Wherefore art Thou Permanent Subcommittee on Investigations?

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The U.S. Senate’s Permanent Subcommittee on Investigations (PSI) ain’t what it used to be. That’s the obvious conclusion to draw from Thursday’s hearing on the “Impact of the U.S. Tax Code on the Market for Corporate Control and Jobs.”

Two years ago, the PSI, under the leadership of Sen. Carl Levin (D-MI), issued detailed investigative reports exposing the egregious tax avoidance practiced by Apple and Microsoft. But the committee’s new leaders are taking an entirely different tack. Committee chairman Rob Portman (R-OH), after listening sympathetically to corporate whining about the nation’s allegedly burdensome corporate tax system, lamented that “if there’s a villain in this story it’s the U.S. tax code.” This was in response to testimony from a number of corporate spokespeople who presented inaccurate pictures of how the tax code treats their companies.

A more critical audience (or a reader of CTJ’s recent memo to the PSI published in advance of yesterday’s hearing) might have drawn different conclusions from yesterday’s testimony. One invited witness, Boston Beer executive Jim Koch, complained that his company pays “a tax rate of about 38 percent” on its U.S. profits. A closer examination, however, shows that Koch’s estimate is hugely inflated.

To be sure, Boston Beer’s 2014 annual report does assert that its current and deferred federal and state income taxes were 38 percent of its U.S. income. But that figure is a fiction, for two reasons.

First, a large share of these so-called taxes were “deferred,” meaning that the company has not yet paid them, and may never do so. Second, Boston Beer benefitted handsomely from a tax break for executive stock options that, for arcane accounting reasons, is not reflected as a tax reduction in companies’ annual reports. Making these two adjustments shows that Boston Beer’s actual federal and state effective tax rate was only 15 percent.

This week’s PSI hearing confirms the analysis of Bloomberg reporters Jesse Drucker and Richard Rubin, who noted earlier this week that the new leadership of the PSI appears far more interested in investigating the U.S. government than in chasing down corporate tax dodgers. That’s a real shame.

Tax avoidance thrives on opacity, and the PSI’s previous in-depth investigations of convoluted international tax schemes brought to light important details of the tax dodges that real reform would bring to an end. The PSI’s new leadership would do well to follow the example set by Sen. Levin. But so far, it seems unlikely that they will do so.

Innovation Boxes and Patent Boxes: Congress Is Focusing on Corporate Tax Giveaways, Not Corporate Tax Reform

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After weeks of hinting about an “innovation box” tax proposal, U.S. Reps. Charles Boustany, Jr. (R-LA) and Richard Neal (D-MA) Wednesday released draft legislation that would provide a massive giveaway for high-tech and pharmaceutical companies as well as other industries that generate income from patents and copyrights. The details of the legislation raise the very serious concern that the “innovation box” could be the tax break minnow that swallows the corporate income tax whale.

The legislation would create a special low tax rate of 10.15 percent for income generated by intangible property such as patents, trademarks and copyrights. This is nearly a three-quarters discount on the 35 percent federal income tax rate.

The big question is how much such a low tax rate would cost. As we have argued, the patent box concept is ripe for exploitation and abuse, for two reasons. First, the legislative process, with immense lobbyists influence, will likely expand the definition of “income from intangible property” beyond recognition, and second, sophisticated corporate tax departments are certain to seek ways of undermining the system by reclassifying  as much of their income as possible to qualify for this tax break.

The federal tax code is littered with examples of a simple concept that morphed into an administrative nightmare once it went through the legislative process. The most salient example is the special lower corporate tax rate for manufacturing. When lawmakers floated this tax break in 2004, the ostensible goal was to lower U.S. manufacturers’ taxes. But when the dust settled, the final law expanded the concept of “manufacturing” to include roasting beans for coffee (an early example of the lobbying clout of Starbucks) and film and television production. When policymakers initially began discussing the manufacturing tax break, few would have imagined that the Walt Disney Company  would reap more than $200 million a year in tax breaks for “manufacturing” animated films.

In the 10 years that the “manufacturing deduction” has been in place, the business world has changed in ways that were unimaginable in 2004, and so has the tax break’s reach. Open Table Inc. now annually collects tax breaks for “manufacturing” reservations at your favorite local restaurant.

 It is reasonable to conclude that the legislative sausage making process will similarly contort the definition of “intangible property”. Even those who think a properly-defined “innovation box” is a good idea may shudder at the product that emerges from Congress.

