Author: tarek

A lot of gimmicky bills are proposed each Congressional session, but few are quite as ridiculous as the proposal by a bipartisan group of lawmakers in the House and Senate to create a new federal income tax break for the cash bonuses received by U.S. Olympic medalists. Not willing to be outdone by Congress, the Obama Administration has even voiced support for the legislation, saying that they want “to ensure that we’re doing everything we can to honor and support our Olympic athletes.”

Unfortunately, this isn’t the first time lawmakers have proposed a special carve-out for Olympic medalists. In fact, this latest push is just a rehashing of identical bills pushed during the 2012 Olympics, which led us back then to have a real facepalm moment. 

First, the income tax system should be neutral in terms of how individuals earn their income and there is no moral or economic case for exempting the earnings of Olympic athletes over other categories of workers. Is the work being done by Olympic athletes really more noble than say the work being done by firefighters, EMTs or soldiers?

Second, aren’t lawmakers always claiming they want to make the tax code simpler? Isn’t it obviously more complicated to fill the tax code with provisions treating different groups of people differently?

And this proposal would, in fact, add provisions to the tax code to benefit a very small subset of people, around 100 or so US citizens who receive an Olympic medal every two years.

The way the proposal is being promoted is also wildly dishonest. The proponents of the bill have based their campaign on the eye-catching, yet false, claim that Olympic athletes could end up owing as much as $10,000 in taxes on the bonus from their gold medal. The reality is that this $10,000 figure is completely bunk because most Olympic athletes are not wealthy enough to pay the full 39.6 percent rate on the gold medal that the figure assumes. In addition, Olympic athletes could potentially wipe out the entirety of the tax by deducting the expense of their training and travel for the event.

As if all of this was not bad enough, it seems that the legislative language is so broadly written that it could actually allow exemptions for huge cash bonuses given to Olympic competitors through endorsement deals. For example, if the legislation passed, the well-known Olympic swimmer Michael Phelps could structure his future endorsement deals such that he receives $300,000 tax-free for each medal earned.

Hopefully, lawmakers will resist the clarion call of publicity surrounding these and other gimmicky tax proposals and push real tax reform options going forward.

Photo of Olympics via U.S. Army IMCOM Creative Commons Attribution License 2.0 

Ohio Governor John Kasich is expected to unveil his latest tax cut proposal soon and it doesn’t take a deep understanding of Ohio politics to know that the Governor’s plan will likely include large across the board income tax rate reductions. Last week he mentioned wanting to lower the top income tax rate to below 4 percent after persistently advocating in recent months for reducing the top rate to less than 5 percent (the current top income tax rate is 5.333 percent).

In anticipation of the governor’s latest proposal, Policy Matters Ohio (PMO) released a new report, using ITEP data,“Income-tax cut would favor well-to-do”, which shows the impact of an across the board income tax rate reduction that lowers the top income tax rate to just under 5 percent. The biggest beneficiaries of this proposal are by far the wealthiest Ohioans. In fact, 69 percent of the benefits go to Ohioans in the top 20 percent of the income distribution.

We often don’t get to talk about tax policy as it relates to pizza, but PMO finds “that the across-the-board cut in rates needed to [get the top rate to below 5 percent] may allow low-income Ohioans to buy a slice of pizza a year, on average. Middle-income Ohioans could purchase a cheap pizza maker. For the state’s most affluent taxpayers, on average it would cover round-trip airfare for two to Italy, with some money left over to pay the hotel bill and buy some real Italian pizza.”

If the Governor aggressively pushes getting the top rate below 4 percent the benefits to the wealthy will be even greater and could mean a second trip to Italy with a stop over in France to pick up a bottle of wine. Either way, reducing the top income tax rate below 4 or 5 percent would enhance the unfairness already apparent in Ohio’s tax structure and makes it more difficult for the state to fund necessary services.

