Month: August 2016

Earlier this week the U.S. Treasury Department proposed new regulations designed to prevent wealthy business owners from avoiding estate tax liability by artificially undervaluing their assets.

The tax avoidance strategy the new regs are designed to prevent takes advantage of a provision of the law that has to do with how minority interests in businesses are valued for tax purposes. Minority interests, and interests in companies that are hard to sell, are worth less than other business interests, and are routinely (and sensibly) valued less for this reason.  But this provision can be abused by wealthy people seeking aggressive estate-planning strategies. Someone whose assets, properly valued, would likely put them in the economic stratosphere—the less than one half of one percent of estates that would actually be subject to the federal estate tax—can reduce their estate’s apparent value by seeking out a business investment in which their minority interest would be valued much lower, for tax purposes, than other investment uses of the same amount of money.

Put another way, if you have $20 million in assets, abuse of this provision can allow you to squeeze it into a $10 million package for no purpose other than tax avoidance. The Treasury regs are intended to prevent these transactions only when they are clearly motivated by tax avoidance.

The technique Treasury wants to prevent clearly isn’t something just anyone is going to try. In 2016, estates and cumulative gifts valued at less than $5.45 million ($10.9 million for a married couple) are exempt from all federal taxes. Nor is it a strategy that’s easily available to owners of a small business or family farm for whom this single asset is the lion’s share of their estate. Rather, it’s a tax dodge that’s available to a small number of super-rich Americans who enjoy enough liquidity to contemplate moving tens of millions of dollars in assets around at a moment’s notice.

As things stand, estate tax cuts over the past two decades already mean the tax only applies to the very largest estates. Reversing this trend would require more than regulatory steps. Fortunately, Congress has reform options available in the form of the Responsible Estate Tax Act, which would reduce the estate tax exemption and crack down on other egregious estate tax abuses such as the “GRAT” loophole. But since Congressional action does not appear to be forthcoming, Treasury’s draft regulations are an important step in preserving the estate tax. 

This week’s Rundown features a reiterated commitment to no new taxes in New Mexico, talk of a special revenue session in Oklahoma, tax shifting debates in Mississippi, and a looming shortfall in Missouri. Be sure to check out the What We’re Reading section for a guide to income inequality trends and an article examining studies on tax and spending levels. Thanks for reading the Rundown!

— Meg Wiehe, ITEP State Policy Director, @megwiehe

• With New Mexico facing revenue shortfalls, some lawmakers are urging Gov. Susana Martinez to consider revenue solutions and save the state’s schools, roads, and public safety services from further funding cuts. But so far, Gov. Martinez has rejected these pragmatic pleas and only reiterated her devotion to her ideologically driven no-tax pledge.
• Oklahoma Gov. Mary Fallin is weighing whether to call the Legislature into special session to consider an alternative plan to fund teachers’ pay. Already under consideration is a 1 percentage point increase to the state’s sales tax, a proposal that will appear on the ballot this fall. Fallin’s proposed alternative would use, in part, $140.8 million that the state collected from cuts to state agencies. The call for a special session, however, faces criticism across the aisle.
• A Mississippi legislative “working group” has begun looking at the state’s tax structure with an intent to shift the responsibility to fund state services even further onto low- and middle-income families by slashing income taxes and replacing them with regressive sales taxes. And some are already hoping for “an overall reduction in taxes” despite the massive, regressive, and short-sighted tax cuts already enacted earlier this year.
• Results are in from a state study showing Missouri‘s state workers are some of the lowest-paid in the nation, and that these low wages “have led to high turnover rates, costing taxpayers additional money in overtime and training.” And the Missouri Budget Project reports that more revenue shortfalls could be looming. But one silver lining on this cloudy outlook is that slow revenue growth has so far saved the state from a tax-cut “trigger” enacted two years ago, buying legislators time to change course and avoid reducing the revenues used to pay state workers even further.

 What We’re Reading… 

• The Florida Policy Institute’s latest report calls for the state to carefully examine the “silent spending” it undertakes in the form of tax expenditures that total nearly $18 billion per year but receive very little scrutiny.
• CBPP’s guide to historical trends in income inequality.
• The New York Times reviews recent studies on tax and spending levels, including one important study that asks “How Big Should Our Government Be?” and concludes that a significantly higher level of public investment would improve security, opportunity, and middle-class lives without sacrificing economic growth.
• The Center for American Progress released a report this week, making the case for rainy day funds as a tool to help enact progressive policies.

If you like what you are seeing in the Rundown (or even if you don’t) please send any feedback or tips for future posts to Kelly Davis at kelly@itep.org. Click here to sign up to receive the Rundown via email. 

The sharp decline in oil prices since summer 2014 has allowed consumers to save hundreds of dollars annually at the pump, but it also has left some energy producing states clamoring to come up with policy ideas to make up for lost revenue.

Before the recent precipitous decline in oil and other fuel prices, states that rely on the energy sector for revenue enjoyed years of fiscal bliss thanks to the high price of natural resources. Rarely fretting about ways to pay for public services, many of these states found themselves so flush with funds that they began cutting taxes and offering corporate giveaways. With energy revenues flowing, lawmakers failed to make the tough, long-term decisions needed to ensure their states had a diverse portfolio of broad-based taxes.