The second concern with the proposed “innovation box” tax break is how corporations might seek to game the system once such a box is in place. It would be very difficult to disprove the claim that a dollar of corporate profit is generated by the research and development that yields patents and copyrights. Corporate profit is the function of many economic forces, of which corporate R&D expenses are only one. When big pharmaceutical corporations claim that huge chunks of their U.S. profits are generated by their investments in intangibles such as trademarks, evaluating these claims will require a huge enforcement effort by the Internal Revenue Service—a vital branch of government that already is finding its enforcement abilities hampered by funding shortfalls.

This second problem—namely, the endless inventiveness of corporations in finding ways of gaming the system to reduce their taxes—may be the reason Congress’s official bean counters at the Joint Committee on Taxation have been unable to produce a revenue estimate on the cost of patent box legislation.

A third huge problem would be the mismatch between the 35 cents on the dollar that deductions for the costs of producing patents, etc. would provide to companies and the 10 cents on the dollar that the profits from such property would be taxed. In effect, the government would pay for 35 percent of the costs, but get back only 10 percent of the profits in taxes. That’s a negative tax rate.

Few would argue directly that the biggest corporate tax dodgers should get a special prize for their tax-avoidance efforts—yet the innovation box would provide huge windfalls for companies such as Apple and Microsoft that appear to have saved billions by artificially shifting their intangible property into low-rate tax havens. The focus of corporate tax reform should be, first and foremost, to make sure that corporate scofflaws are held to account and made to pay their fair share. An “innovation box” would instead offer a brand new tax break for these companies.

At a time when federal corporate income tax collections are near historic lows as a share of the U.S. economy, the unanswered questions about the direction and enforceability of the proposed “innovation box” tax giveaway should, alone, be enough to stop this idea in its tracks.

Memo to Senate Permanent Subcommittee on Investigations: US Corporations Already Pay a Low Tax Rate

July 30, 2015 09:14 AM | | Bookmark and Share

Read the report as a PDF.

On July 30th, the Senate Permanent Subcommittee on Investigations (PSI) will hold a hearing on the impact of the U.S. tax code on foreign acquisitions of U.S. businesses. It is likely that Subcommittee Chairman Sen. Rob Portman (R-OH) will use the hearing as an opportunity to make a case for lowering the U.S. corporate tax rate and moving to a territorial tax system in order to make U.S. companies more competitive, as he proposed earlier this month in an international tax reform framework along with Sen. Chuck Schumer (D-NY).

Lawmakers cite the 35 percent federal statutory corporate income tax rate to argue that the United States has an uncompetitive corporate tax system. But discussing the statutory rate in isolation conveniently ignores the fact that copious tax breaks and loopholes allow U.S. companies pay a relatively low effective tax rate compared to corporate tax rates in other developed counties. Furthermore, adopting proposals in the Portman-Schumer framework could effectively give multinational corporations even greater incentive to shift profits offshore.

1. U.S. multinationals pay relatively low effective tax rates.

A 2014 report by Citizens for Tax Justice (CTJ) found that the 288 Fortune 500 companies that were profitable in each year between 2008 and 2012 paid an average effective federal tax rate of just 19.4 percent over the five-year period, with 26 companies paying no federal income tax at all during that time. Among those companies that had significant foreign profits, the effective U.S. tax rate on U.S. profits (including federal and state taxes) was actually 2.7 percentage points lower than the effective foreign tax rate on these companies’ foreign profits.

According to 2013 data from the Organization for Economic Cooperation and Development (OECD), U.S. corporate taxes as a percentage of GDP were the eighth lowest among OECD countries, with corporate taxes making up 2 percent of GDP relative to the OECD average of 2.9 percent. Similarly, a 2011 study by Rueven Avi-Yonah and Yaron Lahav found that the largest 100 European Union-based multinationals paid a higher average effective tax rate between 2001 and 2010 than the largest 100 U.S.-based multinationals. This evidence suggests that when considering effective tax rates as opposed to statutory rates, U.S. companies are paying substantially less in taxes compared to most of their major foreign competitors.

2. Claims that the U.S. corporate tax system makes U.S. companies vulnerable to acquisitions by foreign companies are unsupported.

While it is true that there has been an increase in foreign acquisitions of U.S. companies in the past several years, both the volume and the aggregate value of acquisitions are now lower than prior to the recession. According to data from a March 2015 Joint Committee on Taxation (JCT) report, there is no clear trend in the volume or value of acquisitions among the United States and other OECD countries between 2006 and 2014. The dollar value of acquisitions involving a U.S. target and another OECD country in 2014 was $155.7 billion, which is higher than 2013 but still lower than the 2007 high of $181.9 billion. Additionally, the ratio of these acquisitions involving a U.S. target to those involving a U.S. acquirer was higher in 2007 to 2009 than in 2014. These data suggest that there is not a growing problem of foreign acquisitions of U.S. companies.

