CA Revenue & Taxation Committee holding hearing at SJSU on 12/5/11

The California Assembly Revenue & Taxation Committee is holding a hearing on the San Jose State University campus on Monday, December 5, 2011. Details:

REVENUE AND TAXATION
PEREA, Chair
9:30 a.m. to 12:30 p.m. - San Jose State University
Student Union, Second Floor - Music
One Washington Square
San Jose

CALIFORNIA'S HIGH TECH SECTOR: PROMOTING JOB CREATION AND INNOVATION
THROUGH SOUND TAX POLICY

The agenda:

1) Introductory Remarks by Henry T. Perea, Chair (3 minutes)

2) Introductory Remarks by Tim Donnelly, Vice-Chair (3 minutes)

3) Tax Policy, Job Creation and Innovation: Perspectives from the Industry
(45 minutes)

a) Corey C. Owens, Associate Manager of Public Policy, Facebook

b) Jim Hawley, Senior Vice President & General Counsel, TechNet

c) Jon Haveman, Chief Economist, Bay Area Council Economic Institute

d) Gail Maderis, President & CEO, BayBio

4) Tax Policy, Job Creation and Innovation: Perspectives from Tax Experts
(60 minutes)

a) James Nachbaur, Economist, Legislative Analyst's Office

b) Robert D. Atkinson, President, Information Technology and Innovation Foundation

c) Dan Berglund, President & CEO, State Science & Technology Institute

d) Robert S. Chirinko, Professor of Finance, University of Illinois at Chicago

e) Annette Nellen, Professor of Accounting and Finance, San Jose State University

5) Public-Private Partnerships (60 minutes)

a) Mohammad H. Qayoumi, President, San José State University

b) Carol Mimura, Assistant Vice Chancellor for Intellectual Property & Industry Research Alliances (IPIRA), University of California, Berkeley

c) Elizabeth Seifel, President, Seifel Consulting, Inc.

d) Kim Walesh, Director of Economic Development, City of San José

6) Public Comments (15 minutes)

7) Chair's Closing Remarks

I'm glad to hear the part about promoting "sound tax policy" - that's always good. How much should the tax law be used as a tool to try to promote job creation and innovation? Well, it should at least not be structured to hinder job creation and innovation. I'll be testifying on how tax policy should be considered in tax design. One point I like to make is that the taxing jurisdiction's economic, societal and environmental goals should be known and the tax law should not work counter to such goals. For example, in 2009, California adopted single sales factor apportionment which is generally good for in-state businesses, but at about the same time, increased the sales tax rate which hurts in-state companies buying equipment.

Well, back to drafting testimony!

Public Understanding of the Tax Structure

As he promised when he campaigned, Governor Brown should be calling for a vote before the end of June 2011 so the public can weigh in whether there should be a tax increase. In California, the temporary .25% increase in rates expired at the end of 2010 and the sales tax increase expires mid-2011. Continuing these is unlikely to be sufficient to balance the budget so there will be spending cuts and perhaps a look for other revenue sources, such as a oil severance tax. Governor Brown has also mentioned eliminating enterprise zone tax provisions and redevelopment agencies.

California's tax system is quite complicated. Can the public adequately determine whether taxes should be increased and if so, how? As I like to note - California's tax problems can't be solved with rate increases, the problems are in the base (see here). I like Dan Walters' op ed in the San Jose Mercury News on Thursday February 3 - "Public's tax ignorance a big hurdle for Brown." He offers a few examples of the low understanding of the fiscal picture. For example, a survey by the Public Policy Institute of California found that while most voters believe they have substantial knowledge of state and local government finances, only 16% knew that K-12 was the largest state expenditure.

How can one single person truly understand the amazing intricacies of California's fiscal system? Most people likely just view it as paying income, sales and property taxes. How many know they also pay a variety of excise taxes and vehicle taxes? How much of the corporate tax is passed through to them? Where do their property tax dollars go? How much of the sales tax goes to the local jurisdictions? How many know that there are 471 cities, 58 counties and over 3,000 special districts? How many people can trace tax dollars after the subventions, triple flips and backfills are taken care of? What is ERAF?

