Month: January 2013

A new working paper on tax reform options from Citizens for Tax Justice has a section describing a category of revenue-raising proposals that has not received much attention: ending tax shelters for investment income. As former Treasury Secretary Larry Summers noted in a recent op-ed: “What’s needed is an element that has largely been absent to date: [reducing] the numerous exclusions from the definition of adjusted gross income that enable the accumulation of great wealth with the payment of little or no taxes.”

The problem addressed by these proposals is partly related to the problem posed by the special, low rates that apply to capital gains and stock dividends. (Congress certainly needs to eliminate those special rates, so that investment income is taxed just like any other income.)

The breaks and loopholes criticized by Larry Summers and explained in CTJ’s new working paper allow wealthy individuals to delay or completely avoid paying taxes on their capital gains — at any rate. It does not matter what tax rate applies to capital gains so long as the wealthy can use these shelters to avoid paying any tax at all.

Path to Reform that Taxes All Income at the Same Rates

If these tax shelters are eliminated, that may make it easier for Congress to tackle the other problem with investment income — the special low rates that apply to investment income that takes the form of capital gains and stock dividends. Currently, the Joint Committee on Taxation (JCT), the official revenue estimator for Congress, assumes that people will respond to hikes in tax rates on capital gains by holding onto their assets or finding ways to avoid the tax, reducing the amount of revenue that can be raised from such a rate hike. (CTJ has explained why JCT’s assumptions are overblown in the appendix of our 2012 report on revenue-raising options.)

But if the various shelters that people use to avoid taxes on capital gains are closed off, JCT could logically assume that raising tax rates on capital gains will raise substantially more revenue.

Tax Capital Gains at Death

The tax shelter that is probably the largest, in terms of revenue, is the “stepped-up basis” for capital gains at death. Income that takes the form of capital gains on assets that are not sold during the owner’s lifetime escape taxation entirely. The heirs of the assets enjoy a “stepped-up basis” in the assets, meaning that any accrued gains at the time the decedent died are never taxed. (The estate tax once ensured that such gains would be subject to some taxation, but repeal of three-fourths of the estate tax has been made permanent in the fiscal cliff deal.)

The justification for the stepped-up basis seems to be the difficulty in ascertaining the basis (the purchase price, generally) of an asset that a taxpayer held for many years before leaving it to his or her heirs at death.

But this difficulty (which is decreasing rapidly because of digital records) does not justify the sweeping rule allowing stepped up basis for all assets left to heirs — even assets that have a clearly recorded value and assets that were only acquired right before death.

It is also not obvious that this difficultly with determining the basis is that different after the death of the owner of the asset. Consider an asset that was held for, say, 40 years and bequeathed at death and an asset that was held for 40 years and then sold to fund the taxpayer’s retirement. In the former situation, the gains that accrued over those 40 years are never taxed, but in the latter situation they are taxed. But any difficulties in determining basis would seem to be the same in these situations.

The proposal to tax capital gains at death, and the others described in the working paper, challenge some breaks that wealthy individuals and their accountants and lawyers are deeply attached to. But the vast majority of Americans whose income takes the form of wages are not able to use these maneuvers to delay or avoid taxes on their income. They would have trouble understanding why these tax shelters for the wealthy should be preserved while Congress considers dramatic cuts to public investments that support all Americans.

Comprehensive New 50-State Study Provides Detailed Profiles and Comparisons of Tax Systems and Distribution Including “Terrible Ten” Most Regressive States

State tax systems take a much larger share from middle- and low-income families than from wealthy families, according to the fourth edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States,” released today by the Institute on Taxation and Economic Policy (ITEP).  Combining all of the state and local income, property, sales and excise taxes state residents pay, the average overall effective tax rates by income group nationwide are 11.1 percent for the bottom 20 percent, 9.4 percent for the middle 20 percent and 5.6 percent for the top one percent. The report is online at www.whopays.org.

The ten states whose tax systems are tilted most heavily towards high earners (from most to least regressive) are Washington, Florida, South Dakota, Illinois, Texas, Tennessee, Arizona, Pennsylvania, Indiana, Alabama. In these states, middle-income families pay up to three times as high a share of their income as the wealthiest families; low-income families pay up to six times as much.

“We know that governors nationwide are promising to cut or eliminate taxes, but the question is who’s going to pay for it,” said Matthew Gardner, Executive Director of ITEP and an author of the study. “There’s a good chance it’s the so-called takers who spend so much on necessities that they pay an effective tax rate of 10 or more percent, due largely to sales and property taxes.  In too many states, these are the people being asked to make up the revenues lost to income tax cuts that overwhelmingly benefit the wealthiest taxpayers.” State consumption tax structures are particularly regressive, with an average 7 percent rate for the poor, a 4.6 percent rate for middle incomes and a 0.9 percent rate for the wealthiest taxpayers nationwide.