In contrast, a much publicized report from the corporate-backed Business Roundtable prepared by Ernst and Young concluded that the U.S. corporate tax rate and its worldwide system of taxation put U.S. companies at a substantial disadvantage in the market for cross-border mergers and acquisitions. The report suggests that lowering the U.S. corporate rate to 25 percent or switching to a territorial system would have resulted in a net shift of $769 billion in assets from foreign countries to the U.S. However, the report has major methodological issues. First, the analysis used inflated estimates of the effective average tax rates for U.S. companies, leading the report to claim that the average effective rate is essentially the same as the statutory rate, which as discussed above is false. Second, the estimate of the benefits of lowering the U.S. corporate rate only considers the effect of a reduction in the tax rate and does not take into account the effects of the offsetting tax increases required to pay for the rate reduction.

Edward Kleinbard, former JCT Chief of Staff and current professor at the USC School of Law, has rejected the argument that the recent wave of corporate inversions is evidence of the anti-competitive effects of the U.S. tax system. He uses as an example the account provided by former vice chair and CFO of Emerson Electric Co. Walter Galvin that Emerson lost in its efforts to acquire American Power Conversion Corp. because its French competitor was able to offer a higher bid due to the advantages of the French system of taxing multinationals. Kleinbard points out that in reality, the French company would have had no real tax advantage in the deal. Emerson’s competitiveness argument is further compromised by the fact that several years later, Emerson won a bid to acquire a UK-based firm against a company based in Switzerland, one of the world’s most popular tax havens.

3. The Portman-Schumer international tax reform framework will further erode the U.S. tax base and encourage more profit-shifting out of the U.S.

The report of the International Tax Teform Working Group, chaired by Sens. Portman and Schumer, cites the need for the United States to update its system of taxing multinationals to allow U.S. companies to remain competitive in the global marketplace. Allegedly in the interest of this goal, the report proposes a transition to a territorial tax system where corporations are only taxed on the income earned inside the U.S. It also proposes a one-time “deemed repatriation” on accumulated offshore earnings at a reduced rate and the creation of a “patent box” regime, which would allow companies a lower tax rate on income generated by intellectual property.

In a territorial tax system, companies would have more of an incentive to move earnings offshore to avoid paying U.S. taxes. This could involve moving operations offshore, which would be detrimental to domestic job creation, or it could simply involve companies disguising U.S. income as foreign income thereby eroding the U.S. tax base. Research conducted by Kevin Markle at the University of Iowa found that between 2004 and 2008, multinationals based in countries with territorial systems engaged in more income shifting than those based in countries with worldwide tax systems. Allowing multinationals to completely avoid U.S. taxes on their “foreign” income puts purely domestic companies at a disadvantage relative to multinationals. As the competitiveness narrative has focused primarily on competition between U.S. and foreign multinationals, this second type of competition is largely ignored.

The Portman-Schumer framework also includes a one-time tax on the accumulated offshore profits as part of a transition to the territorial system, which would be at an unspecified rate far below the current statutory corporate rate (President Obama’s 2016 Budget proposed a 14 percent rate, while former House Ways and Means Committee Chairman Dave Camp proposed an 8.75 percent rate). This “deemed repatriation” tax is meant to address the estimated $2.1 trillion in tax-deferred earnings that U.S. multinationals are currently holding offshore, but taxing these earnings at a lower rate rewards those companies that have engaged in the most aggressive tax-motivated income shifting.

4. Congress should end the deferral of tax on foreign income and step up efforts to curb base erosion and profit shifting.

Whereas moving to a territorial tax system would exacerbate the problem of offshore profit shifting, ending the policy of allowing multinationals to defer paying taxes on their foreign income until it is repatriated would eliminate this incentive since they would be taxed on their worldwide income as it is earned. Ending deferral may also encourage low- and no-tax countries to increase their corporate tax rates, because they would no longer be able to benefit from U.S. multinationals looking to shelter their income.

Additionally, the U.S. should fully engage in cooperative efforts to curtail harmful international tax competition, like the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project, instead of implementing changes that will make these problems worse. While its proposed reforms should be stronger, the BEPS project has the potential to substantially reduce the damaging tax competition that hurts countries throughout the world.

