Stop Studying and Act!

I have a brief post about the release of the PERAB tax reform group's report, but forgot to tie it to comments I submitted via a collection of comments assembled by Tax Analysts. One of my suggestions (#5 - see below) was to stop studying and act! But, it was ignored. :-(

[my prior post with link to the White House report - here]

My 2009 recommendation #5 to the panel:
"5. Stop studying and act. Our tax system has been the subject of many studies by government agencies, academics, think tanks, and federal tax reform commissions. Many of those reports describe weaknesses of the federal tax system and offer proposals for improvement. The reports address complexity, the tax gap, depreciation, penalties, global competitiveness, corporate integration, worker classification, and more. The most comprehensive and objective of them should be reviewed and used by the task force. Rather than continually studying the tax system, it is time to improve it." [click here to see my other four recommendations]

Renewed Focus on Worker Classification

Whether a worker is an employee or independent contractor is a longstanding question. The answer results in vastly different tax consequences for both the worker and employer. For example, a contractor reports his/her earnings on Schedule C and gets full, above-the-line deduction for expenses incurred in generating that income. In contrast, an employee's unreimbursed work expenses are miscellaneous itemized deductions subject to the 2% of AGI floor. For a contractor, the employer owes no payroll taxes (no FICA or FUTA) and the worker pays self-employment tax (and has not unemployment insurance unless purchased on his/her own).

Congress has mostly ignored getting better guidance out on how to classify workers. President Obama has a proposal in his FY 2011 tax plan. Also, his middle-class task force has noted the issue and how misclassification of a worker as a contractor poses problems for the worker.

I've got a short article on the topic in the 8/26/10 AICPA Corporate Taxation Insider - here.

I believe there is a possible remedy. After all, the key end result from a tax perspective is that the government wants to be sure that all payroll and income taxes are properly paid by the employer and worker. Part of the solution would be to allow employees a better deduction for their work-related expenses that are not reimbursed by the employer. Also, better systems for tracking independent contractors to improve their tax compliance would help. I've been working on a paper on this which I put on the shelf for a while, but think I'll dust off and take another look at it.

Worker classification will become a bigger deal as some of the health care legislative changes come into effect because employers need to provide certain coverage to employees, but not to contractors. Also, if we ever do have a VAT added to our Federal tax system, the determination is more relevant because wages are taxable while payments to contractors are not.

What do you think would be a remedy to the classification question?

Report from Obama's Tax Reform Panel

The report that was supposed to be issued in December 2009 by President Obama's Tax Reform Panel was released today - here (+ White House information). This 126 page report does not include recommendations but instead in an analysis of a variety of proposals that have been made by various groups in the past with a brief explanation of advantages and disadvantages of each. So, really nothing new. Several of the proposals have been offered by others for some time, such as consolidate education incentives. The AICPA has been suggesting that for years.

The charge of this panel was to address three areas: "simplifying the tax system, improving taxpayer compliance with existing tax laws, and reforming the corporate tax system."

I'll have more later as I read through all 126 pages.

What do you think of the report? Any surprises?

The Bagel Tax

A few stories have been published this week about New York enforcing it sales tax on certain types of food. The food of focus - bagels. When is a bagel subject to sales tax? The answer is that if it is sliced, it is taxable, and if not sliced it is not taxable. The rationale seems to be that if sliced, it is like taxable restaurant food and if not sliced, it is non-taxable food. But, it all sounds "wacky" - see Forbes article, "Wacky Sales Tax Rules Cover More Than New York Bagels," by Janet Novack (8/25/10). Also see Wall Street Journal, "Sliced Bagels, Taxes on Top," by Jacob Gershman, 8/24/10.

Complexities and oddities easily arise when something is going to be excluded from tax or taxed differently. When a subset of items or activities is exempted, it becomes crucial to define what is taxed and what is not and that is not always an easy thing to do. It would generally be better to not have any exemptions, such as by taxing all food, and then providing relief to low income taxpayers with a refundable income tax credit.

