New Year's Resolutions for Our Tax Systems

As 2021 wraps up we think about what we might do differently in 2022, I offer a few suggestions for improving state and federal tax systems.

1. Modernize tax systems: Computing and paying our taxes should be as easy as e-commerce, online banking, and email. Income taxes should be a just-in-time system where we select software we want to use to compute our tax liability regularly and we pay in or receive any overpayment at least weekly. This will work for businesses if your software accurately computes your taxable income with each transaction you engage in. Also, if you need to amend a return, just log into your account and adjust your return.

2. Simplify!: Why does our federal tax system have over 100 special rules (see the Joint Committee on Taxation list here)? We can easily get rid of the home mortgage interest deduction, especially today when less than 10% of filers claiming it. Move items out of the tax law that don't need to be there. For example, education provisions such as the lifetime learning credit and American Opportunity tax credit. Some of these encourage schools to increase tuition. And for individuals in need of financial aid, increase grants and scholarships.  Also, why are depreciation rules over 50 pages long? Simplify!

3. Prevent budget gimmicks: Starting for tax years beginning after 12/31/21, R&D expenditures are no longer currently deductible as has been the case since 1954. Instead, companies involved in innovation that produces R&D expenditures will have to capitalize these costs and amortize them over 5 years (15 years if it is foreign research). This change was in the TCJA with a delayed effective date to help reach the $1.5 trillion cost limit over 10 years. I don't think anyone expected it would become effective, but it will for calendar year businesses on 1/1/22. While the Build Back Better Act pushes out the effective date four years, it wasn't passed before 1/1/22. These items that are just to help a bill reach a revenue target over a 10 year period should be disallowed.

In the American Rescue Plan Act enacted in March 2021 (PL 117-2), we saw a budget gimmick repealed. This was the section 864(f) change added by 2004 legislation with a postponed effective date and further extended at least two more times to finally be repealed by 2021 legislation without ever going into effect! 

It is appalling that we start 2022 capitalizing R&D which should be incentivized and simplified to expense as incurred. It has worked well since 1954. Most countries offer tax incentives for R&D, we should too.  There are spillover effects with R&D that support some government support such as through expensing (and for some R&D, the research tax credit).

4. Allow tax law improvements without 60 votes in the Senate: The budget reconciliation process limits what can go into a tax bill. For example, it can't have anything to do with Social Security. Provisions need to deal with revenue. Thus, no technical corrections, removal of "deadwood", preparer regulation and many other items. It seems to also prevent many needed reforms, such as simplification. A few years ago the AICPA suggested 13 proposals to truly improve the tax law to reflect how small businesses operate today. I think it is unlikely thought we will see these reforms or similar type improvements when Congress has to use the budget reconciliation process. Of course, bi-partisan efforts to improve the tax system such as occurred in 1986 would also be good.

5. Make the personal income tax work like a personal income tax: Notice 2020-75 that allows even optional state taxes imposed on partnerships and S corporations to be deducted on Schedule E where there is not $10,000 SALT cap is very poor tax policy. Such a workaround causes lots of confusion and complexity as we see by the laws in the roughly 22 states with these optional taxes all operate differently. A "normal" personal income tax includes all income with deductions for a standard deduction and personal/dependence exemptions and the expenses of producing income, such as state and local income taxes. The $10,000 SALT cap is not proper policy and treats C corporations better than other types of business entities for no good policy reason. 

6. Expand high school curriculum to include taxation basics: It is just wrong that many people first learn of taxes via their first paycheck. Why do we teach about the three branches of government and their functions but not how they get their funding? A key responsibility of citizens is to pay taxes. Why not teach the basics of taxes, government budgets and even basic tax policy (such as how different types of taxes are supposed to work), in high school? I think this would enable people to ask better and needed questions of elected officials and those running for office. For example, many people in California should have been asking lawmakers why they made the temporary sales tax exemption on baby diapers permanent this year (AB 150). To those who don't know a lot about taxes and data, this exemption probably sounds good. But the biggest benefit goes to higher income individuals who spend more on diapers (because they can) and don't need an exemption. Before the original diaper exemption was enacted a few years ago, the California Legislative Analyst's Office told lawmakers that it would not do what they thought (help low income individuals). The $70 million cost of this exemption would be much better used to fund child care for low-income workers. That would be a better benefit to the economy as well.

