"Richest" tax expenditures

A CNNMoney.com article of April 26, 2011 by Jeanne Sahadi, has the title "America's Richest Tax Breaks." This caught my attention in that I was thinking it would be about tax deductions, exclusions and credits (and lower capital gains tax rate) claimed by high income individuals. But the article is about the most "expensive" tax expenditures, which the articles states are:

• Health care and insurance at $132 billion/year (not counting payroll taxes; this figure represents the income tax "cost")



• Retirement savings at $103 billion/year



• Mortgage interest at $97 billion/year



• Capital gains/dividends (15% or lower rate) at $81 billion/year



• Earned Income Tax Credit at $54 billion/year

The article notes that the above five represent 42% of all tax expenditures out of the $1.1 trillion we have heard mentioned by President Obama's Deficit Commission and others. As I have noted before, the bulk of the $1.1 trillion is attributable to the individual income tax, not the corporate income tax (see 2/11/11 post and article linked there).

The CNNMoney article does a good job of describing these expenditures in terms of why they exist, who benefits and suggestions for reform. The article also notes that there will be need for bipartisan work to reduce or eliminate many of these tax expenditures for tax reform purposes. Per the author:

"if lawmakers are serious about overhauling the code in a way that substantially reduces rates, they'll have to address the biggest and most beloved tax breaks."

So, back to the word "richest" - appropriate? The 5 tax expenditures focused on in the article are a mix of types:

• exclusion


• deduction


• special rate structure


• refundable credit

Other than the EITC, these special rules provide the highest benefit to individuals in a high tax bracket. For example, a $10,000 mortgage interest deduction represents a tax savings of $3,500 for someone in the 35% tax rate, but only $2,000 to someone in a 20% bracket. The lower rate for capital gains and qualified dividends also mostly benefits high income individuals who would otherwise have a 20% or 35% rate respectively, for these items. The benefit is mostly to this group because they have more capital gains and dividends than other individuals. So, "richest" should have really been "largest."

I think it is good to see the topic of "tax expenditures" getting attention in the popular press rather than only in documents that tax practitioners and economists read. If the majority of voters realize that they don't use many of these tax expenditures, but help pay for them by not getting some tax benefit (such as a lower rate or larger standard deduction) that could benefit more people if the special rule were not in place, I think more people would be speaking for reform.

And, fewer tax expenditures also means the tax law is simpler and more neutral (not affecting decision-making).

What do you think?

California AB 509, EITC and Notice of Refund

The Assembly Revenue & Taxation Committee will discuss AB 509 at its May 2, 2011 hearing. AB 509 would require state agencies to do the same as is required of other employers - to notify workers that they may be eligible for the federal Earned Income Tax Credit (EITC), a refundable credit available to low-income workers. (See EDD information about this employer requirement - here.)

This is a good idea - if other employers are required to do it, why not California employers as well? Also, not everyone entitled to the EITC claims it. Per a memo from CA Board of Equalization member Betty Yee, the IRS estimates that 20% 20 25% of eligible individuals fail to claim the EITC. I'd guess this is due to the fact that the individual is below the filing threshold and does not know about the EITC and that they must file to get it. Or perhaps some people who prepare their own return don't look up the instructions when they get to the EITC line or some preparers overlook it. Here are ten reasons suggested by Hawaii Tax Help as to why some people fail to claim the EITC.

One more item overlooked (based on my anecdotal evidence of talking to students) is the need to file a return to get your overpaid tax withholding back. For example, a student told me recently (not an MST student) that she asked someone if her income level required that she file. That person (not sure if it was a paid preparer) looked it up on the IRS website and said no without asking her if she had wage withholding. She was quite puzzled when I told her she needed to file if she wanted to get her federal income tax withholding back that she had overpaid. I'm guessing this is not an unusual occurrence.

So, why not modify California law, as part of AB 509, to required all employers to not only provide the information (such as on the worker's pay stub) about the EITC, but also of the need to file to have overpaid federal and state income tax withholding refunded? The worker can be referred to the IRS interactive website that asks lots of questions to determine if there is any reason you should file including just to get your withholding refunded (here). Even better information for workers would be to give them one URL where they can go to determine if they need to file federal and California returns, or refer them to a VITA site to help them, and why they should take these actions.

What do you think?