Congress should also enact reforms to address the problem of tax-avoidance-seeking inversions and foreign acquisitions. First, the tax code should be modified so that inverted companies are treated as American for tax purposes as long as the shareholders of the previous U.S. company own at least a majority share of the new company. In other words, the current 80 percent ownership threshold should be reduced to 50 percent. Second, action should be taken to limit earnings stripping, where the American company (now a subsidiary of the new foreign parent company) takes out loans from the foreign parent and then deducts the interest to reduce U.S. tax liability. This can be accomplished by placing limitations on the amounts of interest that can be deducted. Third, Section 956 of the tax code needs to be tightened to prevent inverted companies from avoiding tax on the profits of offshore subsidiaries that are repatriated to the U.S. Currently, these offshore subsidiaries can loan their accumulated earnings to the new foreign parent company, which can then invest that money in the company’s U.S. operations without being subject to U.S. tax. A 2014 CTJ report explains more thoroughly these three issues related to corporate inversions and the actions Congress can take to address them.

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Deus Ex Machina: IRS Has an Epiphany, Realizes It Has the Power to Close a Tax Loophole

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In film, it’s called “deus ex machina” or god from the machine. When heroes find themselves painted into a hopeless corner from which seemingly nothing can save them, an implausible plot twist saves the day. In the original Superman movie, for example, Christopher Reeve’s Man of Steel sees Lois Lane killed by a devastating West Coast earthquake and suddenly remembers that he has the capacity to turn back time by flying around the earth so fast that it temporarily starts spinning backward.

Equally unexpected, and substantially less lame, is the latest development in the endless saga of tax avoidance by hedge fund and private equity managers. The Internal Revenue Service proposed new rules last Wednesday that will make it harder for money managers to disguise their ordinary income as capital gains. That’s right. After years of congressional inaction on hedge fund tax avoidance, the IRS, like Superman, has suddenly remembered that it has had the power to solve this problem all along.

To be clear, the new IRS rules can only solve a small part of the problem. Hedge fund and other investment partnership managers are often paid under an arrangement known as “two and twenty”. Managers receive a 2 percent fee for assets under their management, and later get 20 percent of any profits.

The managers of these partnerships have come up with strategies for avoiding taxes on both the 2 and the 20. On the 20 they get the tax break we know as “carried interest,” through which hedge fund managers brazenly classify their share of the partnership’s profits as capital gains income, despite the fact that the money they’re investing doesn’t even belong to them. The top tax rate on capital gains is lower than the top tax rate on ordinary income, which is why these wealthy fund managers seek to classify as much of their income as possible as capital gains.

What the IRS dealt with last week is the 2, the management fees, which private equity firms have also found a way to convert into capital gains. The scheme here is certainly less gripping than Lex Luthor attempting to destroy California, but it is just as obviously wrong that private equity managers take their management fees, clearly a payment for service that should be taxed as regular income, and pool them into a fund that generates income they can describe as capital gains. This results in huge tax savings. This crafty accounting has fooled no one, and—finally–the IRS is calling these alleged capital gains what they are: “disguised payment for services.”

This isn’t the end of the story, however. Affected parties can submit comments to the IRS during the next several months on suggested modifications to the new IRS rules. Expect those who benefit from these tax loopholes to submit comments arguing why the IRS shouldn’t tighten its rules. Yet it seems highly unlikely that hedge funds and private equity firms will be able to use this tax dodge with impunity going forward.

This leaves the interesting question of whether the IRS can also deal with the much larger problem of carried interest, or the 20 percent of profits that money managers earn if and when an investment becomes profitable. While the profits are indeed capital gains for the actual investors, the money managers (who don’t have to invest a single cent of their own money in the venture) get a share of the profits because of how the deal is structured, thus their share of profits is income in the same way that the money that individuals pay to financial advisors is income.

President Obama, CTJ and other groups have called for legislation to close this loophole, but Congress has repeatedly failed to act. Last year, however, the respected tax professor Vic Fleischer argued in the New York Times that the Obama Administration could close the door on the carried interest loophole through administrative action, just as the IRS has proposed to do with the 2 percent management fees.

It would be more pleasing if Superman could save the world in a plausible way, just as it might be better to see the carried interest loophole closed through legislation. But the current ruling party in Congress is utterly uninterested in doing so. So it would be more expeditious if the IRS has another epiphany and recognizes that it has the power to solve the entire problem on its own. 

The IRS: You Don’t Have to Like Them, but You Do Have to Fund Them

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Congress is considering further gutting the Internal Revenue Service’s enforcement capacities even as a new report from the Taxpayer Advocate shows that previous rounds of budget cuts have put the IRS dangerously close to being unable to perform basic enforcement and compliance functions.