#letsfixthis

What do you think? What would you add?

Happy New Year!

California Lawmakers Miss Opportunity to Help Low-income Parents

Despite better ideas on how to truly help low-income parents of infants, California lawmakers took a route this July that spends a lot of money but doesn't sufficiently help the group in need of assistance. Why does this happen? There is plenty of data and a 2019 report from the Legislative Analysts Office pointing out that their law change won't provide as much help as it could have if better designed.

I'm talking about what started out in 2019 (SB 92, Chapter 34 (6/27/19)) as a two-year exemption (2020 and 2021) from sales tax for infant diapers and menstrual products. The state was required to transfer the lost revenue to local governments. SB 92 also required application of the accountability provision at Revenue & Taxation Code section 41 for the LAO to measure the effectiveness of the exemption in meeting the stated goal of promoting public health by increasing the affordability of and expanding access to diapers.

Prior to its expiration and before the LAO could complete its analysis, lawmakers extended the exemptions until July 1, 2023 and extended the due date for the LAO report to 7/1/22. (AB 85 (Chapter 8, 6/29/20)). Now, with AB 150 (Chapter 82 (7/16/21)), lawmakers have made the diaper and menstrual product exemptions permanent and cancelled the LAO report on the effectiveness of these exemptions.

I wrote about the weaknesses of the infant diaper sales tax exemption in 2019 (8/3/19 post), but repeat the highlights due to this recent example of missed opportunity to really help individuals in need which would end up benefitting us all via healthier babies, greater funds for low-income individuals, and less missed work.

While it may sound good to say you are helping public health and helping to make infant diapers more affordable, we need to ask more questions and apply critical thinking. In my earlier post, I noted that diapers cost between 11 cents per diaper up to 49 cents per diaper. Likely, the more expensive diapers are purchased by parents with more funds who don't need the sales tax savings (roughly 9 - 10% of the purchase price) and likely don't even notice the savings.* 

How much does this cost the state in lost revenue? Per the 2021-2021 tax expenditure report of the California Dept. of Finance, $76 million per year!

Prior to original enactment of the diaper exemption, the LAO told lawmakers that if they really wanted to help low-income families, providing greater subsidies to child care would be better. Per this 2019 report:

"the state can expand a program that addresses one of the biggest expenses parents face: child care. The state funds various types of subsidized child care for low-income families, but the number of eligible children typically exceeds the number of “slots” funded by the state. Due to this shortfall, the state fails to assist part of the targeted population and creates an inequity between those who receive slots and those who do not."

So, why isn't the $72 million per year used to really help low-income parents of infants? 

I think it is because we aren't asking enough questions such as: 

Which income group of parents gets the biggest savings from this tax break? It is the higher income taxpayers who spend more money on diapers and don't need the assistance (wasted spending).* Why are we subsidizing folks who don't need a subsidy?

Will reducing the cost of diapers by the 9 to 10.5 cents of sales tax per dollar help low-income individuals? Of course it offers some assistance, but we still have diaper banks in California and many struggle to pay the sticker price, not just the sales tax. 

What would provide better, more targeted help? Use the $72 million to help those who need it rather than those who do not. Provide diapers to child care centers who serve low-income workers.  I read a report last year on diaper banks for a Tax Notes State article on the need to fix the sales tax base. I learned that some parents get turned away from the child care center if they did not bring diapers for their child so then have to miss work to stay home with the child. Why not use $72 million to prevent this?

Why make the exemption permanent before its expiration date and before getting the analysis from the LAO on the effectiveness of the exemption?  Again, we all need to demand greater accountability from lawmakers regarding spending.