What do you think?

Do 97% of Individuals Warrant the Same Tax Cut?

A recent Rasmussen survey asked people what income category they thought they belonged to ("The Working Poor" 8/14/10). The responses:

16% - working poor
65% - middle class
15% - upper middle class
4% - wealthy

Talk of extending the 2001-2003 tax cuts for lower income individuals covers about 97% of individuals (those with income below $250,000 if married and below$200,000 if not married). That's fairly close to the survey finding that 4% consider themselves wealthy. But why lump the other 97% all together for a tax cut? Why not target cuts more equitably? A married couple making over $80,000 is doing fairly well in this country. Why restore all of their 2001-2003 tax cut?

We need to reduce our deficit and giving continued tax cuts to high income individuals? Where is the talk of the fact that President Obama's $200,000 and $250,000 income levels are very high?

What do you think?

Accountant Traits and Abnormal Passion for the Tax Law?

Something different today - in light of the start of the academic year in a few days and I know that many readers of this blog are accountants. Someone shared this blog post with me - "10 Ways to Know You Were Born to Be an Accountant." I'm not convinced about (1) nothing really bores you. While you do have to have a high tolerance for repetition and fine details, being an accountant offers a wide range of places to work and with constant change in accounting and tax rules and businesses changing and growing, there is usually lots of new things to deal with. Sometimes students overlook #8 - but accountants do have to have strong soft skills.

Is anything missing? Is passion for the tax law abnormal?

Do you remember the pre-2001 tax cut rules?

While it seems most people think that many of the 2001/2003 tax cuts that expire in a few months (at the end of 2010) will be renewed, it hasn't happened yet. And even though the cuts affecting about 96% of individuals (those making under $250K if married or $200K if not married) are excepted from the PAYGO rules (so don't need an offsetting tax increase or spending cut to be renewed), it hasn't happened yet.

So, I ask the question - how well do you remember what the law looked like before the tax cuts - the law that all comes back into effect on January 1, 2011 (pending any renewal)?

I've got a short article in the AICPA Tax Insider for 8/12/10 with a 12-question quiz - give it a try! Click here.

California Budget Plan and Tax Switch

The San Francisco Chronicle has an article today on the Democrats' budget plan with a significant tax change - "Experts praise state Dems' tax plan" (8/12/10). The plan includes increasing the personal income tax rate for all except the highest bracket and the vehicle license fee (VLF), and reducing the state sales tax rate from 6% to 3.5% (ignoring the local sales tax).

It sounds interesting. Our sales tax rate - almost 10% is too high and impedes consumption and business development in the state. But our personal income tax rate is also already high and we rely on this tax for about 50% of state revenues already.

I know it is difficult to make any good tax changes in times of budget crisis, but I would like to see an effort to start expanding the sales tax base to include more types of personal consumption - particularly that of high income individuals (entertainment, personal services and digital goods). The revenue can be used to reduce the sales tax rate and provide exemptions for businesses (such as for manufacturing and R&D equipment). The broadened base would make the sales tax more equitable, help local governments (who must rely on the state to define their sales tax base), and make the state more welcoming to businesses.

Also, a higher gasoline excise tax would be a good idea given the greenhouse gas emission reduction targets the state has.

I've got a few reports and short articles on California tax reform - here.

What do you think?

Process and Policy

Tax policy or tax system design should also consider the application and effects of process of enacting laws and administration of the laws. We've had some odd process things going on in 2010 that affect a few principles of tax policy including simplicity and equity.

What caught my attention on this is an August 6 press release from the Senate Finance Committee - "Committee Republicans Reiterate Call for Mark-up of Expiring Tax Relief." At first I thought they were talking about the 73 provisions that expired at the end of 2009 - many of which a majority of Congress wants to renew, such as the research tax credit. But, they are talking about some of the 2001/2003 tax cuts that they want to extend by the end of this year (after 7 years of knowing they were temporary). The announcements includes this statement of why action now is needed: "to bring some certainty of continued tax relief in a struggling economy."

