Time Running Out To Claim Refunds Owed for 2022 - WHY?

Every year in mid-March, the IRS issues a news release about time running out to claim refunds owed to people for four year earlier where the statute of limitations is going to close on April 15. The latest is IR-2026-37 (3/20/26) stating that time is running out to claim $1.2 billion in refunds for 2022. The IRS has details on this to not only reach this figure, but they also have a table showing the refunds owed by state. 

I have blogged on this a few times before including in 2023 suggesting that a modern system should prevent this situation. For example, why not change the law to allow the IRS to issue the refund?  Some of these refunds likely are for people with wage withholding who did not know they had to file to get their withheld federal income taxes refunded when their income is below the filing threshold.

Some people who have not filed are also missing out on claiming a greater refund such as for the Earned Income Tax Credit.

Please see my March 2023 post for a few ideas on how to not have these refunds not get to the taxpayers they are owed to.

What do you think?

Simplify and modernize by removing exclusive use for a home office deduction

Yet more from the testimony I submitted for the written record of a Senate Finance Committee and Small Business and Entrepreneurship Committee roundtable held June 7, 2023 (see my posts of 7/9/23 and 7/2/23 and 6/25/23). Another way to simplify tax rules for small businesses (such as ones operating out of the owner's home) and modernize tax rules is to remove the exclusive use requirement for the home office deduction.

Modern life makes it unlikely that anyone uses a home office only for business activities. Most people, for example, have a smartphone in their hands and might get a personal call or text message or use a weather app while in their home office.

An alternative would be to allow a home office deduction only if the space is used over 50% for business and to reduce the deduction based on the percentage of personal use of the space, such as based on time. Offering a standard home office deduction, such as allowed by Rev. Proc. 2013-13, would be helpful, with the amount adjusted annually for inflation (and no exclusive use requirement, but adjusting the standard deduction for the percent of personal versus business use of the space based on an average week of use). 

What do you think?

Tech observation in President's FY2020 budget proposal for IRS

President Trump released his FY2020 budget proposal on March 12. [A Budget for a Better America – Promises Kept. Taxpayers First, page 82] It slightly increases IRS funding to “expand and strengthen tax enforcement.” Such efforts “are estimated to generate approximately $47 billion in additional revenue at a cost of $15 billion, yielding a net savings of $33 billion over 10 years.  The Budget also includes several proposals to ensure that taxpayers comply with their obligations and that tax refunds are only paid to those who are eligible, including:  improving oversight of paid tax preparers; giving IRS the authority to correct more errors on tax returns before refunds are issued; requiring a valid Social Security Number for work in order to claim certain tax credits; and in-creasing wage and information reporting.”

The budget also notes that there is $290 million for the IRS’ multiyear effort to modernize its IT. The report notes that while about 90% of individuals file electronically, most other interactions between the IRS and taxpayers is via the mail, “which slows the resolution of issues.”

That is a true and interesting observation. 89% of individuals e-file there return. Yet other interactions with the IRS will be by phone or the U.S. Post Office. Will IT modernization include taxpayer accounts where taxpayer not only pay their taxes but can also change withholding, make estimated tax payments, amend their return, etc.?

Today, March 13, the IRS issues a news release that $1.4 billion is waiting to be claimed by individuals who have not yet filed their 2015 returns! [IR-2019-38] If tax compliance were done virtually, with the IRS using data it has, the filing could be done automatically and refunds issued to bank accounts. Or at least the IRS could more easily reach taxpayer via a text message, for example, to let them know they need to file and are likely owed a refund.

What do you think?

11th Blog Anniversary - Still Aiming for Improved Tax Policies - Modern Entrepreneurship

May 14, 2018 was the 11th anniversary of the 21st Century Taxation Blog. This is my 991th post.

I continue to strive to promote improved tax systems that better reflect the ways we live and do business today and follow principles of good tax policy. My goal this coming year is to have regular posts showing examples of how tax systems can be improved to be more effective.

Here is an example, one I also wrote about in 2012 and submitted to the Senate Finance Committee for the written record of their 7/10/12 hearing on Boosting Opportunities and Growth Through Tax Reform: Helping more Young People Achieve the American Dream. Here is a link to my full testimony and a link to the written record of the hearing.