*I recently learned from reading an excellent book that I highly recommend reading (and hope all lawmakers read it) - Broke in America: Seeing, Understanding, and Ending US Poverty (2021), that some low-income individuals do end up spending more on diapers than would be charged if buying them in bulk from a big box retailer because they might not live near such a retailer and/or they don't have a lot of funds at once so buy the smaller package where the cost per diaper is higher.  Again, this calls out for doing better with taxpayer dollars than occurs with the now permanent California sales tax exemption on infant diapers.

What do you think?

Two New Sales Tax Exemptions in California for Two Years

California SB 92 (Chapter 34, 6/27/19) adds two new sales tax exemptions starting 1/1/20 and ending 12/31/21:

1. “diapers designed, manufactured, processed, fabricated, or packaged for use by infants, toddlers, and children” [R&T 6363.9]
2. “menstrual hygiene products” shall only include the following: (1) Tampons. (2) Sanitary napkins primarily designed and labeled for menstrual hygiene use. (3) Menstrual sponges. (4) Menstrual cups.” [R&T 6363.10]

For these new temporary sales tax exemptions, the legislature applies R&T §41 dealing with accountability. Thus, the legislature had to specify the purpose of the exemptions and require a report from the LAO on the effectiveness of these provisions including whether they should be modified, extended, or allowed to expire. For the diaper exemption, the LAO is also to assess “whether more targeted approaches to providing families in need with adequate access to diapers are available.” For the menstrual products, the LAO is also to assess “whether more targeted approaches to providing individuals in need with adequate access to menstrual hygiene products are available.” The specified goals of these exemptions:

·         Diapers: “to promote public health by increasing the affordability of, and expanding access to, diapers.”

·         Menstrual hygiene products: “to promote public health by increasing the affordability of, and expanding access to, menstrual hygiene products.”

Observation: Often, bills that provide a new credit or exemption state that R&T §41 does not apply. Then there is no need for accountability as to whether the provision meets its purpose or even that a purpose be articulated. Important to this assessment though is whether the LAO will have the information needed for a strong assessment. The legislation should have included a provision and funding to have the LAO identify information it will need the CDTFA to collect.

Other states provide similar exemptions with the sales tax on menstrual products sometimes referred to as the pink tax or the tampon tax. States with an exemption include Connecticut, Florida, Illinois, Minnesota, New Jersey and New York.

Do these exemptions reflect good tax policy? NO. The biggest issue is equity and fairness in that they give the largest break to higher income buyers because they are likely to spend more on diapers. I see that on Amazon, diapers range from 11 cents/diaper up to at least 49 cents/diaper. Someone already buying the more expensive diapers doesn't need a sales tax break to make diapers more affordable as they have already opted to not buy a less expensive diaper that would be more affordable. If the exemption were only given to individuals who need it and who may need even more assistance in paying the price without the sales tax, this exemption is poorly targeted.  A similar argument can be made for the menstrual products.

There are better ways to target relief to taxpayers needing relief rather than also giving relief to those who don't need it. This sales tax break results in reduced revenue for state and local governments. How will they make it up?

More targeted relief would be to provide diaper coupons to individuals already receiving state or local aid, or just giving them diapers which the state would buy in bulk at a reduced cost. Same with menstrual products.

Another concern with these products is that there are added environmental costs of these disposable items. Thus, removing the tax on them means that the costs of disposal and filling up landfills needs to come from elsewhere.

What about the argument that only females need menstrual products so taxing them is a gender disparity. That same argument can be made for other products such as razors, shaving cream, jock straps, football helmets, and I'm sure other items. Exempting these items makes the system more complex, less equitable, and requires that the rate be higher on other items.

The California Legislative Analysts Office issued a report (5/12/19) on these exemptions before enactment of S 92. It notes a few additional issues including the difficulty of defining a "necessity" and whether an income tax credit for the menstrual products would present greater tax relief.

What do you think?