Month: September 2013

This week, the Census Bureau released new data showing that the share of Americans living in poverty in 2012 remained high, despite other signs of economic recovery.  While the national poverty rate (15%) and the rates in most states are holding steady, the number of people living in poverty today is much greater than in 2007, prior to the start of the recession.

The good news is that policy makers have at their disposal several affordable, targeted and effective tax policy tools to alleviate economic hardship and help families escape poverty.  An updated report from our partner organization, the Institute on Taxation and Economic Policy (ITEP), “State Tax Codes as Poverty Fighting Tools,” provides a comprehensive view of anti-poverty tax policies state-by-state, surveys tax policy decisions made in the states in 2013, and offers recommendations tailored to policymakers in each state as they work to combat poverty. As ITEP lays out in its signature Who Pays report, virtually every state and local tax system is regressive, contributing to the challenges of America’s low-income families; State Tax Codes as Poverty Fighting Tools details some options for reversing that.

See ITEP’s companion report, Low Tax for Who?

In most states, truly remedying tax unfairness would require comprehensive tax reform. Short of this, lawmakers should consider enacting or enhancing four key anti-poverty tax polices explained in the report: the Earned Income Tax Credit, property tax circuit breakers, targeted low-income tax credits, and child-related tax credits. (Each of these provisions is also described in an ITEP stand-alone policy brief.) Unfortunately lawmakers in a number of states have moved in the wrong direction this year (North Carolina, Ohio and Kansas are top of the list), pursuing massive tax shifts that would hike taxes on their poorest residents while unjustifiably reducing them for the wealthiest individuals and profitable corporations. 

Given the persistence of poverty in the states as documented by the new Census data, policy makers should be focused on finding ways to boost the incomes of low- and moderate-income families rather than taxing them deeper into poverty in order to provide tax breaks to the well- heeled.

A troubling new report (PDF) released by the Treasury Inspector General for Tax Administration (TIGTA) has revealed that the substantial budget cuts imposed on the IRS meant that it recovered $5 billion less in revenue from enforcement efforts in 2012 compared to 2011. That is, while law abiding citizens and businesses paid the taxes that make up the bulk of our federal revenues, more non-payers, late-payers and under-payers are getting a pass because there aren’t enough IRS staffers to follow up with them.

This drop in revenue should come as no surprise given that the IRS’s annual budget was actually cut by some $329 million dollars from Fiscal Year 2010 to 2012. To absorb these cuts, the IRS was forced to get rid of 5,000 front-line enforcement workers – a 14 percent reduction of its enforcement personnel. Not so coincidentally, the TIGTA report notes that this 14 percent reduction in personnel correlates with the 13 percent reduction in revenue from enforcement over the past two years.

As we’ve noted before, cutting spending on the IRS budget is about the most counterproductive (and we’re being polite – other words are more fitting) ways to reduce the deficit because every one dollar invested in the IRS’s enforcement, modernization and management system saves the federal government as much as $200 in the long run.  So that loss of $5 billion in tax revenue in the TIGTA report amounts to this: every dollar the government cut under the guise of savings actually increases the deficit by $15. How’s that for bad math?

Rather than reversing the budget cuts to the IRS in Fiscal Year 2013, Congress allowed the sequester to cut an additional $600 million from the agency’s budget. Looking ahead to Fiscal Year 2014, House Republicans are pushing to carve an additional $3 billion from the IRS, which would represent a cut of almost 25 percent of its entire budget.

Meanwhile, some of those pushing for these cuts view them as somehow a way to fix the IRS after the recent (trumped up) scandal over the process of granting tax exempt status to certain political groups. The reality that these anti-tax conservatives seem to be missing is that that the lack of resources at the agency was one of the main causes of the administrative issues surrounding the scandal, according to the National Taxpayer Advocate (PDF). In other words, cutting the IRS’s budget further will almost certainly generate more problems within the agency, not fewer. 

Considering that the $50 billion recovered through enforcement in 2012 is only a fraction of the estimated $450 billion total tax gap, Congress should not only restore the funding lost to years of budget cuts, but significantly increase funding to help us reduce the deficit and pay for critical government investments.   