Michael Coleman, expert on local finances, with lots of information on his website to explain the odd route tax dollars flow to get to their ultimate use and the effect of the many propositions and laws that created this maze. Take a look at his presentation from January 2011 with Paul Navazio, Assistant City Manager, City of Davis - Financial Management 101: Financial Management and City Revenues.

So, what should the voters be asked? What public awareness campaigns should take place before then to give voters some chance of understanding the fiscal structures in California as well as principles of good tax policy so they can figure out where problem areas are?

What do you think?

Who will fix California's tax weaknesses?

In a May 20, 2010 article in the San Francisco Chronicle - "Candidates' plans to solve $19 billion deficit," none of the three candidates (Brown, Poizner or Whitman) makes any mention of tax reform. The solutions include cutting 40,000 jobs (Whitman), cutting spending and hiring freezes (Poizner) and public forums (Brown). As noted in the article, none of these measures is completely feasible or realistic to solve the deficit problem.

The deficit problem has many causes and I'll just focus on structural tax system problems which I've been writing about for some time now. The weaknesses include:

1. An out-dated sales tax system that only applies to tangible personal property (and not even all of it). For some time now, our personal consumption of taxable tangible personal property has declined while our consumption of non-taxable services, entertainment and digital items has increased. Thus, we don't tax the same amount of consumption as we did years ago and the situation continues to worsen with new ways of doing business and living (such as buying digital music rather than on a taxable CD). We need to modernize our sales tax system while also reducing the very high rate and transitioning away from imposing the sales tax on businesses.
2. We need to transition out various deductions, exemptions and credits of our personal income tax that do not serve a valid purpose or are outdated. For example, there is no reason for California spending to include the cost of subsidizing individuals with interest on a second home, a mortgage greater than $500,000 or home equity debt. There is no reason to give all seniors a tax exemption regardless of income level.
3. The gasoline excise tax should be increased and different funding model pursued. To meet the state's greenhouse gas emission reduction targets, we all need to be incentivized to buy less gasoline. And with cars getting higher mileage per gallon, we buy less gas so there is less gas tax revenue to maintain roads.
4. We might as well have an oil severance tax. Oil companies are used to them because most other states impose them and the purpose ties to our ambitious GHG emission reduction targets and brings in needed revenue.
5. We should reinstate the vehicle license fee that Governor Schwarzenegger reduced when he came into office. The tax is progressive in effect because the tax is higher for higher cost cars. The tax is easily administrable because it is based on the year and model of the car and assessed on the annual vehicle registration form.
6. We need to review the application of Prop 13 property valuation rules as applied to businesses. The current valuation approach favors older businesses over newer ones and encourages companies to engage in buy-sell arrangements that avoid ownership changes as defined under the law.

I've got a short paper on California weaknesses - here, and papers on most of the topics I've noted above. The papers provide background on the issue, possible solutions and evaluates those solutions against the principles of good tax policy - here.

The longer politicians and elected state officials ignore the need to improve and modernize our tax system, the worse the problems will get and the harder they might be to fix.

What do you think?

Info Hearings Held on Recommendations of 21st Century Economy Commission

On October 8 & 9, 2009, the CA Assembly Revenue & Taxation Committee held informational hearings on the final report approved by 9 of the 14 members of the CA Commission on the 21st Century Economy (COTCE). Several commissioners, including those who did not vote for the report, testified (see agendas). There was also testimony from some public interest groups.

I don't see that any transcript has been posted anywhere yet, but here are some links to observations of people or groups that are listed on the hearing agenda.

• California Budget Project - here - this group does not favor the plan, calling it "fatally flawed" and finding that it shifts too much of the current tax burden from higher income individuals to low and middle income individuals. This group notes that the Business Net Receipts Tax (BNRT) will be paid directly by businesses that can deduct it in calculating their federal income tax, but the higher prices paid by consumers does not produce a deductible tax. Of course, today's sales tax does not produce a tax deduction for California consumers and neither does any of the corporate income tax passed along to consumers. The only taxes individuals can deduct on their federal return are state income taxes (unless they chose to instead deduct sales tax and for those in AMT, neither tax is deductible) and property taxes. There is some interesting data and observations in the CBP presentation.
• California Tax Reform Association - here - I don't know if this is the exact testimony delivered on 10/8/09, but it is an earlier statement voicing opposition to the COTCE report. The concern is disproportionate tax relief to high income individuals. Concern is also expressed over many uncertainties of the operation and effect of the BNRT. There is a statement that the BNRT falls disproportionately on rental housing. I'm not sure of that. Certainly, rental income is subject to the BNRT and expenses paid to other businesses are deductible. Perhaps it is that there are not many expenses paid to other businesses. I haven't read through the many pages of statutory language for the BNRT, but fixed assets purchased by the landlord should be fully deductible when purchased which would reduce the BNRT.
• California Chamber of Commerce - here - they expressed concern the day after the release of the COTCE report. “We must not rush into replacing our 70-year-old tax system with an unproven experiment that may fail to deliver the promised results."