Whenever it’s trying to justify cutting taxes (or not raising them), the Tax Foundation likes to direct readers toward one of its reports from 2012, in which it concluded that “nearly every empirical study of taxes and economic growth published in a peer reviewed academic journal finds that tax increases harm economic growth.”  As it turns out, this conclusion is simply wrong.

In a new report just released this week, the Center on Budget and Policy Priorities (CBPP) digs more deeply into the literature and finds that “12 of the 26 studies that the Tax Foundation cites do not support its flat assertion that tax increases harm growth.”  To take just one example, the Tax Foundation selectively cited a 1997 study in order to obscure its finding that tax increases could actually improve economic growth if they were used to fund education or deficit reduction.

Equally damning is CBPP’s finding that the 26 studies the Tax Foundation cited are hardly the only research on this topic, noting that “the Tax Foundation’s review omitted dozens of relevant studies published in major journals or edited compilations since 2000.”  This is a serious shortcoming given that the Tax Foundation claims to possess insights into the findings of “nearly every empirical study of taxes and economic growth,” and that it says it’s discovered a “consensus among experts” about the negative economic impacts of taxes.

Unsurprisingly, many of the studies omitted by the Tax Foundation contradict its claims about the disastrous effects of higher taxes—and some directly contradict the exact studies that the Tax Foundation chose to cite.

This CBPP study, as well as an earlier one looking just at the state-level studies included in the Tax Foundation report, reveal that the Tax Foundation’s so-called “literature review” is more spin than substance.

Last year, Missouri Governor Jay Nixon, a Democrat, vetoed a regressive tax cut package passed by Republican lawmakers that would have cost the state $700 million annually. In his veto message the Governor called the legislation an “ill-conceived, fiscally irresponsible experiment that would inject far-reaching uncertainty into our economy, undermine our state’s fiscal health and jeopardize basic funding for education and vital public services.” In a victory for tax justice advocates, his veto withstood an attempted override by the legislature.

But, last week, Nixon reached a flawed tentative agreement with Republican State Senator Will Kraus to reduce the top individual income tax rate by half of one percentage point, but only if certain budget conditions are met. Half of the tax cut is contingent on the state bringing in $200 million in revenue growth and fully funding the state’s schools. The other half would be triggered by legislation that lowers the cap on two tax credits: one for low-income housing development and the other for historic building preservation. If all the contingencies are met, the Governor’s proposal would cut taxes by roughly $400 million a year, less than half of what Republicans in the legislature are asking for ($928 million a year when fully phased in), but still a significant tax cut.

In terms of fairness, an Institute on Taxation and Economic Policy (ITEP) analysis published in a brief from the Missouri Budget Project (MBP) found that reducing the top rate to 5.5 percent overwhelmingly benefits the wealthiest Missourians. In fact, ITEP found that 76 percent of the tax reduction would fall to the wealthiest 20 percent of Missourians. The impact by income group of this tax cut clearly illustrates that the wealthier do better under this proposal, Missourians in the top 1 percent, those with average incomes over $1.094 million – would receive a tax cut averaging $3,779 per year. In contrast, the average Missouri family with incomes from $33,000 – $52,000 would receive just a $47 tax cut per year, about enough to buy one hamburger each month. And the lowest income Missourians, those with incomes under $18,000, would get zero benefit.

In terms of adequacy, MBP rightly notes that over the long term there is no guarantee that school funding won’t be cut, “there are no ongoing protections for funding of public education.” There is a long history of states promising to hold services harmless and failing to do so.

Of course, there is a better way. Missouri’s Governor and lawmakers could work together to cut taxes for those who can least afford them and further invest in schools, healthcare and transportation by asking the wealthy to pay more. Let’s certainly hope this “deal” isn’t done.

When individuals fill out their tax returns, billions of dollars — both for individual taxpayers and for the federal government — are at stake. This is one reason why more than half of U.S. taxpayers rely on paid tax preparers to help them.