Lawmakers have cut the IRS’s budget in each of the past five years all while giving the IRS increased oversight responsibility under the Affordable Care Act and Foreign Account Tax Compliance Act (FATCA). Further, the IRS processed 1.5 million more filings this year than last. This is a practice that hurts law-abiding taxpayers and rewards tax evaders.

The IRS budget is down 17 percent from 2010, adjusted for inflation, with another $838 million in cuts scheduled for 2016. These cuts are forcing the IRS to reduce services that help citizens pay their taxes according to the Taxpayer Advocate. During the 2015 tax season, IRS customer service representatives answered 37 percent of phone calls and callers waited an average of 23 minutes to speak with a representative.

Furthermore, the IRS automatically hung-up on 8.8 million callers–a 1500 percent increase since 2014–due to an overwhelmed phone system. The Taxpayer Advocate argues that these dismal levels of customer service will result in fewer people voluntarily paying their taxes.  Currently 98 percent of taxes are paid voluntarily and on time. Any drop in voluntary compliance will lead to greater enforcement costs and less revenue.

Although the IRS is choosing to focus more of its limited resources on making sure citizens pay their taxes, enforcement is still weak and getting worse. The number of employees dedicated to enforcement has dropped by 20 percent since 2010. John Koskinen, the Commissioner of the IRS, stated in January that reduced funding will result in $2 billion of lost revenue this year. This means that the $838 million in ‘savings’ from cutting the IRS budget will really result in $2 billion in losses for the entire federal government. Indeed, losses could be even greater because each additional dollar spent on enforcement yields six dollars of revenue and every dollar spent on “audits, liens and seizing property from tax cheats” yields ten dollars of revenue. In 2011, the commissioner of the IRS even testified to Congress that every dollar spent on enforcement, modernization, and management saves the government $200.

Currently there is a proposal attached to the highway funding bill that requires the IRS to outsource some tax enforcement to private debt collectors. This policy was practiced from 2006 to 2009 and lost money. Critics are also concerned about an increase in scammers who claim to represent the IRS, an alarming trend that has been growing in recent years. Clearly, the government would have to compensate private collectors, but it would be far more cost-effective to fully fund IRS enforcement.

Right now there is no end in sight for the fiscally irresponsible budget cuts to the IRS. Even with the $75 million increase in funding for taxpayer services, Congress is proposing to cut the 2016 budget by more than double the 2015 cuts and spending $2.8 billion less than what President Obama requested. Critics of the IRS argue that reducing the IRS budget will result in more efficient use of funds and more accountability to the American people. The main issue with this argument is that the IRS has already employed many cost saving techniques such as encouraging electronic filing and referring taxpayers to the IRS website rather than speaking with a representative. As noted by the Taxpayer Advocate report, the cuts have already begun to impact taxpayer filing services, fraud prevention, FATCA enforcement, and digital security.

The IRS needs more funds, not fewer, to properly serve taxpayers, maintain high levels of voluntary compliance, and enforce the laws Congress has passed.  

Nike: Just Dodge It

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For fans of creative tax dodging, the release of the Nike Corporation’s annual report is always an enlightening occasion. As we noted two years ago, the company quietly acknowledges having stashed billions of dollars in low-tax offshore destinations, and has inadvertently given some signals about how it might be achieving this.

The company’s 2013 annual report disclosed the existence of a dozen subsidiaries based in Bermuda, almost all of which were named after specific brands of Nike shoe. A sensible inference is that these subsidiaries may exist solely to house the company’s intellectual property—patents, trademarks, logos and slogans, for example—associated with each of these brands.

In 2014 the company apparently got wise to the optics and abruptly stopped disclosing the existence of half of these subsidiaries, reducing to six the number of Nike shell companies allegedly doing “business” in Bermuda.

This shouldn’t be surprising. As has already been documented, technology companies like Microsoft and Google have stopped disclosing the existence of almost all of their offshore subsidiaries, and we now know that Wal-Mart never disclosed its offshore subsidiaries to begin with. This behavior is made possible by lax reporting requirements and abysmal enforcement by the Securities and Exchange Commission, which is tasked with ensuring that corporations submit transparent financial reports to their shareholders.

