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Friday, February 19, 2021

Spending in the tax law exceeds discretionary spending!

Figure from Feb 2021 CBO report
Figure from Appendix of CBO Report (Feb 2021)

On February 11, 2021, the Congressional Budget Office (CBO) released: The Budget and Economic Outlook: 2021 to 2031. It is grim as CBO estimates that the federal budget deficit for FY 2021 will be $2.3 trillion. But, that is $900 billion less than for 2020. The 2021 deficit is the second largest since 1945 (WWII) based on the deficit as a percent of GDP.

Something else interesting in the report is an appendix on tax expenditures. Tax expenditures are spending that exists in the tax law. For example, the American Opportunity Tax Credit provides taxpayers with a $2,500 tax credit for each of the first four years of college. While this government spending could have instead been given by a direct grant payable to the university to cover the students tuition, it was put into the tax law as a tax reduction. Whether as a tax credit or a direct grant, the financial effect to the government budget and the student are the same. Per CBO, there are over 200 tax expenditures (special rules) in the Federal income and employment taxes.

But, as a tax expenditure, the spending exists until Congress repeals it where as the Department of Education has to ask annually for funding for Pell Grants which are direct spending to help college students. As a tax expenditure, the spending is often overlooked as most people think government spending only exists in the budgets of government agencies.

For the past few years, discretionary spending and spending buried in the tax law have each been about $1.3 trillion. Now the CBO reports that for FY2021, tax expenditures represent $1.8 trillion of spending (8.2% of GDP) and "exceeds all projected discretionary outlays combined." [see pages 19-20 of the CBO report]

We tend to ask questions about discretionary spending such as why is $x spent on low-income housing or $x spent on something else but not ask why $25 billion is spent on subsidizing the mortgage interest costs of less than 10% of individuals who itemize and claim a mortgage interest deduction on their return (and 63% of this benefit goes to those with income of $200,000 of more [see JCT report, page 42]).

A few observations:

  • Transparency and accountability to taxpayers are violated when we bury spending in the tax law.
  • Most of these tax expenditures are exclusions and deductions which are designed to provide a greater benefit to taxpayers in higher tax brackets. How do they affect the progressivity of the tax system?
  • Special rules lead to violation of the neutrality and simplicity principles. 
  • Tax rates could be lower without the special rules.
  • How about adding a new form that lists the most common tax expenditures such as mortgage interest deduction and exclusion for employer-provided health insurance to help individuals see their tax savings from the special rules they use. That will also help them see the equivalent of "direct government spending" they are the beneficiary of.
What do you think? Should we pay more attention to tax expenditures? How?

Sunday, February 7, 2021

Ideas for States for Pandemic Tax and Budget Policies

picture of yard waste with several eatable oranges in it

My latest Moving Forward? article for Tax Notes State is: Suggestions for Pandemic State Tax Policy Endurance (12/17/20). I include a variety of suggestions to help individuals, businesses and state and local governments. I hope you'll take a look - here.

Examples:

  • Federally-declared disasters such as the COVID-19 pandemic allow the IRS to extend due datesfor tax returns and tax payments. Last year, the result was a July 15 due date rather than April 15. Most states followed suit. But a big deal for states is that their fiscal years end June 30. The shift of payments to the next fiscal year likely resulted in greater borrowing and costs for the states. However, many high income taxpayers were quite capable of paying taxes normally due on April 15 and June 15. The better message (and true for any future disaster) is to include a plea that if you can pay at the normal time, please do so to reduce costs to the state.

  • COVID-19 legislation included lots of new complexities. This, coupled with state and local rules for paid sick and medical leave, new tax credits and grants, etc. is often too much for many small businesses to deal with. A result is that some may have not claimed benefits they were eligible for or mandated to provide. State and local governments should have systems in place to provide help getting through all of the rules including some online tools. They should also seek assistance from the federal government on this as the benefits and mandates come from all levels of government. There are many retired finance and accountng experts who can help provide these services.

  • Some struggling businesses with tax obligations might prefer to give up unused assets than have outstanding bills that pile up interest and penalties or use cash that is needed for other purposes. A system to take non-cash payments such as buildings and equipment no longer needed, should be in place.

  • Despite tough times, consider clawbacks and safety requirements when grants and tax breaks are misused. For example, any tax break to help with the pandemic should have had the caveat that the business had procedures in place to reduce the spread of the virus. For example, a 1/18/21 Washington Post article reports that at least 5 anti-vaccine groups received PPP funds.