How much did this hearing affect the Tax Cuts and Jobs Act (PL 115-97; 12/22/17)? Not much. While many tax breaks were cut back, some of the most costly ones, such as the exclusion for employer-provided health benefits were untouched. The individual mandate (penalty) to have health insurance was repealed starting 2019 which will cause health insurance costs to increase. The Earned Income Tax Credit was not increased. No first-time homebuyer credit for low to middle-income taxpayers was created. No changes were made to address the growing number of individuals in the "gig economy" who are self-employed.

Here is my suggestion from 2012 to support modern entrepreneurship:

Several trends indicate that workers today are more likely to be self-employed, telecommute or work in their home, and have continual needs for new technologies (such as for hardware and software). Many existing tax rules though, work contrary to support these trends. For example, worker classification rules are unclear causing some employers to label all workers as employees, making it difficult for a self-employed entrepreneur to succeed. Strict home office deduction rules, particularly the exclusive use requirement, make it almost impossible for workers and self-employed individuals to qualify for the deduction. Thus, they are not able to properly calculate true taxable income because some valid business expenses are not deductible.

Additional reforms should be considered to help young people obtain initial funding to start a business. For example, existing tax rules could be modified to provide incentives for established businesses to donate to entrepreneur grant programs where individuals could submit business plans with the hope of being awarded a tax-free start-up grant. The reforms to help fund such grant programs could come from a lowered tax rate on repatriated earnings that go into the fund, or an enhanced charitable contribution deduction for donations to such grant programs.

I'm going to update and further develop that idea - supporting modern entrepreneurship as one more my research projects this year.

What do you think?

Another example of 20th century tax compliance

Happy Tax Day!  One of the email alerts I received from the IRS today was Tax Tip 2017-48, Helpful Tips to Keep in Mind When Amending  Your Tax Return. I want to focus on tip #1 of the nine provided.  Here it is:

"File using paper form. Use Form 1040X, Amended U.S. Individual Income Tax Return, to correct the tax return. Taxpayers can’t file amended returns electronically. They can obtain the form on IRS.gov/forms at any time. Mail the Form 1040X to the address listed in the form’s instructions."

So, two questions:
1. Why can't the IRS accept e-filed amended returns?
2. Why can't we just log onto our taxpayer account at the IRS and fix the error?

I think this might change once the IRS rolls out its Future State system for taxpayers (and perhaps practitioners too) to use. We'll see.

What do you think?

Keep mailing letters to IRS despite the modern era

Chief Counsel Advice 201710027 (3/10/17) states that determination letter requests, such as on Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, cannot be faxed to the IRS because an original signature is required.

Wow!

If you were born before the 21^st century, you likely know the following:

·       What a fax machine is, where to find one and how to use it.

·       How to address an envelope (and you might even own a few) and how to affix a postage stamp (and you likely have a few in your home).

In contrast, members of Gen Z (born in 1998 or later) have always lived without the need to use a fax machine, envelope or postage stamp. They likely want to continue to live this way, as do many folks from earlier generations. They rightfully wonder why the form can't just be completed online and then hit the "send" button.

Why do we still have tax practices that require 20^th century tools?

What do you think?

Pay your taxes in cash at 7-11 - start of even better things to come?

One of the ways individuals and businesses can pay their federal taxes if they don't want to do so or cannot do so via automatic bank withdrawal, credit card or check is to go to their local 7-11 store and pay by cash. Per the IRS instructions, the fee is $3.99 and there are some actions that need to be taken online before going to 7-11. That action includes entering your Social Security number. You then get a number to take to 7-11 to complete the transaction. The cash limit is $1,000. [Also see IR-2016-56 (4/6/16)]

 
This should be helpful to someone without a credit card or bank account but who does have access to a computer and the Internet (school or local library at least).