Now that oil prices have remained comparatively low for the last two years, and the price and demand for coal, natural gas, and other energy commodities also have taken a hit, there is no way to know for sure when the fortunes of the energy industry may rebound. This reality imposes a revenue challenge for states with budgets that are heavily dependent on energy markets.

Many of the most consequential tax debates taking place right now are in states with a significant energy sector presence. States such as Alaska, Louisiana, New Mexico, North Dakota, Oklahoma, Texas, West Virginia, and Wyoming have been forced to find ways to fill budget holes in the past year, which in some cases has necessitated rethinking the very structure of their state tax systems.

How Did We Get Here?

To be sure, these states are reeling in part because of low-energy prices. But that is not the whole story. Most energy-reliant states celebrated “boom” times with ill-advised tax cuts and corporate giveaways. The most egregious example is Alaska’s elimination of its personal income tax some 35 years ago (Alaska is the only state to ever repeal a personal income tax). With near complete reliance on the energy sector, Alaska has no personal income tax or state sales tax to turn to in times of crisis.

Other states did not go as far as to repeal personal income taxes, but many made ill-advised tax cuts when they were awash in energy revenue. Louisiana’s decision to eliminate the “Stelly Plan” in 2008, for example, significantly reduced tax rates for the wealthy. This politically charged policy change cost the state an estimated $800 million a year. Over that same period, Gov. Bobby Jindal handed out lavish credits and rebates for corporations. As a result, this year alone the state has paid $200 million more in tax breaks than it has collected in corporate income and franchise taxes.

New Mexico lawmakers’ phased in cuts to the state’s top personal income tax rate, costing  an estimated $500 million in revenue per year. The damage done in the early 2000s continues to play out as the state struggles with year after year of budget challenges. Oklahoma’s shortfall was driven in large part by generous tax breaks and unaffordable, repeated cuts to the state’s income tax over the past decade. The most recent income tax rate reduction had the poorest timing of all, triggered this January despite an official “revenue failure.” Today this series of cuts comes with an annual price tag in excess of $1 billion in lost revenue.

North Dakota lawmakers slashed income tax rates for years, pushing to lower or even eliminate them as energy prices slumped. 2015 legislation alone reduced both individual and corporate income taxes across the board by 10 percent and 5 percent, respectively. While near the peak of its oil boom in 2011, voters concerned about service cuts overwhelmingly rejected a referendum to eliminate the state’s property tax.

Business tax cuts are a major contributing factor to West Virginia’s fiscal problems. The state’s elimination of its business franchise tax took full effect last year, and over the last several years the corporate income tax has been reduced as well.

State Actions This Year

Booms are followed by inevitable busts. Cutting taxes while flush with revenue is not advisable for energy-dependent states. Particularly for states with narrow tax portfolios that are highly reliant on the success of the energy sector.

To date, the tax policy changes enacted in energy states have been limited largely to regressive tax hikes, though there are indications that more meaningful tax reforms could be on the horizon. 

Tax Increases

Lawmakers in traditionally conservative states such as Louisiana, Oklahoma, and West Virginia all approved tax increases in 2016 to help address significant revenue shortfalls. Legislators in Louisiana raised $1.3 billion in new revenue through a 1-cent sales tax increase, the elimination of certain exemptions from the state sales tax base, and tax increases on beer, alcohol, wine, and tobacco. Lawmakers tried, but failed, to enact long-term personal income tax changes. A task force is now exploring comprehensive reform options for 2017. 

Tobacco tax debates were a common theme in energy states this year—West Virginia lawmakers also opted to raise tobacco taxes and Oklahoma lawmakers came close to doing the same.

While a cigarette tax increase was not ultimately enacted in Oklahoma, lawmakers did raise revenue by repealing the state’s “double deduction,” a nonsensical law that allowed Oklahomans to deduct their state income taxes from their state income taxes. In addition, they voted to change the state portion of the Earned Income Tax Credit (EITC) from refundable to non-refundable, a move that disproportionately affects low-income taxpayers by denying the credit to families that earn too little to owe state income taxes.

In New Mexico, Gov. Susana Martinez has reiterated her “no tax increase” pledge despite the state’s projected $600 million shortfall. Given the breadth of the revenue gap, state legislators have urged her to reconsider her position.

While major tax increases have yet to come to The Last Frontier, the significant fiscal debates that took place in Alaska this year are also worth mentioning. There, lawmakers discussed a range of options to remedy the state’s multi-billion-dollar deficit during the state’s regular legislative session and two special sessions called by Gov. Bill Walker.

Spending Cuts

In 2016, virtually every energy-reliant state cut vital public services. North Dakota saw cuts exceeding 4 percent earlier this year. That was followed by a May announcement for a total of 10 percent across-the-board cuts for the coming biennium. And the problem persists—Gov. Jack Dalrymple called a special session to address yet another shortfall.