And yet, there are no national standards to ensure tax preparers are well qualified to play this critical role (only four states have taken licensing into their own hands) despite the fact that many preparers are error-prone, or worse. When the Treasury Inspector General for Tax Administration sent auditors into the field to pose as taxpayers seeking preparer services in 2008, 61 percent of the resulting tax returns were found to be flawed. While 65 percent of the mistakes were honest lapses, the other 35 percent were “willful or reckless” misstatements or omissions. The Government Accountability Office reached similar conclusions in a 2006 study, and the National Taxpayer Advocate has been sounding the alarm on this issue for years.

The IRS recently found that the net “tax gap” (the difference between taxes owed and taxes paid after enforcement measures are taken) was $385 billion in 2006, and that $235 billion came from individual income tax underreporting. Tax preparers certainly had a great deal to do with this.

And even relatively small parts of this problem — like underreporting related to income tax credits, which accounted for $28 billion of the tax gap — can have huge implications for the individual families affected. For example, the Earned Income Tax Credit (EITC) involves complicated rules and steep penalties for the taxpayer if any misrepresentations are identified, even if the mistakes are inadvertent or caused by preparer error. Roughly half of returns claiming an EITC in 2011 were filed with the help of an unregulated preparer.

While the rate of EITC overpayments has been greatly overstated, the truth is that there are too many overpayments and underpayments of EITC benefits and incompetent or nefarious preparers are partly to blame. Some have been known to offer EITC refunds in the form of deceptive loan products with exorbitant fees.

In reaction to these concerns, the IRS issued regulations in 2011 that would require unenrolled paid preparers to pass a certification exam, pay fees, and take continuing education courses. These regulations are not unprecedented. Some paid preparers who also represent taxpayers before the IRS during appeal proceedings — like attorneys, certified public accountants, and “enrolled agents” — are already regulated. And similar requirements currently apply to volunteer tax preparers who work through the Volunteer Income Tax Assistance (VITA) program.

Unfortunately, the 2011 regulations were never implemented because commercial tax preparers attempting to avoid the certification requirements brought suit and won in federal district court. The challengers claimed that the IRS only had statutory authority to regulate preparers that assist taxpayers in their dealings with the IRS after their returns have already been filed (the aforementioned “enrolled” agents), not those who help prepare the return before filing. While it may not seem like a meaningful distinction, federal judges have now ruled against the IRS twice. The latest rebuke came this week from the D.C. Circuit Court of Appeals.

Assuming the Supreme Court does not take up the case (the IRS has not yet announced if it will appeal), the burden will fall on Congress to give the IRS the explicit authority to pursue these important reforms. As the National Community Tax Coalition and the National Consumer Law Center wrote in their amicus brief to the DC Circuit Court, “Without such regulation, consumers are at the mercy of an industry with no minimum training or competency standards for one of the most critical financial transactions that consumers engage in every year.”

It’s an age-old question: How do you thank legislators who give your profitable company an $8.7 billion tax subsidy? Most etiquette experts agree that a handwritten note just won’t do. But a lavish party thrown in your benefactors’ honor — that’s more like it. Recently, Boeing threw a party for Washington state lawmakers to thank them for the record amount of taxpayer money they delivered to the company in a special legislative session late last year. The reception was conveniently held across the street from the Capitol. Thankfully for Boeing, the cost of the party will likely be written off as a business expense on next year’s taxes.

Indiana lawmakers are looking in all the wrong places for a way to boost their state’s economy. The Indiana Senate has passed a bill eliminating the business equipment tax for companies with less than $25,000 worth of equipment, while the House version would give localities the option of eliminating the tax entirely for new machinery. But a new report (PDF) from the Indiana Fiscal Policy Institute explains that localities are in no position to deal with yet another cut in their property tax bases, and that giving localities the option of eliminating this tax is unlikely to draw any new businesses into the state (though it may reshuffle existing businesses around within the state’s borders).