NY Tax Law Defines "Sandwich"

I have blogged about this before - oddities of state sales tax rule definitions of what is taxable and what is not. For example, certain "toasted sandwiches" in California are taxable (3/10/10 post). On April 13, 2011, the New York Dept. of Taxation and Finance issued Tax Bulletin ST-835 that defines "sandwich" - a taxable item in New York.

In case you are wondering, per the State of New York ...

"Sandwiches include cold and hot sandwiches of every kind that are prepared and ready to be eaten, whether made on bread, on bagels, on rolls, in pitas, in wraps, or otherwise, and regardless of the filling or number of layers. A sandwich can be as simple as a buttered bagel or roll, or as elaborate as a six-foot, toasted submarine sandwich."

The bulletin then lists many examples of sandwiches including peanut butter and jelly (I assume also taxable without the jelly) and burritos.

This might seem odd, but clearly, there must have been some issue of what is a sandwich for this bulletin to be issued. I still have questions though. What does "otherwise" in the above definition mean? Does it include something wrapped in seaweed and rice (otherwise known as sushi)? What about if you order your sandwich without the bread?

This all just illustrates the complexity of having exemptions and special rules in a tax system. They require definitions which then lead to questions like I pose above. The remedy is to tax everything with a lower rate. And to provide relief to low-income taxpayers in a different way (such as a refundable income tax credit). Another remedy regarding sales tax and food would be to exempt very broad categories. For example, exempt all food as defined as anything you eat that goes through your digestive system.

What do you think?

Launch by SJSU MST Students of The Contemporary Tax Journal

I am very pleased to announce that the San Jose State University MST Program has launched a student-run, online tax journal. The Contemporary Tax Journal can be found here:

http://www.sjsumstjournal.com

It includes pieces by MST students on current developments, summaries of the TEI-SJSU Annual High Tech Tax Institute, and tax policy analysis on tax proposals. There is also a section for articles and we are seeking articles on current issues from practitioners, academics and graduate students. Please see the submissions policy on the website above. Articles will be blind, peer reviewed.

While the journal will be published twice per year, students will update the website at least monthly. New tax policy analysis - analysis of existing rules and proposals using principles of good tax policy will be posted and archived monthly at the site.

I hope you will take a look! Thank you.

Proposal for Greater Taxing Authority for California Counties

California SB 653 proposed to give counties greater leeway over the types of taxes they can impose, subject to any required voter approval (such as required by Prop 218). The introduction to this bill states that it would:

"authorize the board of supervisors of any county or city and county, subject to specified constitutional and voter approval requirements, to levy, increase, or extend a local personal income tax, a transactions and use tax , vehicle license fee, and excise tax, including, but not limited to, an alcoholic beverages tax, a cigarette and tobacco products tax, a sweetened beverage tax, and an oil severance tax, as provided . This bill would require the State Board of Equalization, the Franchise Tax Board, or the Department of Motor Vehicles to perform various functions incident to the administration and operation of a local tax if the county or city and county contracts with the state agency to perform those functions."

My observations:

• As evidenced by recent tax rate increases in a few cities that had to be voted in with a majority vote of voters in the jurisdiction (see 4/9/11 post), some voters want tax increases to help local budgets.


• The bill gives local governments more tax options. Today's options are limited - a sales tax rate increase (state controls the base), a parcel tax (flat amount regardless of parcel size) or a new or increased utility user tax.


• With more taxing options for the local government, creation of new taxes by multiple counties will make the law more complex for businesses due to new taxes that are not similar across counties.


• For some of these taxes, such as on sugar beverages, there will be a tax gap because for many taxpayers, it is too easy to go to the neighboring county and buy the item. It will be difficult for the county to get these taxpayers to self assess the beverage tax for such purchases.


• Rather than a county income tax, why doesn't California share part of its income tax with local governments to better match up the goals of the state and local jurisdictions.

What do you think?

Taxes and Car Insurance - Taxes in Our Daily Life

Someone recently pointed out to me this very short article - "5 Ways Taxes Affect Your Car Insurance." One notes that a tax lien can affect your insurance cost. Another way isn't really a tax, but is a good example of how the word sometimes gets used too broadly. The reference is to a "fraud tax." This isn't collected by the government, so it is not a tax, but refers to an increase in auto insurance costs for everyone due to fraudulent claims filed by others.

And one way is a reminder, relevant to today's discussions about tax rates and reform, that prices of goods include some portion of the taxes paid by the seller or service provider.