The income tax in particular is being targeted for elimination by self-described tax reformers across the country, and Who Pays? shows that of the ten most regressive states, four do not have any taxes on personal income, one state applies it only to interest and dividends and the other five have a personal income tax that is flat or virtually flat across all income groups.  “Cutting the income tax and relying on sales taxes to make up the lost revenues is the surest way to make an already upside down tax system even more so,” Gardner stated.

The data in Who Pays? also demonstrates that states commended as “low tax” are often high tax states for low- and middle- income families.  The ten states with the highest taxes on the poor are Arizona, Arkansas, Florida, Hawaii, Illinois, Indiana, Pennsylvania, Rhode Island, Texas, and Washington. Noted Gardner, “When you hear people brag about their low tax state, you have to ask them, low tax for who?”

The fourth edition of Who Pays? measures the state and local taxes paid by different income groups in 2013 (at 2010 income levels including the impact of tax changes enacted through January 2, 2013) as shares of income for every state and the District of Columbia.  The report is available online at www.whopays.org.

Lawmakers in North Carolina are looking seriously at repealing the state’s personal and corporate income taxes, and replacing them primarily with a larger sales tax.  As is often the case with plans to gut the income tax, the proposal is being sold as a way to “kick-start” the state’s economy.  In an attempt to bolster that argument, a conservative group in North Carolina called Civitas recently hired supply-side economist Arthur Laffer to write a report claiming that 378,000 new jobs and $25 billion in new income could be created through income tax repeal.  Our partner organization, the Institute on Taxation and Economic (ITEP) took a close look at the study and found that, as with Laffer’s previous work, the study is severely flawed to the point of making it entirely useless.  Among the study’s many flaws:

– Fails to control for a large range of important non-tax factors that affect state economic growth.
– Confuses cause and effect by assuming that recent declines in personal income were due to taxes rather than the Great Recession.
– Does not explain, or completely ignores, the economic impact of various tax changes it proposes to pay for income tax repeal.
– Cherry-picks blunt, aggregate economic measures in comparing state economies, and simply asserts that tax policy is the driving force behind these measures.
– Ignores the important role that public investments have to play in any successful state economy.

ITEP concludes that “In proposing a policy course that no state has ever taken—repealing the personal and corporate income taxes without a wealth of oil reserves to fall back on—ALME and the Civitas Institute have laid out an untested plan without any evidence that it will benefit the state’s economy.”

Read the full ITEP report

On Friday, the IRS held its EITC Awareness Day, working with local governments, non-profits and community groups to ensure that people potentially eligible for the Earned Income Tax Credit (EITC) file tax returns and claim it. The IRS says that one in five who are eligible for the EITC do not claim it.

The EITC, which is basically a tax credit equal to a certain percentage of earnings (up to a limit) to encourage work and reduce poverty, is widely misunderstood by many pundits and members of Congress. Like the Child Tax Credit, the EITC is a refundable tax credit, meaning it provides a benefit even when the credit is larger than the federal personal income tax that a taxpayer would otherwise owe. This can result in a negative income tax, meaning the IRS will send a check to the taxpayer.

These refundable credits are one reason why some Americans do not owe federal personal income taxes. (There are other reasons as well, like the fact that most of the Social Security benefits that retirees and people with disabilities receive are not subject to the income tax.)

Conservative Opposition to 2009 Expansions of EITC and Child Tax Credit

For the past couple years, conservative politicians and pundits have largely missed or ignored the fact that taxpayers with a negative income tax rate resulting from refundable credits do pay other types of taxes, which tend to be regressive. Federal payroll taxes, to take one example, are paid by everyone who works (and the EITC and the refundable part of the Child Tax Credit are only available to those with earnings). And all Americans pay state and local taxes, which are particularly regressive. The refundable credits in the federal personal income tax offsets some of the regressive impact of these other taxes.

Conservative politicians actually came out against expanding the EITC and the refundable part of the child tax credit in 2009, when President Obama proposed expanding the EITC for larger families and families headed by married couples and expanding the refundable part of the Child Tax Credit for very-low income working families. Those provisions were included in the economic recovery act enacted in 2009 and again in the deal the President made with Republicans at the end of 2010 to extend all the expiring tax cuts for another two years.

