Missouri to Examine Tax Credits

A recent post noted a proposal in Oregon to add sunset dates to many tax breaks in order to bring some scrutiny to them which otherwise does not exist as it would if they were instead budget line items. Another post noted a proposal in Florida to review all of the sales tax exemptions and the exclusion for services.

And a new one - there is a proposal in Missouri to examine all tax credits. In a 10/26/09 "dear colleague" letter, State Senator Crowell states:

Looking at the state’s current fiscal situation, it is my opinion that the General Assembly should provide itself with as many options as possible as we begin to make the tough decisions inherent in our state budget. In an effort to afford Missouri Legislators with an option, I am respectfully proposing that Missouri’s tax credit programs be made subject to the appropriations process.

Tax credits play a vital role in Missouri’s economical development, but these cannot be an entitlement and should compete for Missouri’s limited amount of resources against basic services provided by the state. By being subject to the appropriations process, the General Assembly will be able to provide greater accountability on how Missouri uses tax credits and have a greater ability to ensure our shared budgetary priorities are preserved.

A 11/25/09 article in the Kansas City Star, Missouri lawmakers call for closer look at tax credits, states that in 2008, $438.6 million of credits were claimed.

I've discussed this a few times - the need to periodically review tax expenditures to see if any no longer serve a legitimate purpose or should be modified or reduced (see 11/19/09 post). With states in need of revenue, it would be a good time to see if any expenditures should be phased out to generate needed revenue now and going forward. In better budget times, it is too easy to let unneeded or ineffective deductions and credits be ignored. In tougher budget times, it is inappropriate to jump to rate increases rather than doing the more difficult work of removing unneeded subsidies buried in the tax law.

What do you think?

21st Century Expectation for the IRS - Health Care Enforcer?

Some aspects of the complicated health care legislative proposals have been in the news in the past few months, but it seems that little attention has been paid to some of the tax provisions. Certainly, we should all be used to tax provisions designed to modify behavior. But what about the health care proposals that impose new duties on the IRS? Is this what we expect tax agencies to be doing now or in the future?

The Kiplinger Tax Letter of 11/25/09 describes the likely effect as follows:

"The Service will grow by leaps and bounds as it puts a slew of tax changes related to health care into effect and sets up systems to enforce the rules." [subscription needed]

Some of these possible new duties of the IRS include information collection and enforcement of new excise taxes on employers not providing health benefits and credits for small businesses to help them provide benefits (Sections 501, 511, 512 and 521 of House-passed H.R. 3962).

When you think about it, the whole system seems odd. Due to a rule enacted decades ago regarding employee compensation levels, some employers started providing health insurance benefits. The system grew and employer-provided health benefits became a norm - unlike car insurance which we handle on our own. "Reform" includes keeping this odd system and even has the IRS playing a greater role in the delivery of employer-provided health benefits. I'm only aware of one proposal in the past few years that proposed to break the link between employment and health care - Senator Wyden's S. 334 (110th Congress), the Healthy Americans Act (more info here).

While technology should be allowing the IRS to be more efficient and perhaps not need to replace all of the employees who are retiring soon, new mandates could cause it to grow, without any positive impact on reducing the tax gap! That seems like a poor use of tax agency talent and expertise. I don't see that as helping the IRS move into the 21st century. Why not look for a health care reform option that doesn't shift so much work and enforcement activity to a tax agency?

What do you think?

Costs of Reducing Greenhouse Gas Emissions

The CBO released an issue brief on 11/23 - The Costs of Reducing Greenhouse-Gas Emissions (also see the CBO Director's blog entry on this which has links to several other CBO reports on this topic). The report provides some guidance on the costs and the challenges of estimating them.