Some observations:

• While there is statutory language (lots of it) for enactment of the BNRT, it would be nice to see more explanatory language. That allows those not comfortable with deciphering statutory language to better understand the BNRT and for those comfortable deciphering it, to be able to verify it against what the COTCE expect the BNRT to do.
• More explanation is needed from the 9 commissioners as to why they would want to replace a direct income tax with an indirect consumption tax. A personal income tax is transparent in showing what each income group pays. However, a tax that is paid directly by businesses but indirectly paid by consumers, investors and employees is not transparent. It is unlikely that the thousands of dollars of personal income tax reduction of high income individuals will be replaced with their "share" of the BNRT. This is because high income individuals do not consume all or most of their income while low income individuals do consume most of their income and some portion of the BNRT will be included in prices of many goods and services purchased if a BNRT is in effect.
• Why was there no proposal for some type of carbon tax given California's aggressive plans to reduce greenhouse gas emissions? One example I've suggested before is to replace some part of the personal income tax (to reduce its volatility somewhat) with a sales tax on utility bills of individual consumers. There would be relief (either on the utility bill or via a refundable income tax credit) such that there would be no tax on a bill representing utility expense for a 1200 square foot home with 4 inhabitants. There could also be an increased gas excise tax.
• I would like to see more study on the BNRT to answer the various questions mentioned in this blog and in many other places, such as the oft-mentioned letter from nine law and economics professors to the COTCE.

Please post comments - were you at the info hearings on October 8 and 9? if yes, what was your reaction? What should be the next step regarding the COTCE report? Other comments on CA tax reform?

Tax Reform and Health Care Reform

We hear lots of talk about tax reform and lots about health care reform, but rarely hear about the two together. While there are proposals to change the exclusion for employer-provided health care, such as President Bush's proposal to remove it and provide a standard deduction for health insurance, they typically don't consider either the entire health care or tax reform picture.
There are significant dollars in the tax code that should be on the table in reforming health care. All of the government dollars should be in the picture in looking at how to fund any change, such as universal coverage. The largest federal tax expenditure is the one where employees are not required to include in taxable income the value of the health insurance their employer provides to them. The estimated cost of this expenditure in 2007 was $134 billion. There are other health care tax breaks as well such as the itemized deduction for medical care and health savings accounts.

The employer-provided health care exclusion is a tremendous benefit to employees. For example, Susan's employer provides health insurance to employees. Susan pays about 20% of the cost and the employer pays the rest - about $10,000 per year. Susan's marginal federal and state tax rate is 30%. Thus, she saves $3,000 of taxes from the exclusion. BUT, if the exclusion were removed, she'd end up getting $10,000 of coverage for $3,000 - still a good deal!! And, she'd likely find that she really doesn't need as much insurance as she selected from her employer. She'd also know how much it costs (today, most employees don't have any idea of what their health insurance costs). And removal of the exclusion would mean that more Social Security and Medicare taxes would be collected.

For employees in a lower tax bracket, perhaps some tax relief could still be provided.
For more information on the topic of the intersection of health care and tax reform, see a recent short article of mine from the AICPA Taxation Insider - Pot of Gold in the Employer-Provided Healthcare Exclusion (6/08). It has more of the details as well as links to various proposals and reports.

The New America Foundation recently released a report about the challenges businesses face with employer-provided health care particularly given increasing costs of this fringe benefit.