I think this is a great idea.  I think it would be even better to evolve to a system that should work for over 50% of individuals to have the IRS use the information they have to compute the taxes owed or to be refunded.  If we got rid of more deductions and credits (and lowered the tax rate), this would work for even more individuals.  You could then have a secure PIN that you could use at your own computer or ones available at local IRS offices, libraries, or other government offices to complete your return and direct any refund to where it should go (including cash that could be given out at the office right then) or let you pay.  Better yet, someday when more of our transactions are electronically recorded in a secure manner, tax withholding could be monitored and regularly adjusted so that there would be no significant refund or amount owed or could just be rolled to the next year.  The technology exists, it just needs to be more comprehensive in its use  -  more networked with the reality and perception of the greatest level of security and accuracy.

Yes, I know there is controversy about having the IRS prepare returns.  I think that is unfortunate because with about 2/3 of individuals claiming the standard deduction (rather than itemizing) and many folks not having a Schedule C business or rental income or capital gains, the IRS does have the information to prepare the return. Why should a taxpayer struggle on their own to complete the return or pay someone hundreds of dollars to get a simple return prepared?  Some say you can't trust the government, but we are talking about simple calculations and the IRS can easily do this correctly.  And, individuals would get their completed return to say yes or no to before filing.  Guess what - this is the way it is in many countries today. The GAO issued a report on this way back in the 20th century (1996)!

What do you think?

fyi - The IRS has more information on other payment options here.

Summer hearings on comprehensive tax reform

 

On June 5, 2014, Senators Wyden and Hatch of the Senate Finance Committee announced three hearings for the summer on comprehensive tax reform. The topics:

June - Education incentives

July - (1) Identity theft and taxpayer privacy protection
          (2) Modernizing corporate taxation

They also mention:

• Simplification
• Promoting economic prosperity
• Innovative ways to fix the depleted Highway Trust Fund

A few observations:

• Education incentives - there are over ten today. There really is no need for any. Any government subsidy can take place through existing systems such as Pell grants. Also, a lower rate would help people save for higher education.  The existing provisions are for college, not for vocational training, so are limited. Also, they benefit higher income taxpayers more than lower income taxpayers.
• Modernizing the corporate tax - ideally, this should include some effort at integration, but that is unlikely. I'm guessing that they are mostly looking at a lower rate and a changed international taxation scheme.  If the result includes longer life for intangibles (such as 20 rather than the current 15), we are not really modernizing. The Camp and Baucus proposals included extending the life to help pay for a lower corporate tax rate.
• How to fix the depleted Highway Trust Fund.  While they are studying it, why not raise the rate from 18.4 cents per gallon, where it has been since 1993, to at least the inflation adjusted amount (30 cents).

What do you think?

Modernizing retirement plans and savings

The congressional tax committees have a website for people to submit tax reform ideas and comments - https://taxreform.gov/.

Here is one I submitted on May 26:

Rethink Retirement Plans and Savings Incentives for the Modern Era

Several changes have occurred which make retirement savings more important to workers, but which also make it more difficult to build such savings. For example, years ago, many employees could expect to have a defined benefit type retirement vehicle provided by their employer. This required little action by employees. They did not have to understand investment options, contribution requirements, and tax rules. Today, many employees are offered no retirement plan and thus, must figure out on their own how to establish one. They have a choice of tax vehicles for an IRA (such as regular or Roth) and they have many options as to where to set up their IRA (stock brokerage firm, bank, etc.).

Many workers do not expect to stay, and in fact do not stay, at one employer for many years. Thus, even if an employer sponsors an IRA or 401(k) plan, the employee will need to be involved in the management and movement of the funds when they change jobs. Employees who changes jobs several times could end up with multiple accounts if they do not or cannot consolidate the funds saved at each place of employment into a single retirement plan.

There is a greater need for workers to have retirement savings today than was true decades ago because people are living longer.

Tax law changes to increase the number of workers participating in retirement plans should consider the following:

• A simple system to enable all workers (employees and self-employed individuals) to have a retirement savings account. This should occur for both part-time and full-time workers and even if an employer does not help with administration or contributions.
• Retirement savings contributions should be coordinated with payroll tax deductions. A system to enable self-employed individuals to also make contributions along with self-employment tax payments should also be considered.
• Find ways to help individuals improve their financial literacy.
• Portability. Be sure the system allows for contributions to be made to the one account even if a worker changes employers or also has income from self-employment.
• Strive for simplicity.

The government can play a role in establishing accounts, simplification, and educating individuals.