What could be more lovable than a bipartisan effort to simplify the tax code? A bipartisan effort to simplify the tax code led by a couple of folksy guys in shirtsleeves who call themselves Max and Dave. No matter that they are two of the most powerful members of Congress, they have managed to craft a successful PR campaign playing on the public’s frustration with political partisanship and endemic dislike of the tax code. 

Max and Dave, of course, are Senator Max Baucus, chair of the Senate Finance Committee, and Representative Dave Camp, chair of the House Ways and Means Committee. Their aw-shucks, let’s-get-a-beer-and-fix-the-tax-code routine has received friendly media coverage inside the Beltway and outside too, during their recently wrapped up road show, which took the pair to Minnesota, Philadelphia, Silicon Valley and Memphis.

But as we have said many, many times, if these two are serious about reforming the tax code, they need to get serious about revenues. Indeed, they need to get serious period.  Stop putting the cart before the horse, quit with the campaign strategy and get down to policy.

Most recently, we made our point on the opinion pages of the Memphis Commercial Appeal, the day before Max and Dave showed up for a friendly roundtable with executives from FedEx, one of the squeakier (PDF) corporate wheels when it comes to tax reform.  Our op-ed, “Most of Us Want Corporate Loopholes Shut,” asked why the Senator and Congressman would visit with FedEx for advice about tax reform.

“The venue is apt because FedEx’s taxpaying behavior is emblematic of the challenges facing anyone seeking to fix the United States’ corporate tax system; it’s awkward because FedEx is a heavy feeder on tax breaks enthusiastically supported over many years by bipartisan majorities in Congress.”

We then explained some of what we’d learned in reviewing FedEx’s latest financial statements.

“For example, my organization, the Institute on Taxation and Economic Policy, found that between 2008 and 2010, FedEx paid an effective federal income tax rate of just 0.9 percent on over $4.2 billion in U.S. profits. With two more years of tax filings now publicly available, we know that over the past five years, FedEx paid an average effective federal income tax rate of just 4.2 percent.”

And we took on that worn-out whine about corporations needing a lower corporate tax rate to be competitive.

“FedEx also demonstrates how the U.S. corporate income tax does not appear to make our companies less “competitive,” despite the insistence of legions of CEOs that it does. Between 2008 and 2010, FedEx paid an effective income tax rate of 45 percent in the foreign countries where it does business. That’s about 50 times higher than the 0.9 percent rate they faced in the U.S. In fact, of the Fortune 500 corporations that were consistently profitable and that had significant offshore profits during that same period, we found that two-thirds actually paid higher taxes in the foreign countries where they do business than they paid in the U.S.”

Our op-ed in Tennessee also made reference to FedEx’s vast offshore holdings and how it drives down its taxes using depreciation. You can read the whole thing here. You can also read a small business owner using the Max and Dave visit at FedEx to make a similar point in a Tennessean op-ed.

Our real target, of course, wasn’t FedEx but rather the tax reforming team of Baucus and Camp.  We use individual corporations’ tax payments as case studies – little narratives to show what’s wrong with the corporate tax code.  As these corporations like to say, their tax avoidance practices are generally legal because Congress made them legal, so we like to show Congress exactly how their laws are working when it comes to corporate tax revenues.

Sometimes, though, companies take it personally when we publicize their actual tax payments, (remember our back and forth with GE last year?).  Sure enough, two days after our op-ed ran in Memphis, a FedEx V.P. took to the same opinion page to defend the company, using many of the shell games we’ve come to expect. For example, we had explained that FedEx paid a 4.2 percent effective federal income tax rate on its U.S. profits over five years. FedEx V.P. Michael Fryt retorted with a ten year total tax payments figure in dollars, cited its total bill for state, local and federal taxes over five years, and then wrote that FedEx’s effective tax rate has been between 35.3 and 37.9 percent since 2010 – and was even 85.6 percent in 2009.