Similarly, New Mexico lawmakers passed budget amendments early this year to cut spending across state agencies. New revenue gaps have since appeared, leading lawmakers to request that Gov. Susana Martinez call a special session. In Wyoming, Gov. Matt Mead recently announced another round of cuts, this time nearing $250 million. Those cuts and the associated loss of federal funds are expected to result in massive layoffs across the state.

Alaska, Louisiana, Oklahoma, and West Virginia accompanied their tax increases (or in Alaska’s case, proposals for tax increases) with cuts to state spending. And many additional cuts are anticipated for the coming years. For example, Texas lawmakers have asked most state agencies to lower funding requests for the coming biennium, with a call for 4 percent nearly-across-the-board cuts to many programs that are already underfunded.

Short-Term Fixes

While all of these states have made progress in closing their current budget gaps, there remains a need for revenue and structural reforms in the long run. One-time revenues were used heavily in both Oklahoma and West Virginia. In Oklahoma, 60 to 80 percent of the budget hole was filled with non-recurring revenue such as one-time bond issues and cash transfers. West Virginia filled its gap with a range of one-time funds, including a $70 million withdrawal from the state’s Rainy Day Fund.

Similarly, Louisiana’s solution was primarily dependent upon temporary tax measures. Changes to the state’s inventory tax credit and corporate franchise tax come with expiration dates attached.

And in Alaska, legislative inaction forced Gov. Bill Walker to veto large swaths of the state’s spending plan. In doing so, the governor capped next year’s Permanent Fund dividend, a flat dollar payment that most Alaskans receive each year, at $1,000. This is down more than 50 percent from the state’s 2015 dividend payout of $2,072. A restructuring of the state’s dividend program will likely be revisited next year.

Some Progress, But More Reforms Are Needed

While lawmakers in energy-sector states have taken steps to close their revenue shortfalls, not nearly enough is being done to address the structural inadequacies driving the problem. Inaction or short-term fixes were too often a theme for energy-reliant states in 2016. While partly driven by hope that energy prices will rebound, this tendency for delay is not a long-term solution. Rather than watching desperately for signs of improvement in energy markets, lawmakers should take matters into their own hands by reconsidering past tax cuts that have drained state coffers and by fundamentally rethinking the makeup of tax structures that have become over-reliant on energy revenues.

Earlier this summer, Microsoft announced it would finance its purchase of the professional social networking site LinkedIn by borrowing $26 billion, rather than dipping into its substantial hoard of offshore cash. The ratings agency Moody’s subsequently placed the company under review for a downgrade.

And just last week after Microsoft released its annual report, Moody’s warned that “[t]he long term rating could be downgraded if… the company undertakes additional large, debt funded acquisitions … without a substantial increase in cash balances.” This appears to be a long-winded way of telling Microsoft not to try the LinkedIn strategy again.

Stern warnings from credit rating agencies are generally not shrugged off lightly. Yet Microsoft has a straightforward, if crass, reason for ignoring Moody’s advice: tax avoidance. The company, over the years, has declared $124 billion of its profits to be “permanently reinvested” overseas, much of which appears to have been untaxed. As long as the company keeps these profits offshore, they will stay tax free—but repatriating the profits to (for example) pay for a domestic acquisition would require the company to pay federal income taxes on this income. Microsoft’s executives and tax attorneys appear to have decided it makes more sense to borrow the money domestically than to give up the tax-free status of some of its foreign cash.

How do we know that much of Microsoft’s off-shore cash is tax-free? The company’s latest annual report, released last week, discloses that it has $124 billion in permanently reinvested offshore profits, an astonishing $15.7 billion jump over the $108.3 billion it reported last year. The company says that the unpaid U.S. income tax on repatriation of these profits would be $39.3 billion. Since the tax due on repatriation is 35 percent less whatever has already been paid to foreign governments ($39.3 billion is 31.7 percent of $124 billion), Microsoft has paid an effective income tax rate of just 3.3 percent on its offshore cash. This is a clear indicator that most of its offshore cash is in zero-rate tax havens.

Paradoxically, even though Microsoft is telling the IRS this income is abroad—and staying abroad—much of it likely never left the United States. The U.S. Senate Permanent Subcommittee on Investigations has estimated that more than 75 percent of Microsoft’s so-called offshore cash is in U.S. bank accounts. This means that even though the company can’t invest this cash domestically in ways that create U.S. jobs, it can still enjoy the protections of U.S. banks without paying taxes on profits stashed in these banks.

It shouldn’t take a public scolding from a ratings agency to make corporate leaders stop subverting the U.S. tax system. The choice made by Fortune 500 corporations to hold their cash offshore for tax purposes has real, and damaging, fiscal consequences for our nation. The $39 billion in federal income taxes that Microsoft has not paid on its offshore stash would be more than enough to cover the cost of the Pell Grant program next year, for example. Fortune 500 companies collectively are avoiding up to $695 billion in taxes by stashing profits offshore. Congress, rather than the Moody’s rating agency, should hold corporations accountable and do away with gaping loopholes that allow such egregious tax avoidance. Ending the indefinite deferral of U.S. tax on foreign corporate income would take away the perverse incentive for companies like Microsoft to borrow billions domestically while sitting on far larger troves of unused “foreign” cash.