The report states that market-based approaches, such as cap-and-trade allowances and taxes, are likely to be less expensive than the command-and-control approaches (nothing new there). I'm glad to see the CBO report continue to talk about GHG emission taxes rather than only the cap-and-trade approach in the House passed H.R. 2454 because I think we need to have a real discussion on the varying approaches, their pros and cons in terms of operations and effect and only then, see a bill passed in Congress. The following excerpt from the report is an example of why we should have a serious discussion of cap-and-trade versus tax before committing significant costs to creating and maintaining a cap-and-trade system:

“Most experts conclude that, in the face of such uncertainty, policies that set the year-by-year price of emissions to be consistent with the projected incremental benefits of reducing emissions (as with a tax) would probably yield higher net benefits than policies that specified year-by-year caps on emissions or even a cap on cumulative emissions over many years. The cost of meeting a fixed emission cap is likely to vary substantially from year to year—depending on the weather, economic activity, and the price of fossil fuels. A tax would ensure that firms and households had an incentive to make all reductions that cost less to achieve than that expected incremental benefit. By contrast, a cap could easily generate incremental reductions that cost substantially more or less than the expected benefit.” [p. 4; footnote omitted]

We have some structures in place that would make implementation of a GHG tax less expensive than creating and maintaining a cap-and-trade system. For example, the gasoline excise tax could be increased. Also, utility companies could collect a tax from their customers with the tax adjusted for the percent of energy produced from renewable sources. We know from recent high gasoline prices, that people do respond to them. That awareness leads to behavior changes that will further help to reduce GHG emissions.

Assuming Congress gets back to climate change issues, I hope that despite a House-passed cap-and-trade bill, that the Senate will pursue a discussion of that approach compared to a tax approach.

What do you think?

Florida Idea for Modernizing its Sales Tax

All tax systems have exemptions, exclusions or special rules of some type. Often they are enacted because they seem important at the time. However, if enacted without an expiration date, they can easily remain forever even if no longer needed. For example, many systems have some type of tax break for seniors. Decades ago, many seniors were poor. However, that is not the case today so any system that provides an automatic exemption of some type based on age, should probably be changed to be based on income level instead. California's personal income tax system has this issue (for details - click here).

A Florida senator has proposed a system to review all of the state's sales tax exemptions. SB 216 introduced in Florida in October 2009 calls for the Joint Legislative Sunset Committee to review the states sales tax exemptions over a 9-year period (with 1/3 reviewed over three year periods). They are to recommend whether current and future exemptions be retained, repealed or modified. They are also to review the exclusion of sales of services from the sales tax base. The reports are due November 1, 2010, March 1, 2011, and July 1, 2011. Future review reports are due on December 1.

Exemptions for groceries, medical, guide dogs for the blind, and household fuel are protected. To put some strong effect into the proposal, it also provides that "any exemption from the state general sales and use tax or exemption from imposition of such tax on sales of services which is not prohibited from review by the committee ... and is not modified or reenacted by the end of the regular session after any 9-year review period is repealed on July 1 after the end of the regular session immediately after the 9-year review period."

The rationale for SB 216 includes:

1. Budget problems that "require the state to consider innovative solutions in addressing the long term viability of the state's tax structure."
2. The need for individuals to be treated "fairly and equitably" under the tax structure.
3. The need for sales tax exemptions to "serve an important state interest and ... be uniform in the effect on residents."
4. The belief that "periodic sunset and review of all sales tax exemptions will serve to restore fairness to the state's tax structure."

"In developing the evaluation criteria, the committee shall consider the following principles of taxation:

(a) Equity.—The Florida tax system should treat individuals equitably. It should impose similar tax burdens on people in similar circumstances and should minimize regressivity.

(b) Simplicity, transparency, and compliance.—The Florida tax system should facilitate taxpayer compliance. It should be simple and easy to understand and should provide visibility and awareness of the taxes being paid.

(c) Neutrality.—The Florida tax system should affect taxpayers uniformly and consistently. The primary purpose of any tax should be to raise revenue for appropriate governmental functions, rather than to influence business and personal decisions.