What about the certainty that could have been used earlier this year or even the end of 2009 on the provisions that expired at the end of 2009 including the AMT patch?

While many people believe that many of the expired provisions and the AMT patch would be extended in 2010, the fact that they have not been means that taxpayers cannot consider them in calculating estimated tax payments and businesses cannot consider them in their income tax provisions on their financial statements. When they do get extended, taxpayers find they have paid too much estimated taxes - money they could have used for other purposes during 2010.

What is also puzzling is that the PAYGO legislation passed in February 2010 basically gave a free ride to the AMT patch and many of the 2001/2003 tax cuts that apply to those making under $250,000 (or $200,000 if not married). So Congress hasn't been delayed because of the challenge of finding ways to pay for the AMT patch and many of the expiring 2001/2003 tax cuts. So why the delay? Why the added complexity with respect to delaying the 2010 AMT patch?

[For a nice overview of the PAYGO legislation enacted in February 2010, see this White House/OMB website - here.]

For the provisions that expired at the end of 2009, it is past time to determine which should permanently expire and which should be extended or even made permanent. And, given the delay, Congress really needs to consider any extension as not to December 2010, but to December 2011 at a minimum so they don't have taxpayers rightfully asking in January 2011 what will happen to the provisions that expired at 12/31/10.

Here, it is not only the tax system design (such as flaws with the AMT itself), but also the process that is causing complexity and some inequities.

Troubling and odd.

Carbon tax recommended to President's Deficit Commission

At least one person has suggested to President Obama's Deficit Commission that a carbon tax be enacted to both reduce the deficit and debt and to reduce carbon emissions.

Gilbert E. Metcalf, Professor of Economics at Tufts University, submitted a 6-page proposal that provides a clear and concise rationale for the suggestion. Some of the additional advantages Dr. Metcalf sees with a carbon tax is that it would eliminate the need for creating tax incentives to promote renewable energy and it could prevent the need for "inefficient" regulation of carbon emissions.

He suggests that that a carbon tax start "in 2015 at $30 per ton CO2e and
growing at an annual rate of 5 percent plus inflation."

A summary and link to his paper can be found here.

What do you think?

Chartiable contribution deduction - improving tax system equity

The federal income tax is loaded with special deductions, credits and exclusions that typically violate several principles of good tax policy. For example, allowing a mortgage interest deduction on debt up to $1.1 million - far beyond the median home price, and allowing a deduction for interest on a second home as well as on up to $100,000 of home equity borrowing, provide significant tax reductions to mostly higher income individuals. This rule violates the equity principle. For example, if two individuals each have $90,000 of income and one owns a home and the other does not, the homeowner can borrow against his home equity and deduct it, but the other individual borrowing on a credit card cannot deduct that interest. Also, since these benefits are deductions, they are worth more to those in higher brackets than to those in lower brackets.

The mortgage interest example also points out where government spending can be reduced to help balance the budget. Stop subsidizing interest on expensive homes, vacation homes and home equity loans. But that is another topic - back to equity and charitable contributions.

Another area where greater equity and fairness can be achieved is with charitable contributions. Like the home mortgage deduction, these contributions are worth more for higher income individuals than for those in a lower bracket. That means a greater subsidy to the higher income individual who arguably needs is less. For example, two people donate $100 to charity. Jane is in the 35% bracket and Tom is in the 15% tax bracket. Jane saves $35 on her taxes from the contribution (so is out of pocket $65) while Tom only saves $15 (he is out of pocket $85 to make the same contribution). A tax credit would be better in providing the same subsidy to all donors.

I see at the TaxProf blog (8/6/10) there is an upcoming law review article that looks at the positive and negative externalities of charitable contributions and questions why all get the same tax treatment. The article by Shannon Weeks McCormack entitled "Taking the Good With the Bad: Recognizing the Negative Externalities Created By Charities and Their Implications for the Charitable Deduction" will be in the Arizona Law Review (see SSRN abstract).