Notice how those effective rate figures he cites are all actually higher than the federal statutory rate of 35 percent? There’s a reason for that.  While we focused on the company’s federal corporate income tax as a percentage of its U.S. profits, like we always do, Fryt is trying to divert attention to other taxes and taxes that FedEx has not paid yet, as companies often do.  It’s like CTJ shows the world an apple and these companies jump up and down demanding the world look at their oranges instead.  

We have a full response to those oranges FedEx was pushing last week right here.  Among other things, it’s a case of Fryt including taxes that FedEx paid not just to the U.S. Treasury but to every country and locality everywhere it does business, which is not something that Max Baucus or Dave Camp or any member of Congress has any control over. Members of Congress are debating how to reform federal taxes, and we assume that FedEx is lobbying (and lobbying) Congress to influence the shape of that same federal corporate income tax, not the taxes it pays to states or cities or foreign countries.

What Congress can legislate is the federal corporate tax rate and the loopholes, breaks and other special provisions that are increasingly eroding corporate taxes as a share of revenues.  Senator Baucus has told his colleagues to assume the tax code will be wiped clean of such expenditures, even as he and Camp continue to meet with corporations who unapologetically defend their favorite tax breaks – and demand lower rates on top of that.  Summer is over and with it, Max and Dave’s road trip. When they are ready to get back to work, we are ready to offer constructive ideas for tax reform that generates the revenues we need and delivers the fairness the public wants.

As Senator Max Baucus and Congressman Dave Camp, the chairmen of the tax committees in the Senate and House, took their tax reform road show to the FedEx headquarters in Memphis last week, CTJ released a short report and op-ed concluding that the company had paid just 4.2 percent of its profits over the previous five years in federal corporate income taxes. FedEx’s Corporate Vice President for Tax, Michael D. Fryt, responded with an op-ed of his own (subscription required) that took issue with CTJ but avoided the actual issue raised.

The stakes are high for FedEx when it comes to tax reform. The company’s CEO has called for a lower federal corporate income tax rate and a “territorial” tax system (a tax system that exempts the offshore profits of corporations). FedEx is participating in several coalitions of corporations lobbying to achieve these goals.

The debate before Congress, (which Baucus and Camp are trying to move in a certain direction) is over how to reform the federal corporate income tax, so CTJ’s report and op-ed examined what FedEx pays in federal corporate income taxes as a percentage of its profits. That is FedEx’s effective federal corporate income tax rate, 4.2 percent.

Fryt’s op-ed attempts to confuse the issue by discussing other taxes, like state and local sales taxes, which the corporation does not even pay. A company like FedEx merely collects sales taxes from customers, who do pay them, and then hands the taxes over to whatever state or local government they are owed to.

Fryt goes on to say that FedEx’s effective tax rate was “36.4 percent in 2013, 35.3 percent in 2012, 35.9 percent in 2011, 37.5 percent in 2010 and 85.6 percent in 2009.” These ludicrous assertions are based on accounting practices and gimmicks that corporations like FedEx use when they make their reports to the SEC, but that obscure what they actually pay in taxes.

These figures include taxes paid to other governments as well as deferred taxes — taxes that FedEx has not actually paid but which it might pay at some point in the future. We believe reasonable people would agree that if we want to understand what a corporation pays in federal corporate income taxes as a percentage of profits over certain years, we should divide the federal corporate income taxes actually paid by the company by the profits actually generated by the company.

Fryt then seems to admit that FedEx’s taxes were low during the years we examine, but then explains that this is because of temporary tax breaks for “accelerated depreciation.” Such breaks allow a company to deduct the cost of equipment much more quickly than it actually wears out, and are the reason FedEx can “defer” a lot of its taxes. Fryt argues that there is broad consensus that such breaks create jobs, but this is actually not true.

The non-partisan Congressional Research Service recently reviewed efforts to quantify the impact of these tax breaks and found that “the studies concluded that accelerated depreciation in general is a relatively ineffective tool for stimulating the economy.” Further, we worry that this break is not truly “temporary” because Congress will keep extending it. Bonus depreciation was enacted in 2002 and has only been allowed to expire for two years, 2006 and 2007, since then.