In 2015, the company’s latest annual financial report lists only three Bermuda subsidiaries. Does all this mean that the company has renounced its use of the “Nike Force,” “Nike Pegasus” and “Nike Waffle” subsidiaries it formerly disclosed? It’s possible—but don’t count on it. After all, the company added a breathtaking $1.7 billion to its stash of offshore cash in the past year and quietly discloses that it has paid a tax rate that is likely less than 5 percent on these profits. Tax rates that low are pretty hard to find outside the Caribbean.

Scott Walker’s Tax-Cut-Driven Economic Plan

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After his 2011 election, Wisconsin Gov. Scott Walker aggressively pursued and helped pass a series of tax cuts in 2011, 2013, 2014 and 2015. His policies pushed the state into bad fiscal straits and there is no evidence that tax changes enacted under his leadership have had the positive impact on the state’s economy that he promised. In addition, Gov. Walker has hinted that he favors repealing state and federal income taxes, a move that would make the tax system substantially more regressive.

Record as Governor of Wisconsin

How did Wisconsin’s fiscal situation get so bad that it had to skip $100 million in debt payments earlier this year? The answer is Gov. Walker’s relentless push for ever more wasteful tax cuts.

When Gov. Walker took office in January 2011, Wisconsin faced a significant budget shortfall. The Center on Wisconsin Strategy and other public interest groups called his budget proposal a betrayal of Wisconsin values. The final legislation reduced the Earned Income Tax Credit (EITC), thus increasing taxes on the state’s poorest working families, and the budget capped growth of a property tax credit for low-income families. That budget also included an estimated $135 million in tax breaks in just one year, with these breaks set to become more costly year after year. These breaks took the form of a domestic production activities credit, two different capital gains tax breaks for the rich, and a variety of new sales tax exemptions, including for snowmaking and snow grooming equipment.

Earlier in the budget process, Walker had sought to repeal combined reporting, an important reform that requires companies in the state to report their income for tax purposes on the total profit of all their combined subsidiaries, regardless of the state in which they are located. Ultimately, the Governor was not able to repeal the provision, but lawmakers agreed to cut taxes on corporations by allowing them to carry forward losses and deduct their liability in future years, thus reducing their tax bills by an estimated $40 million annually.

In late 2013, the Governor notoriously toyed with the extremely regressive idea of eliminating the state’s income tax and increasing the regressive sales tax rate to compensate. ITEP crunched the numbers and found that the new state sales tax rate would have to be 13.5 percent to ensure a revenue neutral tax change. Ultimately, lawmakers put aside the income tax elimination plan for unspecified reasons.

His proposed budget for 2013-15 included a plan to cut the bottom three income tax rates. Lawmakers signed a tax cut proposal into law that reduced income tax rates and reduced the number of tax brackets from five to four. According to the Legislative Fiscal Bureau, these tax cuts cost $647.9 million over two years.

In October 2013, with an unexpected $100 million budget surplus, Gov. Walker signed a law that added $100 million in state aid to local school districts over the next two myears—which, due to the state’s strict local revenue limits, meant that local governments receiving the new aid were forced to reduce their property taxes dollar for dollar. This was a short-sighted approach to tax cutting because the forecasted $100 million surplus could be just a memory in future years, but the new state aid will be permanently on the books. As the Wisconsin Budget Project (WBP) points out, using a one-time budget surplus to fund a permanent property tax cut is a recipe for long-term fiscal difficulties.

Walker’s January 2014 budget proposal included yet another round of tax cuts. His proposal, which ultimately passed in March, included $537 million (over two years) in property and income tax cuts. He proposed the tax cuts as a way to “return the state’s surplus to the people who earned it.” The cuts included $404 million in across the board property tax cuts and $133 million in income tax cuts that resulted from lowering the bottom income tax rate from 4.4 to 4.0 percent and reducing the Alternative Minimum Tax.

Taken together, these three tax cut packages cut taxes for all income groups according to an ITEP analysis, but did not meaningfully change the state’s regressive tax system. Between 2011 and 2014, these cuts did however blow a $2 billion cumulative hole in the state’s budget.

The governor’s most recent budget, released in early 2015, proposed expanding a property tax credit and included deep cuts to K-12 education, higher education and conservation efforts. This year’s legislative session was especially contentious and there was much push back to his proposals. In fact, much of his proposed cuts to K-12 education were restored. Ultimately, the governor was able to pass about $262 million in additional annual cuts in revenue, including an increase in the school levy tax credit, increased school aid that required offsetting property tax cuts, the near elimination of the alternative minimum tax and an increase in the standard deduction.