Similar articles could cover ways taxes affect your vacation, your grocery bill (even in a state that doesn't impose sales tax on food), and your utility bills. Other ideas?

Modernizing the California Tax System

An NBC Bay Area Editorial of April 15, 2011 - "Revamping our Revenue Model - Bringing California's Tax System Up to Date" by Suzanne Shaw does a nice job getting right to the point about a few weaknesses in California's tax system.

She notes that the sales tax base is out of date with the new economy. That means an eroding tax base and is part of the reason for the budget problem. We have a consumption tax (the sales tax) that isn't taxing many types of personal consumption including high end consumption like personal services and digital downloads.

Thanks to Suzanne Shaw and NBC for highlighting the issues (and the links in the editorial to some of my reports on the topic). I think more people need to look into the current tax and budget situation and ask serious questions of elected officials on changes that will help the budget and the economy.

What do you think?

"Reduce spending in the tax code"

Last week (April 13, 2011), President Obama said, in his budget/fiscal policy plan speech, that one thing he wants to do is "reduce spending in the tax code, so-called tax expenditures. ... the tax code is also loaded up with spending on things like itemized deductions. And while I agree with the goals of many of these deductions, from homeownership to charitable giving, we can’t ignore the fact that they provide millionaires an average tax break of $75,000 but do nothing for the typical middle-class family that doesn’t itemize. So my budget calls for limiting itemized deductions for the wealthiest 2 percent of Americans -- a reform that would reduce the deficit by $320 billion over 10 years."

That line - "reduce spending in the tax code" was confusing to many. John Stewart puzzled over it, saying it was "code" for tax hike (4/14/11 on YouTube).

I'm not surprised - it does sound odd to think that there is spending in the tax code, but as I've posted here several times (such as 10/16/10 and 3/29/11), that is what special deductions, exclusions and credits that are not necessary for measuring taxable income, are. Instead of the government giving individuals a grant for home ownership, for example, you get a deduction which lowers your tax bill. What is odd about the "spending in the tax code" is that it doesn't work the same way a government grant would. A government grant would likely give more money to people with lower inocme. In contrast, a tax deduction gives more money to people with higher incomes (the higher tax bracket makes the deduction worth more to them).

And, when it comes to itemized deductions, only 1/3 of individuals itemize so 2/3 don't claim those deductions (medical, state taxes, charitable contributions, mortgage interest). They take the standard deduction instead.

President Obama has not talked about removing any itemized deductions or modifying any of them. Instead, he has proposed limiting their benefit to 28%. That still provides a significant benefit to high income taxpayers. He has not talked about other tax expenditures (outside of itemized deductions). I think serious tax reform to simplify and rationalize the system will require reducing the number of deductions, credits and exclusions - and lowering the tax rate. Generating funds to lower the deficit should also consider the spending in the tax code that doesn't need to be there.

What do you think?

New White House Taxpayer Receipt and Its Limitations

The White House has created a website to enable individuals to enter their 2010 Social Security, Medicare and federal income taxes to get a receipt as to what it paid for (you can see it - and use it, at the bottom of this blog page). This is helpful to give individuals (who know about it) a sense of direct spending in the federal budget. The California Franchise Tax Board also has a taxpayer receipt - here. I calculated receipts for a single taxpayer - Jane, with $50,000 of wages and $500 of interest income. Jane's taxes are as follows:

• Social Security $3,100


• Medicare $725


• Federal income tax (after Making Work Pay Credit of $400) $6,075


• California income tax $2,080


• California use tax $13 (Jane is a compliant taxpayer! She also paid lots of sales tax.)

Jane's federal tax receipt shows (with my commentary):

• Social Security $3,100 (this should be $6,200 to include what Jane's employer paid which otherwise would most likely have been extra wages for Jane)


• Medicare $725 (this should be $1,450 for same reason as above)


• Defense $1,598 (the largest amount other than Social Security)


• Health Care $1,477


• Job & Family Security $1,331


• Education & Jobs $293


• Veteran Benefits $250


• Natural Resources, Energy, Environment $128


• International Affairs $103


• Science, Space, Tech $73


• Immigration and related $122


• Agriculture $50


• Community Development $30


• Natural Disaster Response $24


• Other $146


• Net interest expense $450 (perhaps instead of giving Jane a Making Work Pay Credit of $400, that should have been used to pay down the debt)