The Arizona Daily Star reports that “a bid to enact a flat income-tax rate in Arizona is dead.” State Representative J.D. Mesnard had hoped to begin flattening one of the state’s only major progressive revenue sources by reducing the number of income tax brackets from five to three, but he appears to have abandoned that effort after failing to gather any support. But income tax cuts are hardly off the agenda. Mesnard still wants to funnel any new sales tax revenue collected from cracking down on online sales tax evasion into income tax cuts that are likely to benefit the rich. Much more reasonable, however, is his proposal to index the state’s tax brackets to inflation—a change that would actually help retain the progressivity of Arizona’s income tax over time.

Michigan Governor Rick Snyder has a better tax-cutting plan than his colleagues in the legislature. Rather than rewarding wealthy taxpayers with a cut in the state’s income tax rate, Snyder wants to provide targeted property tax relief to middle-income families through an expansion of the state’s circuit breaker program. The expansion would help offset a reduction in the circuit breaker passed in 2011 to help pay for a massive business tax cut sought by the Governor. But while Snyder’s plan is an improvement over plans to cut the income tax rate, the Michigan League for Public Policy notes that Snyder’s plan is hardly perfect: “a critical omission [from Snyder’s budget] was the failure to restore cuts in the state’s Earned Income Tax Credit, the best tool for helping families with the lowest wages.” And there are also serious questions about whether Michigan lawmakers should be discussing tax cuts at all—a new poll shows that in terms of their top priorities, voters rank tax cuts a “distant third” behind spending on schools and roads.

Kentucky Governor Steve Beshear has unveiled a 22-point tax reform plan that includes a new refundable state earned income tax credit (EITC), limits on the generous $41,110 pension exclusion and expanding the sales tax base to include a wider range of services. The plan is based in part on the recommendations of the Governor’s Blue Ribbon Commission on Tax Reform, which were released in 2012. Beshear’s plan also includes a cut in the personal and corporate income tax rates and an increase in the cigarette tax. In total the proposal increases state revenues by $210 million a year.

The proposal is a mixed bag.  While it raises much needed revenue and includes several reform-minded options, it falls short of improving the fairness of the state’s tax structure. The introduction of an EITC and limiting the current pension exclusion are a good start, but changing the corporate income tax apportionment formula to single sales factor and lowering personal and corporate income tax rates are costly ideas that benefit wealthier Kentuckians.

The Kentucky Center for Economic Policy (KCEP) issued a brief containing an Institute on Taxation and Economic Policy (ITEP) analysis showing that Governor Beshear’s proposal doesn’t improve tax fairness in any meaningful way. KCEP concludes that “the combined impact of the tax increases and tax cuts in Governor Beshear’s reform proposal would not help improve the regressive nature of Kentucky’s tax system.”  This is because the new revenue raised from the Governor’s plan comes almost entirely from regressive changes to the sales tax base and hiking cigarette taxes.

Governor Beshear deserves some credit for proposing tax reform despite this being an election year, but he missed an opportunity to truly reform the state’s tax structure by making it more fair and adequate. Let’s hope that Kentucky legislators follow KYCEP’s advice and “build on the good parts of the plan while making improvements.”

If Congress decides it cannot spend money to help working families and the unemployed without offsetting the costs by cutting spending, then lawmakers should also refuse to enact tax cuts for businesses unless they can offset the costs by closing business tax loopholes. Sadly, both Democrats and Republicans refuse to acknowledge this commonsense principle as they discuss enacting the so-called “tax extenders” without closing any business tax loopholes — after failing to extend Emergency Unemployment Compensation (EUC) because of a dispute over how to offset the costs.

If there is any federal spending that should not be paid for, surely it is EUC and other temporary spending that is designed to address an economic downturn. As our friends at the Coalition on Human Needs explain:

In January, the national unemployment rate dropped to 6.6 percent from 6.7 percent in December, but jobs grew by a less than expected 113,000. Congress, by failing to renew unemployment benefits, is making things worse.  According to the Congressional Budget Office, restoring EUC throughout 2014 will increase employment by 200,000 jobs… EUC has long been considered an emergency program that does not have to be paid for by other spending reductions or revenue increases. Five times under President George W. Bush, when the unemployment rate was above 6 percent, unemployment insurance was extended without paying for it and with the support of the majority of Republicans.