I also recall reading in a New America Foundation book, I believe it was The Radical Center by Ted Halstead and Michael Lind, that the charitable contribution deduction should be reformed so that a deduction to the opera or symphony is not worth as much as a donation to a homeless shelter. I think these are good points, along with why donations to some groups, such as some well-endowed universities and foundations are worth as much as for struggling organizations trying to help the needy. Has someone truly made a charitable contribution if the donee is just going to put the funds in their big bank account?

Hopefully reform of the income tax will happen soon so it can better meet the principles of good tax policy, particularly simplicity, equity, neutrality and minimum tax gap. Part of the process will undoubtedly require reduction or elimination of some tax breaks as a way to lower rates (or keep them from rising) and make the system simpler. There are possible improvements to most tax breaks, including charitable contributions.

What do you think?

More sales tax holidays - back to school in Oklahoma

I found a press release on the Oklahoma Senate website touting a great savings opportunity - a sales tax holiday this weekend (August 6 - 8) on clothes and shoes valued at less than $100 per item. It is touted as a back to school program, but is not limited to purchases for school children.

Per one FAQ from the Oklahoma Tax Commission, accessories and athletic clothing are not covered by the holiday. Yet, another FAQ lists athletic uniforms as an example of exempt clothing. That FAQ also lists wedding apparel, costumes and diapers (adult and children) as examples of exempt clothing! The exemption covers both the state and local sales tax. (For more information, see 8/3/10 press release from Senate and FAQs from the Oklahoma Tax Commission).

Per the Senate press release:
“Every year, more and more people have taken advantage of this great program not only helping their pocketbooks, but giving the state a much-needed economic boost,” said Barrington, R-Lawton. “We’re just now beginning to see signs that our state may be recovering from the nationwide economic crisis. Many are still out of work or struggling to make ends meet, and this will provide them an opportunity to provide clothing for their children.”

According to a nice tool at the Oklahoma Tax Commission, which gives you the sales tax rate by zip code or city name, the combined state and local sales tax rate in Oklahoma City, for example, is 8.375% (that's fairly high).

I think that if we didn't hear statements like the one in the press release and applied our own critical thinking to such ideas as a sales tax holiday, citizens would demand better of their elected officials. Here are some of the problems with a sales tax holiday:

• It provides a benefit to many taxpayers who don't need it leaving fewer funds to provide benefits to those who need assistance. The people described in the Senate press release as out-of-work and struggling to make ends meet, likely need more than an 8.375% break to get clothes and shoes for their kids. They may not be able to take advantage of the holiday because they can't afford the price even without the sales tax. Meanwhile, people who can easily afford expensive clothes and shoes will get a tax savings as long as each item is under $100. That tax savings should instead be used to benefit those who need it. The state could provide discount coupons or free items to those in need.
• If relief is needed from a high rate, why not improve the system by broadening the base and lowering the rate. There may be exemptions for some consumption (such as for food, personal services, utilities and digital items) that can be eliminated to allow for a lower rate. Relief from added regressivity can be provided through a refundable income tax credit.
• It provides an incentive where one is likely not needed. How many people are buying clothes and shoes they don't need just because they can save the 8.375% sales tax? If you and your kids need clothes and shoes, you'll likely buy them anyway. So the incentive is encouraging a lot of behavior that would have occurred anyway, with a revenue loss to the state.
• Special exemptions are often confusing. As noted above, even the state provided FAQs explaining the holiday seem to be in conflict regarding athletic clothing. (I think it might be saying that a football uniform is tax-free, but not the helmet - which seems odd, I think the government and its citizens would benefit from making helmets more affordable!)
• It creates complexity for businesses in tracking and documenting the eligible sales.

Despite the flaws of sales tax holidays, various forms exist in over 15 states. The Federation of Tax Administrators (FTA), maintains a list of them - here.

In my list of "tax oddities," sales tax holidays fit right in - here.