Jane's California taxpayer receipt for $2,080 of state income tax shows:

WHAT'S MISSING? Plenty! (and see my prior post- 10/14/10)

• What is Jane's total federal income tax? The White House tells Jane to pull the number from line 55 of Form 1040. But that is before her tax credits. Since the tax credits are not included in the spending amounts (most likely), she should pull her line 55 amount and subtract credits from it to get her federal tax paid (Jane got the Making Work Pay Credit in 2010). In fact, the Form 1040 should be re-ordered to make it obvious what her net federal tax liability is or have a line at the very end to show this. That would result in greater transparency (and we also know that many people think what they owe on April 15 or get as a refund is their actual federal income tax).


• Jane also paid some portion of the federal and California (and other state) corporate income tax.


• As noted above, the payroll taxes Jane's employer paid should be attributed to her since without them, her wages would have been higher.


• Jane likely also paid about $1,000 of sales tax.


• Jane also paid various federal and state excise taxes and various local taxes such as a utility user tax.


• The expenditure amounts above are not accurate because of spending that is in the tax rules (special deductions, exclusions and credits) that don't show up in the agency budgets. For example, for 2010, the Joint Committee on Taxation estimates that higher education related tax expenditures were $18 billion (JCS-3-10, pages 44-45). Jane did not claim any of these benefits, but through higher taxes, she in effect, paid them. That is, without these tax provisions, her overall tax bill could have been lower.


• What is Jane's share of the national debt? About $46,000! ($14.2 trillion debt/311 million people in the US)


• What is Jane's average federal income tax rate? 12% This information, along with her marginal tax rate (next), may be useful to Jane as she listens to tax reform debates. Her average CA income tax rate is 4%.


• What is Jane's marginal federal income tax rate? 25%


• What would her receipt look like if federal spending percentages of five and ten years ago had been used? Data is most useful when compared to something.


• What were average federal tax bills in different income quintiles? Again, data is most useful when compared to something.

What do you think? What additional information do you think Jane should have?

Reviewing the sales tax checklist

One certainty in tax practice is that sales-tax rules are never constant. Issues come up because of new types of transactions (such as cloud computing and software-as-a-service), modifications to transactions and law changes. I have an article in the AICPA Tax Insider this week - Do You Know What Is Now Subject to Sales Tax? that covers some updates.

I tried my best to make this all practical by offering how these updates are relevant to a sales tax compliance checklist. I hope you find it useful (it doesn't ask all necessary sales tax compliance questions, it just suggests ones related to some recent developments).

It is important to be compliant for sales tax because past due liabilities, interest and penalties can pile up in multiple states. And, if a taxpayer's compliance system isn't adequate, resulting in liabilities, and the vendor is subject to SEC rules, the SEC might impose a penalty. Read on ...

Hudson Highland Group was assessed a $200,000 penalty. Sanctions were brought for failure to “maintain appropriate internal controls and books and records relating to its sales tax liabilities.” A unit failed to consistently collect sales tax from customers and remit them to the taxing authorities. The problem was due to lack of adequate and proper software to calculate sales tax owed. Hudson hired a third party, but that did not relieve the company of liability. Hudson was found to have violated Section 13(b)(2)(B) of the Exchange Act – having improper internal controls such that records did not properly reflect tax liabilities.

Testimony before House Ways & Means Committee

On April 13, 2011, I had the opportunity to represent the AICPA in testifying before the House Ways & Means Committee on the "Tax Code’s Burdens on Individuals and Families Demonstrate the Need for Comprehensive Tax Reform." I chair the AICPA Individual Income Taxation Technical Resource Panel so got the honors to testify, which I do view as an honor.

Here are some stories on the hearing and testimony:

• AICPA


• Journal of Accountancy (4/14/11)


• Bloomberg


• Accounting Today (4/14/11)


• Accounting Today (4/15/11)


• American Banking & Market News

Since at least the 1980s, the AICPA has been focused on reducing the complexity of the tax laws. We have offered suggestions for reform, as well as principles for simplicity (see links in the 4/13/11 AICPA written testimony - here and the AICPA Tax Reform website). So, it was a nice opportunity to share current ideas of the AICPA Tax Section on how to simplify the tax law. Many thanks to the AICPA Washington DC personnel, particularly Melissa Labant, who drafted the written testimony.

Why do we have this complicated system? Here are some of my suggestions.

Why is the tax law complicated?