  • While many struggle in the pandemic, some individuals and businesses were doing fine or perhaps even with increased revenues. There is a need for ways to easily enable those doing well do help get supplies and other assets to those in need.  Platforms where people can match resources and needs can help, with governments providing some of the pick up and distribution outlets to help ensure safety of such a system.  My picture above of the oranges in the yard waste garbage is a good example of waste. There were many people who would have been thankful to have had these oranges someone with too many treated as garbage and likely did not have a good way to get them to someone who needed them.
There are more suggestions and perhaps the article will lead you to identify more relief ideas for now and going forward.

What do you think?

Sunday, January 31, 2021

We Need More Tax Policy Discussion

We have a few proposed changes under consideration that very much need a deep policy discussion rather than only a cost estimate and a general like or dislike. Here are three such items:

1. What is an appropriate phase-out rule for the next economic impact payments? The current ones cause a credit to still be allowed for high income taxpayers who have a few children. The CASH Act (H.R. 9051; 116th Congress) that the House passed late 2020, called for EIP of $2,000 including for dependents. If a married couple has 4 dependents, they credit would be $12,000. The phaseout rule would not cause this entire credit to reach $0 until AGI reached $390,000!  That is not an income level in need of assistance typically.

2. Should the TCJA be made permanent? On 12/22/20, Senator Grassley sent a letter to President-elect Biden suggesting this. While this could be done with a single piece of legislation, it really needs major tax policy discussions. This should include what the goals were of the TCJA beyond the need to reduce the corporate tax rate and move the international tax system for businesses to be more territorial rather than worldwide. Examples of things to discuss:

  • What is the proper rate structure for all buisnesses and individuals. For individuals, a discussion of progressivity and relevance for capital gains and ordinary income as well as looking at the impact at each quintile as well as top 1% and further breakdown that top 1% given the income range from 6 figures to 9 figures.
  • Besides the rate, the base is crucial. What are appropriate deductions and exclusions and phaseouts for any of them?
  • The TCJA denied deductions to employers for certain employee fringe benefits. Seems the more appropriate policy is to allow the business to deduct its normal business expenses and any desire to have wage income equal wage deductions should be done via repeal of certain fringe benefits. Also, transparency and accountability are missing from one of these changes - the denial of a deduction by an employer providing qualified transportation fringe benefits. Why wasn't that prohibition put in section 162 or at a new section 280I? Placing it in section 274(a)(4) makes the exceptions at section 274(e) applicable so some of these QTF expenses are actually deductible.
  • And there is more.  And just a reminder that for the Tax Reform Act of 1986, there were extensive reports written in advance and lots of hearings (for about a year).

3. Should the TCJA $10,000 SALT cap be changed and how? The policy discussion need to include is the point of limiting all taxes of individuals? This is not a new topic as denial of the deduction was proposed back with the Tax Reform Act of 1986. The current SALT cap includes state and local income taxes that sole proprietors and partners pay on their business income even though corporations have no such limitation. Such taxes should be a deduction for AGI. A common argument about tax deductions is that they are mandatory payments. That is true, but some have some optional aspects to them. For example, if someone buys a very large home or a second home, that is their choice. Why should they deduct all of their property taxes? That deduction can be limited to the property taxes on a median priced/sized home for that county and just one home. These are just examples of some of the discussions needed here. This makes more sense than writing regs and encouraging states to enact optional or mandatory income taxes on partnerships and S corporations which the IRS has said it will treat as above the line even though the owners still report the income on their federal income tax return. [See Notice 2020-75]

What do you think?

Monday, January 25, 2021

Federal Tax Guidance Considerations


To help figure out all of the COVID-19 tax law changes enacted since March 2020, we have seen a variety of
guidance from the IRS. This includes FAQs and some items just posted to an IRS website. These are non-binding items. Some guidance was published in the weekly Internal Revenue Bulletin (revenue rulings, revenue procedure, notices and announcements) so is binding on the IRS.

Since these changes mostly expired in less than one year, there wasn't time for public comment and binding guidance for everything. Taxpayers and practitioners wanted insights as quickly as possible.

But what about other tax rules that are here for longer? Why aren't regulations used mroe often particularly for unclear areas where public comments would be useful. For example, some of the information on taxation of virtual currency are FAQs or a revenue ruling where there was no public comments and there are issues as to whether the guidance is correct.