Example of a new approach: The first time an individual receives a W-2 or pays self-employment tax (whichever happens first), the government could set aside a set dollar amount in a retirement account for that person. This would constitute the start of their retirement account that would be used for all future contributions; there would be only one account. When the individual works for an employer who also wants to contribute to employee retirement accounts, such funds are placed in the individual's existing account. Also, for each paycheck or quarterly estimated tax payment of a self-employed individual, an amount would be contributed to their retirement account. Individuals could be allowed to transfer their retirement account to a commercial broker for management or let it stay with the federal government. The federal government could be allowed to transfer management to third parties for a fee.

Annual reporting would be required to let individuals know their account balance and other details. Rules would continue to exist, but in more simplified form, governing how much could be contributed annually, how much employers could also contribute, the age when distributions may begin, hardship withdrawals, etc.

Benefits of this type of approach:

• All individuals who work have a retirement account. This single account would be used whether they are an employee or sole proprietor or both.
• The initial contribution from the government ensures that all workers start a retirement account.
• The initial contribution from the government may also encourage individuals to be tax compliant from the start of the time they begin earning money.
• The system ties to payroll tax withholding and so should not be burdensome to any size employer since they already are required to comply with payroll tax rules.
• For low-income workers, the annual contribution could be made via part of the earned income tax credit (EITC) the worker receives.

What do you think? 

Have you submitted any proposals?

 

Tax system modernization recommendation in Colorado

Recently, TBD Colorado, a non-partisan, community group issued a report (11/14/12) with various recommendations to help improve the state's tax system, budget, education, transportation, workforce and health care.  I like the tax system recommendation as it seems to be getting at the need to modernize and update the system.  The recommendation states:

"Consider changes to the tax code so that it more accurately reflects Colorado’s underlying economy. Some of the fastest growing sectors of the economy are either exempt or taxed at a lower rate than others. Changes to the tax system that are revenue neutral on a current basis, reduce marginal rates, exemptions and deductions, but simplify the tax code and broaden the tax base should be considered."

There is not much detail in the report on what is exempt. But a review of Colorado sales tax rules shows that while electronically delivered software is taxable, there is no tax on digital goods or most services. These are growing sectors of the economy. Broadening the tax base to include these items when sold to individual consumers, would be more equitable and allow for a lower tax rate.

I also like their last sentence which needs to be said more often at state and federal levels .... a tax system with a broader base is more likely to meet principles of good tax policy such as equity, neutrality, efficiency, transparency and simplicity.

Unfortunately, these wasn't said enough in California which after the recent election ended up with increased rates for the personal income tax and sales tax which exacerbate problems such as PIT volatility, and inequities in the sales tax.  California's tax problems are with its tax bases, not the rates which were already high.  But I'll save that analysis for a blog post on another day soon.

But in the meantime - nice job by TBD Colorado and the citizens involved with the report in identifying how to truly improve a tax system.

What do you think?

North Carolina Tax Modernization Efforts

"to be rather than to seem"

About a year ago, SB 658 was introduced in the North Carolina legislature. It is entitled the "21st Century Tax Modernization Plan" (great title!). Apparently, it didn't move.  But, there are other efforts in the state focused on modernizing the tax system.  I'll share a few statements from the bill and the other efforts that I find interesting in terms of needed steps to modernization of any tax system.

First, the introduction to SB 658 provides:

"The General Assembly of North Carolina finds the following:

(1) North Carolina's current tax structure has not been comprehensively revised since the Great Depression. The tax structure adopted then, while amended extensively over the years in a piecemeal fashion, no longer reflects North Carolina's 21st Century economy.

(2) Over the years, the multiplication of credits, allowances, special rates, and exemptions has progressively narrowed the base of the State's individual and corporate income taxes, with the result that the rates for those income taxes are now among the highest in our region and among our peer states.

(3) North Carolina's current tax structure undermines the State's competitive position and acts as a deterrent to new business investment and the creation of new jobs.

(4) The State's reliance on temporary and expedient tax changes to meet budget shortfalls has created a tax structure that is unpredictable for taxpayers and a revenue stream that is unstable for the State."