None of this is to say that there is something immoral or evil about FedEx’s corporate tax practices. Members of Congress are responsible for the tax laws, which FedEx is following as far as we know. Of course, FedEx is lobbying to preserve and even expand its breaks, and it is unsurprising that it manipulates facts and figures to further its goals.

Despite holding a supermajority in Missouri’s House and Senate, Republican lawmakers failed this week to muster enough votes to overturn Governor Nixon’s veto of their $700 million tax cut (which passed overwhelmingly in both chambers just a couple of months ago).  A misguided effort supporters touted as a way to keep up with neighboring Kansas, opponents of the measure accurately described it as little more than a big give away to the state’s wealthiest residents at the expense of vital public services, primarily K-12 education. Tally this one as a victory for state tax fairness and adequacy. And watch Governor Nixon, who’s getting national kudos for holding the line on this.

Florida Governor Rick Scott isn’t sure what policy agenda he wants to pursue in 2014, but he knows it has to involve more tax cuts of some kind. How’s that for original thinking?  In related news, Politifact recently chided the Governor for exaggerating the health of the state’s revenue collections, and for claiming that his policies had anything to do with the modest revenue growth Florida has seen.

The ink is barely dry on North Carolina’s regressive tax overhaul and yet lawmakers are already discussing fully eliminating the state’s personal income tax and replacing it with an even more regressive broader consumption tax in 2015. Senator Bob Rucho told a Washington Post reporter that he thinks the state will  “go to zero” with the income tax in a matter of time.  Speaker of the House and US Senate Candidate Thom Tillis agreed, “I think moving to a consumption-based model is something we all agree on.”

Wyoming lawmakers are considering raising the state’s tax on beer in order to pay for alcohol abuse programs. The 2 cent per gallon tax hasn’t been raised since 1935 and is currently the lowest in the nation.  After almost eighty years of neglect, it’s safe to say that the tax is probably in need of another look.

In July, a letter signed by thirty national organizations and a report from Citizens for Tax Justice (CTJ) both warned members of Congress about a proposal from Congressman John Delaney of Maryland that would have the effect of rewarding corporations that use offshore tax havens to avoid U.S. taxes. Rep. Delaney’s staff responded with a “rebuttal” that is itself based on misinformation about corporate tax law and about the likely effects of the proposal, which would provide a tax amnesty for offshore profits (often euphemistically called a “repatriation holiday”) for corporations that agree to finance an infrastructure bank.

A new report from Citizens for Tax Justice addresses each point made by Rep. Delaney’s “rebuttal” as well as the myth that a huge amount of money is “locked offshore” and waiting for a tax break to lure it back into the U.S. economy.

Read the report.

This November, Coloradans will vote on whether to invest $950 million in their state’s education system under a newly approved ballot measure (Amendment 66) that would convert the state’s flat income tax into a more progressive, graduated rate tax.  Given the steep regressivity (PDF) of the state’s tax system, moving toward a more progressive income tax would be an equitable way to raise revenue.  Watch this space for more discussion of the impacts of Amendment 66 in the coming weeks.

Hawaii Governor Neil Abercrombie is calling lawmakers back to Honolulu for a special session next month to legalize gay marriage in the Aloha State. The state already allows civil unions, which grant same-sex couples state benefits and protections, but not federal.  In the wake of the Supreme Court ruling this summer on marriage equality, the Governor wants to ensure all of his state’s citizens are able to take full advantage of federal tax benefits and other protections as soon as possible.

Later this month, Nebraska’s Tax Modernization Commission will begin holding public hearings to get feedback on a list of potential tax reform options.  As this editorial from the Lincoln Journal Star explains, the Commission is looking to hear from citizens about the best ways to improve the state’s tax system, not simply “a parade of people saying they want to pay less in taxes”.  The committee is looking at “equity — creating a fair and balanced tax system for all Nebraskans.”  Committee members have also said they will not support eliminating the personal income tax, part of a reform plan Governor Heineman pushed for earlier this year. In the wake of the governor’s tax reform failure, the legislature created this Commission.