Unfortunately, on February 6, a measure to extend EUC by three months and another to extend it by 11 months both failed to garner the 60 Senate votes needed for passage.

Compare this to Congress’s approach to provisions that are often called the “tax extenders” because they extend a variety of tax breaks that mostly go to business interests. Unlike EUC, these provisions cannot be thought of as temporary, emergency measures. Even though these tax cuts are officially temporary, Congress has routinely extended them every couple of years with little or no review of their impacts, so that they function as permanent tax cuts.

And, sadly, lawmakers of both parties are guilty of enacting these provisions time after time without closing any business tax loopholes to offset the costs. In some years, Democrats have introduced bills that would close tax loopholes to offset the cost of the extenders. For example, in 2009, Citizens for Tax Justice and several other organizations supported legislation that would have offset the costs of the tax extenders by closing the “carried interest” loophole and other tax loopholes.  

But in other years, neither party even bothered to discuss paying for the tax extenders. This happened the last time they were enacted as part of the “fiscal cliff” legislation that also extended most of the Bush-era tax cuts. Sadly, 2014 may be another year when neither party even pretends to be “fiscally responsible” when it comes to lavishing businesses with tax breaks. Several news reports indicate that Senators are discussing how to enact the tax extenders with as little debate as possible. 

There Is No Provision among the “Tax Extenders” that Is So Beneficial that It Justifies Enacting the Entire Package Without Offsetting the Costs

The feeling among lawmakers that the tax extenders must be enacted under absolutely any circumstances is simply not justified, as demonstrated by examining the most costly provisions among them. This is explained in detail in CTJ’s report on the tax extenders.

The pie chart above, which is taken from the CTJ report, illustrates the costs of the individual tax extenders provisions the last time they were enacted, at the start of 2013 as part of the “fiscal cliff” legislation.

The most costly is the research credit, which is supposed to encourage companies to perform research but appears to subsidize activities that are not what any normal person would consider research, and activities that a business would have performed in the absence of any tax break including activities that the business performed years before claiming the credit. The second most costly is the renewable electricity production credit, which even many supporters agree will be phased out at some point in the near future. The third most costly is the seemingly arcane “active financing exception,” which expands the ability of corporations to avoid taxes on their “offshore” profits and which General Electric publicly acknowledges as one of ways it avoids federal taxes. These three tax provisions make up over half of the cost of the tax extenders.

Next in line is the deduction for state and local sales taxes. Lawmakers from states without an income tax are especially keen to extend this provision so that their constituents will be able to deduct their sales taxes on their federal income tax returns. But, as the CTJ report explains, most of those constituents do not itemize their deductions and therefore receive no help from this provision. Most of the benefits go to relatively well-off people in those states.

Even the provisions that sound well-intentioned are really just wasteful subsidies for businesses. The Work Opportunity Tax Credit ostensibly helps businesses to hire welfare recipients and other disadvantaged individuals, but here’s what a report from the Center for Law and Social Policy concludes about this provision:

WOTC is not designed to promote net job creation, and there is no evidence that it does so. The program is designed to encourage employers to increase hiring of members of certain disadvantaged groups, but studies have found that it has little effect on hiring choices or retention; it may have modest positive effects on the earnings of qualifying workers at participating firms. Most of the benefit of the credit appears to go to large firms in high turnover, low-wage industries, many of whom use intermediaries to identify eligible workers and complete required paperwork. These findings suggest very high levels of windfall costs, in which employers receive the tax credit for hiring workers whom they would have hired in the absence of the credit.

It’s Time for Congress to Change How It Does Business

For Congress to enact unnecessary tax cuts for businesses without closing any business tax loopholes would be very problematic under any circumstances. To do so now, after making clear that help will not be provided to the unemployed unless the costs are offset with spending cuts, is simply outrageous.