(d) Stability.—The Florida tax system should produce revenues in a stable and reliable manner that is sufficient to fund appropriate governmental functions and expenditures.

(e) Integration.—The Florida tax system should balance the need for integration of federal, state, and local taxation.

(f) Public purpose.—Any sales and use tax exemption or exclusion under the Florida tax system should be based upon a determination that the exemption or exclusion promotes an important state interest and should benefit citizens as equally as possible."

Oregon recently did something with similar effect - it added sunset dates to most of its exemptions and exclusions (here).

I think the Florida proposal is a good one. Special tax rules that provide some type of tax break or subsidy can easily get buried in the system and remain even if not best addressing the original problem or no longer needed. With states hurting for money, it is past time for them to take a careful look at updating their tax systems (also see my last post of 11/19/09).

California's continuing budget shortfalls and appropriate tax changes

On November 18, 2009, the California Legislative Analyst's Office released a report - California's Fiscal Outlook: The 2010-11 Budget. The LAO projects an upcoming budget shortfall of about $21 billion.

In addition to more spending cuts, it makes sense to also consider this the time to address unnecessary spending that is buried in the tax law. For example, why should California continue to allow a deduction for mortgage interest on second homes and on home equity debt? Also, let's phase down the allowance of mortgage interest on debt greater than the median home price (which is under $500,000; the current debt limit is $1 million as used in federal law). There are others as well. I've written about this before - here.

Also, it is past time to broaden the sales tax base to tax more types of personal consumption. While we do have a budget shortfall, it would still be appropriate - both due to our already very high sales tax rate and because there is a lot of revenue potential in the currently untaxed consumption, to LOWER the sales tax rate at the same time. Good candidates for the initial phase of broadening the sales tax base would be to start taxing digital downloads by consumers (other states are already doing this including Wisconsin, Washington, Mississippi, New Jersey, Tennessee and a few others). Also, entertainment - concert, theater, and movie tickets would be appropriate.

These changes would not only help balance the budget, but would modernize the tax system and bring greater equity to it. California's fiscal system has a variety of problems. Continued shortfalls should be a wake up call to stop subsidizing million dollar mortgages and some other questionable tax expenditures, as well as to address an eroding and inequitable sales tax base that has led to a rate that is too high. Other changes are also needed, I just mention these few as starters.

What would you propose?

Software and Income Tax Nexus

Companies that transfer software to customers that are not in the same state and the software company face issues as to whether income tax is owed in the state where customers are located. Nexus guidance of PL 86-272 only applies if the transaction involved the "sale" of "tangible personal property." Software transactions generally challenge both of these terms. That is,

• Software is typically "licensed" rather than "sold." However, for prewritten/canned software, the result looks a lot like when one buys a book. Tax rules have typically viewed this as equivalent of a "sale" (such as Income Tax Reg. Section 1.186-18).
• Software is really intangible. Considering physics, it has no mass. However, cases and state laws have sometimes either just labeled prewritten software as tangible (typically so they can apply sales tax to it) or may find it to be tangible because it is on tangible media or needs to be on tangible media (such as a hard drive) to function. However, for federal depreciation rules, software is intangible (see for example, Internal Revenue Code Section 197).

So, it would seem that PL 86-272 can never apply to software. However, that was not the result found in a recent NJ Tax Court decision involving two different software vendors who transferred canned software on tangible media (AccuZIP and Quark).

I've got a short article from the AICPA Corporate Taxation Insider (11/12/09) that summarizes the case and explains some of the income nexus issues - see Software and Nexus.

Need for Penalty Reform at Federal Level

There are about 130 civil penalties in the Internal Revenue Code. That seems like far too many to me. Too many penalties can cause them to not be as effective - people can't possibly know of them all - including Revenue Agents. This is an area that has been studied extensively over the past 12 years, but no actions have been taken.

I've got a short article that notes the numerous studies on penalty problems and the need for reform and summarizes some of the key problems and solutions. It is from this week's AICPA Tax Insider - here.