More state lawmakers are beginning to give serious thought to whether special tax breaks are doing anything worthwhile for the vast majority of their constituents. Elected officials in Maine, Nebraska, West Virginia, and the District of Columbia have each addressed this issue in recent weeks.  Will any of them choose to follow Rhode Island’s lead in implementing a new process for evaluating tax breaks?

No one should be taxed out of their homes. It’s a sentiment that finds support across the political spectrum: homeowners, especially senior citizens and low-income families, should not lose their homes because of their property tax bills. Yet as a Washington Post investigation revealed this week, the DC city government’s use of “tax lien sales,” through which the government allows a small number of private agencies to act as debt collectors for unpaid property tax levies, has given “predatory” private investors license to foreclose on the homes of hundreds of city residents over the past five years.  As a result, some low-income and elderly homeowners have been left with nowhere to live and with no equity in the homes many had owned outright.

The Post article profiles Bennie Coleman, a 76-year-old widower who ultimately lost his house after not paying a $134 property tax bill. When Coleman didn’t pay his bill, the city imposed a tax lien on the property, and then sold the lien to a private investor who was allowed to charge Coleman double-digit interest until the debt was paid. But the interest and penalties charged by this predatory investor pushed the total debt up to $5,000, and the investor foreclosed on the property.

Within a day of the Post report’s publication, Mayor Vincent Gray was vowing that “we cannot allow those kinds of things to happen again,” and City Council chair Jack Evans was preparing emergency legislation to limit private investors’ use of tax lien sales.

As the Post’s coverage makes clear, the cause of these foreclosures was not an out-of-control tax system, but rather the practice of allowing private debt collectors to charge exorbitant fees on top of the often minimal property tax debt. As it happens, Washington DC’s property tax system goes further than many states in minimizing property taxes on at-risk families and seniors: the city allows low-income families to claim a property tax credit of up to $750, and also allows low-income seniors to simply defer unaffordable property tax bills.  Until recently, the tax credit was only available to families with incomes under $20,000 – an amount unchanged for 35 years – leaving out many families living at or below the federal poverty level.  But just this summer, the DC City Council made significant improvements to the property tax credit, increasing income eligibility to $50,000 (about 200 percent of poverty for a family of four) and boosting the credit to $1,000.

In most states, there are only limited mechanisms in place to relieve unaffordable property tax bills for low-income taxpayers. And as an ITEP survey finds, virtually every state could take sensible steps to enact more generous low-income property tax relief programs.

The clear lesson of the abuses documented by the Post is that Washington DC’s system for collecting unpaid property taxes must be overhauled. But a more basic lesson any state’s policymakers can learn from this harrowing tale is that it’s vital to design property tax rules in a way that don’t jeopardize low-income, fixed-income and senior homeowners through judicious use of “circuit breakers” and tax deferrals.

For several years, Citizens for Tax Justice has raised the alarm about a payroll tax loophole that allows many self-employed people, including two former lawmakers, John Edwards and Newt Gingrich, to use “S corporations” to avoid payroll taxes. Unfortunately, Congress passed up an opportunity to address this loophole as part of health care reform. Despite a few recent court decisions in favor of the IRS’s attempts to slightly restrict this loophole, it will continue to be a problem until Congress takes our advice and closes it.

The IRS and Tax Court Lets Some Self-Employed People Avoid Social Security and Payroll Taxes — Unless They Go Too Far

Payroll taxes are supposed to be paid on income from work. The Social Security payroll tax is paid on the first $113,700 in earnings (adjusted each year) and the Medicare payroll tax is paid on all earnings. These rules are supposed to apply both to wage-earners and self-employed people.

“S corporations” are essentially partnerships, except that they enjoy limited liability, like regular corporations. The owners of both types of businesses are subject to income tax on their share of the profits, and there is no corporate level tax. But the tax laws treat owners of S corporations quite differently from partners when it comes to Social Security and Medicare taxes. Partners are subject to these taxes on all of their “active” income, while active S corporation owners are supposed to determine what salary they would pay themselves if they treated themselves as employees.