But each time Congressional Republicans introduced a proposal to extend tax cuts, it allowed these particular provisions to expire. CTJ’s figures showed what was at stake if these 2009 provisions expired. For example, CTJ’s state-by-state figures showed that in 2013, benefits for 13 million families with 26 million children would be lost if the provisions were not extended.

All Americans Pay Taxes

Conservative pundits claimed that these provisions led to nearly half of Americans not paying taxes. Paul Krugman at the New York Times, Ruth Marcus and Ezra Klein at the Washington Post and other observers have noted CTJ’s data showing that once you account for all of the different types of taxes, Americans in all income groups do, in fact, pay taxes and that our tax system overall is just barely progressive.

Mitt Romney and the 47 Percent

Perhaps the misinformation came to its spectacular climax when presidential candidate Mitt Romney was recorded making disparaging remarks about the 47 percent of Americans who, in his words, “believe that they are entitled to health care, to food, to housing, to you-name-it… These are people who pay no income tax.”

2009 Expansions of EITC and Child Tax Credit Extended for Only Five Years

One might think that the backlash produced by Romney’s comments, and his subsequent electoral loss, might have prompted conservatives to change their thinking. But they can only evolve so much, so fast. As an apparent concession to the right, the fiscal cliff deal approved by the House and Senate on New Year’s Day extended President Obama’s 2009 expansions of the EITC and Child Tax Credit for just five years — even though it made other tax cuts permanent.

Making permanent the EITC and Child Credit expansion would have cost in the neighborhood of $100 billion over a decade, and the five-year extension of these provisions cost around half that amount. This is real money, but insignificant compared to the $369 billion spent on making permanent estate tax cuts for millionaires or the $3.3 trillion spent on making permanent most of the income tax cuts first enacted under George W. Bush.

The EITC and the Child Tax Credit do a lot to offset the regressive impacts of the many types of taxes paid by low-income Americans. Congress should remember this and make the recent expansions of these refundable credits permanent.

A two-page report from Citizens for Tax Justice explains new evidence of offshore tax avoidance by corporations unearthed by the non-partisan Congress Research Service (CRS).

In a nutshell, CRS finds that U.S. corporations report a huge share of their profits as officially earned in small, low-tax countries where they have very little investment and workforce while reporting a much smaller percentage of their profits in larger, industrial countries where they actually have massive investments and workforces.

This essentially confirms that corporations are artificially inflating the share of their profits that they claim to earn tax havens where they don’t really do much real business. Remember that offshore tax avoidance by corporations often takes the form of convoluted transactions that allow U.S. corporations to claim that most of the profits from their business are earned in offshore subsidiaries in a tax haven like Bermuda, and that the offshore subsidiary my be nothing more than a post office box.

And Bermuda is a great example. CRS finds that the amount of profits that U.S. corporations report to earn in Bermuda is 1,000 percent of Bermuda’s GDP! That’s ten times Bermuda’s gross national product — ten times the tiny country’s actual economic output. This is obviously impossible and confirms that much of the profits that U.S. corporations claim are earned there represent no actual economic activity but rather represent profits shifted from the U.S. or from other countries to take advantage of that fact that Bermuda has no corporate income tax.

Sadly, most of the tax dodges practiced by U.S. corporations to shift their profits to tax havens are actually legal. CTJ’s report explains what type of tax reform is needed to address this.

Note to Readers: This is the second of a six part series on tax reform in the states.  Over the coming weeks, The Institute on Taxation and Economic Policy (ITEP) will highlight tax reform proposals and look at the policy trends  that are gaining momentum in states across the country. This post focuses on “tax swap” proposals.

The most extreme and potentially devastating tax reform proposals under consideration in a number of states are those that would reduce or eliminate one or more taxes and replace some or all of the lost revenue by expanding or increasing another tax.  We call such proposals “tax swaps.”  Lawmakers in Kansas, Louisiana, Nebraska and North Carolina have already put forth such proposals and it is likely that Arkansas, Missouri, Ohio and Virginia will join the list.

Most commonly, tax swaps shift a state’s reliance away from a progressive personal income tax to a regressive sales tax. The proposals in Kansas, Louisiana, Nebraska and North Carolina, for example, would entirely eliminate the personal and corporate income taxes and replace the lost revenue with a higher sales tax rate and an expanded sales tax base that would include services and other previously exempted items such as food.   