In trying, for my own benefit (and a future article), to identify the reasons for complexity, I come up with these:

• Too many provisions. There are multiple tax relief measures with similar purposes. For example, family measures (head-of-household filing status, dependent deduction, child care credit, child credit, EITC), education, retirement, mileage rates, depreciation, and more.


• Using the tax law to remedy all problems. For example, subsidizing higher education costs for families and individuals, encouraging green behavior, and much more. Adding new provisions without removing any old provisions.


• Trying to make the law more progressive or less regressive without changing the tax rate or tax rate structure. For example, phase-outs, partially refundable credits for some individuals (such as child credit and Amercian Opportunity Tax Credit).


• Using the same word but with different meanings. For example, phase-out, modified adjusted gross income (a term used for most phase-out rules, but not always defined the same way), child, small, and others.


• Ignoring existing rules. For example, odd due date rule for FBAR (June 30), creating a child credit rather than increasing the dependent deduction, and more.


• Overly complicated approaches to prevent possible abuses. Examples – kiddie tax, AMT, among others.


• Desire for accuracy. For example – not excluding small amounts of cancellation of debt income, the "kiddie tax" calculation, and others.


• Having two parallel tax systems. We have both a regular tax system and the AMT, rather than reducing or cutting back the number of tax deductions, exemptions and credits. (Please see my December 2007 op ed in the Business Journal for why the AMT should be repealed.)


• Budget related problems. For example, temporary provisions that are continually renewed because to make them permanent costs too much in a ten-year budget projection and a single bill that needs to be revenue neutral (more spending cuts or tax increases would be needed in the bill to make the provisions permanent).

What do you think?

President Obama and Deficit Related Tax Reform

In his speech on April 13, 2011, President Obama included tax reform in his plan to reduce the deficit. Per the White House fact sheet, the president is "setting a goal of reducing our deficit by $4 trillion in 12 years or less."

The tax reform plan is explained as follows: "The President is calling on Congress to undertake comprehensive tax reform that produces a system which is fairer, has fewer loopholes, less complexity, and is not rigged in favor of those who can afford lawyers and accountants to game it.

"He believes we cannot afford to make our deficit problem worse by extending the Bush tax cuts for the wealthiest Americans.

"He also supports efforts to build on the Fiscal Commission’s goal of reducing tax expenditures so that there is enough savings to both lower rates and lower the deficit. Reform should be designed to ask more of those who can afford it while protecting the middle class and promoting economic growth.

"In addition, as he explained in the State of the Union, the President is continuing his effort to reform our outdated corporate tax code to enhance our economic competitiveness and encourage investment in the United States. By eliminating loopholes, reducing distortions and leveling the playing field in our corporate tax code, we can use the savings to lower the corporate tax rate for the first time in 25 years without adding to the deficit."

A January 2011 CBO report on the budget shows the deficit as $1.4 trillion for 2011. In 2013, assuming tax cuts are allowed to expire at the end of 2012, the deficit is $704 billion. Here is the CBO chart:

The deficit will be higher if any of the 2001/2003 tax cuts are extended (I understand that some will believe it will be lower because tax cuts will generate new revenue - see a later post on this one). So, it is always a good idea to look at the fine print for any deficit or revenues table for 2013 and beyond - is it based on current law (tax cuts expire at end of 2012) or is there an assumption that any or all are extended.

Back to the president's tax reform. What does he propose to reduce in terms of tax expenditures? The co-chairs of the Deficit Commission proposed removing all of them (final report, page 29)! President Obama's revenue proposals for FY 2012 include extending and creating some tax expenditures (in addition to cutting some, such as the Section 199 manufacturing deduction and some oil and gas incentives).

What will he cut for the group of taxpayers that get the bulk of the benefit from tax expenditures - individuals? (See 2/11/11 post.) I think he'll need to cut more than indicated in his FY2012 revenue proposals to achieve any serious reduction in the deficit and debt.

What tax reforms would you propose to reduce the deficit?