Naturally, many S corporation owners make up a salary for themselves that is much less than their true work income.

The Tax Court recently found that a California man named Sean McAlary attempted to do this in 2006 with an S corporation. He was the sole owner of the company, and he had only a handful of other real estate agents working sporadically for him (as independent contractors).

In 2006, McAlary, through his S corporation, had net income (income left after paying the other agents and paying other expenses) of $231,453. McAlary, who worked 60 hours a week at his company, initially did not report any of this income as compensation for work. And thus he paid no payroll taxes on it. When the IRS challenged him, he later claimed that only $24,000 was compensation for work. The other 90 percent, he said, was profit, not subject to Social Security or Medicare tax.

Logically, one would think that all of the net income of the company was income from work, since it all stemmed from McAlary’s efforts in selling real estate (and to a slight degree, from managing his sales agents).

But the IRS and the Tax Court totally missed the point. First, the IRS decided that less than half of McAlary’s income, only $100,755, was earned income. It came to this figure by multiplying what it guessed should be McLary’s hourly wage times the number of hours he worked. The Tax Court adjusted that down to $83,200 by making up a slightly lower average hourly wage.

Imagine if such a rule applied to ordinary wage earners. “So you were paid $75,000,” the IRS might say, “but you claim you were only worth half that much. Well, you have a point, but we’d say you were worth $50,000.”

By engaging in such fictions, the IRS and the Tax Court go to absurd lengths to give Subchapter S owners a tax break — just not as absurd as the numbers that many of the owners make up.

Medicare Tax Reform Was Missed Opportunity to Close Loophole

Two famous politicians have gained notoriety for low-balling their work income from Subchapter S corporations. The first was former Senator John Edwards, who actually claimed that his name was an asset, and that this asset (rather than his labor) was generating most of the income from his one-man law firm. The second was former House Speaker Newt Gingrich, whose tax returns released during the 2012 Republican primary demonstrated that he, too, took advantage of this dicey tax dodge.

In 2009, as members of Congress considered revenue-raising proposals to pay for health care reform, they eventually looked at an idea from Citizens for Tax Justice to reform the Medicare tax. We proposed that the Medicare tax, which was a flat-rate tax on wages, should have a higher rate for higher-income workers and that Congress create a matching Medicare tax applying to investment income (excluding retirement income) for people above a certain income threshold.

We assumed that if our proposal was adopted, then what was called the “John Edward Loophole” (and later called the “Newt Gingrich Loophole”) would be closed. Essentially all income over a certain threshold (not counting retirement income) would be subject to the Medicare tax one way or the other. Most of the disputes between the IRS and S corporation owners over how much of their income constitutes compensation would become unnecessary.

But Congress had other ideas. Although the health care law as enacted did include most of our proposal, an exception was made for “active income” of S corporations that the owners do not characterize as compensation for work.

This has created a strange situation in which wages and salary are subject to the Medicare tax and even most investment income (capital gains, dividends, interest, royalties, rents, to the extent they make up a taxpayer’s income in excess of $250,000 for married couples and $200,000 for singles) is, effectively, subject to the same tax. But “active income” that can be characterized as not wages and salary still escapes the tax, and thus taxpayers like McAlary still have an incentive to mischaracterize this income.

The most obvious and simplest solution would be for Congress to simply apply the Medicare tax to all “active income” of S corporations.

Some lawmakers have proposed a more limited solution that is overly complicated but which would at least solve part of the problem. Such legislation was first introduced as part of a tax “extenders” bill in 2010 (in order to offset some of the cost of those tax breaks) and a version has been introduced this year by Congressman Charlie Rangel. This legislation would address situations in which an S corporation provides a service and generates most of its profits based on the reputation or skills of three or fewer people. If this rule had been in place, Edwards and Gingrich probably would not have been able to avoid their Medicare taxes. But it might have left the courts to deal with cases like McAlary’s (because his business arguably relied on the skills and reputation of more than three people).