The stated goal of Gov. Walker’s tax cuts is that they will help the state create jobs and lead to economic growth. The problem, however, is that this strategy has not worked out all that well. While his tax cuts have not delivered significant growth, they have forced the underfunding of the real long term drivers of economic growth like the state’s education system and infrastructure.

Approach to Federal Tax Reform

Unlike many of his rivals for the Republican nomination, Gov. Walker has not laid out any clear vision for how he would change the federal tax system as president. Talking broadly, Gov. Walker has outlined his admiration for President Ronald Reagan’s approach to taxes, which he says means lowering the tax rate and simplifying the tax code. In another interview, Gov. Walker said that he thought eliminating the federal income tax “sounds pretty tempting.” He did not however provide any sense of how he would fill in the $1.4 trillion dollar hole in the annual budget that such a move would create.

In talking about taxes on the campaign trail, Gov. Walker relates his strategy to that used by the department store Kohl’s, in which they lower the prices of goods in order to sell a higher volume of goods to consumers. He calls this strategy the “Kohl’s Curve” and believes that for the tax system it means we should lower the tax rate and expand the number of people who pay taxes. This new Kohl’s Curve is supposed to mirror the Laffer Curve, which has been used to promote failed tax-cutting economic policies throughout the country. 

The Truth about Sales Tax Holidays

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Everyone loves a bargain (and a holiday), so it’s no surprise that sales tax holidays are hugely popular in the 17 states that will hold them in the coming weeks.

Most state sales tax holidays will coincide with back to school season to help consumers save on school clothes and supplies, but a subset of states also hold separate sales tax holidays to help consumers save on purchases tied to hurricane and hunting season. State lawmakers reap public relations benefits from these “holidays”, and media tend to cover them favorably.

But taxpayers would be wise to look beyond political talking points, long lines and bargains. The truth about sales tax holidays is that they are a costly gimmick. While they may provide taxpayers some savings on necessary purchases, they are a distraction from the bigger picture problem with regressive state tax systems.

Virtually every state’s tax system takes a much greater share of income from middle- and low-income families than from wealthy families. Nationwide, the poorest 20 percent of households pay 10.9 percent of their income in state and local taxes on average, compared to just 5.4 percent for the top 1 percent. States’ heavy reliance on sales taxes exacerbates this problem.

In theory, sales tax holidays should help mitigate this problem. But temporary reprieves from taxes on back to school items aren’t well targeted. In fact, temporarily suspending sales taxes often benefits wealthy families more than low- to moderate-income families.  Better-off families are positioned to time their big purchases to occur during sales tax holidays–a luxury that often isn’t available to folks living paycheck to paycheck. One study found that households earning more than $30,000 per year are more likely to shift the timing of their clothing purchases to coincide with sales tax holidays compared to lower-income households. Further, low-income seniors and families without children who have no need to purchase “back to school” items get nothing from sales tax holidays.

Sales tax holidays will collectively cost states more than $300 million this year. This is money states can ill afford to lose. The revenue lost through sales tax holidays will ultimately have to be made up somewhere else, either through spending cuts or increasing other taxes.

Instead of expending resources planning, promoting and implementing sales tax holidays, policymakers would do better to focus on long-term solutions with real benefits for working families.  They could implement policies such as sales tax credits for low-income taxpayers, expand or implement a state earned income tax credit, or permanently reduce sales taxes rates and shift toward a progressive personal income tax.

If lawmakers really want to help families’ bottom lines, they should look to these more thoughtful and permanent reforms. To read ITEP’s full brief on this issue click here.


State Rundown 7/22: The Dog Days of Summer

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The Illinois budget saga continues as Gov. Bruce Rauner and Illinois House Speaker Michael Madigan remain at odds. After Rauner vetoed the FY15-17 spending plan passed by the legislature, lawmakers were unable to override it – resulting in a one-month stop-gap state budget passed last week. However, the governor insists that he won’t sign these piecemeal measures, and demands that Madigan embrace his reforms. Any new revenues will have to be passed with a veto-proof majority, as Rauner has pledged not to raise taxes.

Impasse continues in Michigan as well, where the House lacks the votes to pass the roads funding bill that barely passed the Senate. The Senate plan would have increased the gas tax by 15 cents, raised diesel taxes and cut non-transportation areas of the state budget by $700 million. Legislators are wary of enacting gas tax increases after a ballot proposal that would have raised revenue for transportation was defeated by the voters in May. The state legislature will adjourn until mid-August, when new proposals could be offered.

The Maine Republican Party has signed on to help fund and promote Gov. Paul LePage’s plan to put a proposal to phase out and eliminate the state’s income tax before voters. GOP Chairman Rick Bennett said the party would help collect the tens of thousands of signatures required to put the measure on the 2016 ballot. The deadline for gathering signatures is in January.