IRS Data for 2009 for Individuals

The IRS recently released some preliminary data for 2009 individual tax returns. I haven't had time to analyze all of it or crunch numbers, but with a quick review, this looks interesting:

• 140.5 million individual tax returns were filed


• 60% were 1040, 28% were 1040A and 12% were 1040EZ


• 83% of returns report salaries and wages


• 41% reported taxable interest income


• 21% reported qualified dividend income


• 7% claimed student loan interest deduction


• 1.7% claimed the tuition deduction (likely low because they also likely qualify for an education credit and claim that instead)


• 7.6% claimed an education credit (up 37.2% from 2008, likely because the temporary American Opportunity Tax Credit covers four years of college while the Hope credit which it temporarily replaces only covered two years)


• 17% claimed the child credit

This data can help in identifying provisions that perhaps are not needed, such as the tuition deduction. The Hope and Lifetime Learning Credits cover a lot of education, perhaps it is just not worthwhile to provide a deduction claimed by very few who do not qualify for either of the credits.

The data also shows the number of returns and dollar amounts for various income levels which can also help identify if any special rules are skewed to any one particular income group.

The data is just figures. Since there is no requirement to gather data on whether the purpose behind various tax incentives is being met. That would be interesting and helpful in evaluating provisions - an accountability analysis. For many provisions, the goals would need to be better articulated so an accountability measure could be designed.

More later.

IRS Commissioner Shulman and 21st Century Compliance

In a speech to the National Press Club on April 6, 2011, IRS Commissioner Shulman laid out the basics of a plan to improve compliance, audit efficiency and make use of an approach already available from banks and investment firms. He proposed "a potential new structure of tax administration … a structure of opportunity …and a fundamentally different way to run our tax system.

"In essence, I believe taxpayers, third parties in the tax system, and the government would be better served if we moved our processes forward and reduced the need for after-the-fact look-backs as a mode of operation.

"The vision is relatively straightforward. The IRS would get all information returns from third parties (W2s, 1099s, etc) before individual taxpayers filed their returns. Taxpayers or their professional return preparers could then access that information, via the Web, and download it into their returns, using commercial tax software. Taxpayers would then add any self-reported and supplemental information to their returns, and file the returns with us. We would embed this core third-party information into our pre-screening filters, and would immediately reject any return that did not match up with our records. That’s right; we reject the return and ask you to fix it before we process it. We would then have more accurate returns and deal with many more problems up-front. We could shift resources to spend more money getting it right in the first place, and do less back-end auditing."

He noted that today, some people get a notice from the IRS months and years after they have filed their return noting a missing information return. The taxpayer then owes tax, interest and likely a penalty as well. Shulman wants to reorder the processing to let taxpayers know before they file their return, what information returns the IRS has received for them.

I think this makes a lot of sense, is a good use of technology and should reduce compliance costs for individuals. Simplification of the income tax could enable the IRS to actually send a completed return for many individuals. If, for example, the dependency exemption, child credit and other family provisions were consolidated to one deduction or credit, the IRS could use W-4 data to input that. Based on family size and income level, the IRS could calculate an EITC for eligible taxpayers.

Shulman also states: "What I’m offering is a vision for a journey that’s firmly grounded in reality but brims with potential." ... "And this is all about working smarter… a theme of mine too since I became Commissioner. In the case of the IRS, it means evolving to keep pace with change, constantly looking ahead, and being innovative and more imaginative with available resources inside and outside the agency."

Sounds good to me - our tax system was designed in an era of paper and pencil, carbon copies and the abacus. It is past time to move it into the Internet era - doing the same thing that private industry has done to be more efficient and provide better information and service to customers.

What do you think?

Sales Tax Rate Increases in Some California Cities

The California Board of Equalization points out that effective April 1, 2011, the sales tax rate increases in 13 cities where voters approved them. That makes the rate 10.25% in a few cities including Union City, El Cerrito and Santa Monica. That's a high rate!

Certainly, the cities need the money and voters wanted to continue services that otherwise might have been cut. The problem is that local governments do not control the base of the sales tax. That is controlled by the state legislature. A rate increase most likely could have been avoided by broadening and modernizing the sales tax base. This could be done by including more types of consumption - entertainment, personal services and digital downloads purchased by consumers (not businesses). I think this would also make the sales tax more equitable because a lot of the currently exempt consumption is consumed in larger quantities and dollar amounts by higher income individuals who can afford such items.

For more - please click here.

What do you think?

Media, the public, election year - obstacles to a lower corporate tax rate?

I was surprised to learn yesterday while making a presentation about the basics of taxes to a general education financial literacy class at SJSU that several students had read or heard the news that GE had paid no taxes. More students knew of that than had ever heard of a use tax!