There is a lot of money in the employer-provided health care exclusion (a pot of gold!). It is time to make a significant modification to it in order to better target the government dollars in this tax break, remove the adverse impact it has on health care spending, recognize the changed ways of living and working such that expectations of getting health insurance from your employer rather than on your own are outdated and too costly in our global economy, and to improve the federal income tax by broadening the base and lowering the rates.

Decennial Tax System Discussions

At least once every decade since at least the 1960s, there has been talk of serious tax reform in Congress. I came across a 1998 quote from then chair of the Senate Finance Committee, Senator Roth announcing his desire to review the international tax provisions in light of the current state of global markets. He stated: "We need to fundamentally rethink the tax code with a view to enhancing American competitiveness in the new global economy and helping the American workforce. In order to ensure that we enact policies that will lead the United States into the 21st Century at the forefront of competition, as Chairman of the Finance Committee, I intend to hold hearings over the coming year to explore the ramifications of the changing world economy and the needed reforms in both the international tax and trade areas. The cornerstones of these hearings will be ensuring economic growth in our domestic economy and competitiveness overseas. We must determine how our existing international tax regime, which was designed to address the needs of a totally different age, can be reengineered to complement the changing international marketplace and changing business profiles. We must also strive to encourage the creation of more jobs that draw on these new opportunities." [Source: "U.S. Finance Committee Chair Roth's Address at Forum on Taxation of Multinationals," 98 TNI 192-24, October 1, 1998.]

Wow! It sounds like this could have been said in 2008. The Senate Finance Committee held a hearing on 4/15/08 to get ready for tax reform discussions. Treasury held a conference and issued a background report on reform proposals in 2007. The Joint Committee on Taxation has issued reports on international tax issues and reforms in the past few years (2007 and 2006). In 2006, the House Ways and Means Committee held a hearing on international competitiveness and tax reform.

Other than repeal of FSC rules, not much has happened for fundamental international tax reform. Discussions on worldwide versus territorial taxation will continue, along with discussions on border-adjustable taxes, tax havens and more.

What do you think we'll be talking about in 2018?

Helping the Federal Income Tax Cry Out for Reform

While well-intentioned and needed, a recent bill passed by a tax-writing committee also indicates the need for a serious look at our federal income tax system to see how it can be simplified, made more logical in terms of what we want it to do in addition to raising revenue, and how it can support economic growth. This bill makes it even more obvious that our federal income tax is in need of some type of reform.

On May 15, 2008, the House Ways & Means Committee passed HR 6049 which makes many changes to our federal income tax. Many of these changes are 1 year extenders of provisions that expired at 12/31/07, such as the itemized alternative deduction for sales tax, the deduction for qualified tuition and expenses, and some energy incentives. In total, 33 expired provisions were extended for one more year! That avoids the issue of having to determine if they should be made permanent or if they have served their purpose and are no longer needed. These temporary provisions make tax planning difficult (for example, will the benefit be renewed or should alternatives be pursued by taxpayers).

HR 6049 also includes a few new provisions, such as a temporary above-the-line deduction for real property taxes, limited to $350 ($700 for a joint return). Why? What is the rationale for allowing a deduction for state and local taxes? [For more on this topic, see a short article - Goodbye State Tax Deduction (5/08); perhaps I should have called it "Hello new state tax deductions."]

Some of the funding for HR 6049 comes from a temporary modification in corporate estimated tax payments (a non-permanent source of funding).

These elements of HR 6049 are an indication that it is time for some type of tax reform. Isolated changes, such as the temporary deduction for real property taxes by non-itemizers, should instead be done in the larger context of what type of income tax do we want/need and how do we get there. For example, do we want an income tax wtih a broader base and lower rates? Do we want an income tax with lots of temporary provisions? The presence of so many temporary provisions in the tax system add to its complexity, hinders effective tax planning, and takes time away from serious tax reform discussions. It also perhaps helps those wanting reform to point to a tax law in even greater need of reform!

Taxes and the Modern Economy

Ideally, tax reforms, of any size, should follow the principles of good tax policy. There are many views of exactly what these principles are, dating back to at least Adam Smith in the late 1700s (and even back to Aristotle if considering "fairness" in general - "equals should be treated equally and unequals unequally"). Most of the lists are fairly similar (see this chart for an example).