NC State University's Institute for Emerging Issues has a brief position paper - Statement of Principles:Tax Modernization in North Carolina with some suggestions in line with principles of good tax policy and modernization. IEI suggests that notes competitive disadvantages to not modernizing its tax system and that the sales tax base has eroded over the years. Their suggestions to achieve a system that is "competitive, stable, adequate and fair:"

1. Broaden the sales tax to "many services and previously exempted tangible items" (other than medical services and prescription drugs) with a relief mechanism for low-income individuals. At the same time, the rate should be lowered.
2. Use federal AGI as the base for the state income tax "with minimal deductions and exemptions" while also lowering the rates to be competitive with nearby states.
3. Be sure there is adequate funding for local services.

And, I found a presentation by Michael A. Hannah, Esq., CPA, counsel to the NC Senate Finance Committee, entitled "Tax Modernization in North Carolina — One Step to Economic Growth and Fiscal Stability" presented to the Tax Policy Subcommittee of The North Carolina Economic Development Board on 2/10/12. It has a lot of data on changes in the NC economy and tax collections. For example, in the past 40 years, employment in manufacturing dropped 24% and employment in services sector increased 25%. As Mr. Hannah notes on slide 17 - "First We Need to Understand What the Problem Is!"

His presentation also notes that some incentives have not achieved their goals or even bigger goals of increasing the state's economy relative to the nation. For example, he notes: "While NC has spent billions on economic development over the years through tax credits, incentives, etc., we have not seen per capita income in relation to the U.S. average grow as a result" (slide 3).

The presentation also notes that credits are expensive to administer and many businesses would just prefer lower rates. He also notes that more credits have been claimed for new machinery than for job creation (slide 5). It is a good presentation to provide an overview to the state's economy and tax system, its weaknesses (such as the eroding sales tax base and increasing tax rate), and the need to act so the state won't be left behind other states.


The themes from North Carolina's talk of tax modernization are similar to modernization needs in most states.  Focal points for modernization should be:

1. Broaden/modernize the sales tax base to cover today's types of personal consumption while lowering the rate and phasing out application of the sales tax to business purchases.
2. Simplify personal income tax by eliminating special deductions, exemptions, rates and credits and lowering the rate.  States should also encourage Congress do to the same with the federal income tax and then they can start the state income tax calculation with federal taxable income.
3. Review all incentives to see if they are meeting their intended purpose (also be sure they even have a stated purpose). Consider if any deemed worthy should be in the tax law or run by a state agency. For more, see my February 2012 testimony delivered to CA Committee on Revenue & Taxation and Committee on Accountability and Administrative Review.
4. Ensuring that the goals of state and local governments are aligned as evidenced from their tax and budgeting systems. For example, local governments may need to share in income tax revenues to be help support state economic growth goals.

What do you think?  What tax modernization is needed in your state?

National Taxpayer Advocate Trying to Move IRS Into the 21st Century

On April 4, 2012, the National Taxpayer Advocate, Nina Olson, posted news about a new project from her office to help the IRS move into the 21st century ("Virtual Face-to-Face Audits: A prescription for curing the IRS’s ailing correspondence examination process"). She notes that people don't always enjoy correspondence audits. She notes:

"While the IRS instituted correspondence or “corr” exams in an effort to conserve its resources and minimize taxpayer burden, IRS customer satisfaction surveys and Taxpayer Advocate Service (TAS) research studies have consistently shown that for the majority of taxpayers subject to this method of auditing – many of whom are low income and unrepresented – corr exams are an unnavigable labyrinth."

Helping my mother recently with a correspondence audit, I could not agree more.  The notice assumed that the return was incorrect because someone at the IRS did not believe there was a retirement plan rollover.  When documents were then provided to show the rollover, a much smaller bill came back, but it was larger than expected. In questioning it, a response came back with no information, just the liability. Given that at that point it was under $1,000, my mother is 80 years old, recently widowed, and tired of the stress, she paid it. She did not see any other viable option because her letters explaining the correct amount were met with a response indicating the IRS had not read her letter. One solution to this type of problem in the future would be for the IRS to ask on the original return for proof of a rollover rather than presume that it is incorrectly reported and try to get the records two or more years after the event. There would be no need for a correspondence audit in this situation if the IRS asked for records timely in situations where it doesn't believe what was reported on the return.