An Arizona personal income tax credit for contributions to public schools is drawing attention from citizens concerned that it exacerbates inequality. According to The Arizona Republic, a small number of schools in wealthy areas receive most of the donations eligible for the dollar-for-dollar credit – on average nearly $400 per student. One school received almost $900,000 in one year. The average per-pupil expenditure statewide is just $45 in state income tax revenue. The donations were restricted to extracurricular spending, but the legislature approved a change this session that will allow the money to be spent on SAT and AP tests – worsening academic inequality between rich and poor districts. Coupled with proposed K-12 budget cuts at the state level, this income tax credit funnels resources from lower-income to upper-income school districts.

Ohio legislators inadvertently raised taxes on businesses despite attempting to enact deep cuts for them in the recently passed budget. Under the terms of the budget, business income above $250,000 was to be taxed at a reduced rate of 3 percent under the personal income tax. Instead, the legislative language omitted the $250,000 cutoff, saying that all business income would be taxed at a rate of 3 percent. And under Ohio’s graduated income tax structure, most business owners paid a rate lower than 3 percent on their business income. Lawmakers trying to give businesses a break through a flat tax and mistakenly taxing them more is the height of irony. State Senate President Keith Faber says the legislature will fix the error in the fall. For more on how this mishap highlights the need for a graduated income tax, check out this piece from Policy Matters Ohio.

New Jersey officials are considering an increase in the state’s tax on wholesale petroleum (currently at 4 cents a gallon) in the wake of a transit fare hike.  Lawmakers failed to pass an increase in the gasoline tax during the session – at 10.5 cents a gallon, New Jersey’s gas tax is among the lowest in the nation. The wholesale petroleum tax and gasoline excise tax support the state’s transportation fund, which is dangerously close to running out of money.  


Yes to Broadway, No to Blueberries: The Arbitrary and Bizarre Giveaways in the Latest Tax Extenders Bill

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This is how the tax code unravels.

The Senate Finance Committee, in a rare show of bipartisanship, took less than two hours Tuesday to approve the tax extenders, a hodgepodge of more than 50 temporary tax breaks that expired at the end of 2014. The extenders are primarily a giveaway to business and should remain expired­–an option that doesn’t require any congressional action–but on these corporate giveaways, the nation’s lawmakers agree.

This is bad enough — but it gets worse. Committee members presented a jumble of amendments that would broaden these tax breaks, and actually approved a handful of them. For example, one of the existing provisions gives a special tax break for film and television productions. Producers can immediately write off the costs associated with creating a film or TV show, instead of gradually writing off their investments over the life of the asset as required of most other businesses. But there are meaningless limits: production companies can only write off the first $15 million in costs per film or per television episode (which essentially means the entire cost of a single television episode could be fully tax deductible), and only the first 44 episodes of a TV series are eligible for the tax break. This, however, may reflect lawmakers’ awareness of the jumping the shark phenomenon rather than legislative restraint.

Committee Chairman Orrin Hatch decided that it’s unfair to give the producers of “House of Cards” a tax break without extending the same privilege to their counterparts on Broadway, and so the committee broadened the film and TV tax break to include “live theatrical productions.” This revision could have saved such gems as the big budget disappointment “Spiderman: Turn off the Dark,” and, if passed, would provide generous tax write offs for those who produce economically devastating Broadway duds in the future.

Discerning lawmakers decided a tax break for Broadway is one thing, but southern-grown blueberries went a step too far. Sen. Johnny Isakson (R-Georgia) offered an amendment to expand the “bonus depreciation” tax break to include expenses related to blueberry production. Georgia, it turns out, is the largest blueberry-producing state in the nation. Isakson’s proposal thankfully fell on deaf ears.

The committee’s actions Tuesday reflect a disappointing lack of legislative interest in achieving real tax reform. The tax fairness victory achieved by allowing this motley array of tax breaks to expire at the end of 2014 was purely accidental. The committee should have simply allowed the extenders to remain dead and buried. At the very least, they could have spent more than two hours on these corporate giveaways and taken the time to ask hard questions about each and every one of them.

Instead, they simply brought them all back to life in the legislative equivalent of A&E’s The Walking Dead. Of course, the enthusiasm of the members of the tax-writing committee for the extenders has nothing to do with good tax policy. Rather the tax   extenders are simply a periodic campaign fundraiser for senators and representatives at the expense of ordinary American taxpayers.