In the end, tax swap proposals hike taxes on the majority of taxpayers, especially low- and moderate-income families and give significant tax cuts to wealthy families and profitable corporations. For instance, according to an ITEP analysis of Louisiana Governor Bobby Jindal’s tax swap plan (eliminating the personal income tax and replacing the lost revenue through increased sales taxes) found that the bottom 80 percent of Louisianans would see their taxes increase. In fact, the poorest 20 percent of Louisianans, those with an average annual income of just $12,000, would see an average tax increase of $395, or 3.4 percent of their income. At the same time, the elimination of the income tax would mean a tax cut for Louisiana’s wealthiest, especially in the top 5 percent.  ITEP concluded that any low income tax credit designed to offset the hit Louisiana’s low income families would take would be so expensive that the whole plan could not come out “revenue neutral.” The income tax is that important a revenue source.

These proposals also threaten a state’s ability to provide essential services, now and over time. They start out with a goal of being revenue neutral, meaning that the state would raise close to the same amount under the new tax structure as it did from the old.  But, even if the intent is to make up lost revenue from cutting or eliminating one tax, these plans are at risk of losing substantial amounts of revenue due in large part to the political difficulty of raising any other taxes to pay for the cuts. Frankly, it’s taxpayers with the weakest voice in state capitals who end up shouldering the brunt of these tax hikes: low and middle income families.

Proponents of tax swap proposals claim that replacing income taxes with a broader and higher sales tax will make their state tax codes fairer, simpler and better positioned for economic growth, but the evidence is simply not on their side. ITEP has done a series of reports debunking these economic growth, supply-side myths. In fact, ITEP found (PDF) that residents of so-called “high tax” states are actually experiencing economic conditions as good and better than those living in states lacking a personal income tax. There is no reason for states to expect that reducing or repealing their income taxes will improve the performance of their economies; there is every reason to expect it will ultimately hobble consumer spending and economic activity.

Here’s a brief review of some of the tax swap proposals under consideration:

Last week Nebraska Governor Dave Heineman revealed two plans to eliminate or greatly reduce the state’s income taxes and replace the lost revenue by ending a wide variety of sales tax exemptions. ITEP will conduct a full analysis of both of his plans, though it’s likely that increasing dependence on regressive sales taxes while reducing or eliminating progressive income taxes will result in a tax structure that is more unfair overall.

If Kansas Governor Sam Brownback has his way he’ll pay for cutting personal income tax rates by eliminating the mortgage interest deduction and raising sales taxes. An ITEP analysis will be released soon showing the impact of these changes – made even more destructive because of the radical tax reductions Governor Brownback signed into law last year.

Details recently emerged about Louisiana Governor Bobby Jindal’s plan to eliminate nearly $3 billion in personal and corporate income taxes and replace the lost revenue with higher sales taxes. ITEP ran an analysis to determine just how that tax change would affect all Louisianans. ITEP found that the bottom 80 percent of Louisianans in the income distribution would see a tax increase. The middle 20 percent, those with an average income of $43,000, would see an average tax increase of $534, or 1.2 percent of their income. The largest beneficiaries of the tax proposal would be the top one percent, with an average income of well over $1 million, who’d see an average tax cut of $25,423. You can read the two-page analysis here.

North Carolina lawmakers are considering a proposal that would eliminate the state’s personal and corporate income taxes and replace the lost revenues with a broader and higher sales tax, a new business license fee, and a real estate transfer tax. The North Carolina Budget and Tax Center just released this report (using ITEP data) showing that the bottom 60 percent of taxpayers would experience a tax hike under the proposal. In fact, “[a] family earning $24,000 a year would see its taxes rise by $500, while one earning $1 million would get a $41,000 break.” The News and Observer gets it right when they opine that the “proposed changes in North Carolina and elsewhere are based in part on recommendations from the Laffer Center for Supply Side Economics.  Supply-side economics (or “voodoo economics,” as former President George H.W. Bush once called it) didn’t work for the United States…. We wonder why such misguided notions endure and fear where they might take North Carolina.”

In reference to Indiana Governor Mike Pence’s proposed tax plan, The South Bend Tribune urges lawmakers to “pass on this tax cut” and cites data (PDF) from our partner organization, the Institute on Taxation and Economic Policy (ITEP), to makes its case.  As the Tribune explains, “Needs of poor children, the elderly and mentally ill aren’t being met … now is not the time to further stem income tax revenue. Gasoline tax revenue is down. Corporate taxes have been trimmed. The inheritance tax is being phased out. And then there’s the Institute on Taxation and Economic Policy’s analysis of Pence’s across-the-board tax cut plan which concluded it would mostly benefit the wealthiest taxpayers. The poorest Hoosiers, who devote more of their household budgets to state and local taxes than any other income group, would be helped little, if at all.”