I've got a short article in the AICPA Tax Adviser that delves into types of guidance and some current issues. As this excerpt notes, the National Taxpayer Advocate has concerns too. "FAQs can be renumbered, removed, or modified with no archival remnant to help in finding the original. That is, the IRS has no responsibility to archive FAQs and other items only published on its website. In contrast, items published in the IRB are in a permanent depository. In a July 7, 2020, blog post, available at taxpayeradvocate.irs.gov, National Taxpayer Advocate Erin M. Collins noted this FAQ problem and described it as a violation of the Taxpayer Bill of Rights, namely, the rights to be informed and to a fair and just tax system."

Please check it out as it explains various IRS pronouncements and their differences and issues, including a chart that I hope you find useful - here.



Saturday, January 2, 2021

Tax Policy Observations of COVID-19 Legislation


The FFCRA and CARES Act enacted in March 2020 and CAA-21 enacted Dec. 27, 2020 provide a variety of financial relief to individuals and small businesses. The recovery rebates (called "economic impact payments" by the IRS) in the CARES act ($1,200 per adult and $500 for child under age 17) helped over 160 million people. The $600 payments in CAA-21 should help a similar number.

Is that the best way to help? There was also increased and longer payments of unemployment compensation to clearly help those who lost their jobs. There were changes to allow those with sufficient retirements accounts to pull out up to $100,000 without penalty and even to pick it up into income over three years as well as to pay it back.

The changes also included odd ones or odd features. I call them odd because the purpose was to help people in financial need. Yet rebates went to retired individuals who likely continue to have their same income despite the pandemic. While they may have extra costs of obtaining food and household items, perhaps a greater benefit would have been for state and local governments to get funds to help people unable to get to the store safely to get items delivered or to help them make online orders.

The recovery rebates phase-out at specified income levels shown below without any child credit:


The way the phaseout works, is that individuals continue to get them the larger their original credit is. So the more children, the more income someone can have and still get a credit. For example, a married couple with four children under age 17 can still get a very small credit at just under $238,000 of adjusted gross income (AGI).  The full credit would be $4,400 [($1,200 x 2) + ($500 x 4)]. Here is that formula:

   ($AGI - $150,000) x .05 = $4,400

   AGI of $238,000 brings the credit to $0

Is that the right policy? Does anyone with over $150,000 of AGI need assistance? Certainly some might, but most likely do not. Per the U.S. Census Bureau, for 2019, median household income was $65,712.

It will really depend on many factors as to need. For example, some people continue to earn the same amount of income before and during the pandemic. Again, there might be increased costs, but also likely some decreased costs (such as travel, gasoline, etc.).

Some people needed more than what they got while some got money they did not need. And some of these folks found ways to get the money to those in need.

The cost of the CARES Act recovery rebates was $292 billion. Some of this went to people who didn't need it and some needed more. What is an alternative to better target these needed funds?

A bigger policy issue with CARES and CAA-21 is that limited funds were used for.  Here is an example from both acts.

CARES - The IRC Section 461(l) loss limitation of the Tax Cuts and Jobs Act was delayed three years. The estimated cost was $170 billion. That is 58% of the cost of the recovery rebates. The policy issue is that the roughly 130,000 individuals who got the benefit of the $170 billion are generally very high income individuals who most likely don't need assistance. How does a bill get enacted that provides $292 billion to over 160 million individuals and 58% of that amount to benefit 130,000 individuals? Or stated another way: how is relief designed to help less than 1% of individuals who don't need it by giving them 58% of what is given to help 160 million individuals?  Without the section 461(l) change, the 160 million could each have received about $1,060 more!

CAA-21 - Included extending 33 items that expired at 12/31/20. While some are likely worth extending, there was no policy discussion on this and it wasn't an immediate need. The cost of the CAA-21 recovery rebates was $164 billion. The cost of the extenders was $104 billion or 63% of the cost of the rebates. So, the rebates could have been $650 higher and we could have delayed or ended a special 7 year life for motor sports complexes and 3 year life for racehorses, among many other extended tax rules.

How did the above happen? It is puzzling. The House passed the HEROES Act in May 2020 with  various COVID change including putting back the effective date of section 461(l) on losses. But why didn't they notice the effect or realize that only a few thousand individuals had losses subject to that TCJA provision? 

Possible solutions:

1. Require a distributional analysis of all provisions before a vote.

2. Show the tax benefit (or cost) per person affected.

3. Make the above available not only to lawmakers, but also the public.

What do you think?