So, I fully agree on the issue of correspondence audits.  They really misuse the word "correspondence" because true correspondence should be both parties listening to each other and responding in plain English rather than with standard form letters that make it look like they did not read your correspondence.

The trial being conducted to move the system into the 21st century came from the observation of a system used in Sweden. The trial in Tampa, will enable taxpayers to go to the IRS office and log onto a computer to interact face-to-face virtually with a real person at the IRS who will have access to information and tools to resolve the issue.

I think this is great idea. Many businesses and individuals have been doing similar things for years, such as with GoToMeeting, WebEx, and Skype.

Kudos to the National Taxpayer Advocate.

What do you think?

Moving California's Tax System into the 21st Century

Governor Schwarzenegger has spoken a few times about the need to move the California tax system into the 21st century. This includes creating the Commission on the 21st Century Economy (COTCE) many months ago (their final report was issued in September 2009). Most recently, he mentioned tax reform in his State of the State address (1/6/2010).

A fact sheet accompanying the governor's State of the State address states:

"The Governor today encouraged the legislature to seize the opportunity to modernize and stabilize the tax structure while encouraging economic growth by taking up the bipartisan Commission on the 21st Century’s recommendations to restructure the way California funds state Government.

The current, outdated system produces dramatic fluctuations in revenue – these bust or boom cycles have made budgeting and funding of essential services year after year very difficult. The Commission’s recommendations are designed to broaden the tax base, making revenues less volatile while being fair and equitable for all Californians."

A few observations:

1. What is meant by the 21st century economy?

Well, this really wasn't discussed by the COTCE. Before the COTCE, California had the Commission on Tax Policy in the New Economy which issued a report in 2003. It engaged in discussion of what the new economy is. In addition, the statute that created the earlier commission described key elements of the "new economy." This included the following provision (I have highlighted terms that describe the 21st century economy).

"California’s current tax structure is largely based on a 20th century industrial economy that produced most of its wealth from manufacturing and agriculture. California’s 21st century technology-dependent economy is already based largely on information and services, part of a new global economy that is built on the rapid development of ideas and the exchange of information using multiple communications media. It is characterized by rapid restructuring of business-to-business and business-to-customer relationships in the state and across the world and a shift from production and consumption of tangible goods to use of intangible goods and services."

2. What elements of California's tax structure reflect the 20th century rather than the 21st century?

Here are a few:

• Consumption has changed: Consumption patterns began changing a few decades ago as people's consumption of services increased (likely tied to the increase in dual-worker households and increased wealth). The patterns continue to change due to technology which enables consumption of digital goods and more services (such as web hosting and consulting). California's consumption tax - the sales tax, is very much stuck in the 20th century because it only taxes consumption of tangible personal property. That is, buy your music on a CD and you owe sales tax, but download it onto your mp3 player and you owe no sales tax. The 2003 report of the New Economy commission recommended: "Broaden the sales tax base to include selected services, while lowering the state rate to retain revenue neutrality." I think this is the most obvious modernization needed. Why let the sales tax continue to just apply to 20th century consumption rather than 21st century forms of consumption? (I've written about this one a lot - here)
• Business models have changed: E-commerce enables businesses to have customers in all states even without a physical presence in the customer's state. This challenges 20th century tax models where physical presence and borders were more important. One issue it causes is that consumers have a growing amount of use tax they need to self assess. The New Economy Commission recommended that the Board of Equalization make greater efforts to collect use tax. This is an area where today's technology can help in addition to simplified compliance approaches. (I've written on this one too - here) California should also look into joining the Streamlined Sales and Use Tax Project as that will likely lead to the ability for the state to have remote vendors collect sales tax (rather than rely on consumers to self-report use tax).
• More fierce business and interstate competition for business: All states compete to keep high quality jobs in the US. To that end, lots of incentives are offered. This is often described as a "race to the bottom." The 21st Century Tax Reform Commission in Minnesota, which issued a report in February 2009, recognized this issue as well as the growing complexity of applying the state income tax to multistate corporations. They recommended repealing the corporate income tax. I think that is an idea worth considering. It simplifies the tax system (all of the incentives and efforts to create new ones goes away) and it ends tax planning efforts to move operations around to minimize state income tax. The state would still collect payroll taxes, property taxes, excise taxes and sales taxes.
• Growing income gaps: This seems to be a continuing reality. The California Budget Project has a nice overview of the issue in a June 2009 report. I think this means that overall equity in a tax system needs to be reviewed. This overlaps partly with the need noted above to broaden the base of the sales tax. Much of the consumption that is currently exempt is that of high-income individuals which makes the system inequitable. In addition, income tax structures should be reviewed to see if the income groups makes sense. For example, perhaps those with $100,000 of income should not be in the same bracket as those making over $500,000 (or even more).
• Greater attention being paid to climate change: California probably has the most ambitious targets for reducing greenhouse gas emissions among the states. Some type of polluter-pays tax to encourage people to reduce emissions makes sense, and will generate revenue allowing for some other tax rate to be reduced.