Penalty reform is one of the many areas where it is time to "stop studying and act" (as I've noted before in a Tax Notes article)

What do you think? How would you fix this monstrosity of a compliance and enforcement tool?

Tax Reform Reruns - What Will Change This Time?

On December 4, 2009, President Obama's tax reform group is to issue its report. It is not intended to include recommendations for major reform, but to address simplification, the tax gap and corporate "loopholes." Yet, it could easily be a starting point for larger scale reforms. Last year the Senate Finance Committee held hearings in anticipation of reform and Congressman Rangel introduced H.R. 3970 in the 110th Congress calling for significant changes to the tax law. The Tax Council Policy Institute in DC is holding its February 2010 program on Tax Reform: In Search of a 21st Century U.S. Tax System (nice title!)

I came across a 1996 report I wrote for the Tax Foundation on many aspects of tax reform (this was back when Congressmen Archer and many others were last seriously considering major federal tax reform) - here. Despite the age, the explanations and issues explained in the report are all mostly still relevant today. For example, here is an excerpt on some issues to be addressed in the tax reform process.

"What are the goals of tax reform? Various goals have been offered for why major federal tax reform should occur. Not all goals are achieved under all proposals . In addition, some of the goals, such as simplification, are achievable by "tinkering" with our current tax system . In order for effective reform to occur, Congress (and the public) should carefully identify the goals to be attained so that an appropriate and worthwhile debate can follow .

Should/can taxes be reformed without spending reforms? Current discussion focuses on government revenues and how they should be assessed . But, what is the goal from the spending side? The present income tax system includes hundreds of indirect government "subsidies" in the form of special tax rules designed to encourage certain activities, such as the research tax credit and charitable deduction . These tax preferences are also referred to as tax expenditures . If the government believes that these indirect expenditures or subsidies are worthwhile, will they be converted from indirect subsidies to direct subsidies under a new tax system or otherwise incorporated into the new system? For example, if the research tax credit is removed, will the value of that indirect subsidy be converted into direct government subsidies? If the child care credit is eliminated, will the current level of this subsidy be continued in another form, such as government funded child care centers?

Employment tax reform. Can or should federal income tax reform realistically occur without reform of employment taxes. For example, if federal income taxes are reformed first and later employment taxes are reformed by raisin g the tax rate for social security and Medicare taxes, would public outcry follow?

Simplification. Will the new system by simpler than the present system? Perhaps some complexities, such as international issues and those involving innovative financing cannot easily be removed . Another complexity that could arise is where a system requires non-cash employee benefits to be valued . For example, the Hall-Rabushka flat tax book notes that an employee would be required to include the market value of stock options received from the employer, when received, and whether or not exercised . The valuation of stock options when received is difficult and has already been a major issue with respect to financial accounting rules. Are the touted simplifications of the proposal legitimate? For example, a single tax rate does not necessarily make a tax system simple because taxpayers use tax tables and computers. Also, removal of the mortgage interest deduction is not simplification because little recordkeeping is involved . (However, removal of the deduction does remove federal income taxes from the home-buying decision.)

Efficiency. Does the reform proposal remove distortions from the current tax system that tend to affect decisions to work, invest, or spend? For example, the current tax system may affect investment decisions due to the difference between capital gains and ordinary income tax rates . Also, does the tax proposal remove distortions caused by differences in tax rates (such as where a corporation in a 35% tax bracket borrows from an individual in a lower tax bracket), preferences for different types of income (such as fringe benefits), and the double taxation of corporate income which can affect business entity decisions ?