Hidden in the footnotes of the financial report released last week by Netflix is an admission that the company reduced its taxes by $80 million in 2013 by deducting the “cost” of executive stock options. This means that as a result of this single tax break, the company didn’t pay a dime of federal or state income tax on its $159 million in US profits last year.

Last year CTJ reported that a dozen emerging tech firms, including Twitter, Facebook and Priceline, were poised to shelter as much as $11 billion in profits from tax using this arcane loophole. For some of these companies, the stock option tax break can singlehandedly wipe out all income tax liability, as it did for Facebook last year.

Stock options are rights to buy stock at a set price. Corporations sometimes compensate employees (particularly top executives) with these options. The employee can wait to exercise the option until the value of the stock has increased beyond that price, thus enjoying a substantial benefit. The problem is that poorly designed tax rules allow corporations to deduct the difference between the market value of the stock and the amount paid when the stock option is exercised. In practice, corporations are often able to deduct more for tax purposes for stock options than they report to shareholders as their cost.

The defenders of this tax break sometimes argue that when companies pay their employees, it shouldn’t matter whether the pay takes the form of salaries and wages or stock options. But this argument glosses over the fact that while paying salaries imposes a dollar-for-dollar cost on employers, issuing stock options simply does not. As we have argued elsewhere, a sensible analogy is airlines giving employees the opportunity to fly free on flights that aren’t full, which costs the airlines nothing. It would be ludicrous to argue that airlines should be able to deduct the retail value of these tickets.

Senator Carl Levin (D-MI) has introduced legislation that would pare back (but not repeal entirely) the stock option tax break. Levin’s legislation (the Cut Unjustified Tax Loopholes Act) would address situations in which corporations take tax deductions for stock options that exceed the cost they report to their shareholders. It would also remove the loophole that exempts compensation paid in stock options from the existing rule capping companies’ deductions for compensation at $1 million per executive.

Allowing high-profile tech companies to zero out their taxes using phantom costs erodes the public’s faith in the tax system; any meaningful attempt to reform our corporate tax should remedy this situation.

Last week, CTJ published its finding that International Business Machines (IBM) has paid U.S. federal corporate income taxes equal to just 5.8 percent of its $45.3 billion in pretax U.S. profits over the five year period from 2008 through 2012. Today IBM responded by trying to change the subject to what it paid in one single year, and what it may or may not pay in future years.

To understand IBM’s evasive argument, first remember that CTJ’s corporate tax numbers are from the form 10-K, the document corporations file with the Securities and Exchange Commission (SEC) to disclose relevant information to shareholders. We report what are recorded on the 10-K as “current” U.S. income taxes (the federal income taxes paid by the corporation in a given year) and the profits earned by the corporation in the U.S. that year. The current taxes paid over a five-year period divided by the U.S. profits earned over a five-year period is the effective federal corporate tax rate over a five-year period.

Here the description from Politico’s “Morning Tax” of what happened when IBM was asked about CTJ’s analysis:

IBM argues that the CTJ analysis does not take into consideration the fact that the tech company heavily relies on deferrals to lower their year-to-year income tax bill noting that, according to its calculations, the company paid more than $2.5 billion in taxes for its 2012 domestic operations. That comes out to a tax rate of 27 percent, a spokesperson for the company told Morning Tax.

First, IBM focuses only on its U.S. effective tax rate in 2012, which our own figures show was in fact higher than in the previous four years. But IBM’s federal tax rate wasn’t 27 percent; it was only 14 percent. In the previous four years, IBM’s federal tax rate was only 3.5 percent, which is why IBM’s five-year effective rate is 5.8 percent.

Second, IBM seems to think that we should give the company credit for taxes that it did not pay, specifically the “deferred” taxes that it may or may not pay in the future. But quite reasonably, we count such “deferred” taxes only when and if they are actually paid.

“IBM is happy to minimize its federal tax bill, but apparently not so happy for the public to know just how little it pays to support our country,” said CTJ director Bob McIntyre. “If and when IBM starts paying its fair share in taxes, we’ll be pleased to report it. But that hasn’t been the case for at least the past 12 years.”