3. Do the COTCE recommendations move California's tax system into the 21st century?

I don't think so. For example, instead of recognizing growing income gaps, the COTCE recommended a significant income tax reduction to very high income individuals with most of that being replaced with a consumption tax which would fall upon middle- and low-income individuals disproportionately (in terms of the percentage of their income being used to pay the tax).

The COTCE's business net receipts tax (BNRT) proposal would likely encourage employers to purchase goods and labor from outside of the state and to try to get more employees to become contractors. The BNRT also relies on the ability to get out-of-state businesses to pay the tax on sales into California. However, a bill before Congress that I think will get enacted sometime in the next few years, would say that California could only collect BNRT if the business has a physical presence in California exceeding 15 days during the year. That would be a big blow to state revenues if the state general sales tax and corporate income tax had already been repealed and replaced with the BNRT. The BNRT has several issues that make it unlikely to be the vehicle to promote 21st century business activity and growth in California. (I've got more on this here and you can do a search using BNRT and economy and find many reasons why this would not be good for California).

The COTCE makes no mention of a polluter pays tax even though there were suggestions from at least one commissioner and public comment.

I hope the legislature will discuss how the existing tax structure both supports and hinders the 21st century ways of living and doing business so it can find the right ways to modernize our tax system so that it can promote a strong economy, society and environment.

What do you think?

Call for 21st century tax system by Georgia State Senator

Georgia State Senator Doug Stoner (D-Smyrna) had an op ed in The Atlanta Journal Constitution on 1/7/2010 entitled, "State suffers from revenue problem." I think he did a nice job explaining that tax systems need to be modernized and clarifying some misconceptions that can lead to continued weaknesses such as inequities and lack of transparency and accountability in tax systems.

He reminds readers that tax cuts for some mean tax increases for others. Consideration should be given to what the effect of such cuts is on overall equity in the system. He also notes that too often, tax breaks enacted under the guise of job creation, do not have any accountability measures associated with them so it is not known if the goal was reached. I'd add to this that such credits also are often enacted without any "clawback" provision that requires taxpayers to repay the tax if they ultimately do not create and keep the jobs created. Senator Stoner reminds us that no one would run a business this way. [Note: Tax Notes' blog has a post on 1/8/2010 about the lack of any proof that Georgia's tax credits for job creation are working.]

Senator Stoner concludes with a statement applicable to all states: "Georgia needs fundamental tax reform, linking our budget needs to a 21st century tax system. We must develop a fair and adequate tax structure that enables us to fund high-quality services and make long-term infrastructure investments in education, transportation and water resources, if Georgia is to prosper in the global economy."

Taxing Digital Products - Let's Also Use the Technology to Modernize Collection

When today's forms of taxes were created decades ago, there wasn't any technology to consider in making computations and collection easy. But that is not true today. While some states are slowly modernizing their laws to address new ways of living an doing business that are partly due to changes in technology, the technology as a tool of tax compliance and administration is often overlooked.