New Jersey’s expiring film tax credit is still paying out big bucks for TV shows and movies filmed years ago – even though these credits are billed as incentives. The state Economic Development Authority just handed the makers of Law & Order SVU $10.2 million of New Jersey taxpayers’ dollars for work done on the 2009-10 season of the show.  Hopefully New Jersey’s credit won’t be resurrected after 2015, given that studies have repeatedly shown them to be a poor use of taxpayer dollars.

Kudos to Wisconsin’s Transportation Finance and Policy Commission which will recommend to the legislature that the state increases its gas tax by five cents. This would be the first increase in the state’s gas tax since 2006. In more gas tax news, Washington State Senate Majority Leader Rodney Tom recently said that he would support an increase in the state’s gas tax. For more on the vital role that state gas taxes play in funding transportation needs across the state (and why states should raise theirs) read ITEP’s  Building a Better Gas Tax Report.

And in housekeeping news… We’ve done lots of behinds the scenes work to improve your experience when visiting the Institute on Taxation and Economic Policy (www.itep.org) and Citizens for Tax Justice’s (www.ctj.org) websites. Please take a minute and check out our slightly reorganized (and improved) site!

This weekend, Professional Golf Hall of Fame member Phil Mickelson hinted that he might move from California, and even expatriate to Canada, because of recent tax increases on the wealthy in his home state.  Aside from the fact that he would face higher taxes in Canada, if his tax rate is such a concern, Mickelson might consider Myanmar or Chad whose citizens enjoy some of the lowest tax rates in the world.

Many have been critical of Mr. Mickelson’s comments, since he is the 7th wealthiest athlete in the world, and yesterday he walked them back. “Finances & taxes are a personal matter and I should not have made my opinions on them public. I apologize to those I have upset.” 

We tried to guess which of his corporate sponsors was most upset by the remarks and persuaded their 50-million dollar man to quit talking about taxes and issue the apology.  The pharmaceutical giant, Amgen, perhaps, which is uniquely skilled at dodging taxes by parking its profits in tax havens?  Or maybe it was Exxon Mobil, which has found ways to pay less than half the U.S. corporate tax rate in recent years.  Most ironic would be accounting behemoth KPMG, whose job is to help multinationals and high wealth individuals reduce their tax bills year after year.  Mickelson’s message that there are some tax increases you just can’t avoid can’t be good for business.

During his walk-back, Mickelson also said he was still learning about the new tax laws.  He might also want to brush up on his math, too, because he said his combined state and federal tax rate is 62 or 63 percent.  But with the highest average combined tax rate on the very wealthiest Americans hovering around 30 percent, that’s not likely.  Maybe that’s why it’s so very rare that Americans move to lower to their tax rates, once they understand how they work.

While the fiscal cliff debate may have seemed abstract and technical to many Americans, the results of the tax deal has become much more tangible to 77.5% of Americans who are seeing their take-home pay decrease in their first paychecks of the year, due to the expiration of the payroll tax holiday.

Anti-tax, anti-government types in the media and politics have taken advantage of the confusion over the fiscal cliff deal to make it seem like it was one big tax hike. One even argued that President Obama tricked the American public when he said he would only increase taxes on the wealthiest Americans. This is utter nonsense because what the deal really did was simply let a slew of temporary tax cuts expire. 

As to the payroll tax holiday, President Obama actually supported another one year extension, but was forced to abandon it by House Republicans who largely opposed extending the holiday as part of the fiscal cliff deal. Going back even further, the temporary payroll tax holiday was only even put into effect in 2010 because President Obama demanded it, (albeit as a second choice to the much more effective Making Work Pay Credit which Republicans opposed), as part of his economic stimulus package.

Moreover, while many Americans may feel the pain from lower take-home pay this year compared to last, the reality is that the fiscal cliff deal made 85 percent of the Bush income tax cuts permanent. These rate reductions and other provisions were all written to be temporary and expire in 2010, but now they are permanent parts of the tax code and amount to $3.9 trillion in tax cuts over the next 10 years. In other words, rather than shifting America back to the Clinton-era tax rates, President Obama instead opted to make permanent the historically low Bush-era tax rates for 99.1 percent of Americans.

Finally, it’s worth remembering why we pay the payroll tax to begin with. It is the funding source for Social Security, one of the most successful government programs in US history. Although paying lower payroll taxes was nice for a couple years, the reality is that the holiday could not have been extended forever without endangering the long-term viability of Social Security’s funding.