A while back I came across a 1967 report of the Ohio Tax Study Commission that included a principle to follow in its work that we don't often see. It ties well to the point of the 21st Century Taxation Blog. The extra Ohio principle was:

"Relationship to the Modern Economy

Insofar as possible, a tax or tax structure should be capable of growing with the economy of the state and should be revised from time to time so as to correspond with the true makeup of that economy as it develops and changes. Some products, habits of consumption, and classes of enterprise decline, while others rise to take their place. Ideally, a tax structure should be reviewed and revised as necessary so as to bear a relationship to the way people are doing things, regardless of whether additional revenues are needed at a given time."
That's great! Tax systems should be reviewed even when revenue isn't needed. Actually, that is likely the best time for reforms because in dire budget times, principles of good tax policy are often overlooked, which may put the state into a chronic state of budget problems.

btw - the other factors used by the 1967 Ohio Tax Study Commission to evaluate tax policy were:

• Effect on economic growth
• Neutrality
• Equity, or Fairness
• Administrative feasibility
• Compliance costs

A Dynamic Tax System

Tax systems can get out of date. For example, an income tax designed with a rate structure to apply to specified income levels (some type of progressivity goal), will become out of date if the tax brackets are not adjusted for inflation. That is, if individuals with income between $30,000 and $40,000 are to have a 15% rate, they will start to creep into the next higher rate as their income increases with inflation (for example, a person gets a cost-of-living raise), even though their buying power has remained constant (they are really no richer). So, one way to keep the system current, is make an inflation adjustion to the income levels at which each tax rate bracket begins.

What about keeping a tax base current and relevant? That is, enabling a tax base to reflect current ways of doing business and how people live even as things change. That's harder than the rate adjustment which can just be built into the law by having a rule that tells the IRS to adjust the rate structure annually for inflation. Keeping a tax base current and relevant requires regular attention from legislators and making tough decisions. For example, perhaps decades ago it made sense to provide special tax breaks to a particular industry. Yet, if such breaks are not looked at regularly, they remain even when no longer needed. And, it is politically difficult to get a tax break removed once it has been there for a while.

One remedy to the need to regularly update the tax base is to have a broad tax base (with few special rules) and a lower rate. This should reduce the need for special rules. Another solution is to have a termination date on all special rules. What about drafting rules that can self-adjust?
Keeping a tax base relevant is challenged due to changes in technology, society and the ways of doing business. A significant example today is the sales tax base in many states. Most sales tax systems include tangible personal property and a few services in the base. Today, some things that traditionally were consumed in tangible form can be consumed in digital form, such as books, movies and music. These changes (assuming these digital items can't be called "tangible" under the state's law), cause the tax base to decline even though consumption levels are the same. The solution is to modify definitions of what goes into the tax base. Not doing so, can lead to drops in tax collections.

In California, the California Budget Project did the work to measure the drop in revenue that can result when a base has not kept up with changes in consumption and the meaning of "goods." The CBP estimates that if the same percentage of personal income were subject to sales tax today as was subject to the tax in 1966-1967, California would collect almost $16 billion more in sales tax today (source, pg 33) Of course, prices and income need to be considered as well, but clearly, the base has diminished to some degree just due to the change in the form of products people can consume today.

Given continued changes in technology, consideration should be given to use of language that will not be outdated in a few years (although not always an easy thing to do). One interesting example of trying to keep a tax base from getting outdated by technology (and being clear in describing what you're trying to tax) was a change Florida made a few years to ensure that "communications services" would be taxed despite the possibility that new ways to make a phone call would continue to arise. Here is their definition (emphasis added):

"Communications services” means the transmission, conveyance, or routing of
voice, data, audio, video, or any other information or signals, including cable
services, to a point, or between or among points, by or through any electronic,
radio, satellite, cable, optical, microwave, or other medium or method now in
existence or hereafter devised, regardless of the protocol used for such
transmission or conveyance."

Back in the 1930s when many states enacted sales tax laws, if they had considered the possibility that goods might someday be acquired in intangible or digital form, they would have most likely written their tax rules differently. To be clear that they wanted to tax certain types of consumption, they would have said the sales tax applied to "goods or products no matter how obtained, provided they are used for personal consumption/enjoyment."

