject to the single sales factor option that starts in 2011 - which is also when the broader nexus standard of Sec. 23101 applies (see above) for entities that do more than sell tangible personal property. I think the LAO's conclusions and comparisons of how apportionment formulas operate given varying levels of property, payroll and sales in different states is still fine (and assumes that the entities have nexus in the states), it just seems that more should have been devoted to how the new apportionment formula operates along with the revised Sec. 23101 when it will be harder for some non-present entities to avoid income tax nexus in the state (such as because they have over $500,000 of sales into California).

The topic is also interesting from various policy perspectives. Generally, the reason why a business should pay income taxes in a state is because it is using state services. That is most likely when the business has property and payroll in the state. But, a sales only apportionment scheme, is really more of an economic development approach where in-state businesses are encouraged to put all of their property and payroll in the state and make lots of sales outside of the state to keep their California income tax low. The property and payroll in the state should result in greater tax collections compared to if these factors were located outside of California.

For more pros and cons on the single sales factor approach:

• Con - California Budget Project - To Have and Have Not (6/09) which points out that the biggest benefit of the single sales factor option will benefit a small number of very large companies.
• Pro - The Business Council of New York

A list of the apportionment formulas used in the states can be found at the website of the Federation of Tax Administrators.

What do you think the legislators should do -

• Delay the effective date of the elective single sales factor option?
• Repeal the single sales factor option?
• Require a particular approach rather than give businesses an option of which to use?
• Add an accountability measure of some sort to use single sales factor, such as having so many jobs in California per some revenue amount generated (such as 10 California jobs per $500,000 of sales anywhere)?
• Something else?