I think this is interesting in terms of what it might mean for Congressional efforts to lower the corporate tax rate - how will that play in the popular press and among the taxpaying public? Certainly, any rate reduction needs to be done before the individual tax rate cuts expire at the end of 2012. And it likely needs to be done with attention also drawn to the tax breaks corporations will give up for the rate reduction. It might also have to be done with promise of rate cuts for individuals. Will members of Congress and President Obama be leery of how a corporate rate reduction will play in the press during the upcoming election year? What is needed for corporate tax reform to occur?

I was quoted recently in a story (3/29/11) in Emirates 24/7 News. The writer who interviewed me said it was about corporate tax reform, but the headline turned out to be - "GE 'zero' US tax furor reignites calls for reform" - clearly taking advantage of the attention that news would get. I note in the article that if Congress hears from corporations that they do not want to give up any tax credits, deductions, exemptions or other special rules, Congress likely will move on to other reforms. And, President Obama has already noted that reform must be revenue neutral. What do you think?

Enterprise zones and the role of the tax system

I saw an interesting article in the Daily News (San Fernando Valley) - "Local entrepreneurs thrive in enterprise zones" by Dana Bartholomew (3/26/11). I'll admit that what first came to mind is - well, if you are going to get tax credits and exemptions, won't that make it easier to "thrive"?

The article notes that "benefits to companies include a $37,440 tax credit for each worker hired, sales tax credits for new machinery, a 35 percent cut in city utility rates, reduced requirements for parking." How do you measure whether you have a going business with such subsidies? But ... many businesses (and individuals) get tax subsidies of some sort (percentage depletion, manufacturing deduction, various credits, and more). Generous ones for businesses can mask whether the business is truly a going concern. But how much does the subsidy have to be to get to that point? Certainly, a negative tax rate should call into question whether the business is viable and whether the government outlay could be more productive elsewhere. These can certainly be difficult issues to resolve.

The purpose of enterprise zones should be to encourage businesses to invest in areas where buildings may need major improvements and the workforce may need training. That sounds like a win for the state that would otherwise end up spending money to make improvements. If the state can help businesses to improve the area, should be a win for everyone. But how much subsidy should the business get? Should the state instead use the money directly for training centers and hiring people in the area to improve the area and start their own businesses?

Also, as noted in the article, some enterprise zones include affluent areas, such as the Warner Center area in Woodland Hills. That seems odd.

The article also quoted an accountant "who specializes in enterprise zones." Yes, this area of the tax law, like others, has generated a practice area! This accountant noted that "four out of seven failing clients in recent years [were] saved by zone tax incentives, many by filing amended returns." Well, claiming this tax incentive on an amended return points to a problem - how can you have a retroactive incentive? If the reason for the amended return was that the business only learned after the fact that it could claim tax breaks, then the tax breaks are not what led the business to invest. In such a case, the tax breaks just reward for something they were going to do anyway.

What about this approach:

• removal of special tax breaks


• lowering of tax rates


• infrastructure spending to improve areas with low business activity

Principles of good tax policy, particularly, simplicity, certainty, neutrality and economic growth and efficiency, are better met by a tax with a broad base and low rate.

Of course, part of the problem in California now is that the talk is about removing tax breaks but not lowering the rate because we are trying to resolve a budget shortfall. I'm not convinced that the shortfall is due to special tax breaks alone, but also to an outdated tax system (such as the sales tax). But, can the state do more than piecemeal reforms in a time of budget crisis?

What do you think?

Millionaires and the Income Tax

Two recent stories are interesting as they relate to tax system design issues. How progressive should an income tax be? How does the distribution of income play into this? These questions come up in discussions about what to do with the expiring federal tax rate reductions, whether high state income tax rates drive out millionaires, and how a rate structure affects stability/volatility of the tax system.

An article in the March 26 Wall Street Journal - "The Price of Taxing the Rich" by Robert Frank, includes a description of a California tax problem and the person who used to work for the Legislative Analyst's Office who highlighted it - Brad Williams. He observed that the California personal income tax was volatile because of the nature of the income derived by the high income individuals who were paying most of the tax.

Per the article: "By the late 1990s, Mr. Williams realized that his job had changed. California's future was no longer tied to the broader economy, but to a small group of ultra-earners. To predict the state's revenue, he had to start forecasting the fortunes of the rich. That meant forecasting the performance of stocks—specifically, a handful of high-tech stocks."