As Congress and state legislatures continue to consider tax reforms, they should also think ahead and carefully chose the language for defining the tax base to enable the law to self-adjust as business practices and ways of living change. Where feasible to do this, it will possibly lead to a more certain tax law (the intent is more clear), eliminate delays in updating tax bases and keep tax revenues where expected.

How Do/Should We Tax? Tax Reform for California's New Economy

This is the title for a 2/27/08 New America Foundation and UC Center Sacramento workshop in Sacramento. It will look at a variety of California tax and budget issues and possible remedies that also bring California's depression-era, industrial-based tax system into the 21st century.

This blog post serves as place for further discussion on the topic and the workshop presentations.

Here is a link to my presentation topic on broadening the California sales & use tax base and lowering the rate. If other workshop materials are posted on the web, I'll add a link to them at this blog entry.

I look forward to your comments and online discussion.

Minnesota Governor to Form 21st Century Tax Reform Commission

In his 2/13/08 State-of-the-State address, Minnesota Governor Tim Pawlenty announced that he would create a 21st Century Tax Reform Commission to recommend tax reforms for the 21st century economy. Related to this, he also noted:

• the state has a serious deficit
• tax policies, job climate and large government have harmed economic growth
• there is a need to reduce taxes
• Minnesota should join other states and cap property taxes
• there is a need to move the tax system from the 1960s to the 21st century
• tax reforms should "encourage job growth, income generation, investment, entrepreneurial activity, research and exports"

Well, as the title of this blog would suggest, I think this is a good move for Minnesota. But, it won't be easy -- change rarely is.

Many states have had tax reform commissions that travel the state holding hearings and receive many comments from businesses, individuals, academics, and various organizations with lots of complaints and ideas. The final report is delivered and then, usually sits on a shelf. The National Conference on State Legislatures (NCSL) maintains a website with links to many of these reports. I testified before California's last tax reform commisssion (California Commission on Tax Policy in the New Economy) three times. The Commission's 12/03 report has lots of useful information and ideas, but sits on a shelf while California faces a budget shortfall partially due to not moving its tax system into the 21st century ways of living and doing business.

Some ideas for success:

1. Get serious legislative buy-in. While a governor can establish his/her own tax reform commission, there is no guarantee that anyone will do anything with the recommendations. And, if the recommendations are politically unpopular, which might happen, perhaps no one will use the report. This happened in 2003 with the President's Advisory Panel on Federal Tax Reform. It delivered its report in 11/05 and almost no discussion occurred anywhere. While President Bush has pushed for tax reform in a variety of ways (the panel, recent Treasury studies, and various tax law changes such as a reduced dividend tax), the work of the panel hasn't led to anything.
2. Why not introduce legislation to establish the Commission, let the legislators select some of the commission members and require that there be X number of legislative hearings on the final report within 3 months of its issuance and that the tax-writing committees and governor propose a set of coordinated tax law changes in response to the report and result of legislative hearings by a specified date.
3. Start educating the public now on the problems with the Minnesota tax system and the adverse impacts it causes now and in the future on the economy and the lives of Minnesotans.
4. Read the reports of other state tax reform commission. A lot of work has already been done in other states and a decent amount of it is likely relevant to Minnesota. (See the NCSL website.)
5. Use research already done in Minnesota and by various tax policy organizations. For example, see the list at the end of this blog entry (*).
6. Review tax reform work done by various state government organizations such as the NGA and NCSL.
7. Use and follow the principles of good tax policy in analyzing the current structure and any proposals. Doing so should lead to better proposals and help make the case for them. The California Commission used a set of principles designed by the AICPA Tax Division (disclaimer -- I chaired the AICPA committee that produced that set of principles). A Silicon Valley policy group modified the principles into a workbook with examples. When the State of Washington did a recent study, it also included home ownership as a principle to follow. For more information on tax principles to consider and details and links: (1) summary chart I prepared; (2) 9/05 GAO Tax Reform report, see section on "criteria for a good tax system;" and (3) the various reports of state tax commissions (see earlier NCSL link).