Change in tax burden. If the proposal is intended to raise the same amount of revenue as under our current tax system, will the distribution among income groups be the same? If not, who will pay more and who will pay less ? (Who will the winners and losers be?) How easy will it be to make this determination when the tax base has changed and the distribution of the burden between individuals and businesses may have changed? For example , flat tax proponents stress that investment is taxed at the source (business level) rather than also at the individual level. However, will the incidence of that tax at the business level be shouldered by the investors/owners, or won't some also be shouldered by employees? How can this be determined? Where will the incidence of the new tax fall as between a businesses' owner and employee or individuals? Where will it appear to fall? For example, under a subtraction VAT where only businesses file tax returns, the tax would appear to fall on the businesses' owners and employees . Where does the burdens of corporate taxes fall under our current tax system? If the incidence of the tax changes, what will be the affect ? Will the incidence of the new tax fall among different types of industries similarly to our current system? If not , who will the winners and losers be? For example, some industries tend to have little debt (such as high tech) and might therefore be "winners" under a tax system where interest expense is not deductible .

Global competitiveness. How would the new system affect the ability of businesses to compete globally?"

What do you think? What is the biggest obstacle to reforming our federal system which clearly has issues of complexity, a large tax gap, hinders global competitiveness for US firms, etc.?

Health care reform and our tax law

Health Care Reform Needs to Reach the Buried Treasure

Much of the current health care debate is about how to provide coverage to everyone. Current reform proposals would cost about $100 billion annually and will drive up deficits for years. Meanwhile, buried in our tax system are billions of dollars of health care benefits that go to a select group. Why is there no reform plan with a smaller price tag that doles out more equitably the federal dollars going to this select group?

The select group? Employees with employer-provided health insurance. Despite the fact that employers can deduct their costs of providing that insurance, the employees are not required to report it as income.

For example, if Jane's employer pays $10,000 for her health insurance, Jane does not have to treat that benefit as income. If Jane is in a 35% tax bracket, the benefit to her is a $3,500 lower tax bill. But really, Jane is even further ahead because she did not have to write a check for the $10,000 of insurance coverage. Asking Jane to pay tax on even half of the insurance benefit she gets is still a great deal for her (she'd get $10,000 of coverage at a cost of $1,750).

At about $117 billion per year, this special rule is one of the most expensive tax breaks in the federal tax system. This special rule benefits only the 60% of individuals with employer-provided health care coverage. Because this benefit is part of the tax law, it's cost is buried. You won't see any federal agency with an expenditure of $117 billion for issuing payments to individuals to subsidize their health insurance premiums.

Reducing this tax break would free up funds that could be used to provide a government benefit to everyone. Change would also make the system more fair by treating employees with employer-provided insurance similarly to individuals who must purchase their own insurance. For example, the health care benefit could be included in wage income with a capped deduction or tax credit for health insurance available to all individuals whether they buy the insurance on their own or get it from their employer.

The current reform plans are too expensive and it is wrong to ignore the buried treasure that could be dug up and used to reduce the cost as well as to spread federal health care dollars more equitably.

Changing nature of work and technology

I've written about this a few times before* and hope to someday (soon) complete a more thorough analysis of economic, social, technological and environmental trends and how they illustrate where our tax laws are out of date and how we might change them to make the most of current technologies and ways of doing business.

I saw a short video today released by the AICPA to recruit young people to become CPAs, that highlights some of these trends, such as that young people entering the workforce today will want to work from outside of the office. After all, why be tied to an office from 8 - 5 (although I recall it was 8 am to 2 am most of my days in public accounting - a long time ago) if you can reach clients and conduct research from anywhere? Even client and employee recruitment will continue to change.

Some of the tax questions this raises is the reality that we will have a more mobile workforce and location will really matter less in a firm's ability to generate revenue. People will expect to be able to communicate with their advisers and tax agencies just as they might on a social network.

The video can be found here. Here is more of the AICPA "Start Here, Go Places" recruitment campaign.

What do you think - (1) of the direction the tax law needs to move to be in the 21st century - and (2) of the video?

* Some prior posts and writings on trends and tax reform:

• 6/16/08
• "Strive for a Sound and Respected Tax System" (9/09)