Back in the time of the hearings of the Commission on the 21st Century Economy (COTCE), several people commented that it was ok that California's income tax was volatile because it was just tracking the economy. I don't agree with that. I think the structure - with so much collected by a small number of very high income individuals, is too unstable making it difficult for elected officials to balance the budget. Also, the incomes of high income individuals could go down for reasons that do not necessarily mean that California's expenses will decrease.

One solution is to bring more people into the income tax paying system. California did this by lowering the dependency exemption by about 75%. This likely was not the best approach given the weak economy - making low and middle income families pay more income tax. But it happened with what seems to me to be little attention or concern by the larger public.

Another solution would be for a portion of income tax collected to go into a Rainy Day Fund.

Another solution would be to broaden the base of the sales tax to bring in personal services, entertainment and digital items, much of which is consumed tax-free today by higher income individuals. I have written about these topics before - here.

Well, back to the recent articles. The WSJ article notes that some people advocate a flatter rate structure to reduce the volatility of a personal income tax, while others say that is just a tax cut for high income and a tax increase for lower income. That seems obvious. But, can some of the volatility be reduced and a regressive tax reduced by broadening the sales tax base, lowering the sales tax rate and flattening some of the personal income tax, such as what California partly did when it reduced the dependency exemption amounts? It would be interesting to see an analysis of this.

Another design consideration is how progressive the rate structure should be? President Obama has been using $200,000 (single) and $250,000 (married) as the amounts that distinguish the wealthy who don't warrant tax cuts and others who warrant tax cuts. He has also acknowledged that this means that 98% of individuals warrant tax cuts. Within the 2% wealthy group, there is wide disparity of income. An individual making $200,000 is able to live well in any US city and pay taxes. But compared to someone making $1,000,000 or more, these individuals are in much different lifestyles yet could have the same marginal tax rate. Of course, if the higher income individual has mostly capital gain income, at the federal level, that today has a 15% rate rather than a 35% rate on ordinary income.

I'd like to see discussion of whether an income tax rate structure should not lump all of the 2% into the same rate structure, but provide some progressive rates within this group.

Another point that often arises at the state level of taxing the rich is that they will leave the state. That brings up the second recent article on taxing millionaires. This one is from the Huffington Post - "The Millionaire Migration Myth: Don't Fall for This Anti-Tax Scare Tactic" by Carl Davis (3/31/11). The author, a senior analyst with the Institute on Taxation and Economic Policy, notes that this is a myth. He states that often data on decline in millionaires is not that they left the state, but that their income dropped.

He states: "once you scratch the surface of the millionaire migration issue, it becomes abundantly clear that the anti-tax side's claims have no substance. It's long past time to stop letting the millionaire migration myth get in the way of progressive tax reform."

But, myth or not, taxing that group is no reason alone to tax them more. This all needs to be considered within the context of the entire tax structure - whether federal or state. If we look solely at the state income tax and decide to generate revenue by increasing the income tax rate on the highest earners, we miss the opportunity to consider the entire structure and how it all can best meet principles of good tax policy. For example, in California to continue to ignore the very regressive sales tax (with its very high rate and narrow base that exempts a lot of consumption of high income individuals) is a problem. At the federal level to ignore a debate on capital gains rate structure and the Social Security tax (which is the biggest tax expense for many individuals) and focus only on the ordinary income tax rates, misses an opportunity to look at the entire tax structure.

There is a lot to learn from looking at the distribution and range of income levels, what taxes these income groups pay and how improvements can be made to address regressivity, increase equity and not harm economic growth.

What do you think?

State tax revenues up, but budget and tax system problems remain

The US Census Bureau reported on March 29 that state tax collections were up in the fourth quarter, other than property taxes. A March 30 Wall Street Journal article - "State Tax Revenues Snap Back" by Dougherty, notes that states still face problems due to ending of federal stimulus dollars and growing pension and health care costs. And some of the tax law changes made to balance state budgets have not been pretty - suspension of NOLs, changes in estimated tax due dates, increase taxes on low and middle income taxpayers (California did each of these), nexus grabs, and rate increases. Modernizing tax systems and ensuring that they meet principles of good tax policy have not been focal points although various state tax commissions have noted these needs. How did the increase occur given drop in consumer spending and drops in income? Will this lead states to start considering improvements to their tax systems rather than continued desperate changes to balance budgets? What do you think?