Many states do have tax systems based on the economy and ways of living in the 1960s. Moving them into the 21st century will not be easy. It will likely involve broadening the sales tax base to include more services and digital goods; moving to combined reporting (Minnesota already does this); eliminating expensive, overly generous, out-dated tax expenditures (even if it increases non-conformity with federal tax rules); improving use tax collection; eliminating tax pyramiding; considering green taxes, such as a carbon tax designed in a progressive manner (such as taxing utilities with a higher rate for homes greater than the average size); considering a split roll for any property tax cap; and not harming local governments in the tax reform process.

Remember that the longer a state takes to update its tax systems, the harder it becomes. For example, for states that tax the purchase of a music CD, but not downloaded music, the longer it waits to do so, the harder it is to convince the public that the downloaded music is equivalent to the purchase of a taxable CD, and the greater the total loss of revenue from the eroding tax base.
Examples of information already in existence for the Minnesota Tax Reform Commission:

• Minnesota House Research on the sales tax base (10/02).
• Minnesota Sales Tax Gap study (11/02).
  (there are likely many more reports and data sets from Minnesota government agencies).
• The Center on Budget and Policy Priorities has done some analysis of Minnesota's tax system (search for "Minnesota" at their website).
• The Tax Foundation has also analyzed various aspects of Minnesota's tax system and business climate (which it ranks in the bottom 10). A search for "Minnesota" at its website produces several hits.
• Various other local, state and national organizations that have studied various aspects of Minnesota's tax and fiscal structure.

Let's see what happens.

The President's Tax Fix for Health Insurance - Improved Tax Policy

President Bush has mentioned providing a tax deduction for health insurance. His 2009 budget proposal has more of the details:

1. Employees would be required to include in income the amount their employer pays to provide health care coverage for them. This amount would be reported on the employee's W-2 so they wuold know how much it is.
2. Employees (and others) could deduct what they spend on health insurance (or what their employer spends on them and they have to report as income). The deduction is limited to $15,000 ($7,500 for single coverage) and appears to be allowed as a deduction even if the individual does not itemize their deductions. It is also called a "standard deduction" and it appears you get that much even if you don't spend that much on your "qualified coverage."

Basically, the rationale is that this change should bring the insured - the patient, back into the health care COST decisions. Today, most employees with employer-provided health benefits probably cannot tell you how much their employer pays and how much they pay. They are also likely not aware that the government is giving them a tax break by not requiring them to pay income or payroll taxes on the benefit they get when their employer pays for their health insurance. And, most states match the tax break. It is very generous.

For example, Gina's employer provides her health insurance coverage and it costs the employer $10,000 each year. Gina contributes $3,000 towards the coverage which comes out of her payroll deductions. The total cost of the coverage is $13,000. The employer gets to deduct $10,000 on its tax return and Gina does NOT have to report the $10,000 benefit on her tax return (it is an "exclusion"). It is a great recruitment and pay strategy. An employee is much better off earning $10,000 less in taxable pay and instead having their employer use that money to buy them health insurance.

Because Gina isn't involved in much of the health insurance decision, she doesn't negotiate whether she is getting a good deal (as someone may likely do in getting car insurance). Also, the health plan may be quite generous and Gina just pays $10 every time she visits a doctor and doesn't know (or care) what the doctor is charging the insurance plan. Gina has no incentive to even ask about costs or whether all of the medical procedures she gets are crucial because it costs her so little.

All of this leads to increased medical care and health insurance costs for everyone.

Also, the current system provides a greater benefit to higher income individuals because they are in a higher tax rate. For example, if Gina has a marginal tax rate of 30%, the tax break saves her $3,000 in taxes each year. If she were instead in a 10% tax bracket, her savings would be $1,000.

Another rationale for the President's proposal is that employees with employer-provided health care get a better tax break then people who have to purchase their own insurance. While the tax law does include a medical deduction, it is only for those who itemize deductions and you can only deduct the excess of medical expenses over 7.5% of your adjusted gross income.

Back to Gina - President Bush is proposing that she include the $10,000 in her taxable income, but she would also get a deduction of $15,000 (apparently whether or not she itemizes her deductions). If her employer were instead paying over $15,000 for her health coverage, Gina would be limited to a $15,000 deduction.

It is not clear why the proposal allows a $15,000 deduction ($7,500 if single) even if the employer and employee are not paying that much for coverage.