Tennessee enacted various tax law changes which the governor signed on June 5, 2008, including expanding its sales tax to include most digital goods provided the tangible equivalent is something already subject to sales tax. [SB 4173 enacted as Public Chapter Number 1006]

"The retail sale, lease, licensing, or use of specified digital products
transferred to or accessed by subscribers or consumers in this state shall be
subject to the tax levied by this chapter on the sales price or purchase price
thereof at a rate equal to the rate of tax levied on the sale of tangible
personal property at retail by the provisions of § 67-6-202."

The law defines various types of digital goods and notes a few exemptions. To determine where the buyer resides, the new law provides:
"(g) The tax imposed by this section shall apply to retail sales in this state, indicated by the residential street address or the primary business street address of the subscriber or consumer."

Thus, Tennessee joins New Jersey, Nebraska and a few other states that have modernized their sales taxes to include today's forms of consumption, although they don't also address using the technology for collection ease. For equity reasons and continuation of the tax base, as forms of consumption progress beyond what yesterday's legislators ever envisioned, such as the digital equivalent of tangible goods, including software and music downloads, a state needs to update its laws.

First - why include digital downloads in the sales tax base? As a consumption tax, there is no reason to tax a song sold on a CD that you'll play in your CD player, but not one downloaded online onto your MP3 player or computer to listen to. The result in both situations is the same - you enjoy the music. And both forms are consumption which is what a sales tax is designed to tax.

One argument sometimes voiced about including digital downloads in the sales tax base is that you may not know the location of the buyer. But, unless the song is free (in which case it is unlikely to be taxed unless it was bundled with something else that is taxable), the consumer is using a credit card which includes their address. While the credit card user could have the card registered in a different state, it is unlikely and there are ways to still require the user to let the credit card company know where the cardholder is located.

Another argument against taxing digital goods is that it will hurt Internet companies. This is a distractor argument. The sales tax is paid by the consumer, although collected by the seller if the seller has a physical presence in the state (if not, the buyer pays use tax on their own). Will people stop buying digital downloads because of sales tax? It seems unlikely because if they really want the product, their alternative is to buy the taxable tangible equivalent. Also, retailers of tangible personal property have been collecting sales tax for decades and they seem to be able to remain in business. Certainly, moving something from being non-taxable to taxable is shocking at first, but people will get used to it. If the states that are modernizing their laws to comport with today's ways of consuming and doing business help explain why the change is needed - equity, fairness, neutrality, to keep state tax bases from eroding, consumers are more likely to understand. And, the sooner the states update their laws, the better because the longer the delay, they are really indirectly educating consumers that digital consumption is not subject to sales tax.

Many states with sales tax, added it in the 1930s when digital goods were not in existence. So, most laws were written to apply to the key type of consumption - tangible personal property. If states had originally written their laws to apply to consumption of goods without using the word "tangible", digital downloads would have been taxable from the start and I don't think consumers would have questioned it. After all, if you pay sales tax on your music CD, why wouldn't you also pay it when you download the music onto your MP3 player to enjoy.
Another issue sometimes raised is the cost to vendors of collecting the tax on digital items. This is also a distractor in that other vendors have been incurring costs for decades to collect sales tax on the tangible items they sell. I do think though that vendors should recieve some relief for these costs, something very few states do today. I also think this is an area where technology could be better used to collect the tax. Again, when sales taxes were enacted decades ago, the use of technology to collect the tax was primarily paper and pencil.

Better Use of Technology:

Today, the sales tax could be collected by the state tax agency at the same time the buyer's credit card is billed for the item. This would enable the state tax agency to get the money sooner, there would be no need for the vendor to file any reports and it would still be transparent in that the buyer would see the sales tax charge when they buy the item. Checks and balances could still be in place in that in auditing a vendor, the state agency would primarily review the system for charging to see that it works as intended and check a sample of transactions to be sure the collected tax was charged by the correct state tax agency.

This sales tax billing system could also be used for tangible goods. Whenever the credit card is charged, the sales tax portion gets charged by the state tax agency. The credit card or other payment card would just need to have the customer's state noted or they could be asked at the register (already, many stores ask for a zip code - apparently for marketing purposes).
Let's truly act like we're in the 21st century and not only modernize sales tax to apply to the digital equivalent of tangible consumption, but use technology to make it easier and more cost effective for vendors, consumers and state tax agencies.

[For further information, see my 21st Century Taxation website.]

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.