More information on the health insurance tax proposal can be found at pages 19 - 22, and 92 of Treasury's explanation of the budget's revenue proposals.

There are specific rules on the type of coverage and several other details (as typical for special tax rules).

Some questions:

1. Treasury's explanation notes that this proposal would result in a revenue loss of $23 billion in 2009 and later years, but a revenue increase for 2009 - 2018. Is that a mistake? How was this all deterimined?
2. How would this change affect health care and spending decisions of employees, employers and those without employer-provided health insurance?
3. How would this proposal workwith other proposed and needed health care changes?
4. Would a tax credit be better? The income inclusion and deduction should offset, but if an individual's income inclusion from employer-provided health insurance is less than $15,000, they get a tax break (deduction is greater than the income hit) that is worth more to individuals in higher tax brackets while the credit is worth the same to everyone. Similarly for someone who buys their own health insurance - the credit would be more fair. And the credit should be refundable so that individuals who owe tax less than the credit would get it refunded (which would help them pay for the insurance).

Tax policy considerations - the proposal will bring transparency and greater fairness to the tax rules on health insurance taxability and deductions.

Other policy considerations - the proposal may also help control health care costs if it does lead patients to be more involved in spending and treatment decisions.

What do you think?

Corporate Tax Under the Microscope

2007 was a year of examining our corporate income tax system and considering alternatives -- but only as a preliminary step to further discussions and debate.

The US combined federal and state corporate tax rate is one of the highest among industrialized countries due to reforms in those countries in the past several years. Many believe that lowering the federal income tax rate on corporations would help make U.S. companies more competitive in the global market. House Ways & Means Committee Chairman Charles Rangel included a corporate rate reduction in his "mother of all tax reform" bills (H.R. 3970) introduced in October 2007. That bill also included some base broadening to help pay for a lower tax rate.

But, there are many issues to consider:

1. Should the analysis only look at the statutory tax rates or the effective tax rate (tax as a percentage of income)? Many U.S. corporations have ETRs below the statutory rate.
2. Corporate tax revenues are already declining. What would be the effect on the budget and economy of lowering tax rates further?
3. Should a rate reduction be offset to make it revenue neutral? Some say no because the rate drop will lead to greater investment and revenue, others (including a recent report by the Congressional Research Service) say yes.
4. Unlike many other countries, a lot of business income in the U.S. is subject to the individual income tax rather than the corporate income tax because we have so many sole proprietorships and flow-through entities. Would corporate reform alone help businesses be more competitive?

For more information and a link to several studies and reports released in 2007, please see Corporate Tax Under the Microscope.

How we make budget problems worse

In my 11/22/07 post on ideas for addressing California's $10 billion budget shortfall, I included reinstating the vehicle license fee (VLF). Apparently I'm not alone on that suggestion. But as Dan Walters recently reported, when the VLF was cut a few years ago, it was done in a way that prevents it from being restored. See his 12/11/07 article in the Sacramento Bee.

Lots of restrictions on budget options is a poor way to run a government. California has too many restrictions that tie the legislators' and governor's hands. These restrictions include Prop 98 that mandates that a certain percentage of the budget go to K-14. Of course, funding education is an extremely important role of government (and should include beyond grade 14!), but the restriction ignores that every year is different and ignores the role of lawmakers. Other restrictions include Prop 13 and 218 among others.

I was once on a panel that included a former California legislator. When I noted that these laws are too restrictive and prevent legislators from doing their job, this person noted something along the lines of "but we have to do that because you can't trust legislators to do the right thing." I about fell off of my seat that such a comment would be made publicly or even believed by someone who had served in the legislature. Apparently, we need to have better civics education.

Well, the VLF restriction can probably be undone, but would not be easy or politically wise so soon after going into the law. But, the state definitely needs revenue and should never have removed a tax that was working and was even progressive in that higher income people are the ones who tend to have higher value cars. We could increase the state gasoline excise tax with the additional funds going into the general fund. Unfortunately, that tax is regressive and some relief for lower income taxpayers would be needed. Or perhaps a state version of the federal gas guzzler tax could be enacted as that would primarily affect higher income taxpayers.

In the meantime, we need to stop putting "shackles" into the law so that elected officials can have more options for solving budget problems.

Your thoughts?