The Tax Foundation

Rhode Island Governor Proposes Tax Hikes on Sales, Tobacco, Lodging, Vehicle License Fees, Kitchen Sink

Posted on February 1, 2012 by Scott Drenkard

Gov. Chafee (I) of Rhode Island proposed a budget yesterday that would cobble together $92 million from arbitrary places, with an effort to increase spending on education. He announced parts of his proposal in his State of the State address (summary here).

Here are the tax highlights of the proposal (full analysis at Tax Analysts, subscription required):

• Increase statewide meal and beverage tax from 1 percent to 3 percent.
• Expand 13 percent lodging tax to vacation home rentals and bed-and-breakfasts.
• Remove the sales tax exemption on clothing items selling for more than $175.
• Broaden base of Rhode Island's 7 percent sales tax to apply to taxi operators, moving services, non-veterinary pet services, and car washes.
• Increase cigarette tax from $3.46 to $3.50 per pack.
• Doubling the cigar tax from $0.50 to $1.00.
• Move up scheduled fee increases of $30 on vehicle registrations and driver's licenses.

The total budget is estimated at $7.9 billion, which is a 3.1 percent more than last year's budget.

These sorts of budget proposals highlight the need for fundamental tax reform. They go against the principle of neutrality, which states that governments should not construct taxes that preference one industry over another. While Chafee's budget has some elements of base-broadening, there is no effort to lower rates accordingly, and the base-broadening essentially just snipes off specific industries like taxis or car washes and taxes them because they are politically expedient.

If you must raise taxes, raise them on everyone, don't pick and choose winners through the tax code.

More on Rhode Island here.

Learn how Rhode Island's tax climate ranks here.

Follow Scott Drenkard on Twitter @ScottDrenkard.

Fix the Current AMT Before Creating a New One

Posted on January 31, 2012 by Nick Kasprak

In response to President Obama's State of the Union address, in which he called for a "Buffett Rule" setting a minimum tax of 30% for households making over $1 million, a group of Democratic senators have introduced legislation doing just that. The motivation for this legislation is Warren Buffett's claim that he pays a higher effective tax rate than his secretary - a claim that, as I've pointed out, is dubious, at least with regard to the specific numbers he gives. I've put together a chart showing that his claim does not reflect the distribution of tax burdens generally:

(Note: this chart has been modified since it was first published.)

I've included all payroll taxes (both employer and employee side), but the shape of this chart is still what you'd expect in a country with a progressive tax system: high-income people generally pay higher rates. Admittedly, effective rates trail off slightly at the very high end of the income spectrum, reflecting the fact that most of this income is taxed as capital gains rather than as ordinary wage income. However, even when payroll taxes (which are regressive) are considered, the (very small) $10 million+ group still pays a higher effective rate than all groups making under $100K, and is about even with the $100K-to-$200K group. I'll also point out that the Buffett Rule, as proposed, doesn't target the extremely small number of taxpayers in this elite group, but instead casts a wider net with its $1 million threshold.

The point is that, anecdotes aside, the tax code is progressive, especially if payroll taxes are excluded (there are reasonable economic arguments for doing so, given that in many ways they are more like fees for specific social insurance programs than general government revenue raisers.) Those on the left, such as the President, would like to make the tax code more progressive, and those on the right would like to make it flatter. Without delving into a discussion of which direction we ought to choose, I'll simply point out that, if you want to make the code more progressive, the Buffett Rule is probably the worst possible way to do so. It's a rehash of a failed policy.

In 1969, the tax code had various tax preferences which primarily benefited wealthy households, to the point that a small number of high-income households paid no income tax at all. In response, Congress enacted a "Minimum Tax," requiring all households to pay an add-on tax equal to 10% of these tax preferences in excess of a particular threshold. Then, as now, the motivation for the change was a perception that very wealthy households were unfairly benefitting from various forms of preferential tax treatment. In 1984, this idea grew into the modern Alternative Minimum Tax, which is (sound familiar?) an alternate tax system that sets a minimum amount each household much pay, regardless of various preferences and deductions.

Additional preferences and deductions have since been added to the AMT, and it has grown in complexity. It has essentially become an entirely parallel tax code, more or less equal in complexity to the regular tax code, except with alternate definitions of income, deductions, tax brackets, and rates. Many taxpayers need to do their taxes twice and pay whichever is higher.  It's the kind of absurdly complex system that leads the IRS to write tortured instructions like this:

Enter the amount from line 6 of the Qualified Dividends and Capital Gains Tax Worksheet in the instructions for Form 1040, line 44, or the amount from line 13 of the Schedule D Tax Worksheet in the instructions for Schedule D (Form 1040), whichever applies (as refigured for the AMT, if necessary) (see instructions)

-Instructions for IRS Form 6251, Line 37 (2011)

The Buffett Rule is the same thing: an alternate, parallel minimum tax (in this case, a flat 30% tax with very few deductions). Why should we expect that it won't morph into the same kind of beast that the AMT has become? We already have a minimum tax whose original purpose was to fix the exact same problem that the Buffett Rule is trying to address; if anything, we should try and fix the current AMT rather than adding a second one.

There's another problem with the Buffett Rule: current descriptions of it give no indication that it phases in at all. Rather, once a taxpayer's income reaches $1M, the 30% minimum requirement suddenly activates. This is in stark contrast to the marginal structure of our income tax code, where higher rates only apply to income above the bracket threshold. The problem here is obvious: someone with an income near, but under $1 million (whose effective tax rate is almost certainly below 30%, according to the table above), has a huge incentive to keep his income below the threshold. If he exceeds it, his after-tax income suddenly falls significantly. (Citizens for Tax Justice, in a preliminary score of the proposal, assumes that it gradually phases in between $1 and $2 million, thus avoiding this problem to some degree, but as far as I know, this is just speculation on their part; it's unclear if the actual proposal will have a phase-in when it's introduced tomorrow.) (Update 2/1/12: According to Sen. Whitehouse's official press release, the proposal does indeed include a phase-in between $1 and $2 million.)

Even if it does phase in, we're left with a peculiarly arbitrary set of marginal tax rates, where the effective marginal rate for most people with incomes between $1 and $2 million is higher than it is above $2 million, because of the "bubble" rate effect caused by the phase-in. Nobody designing a tax code from scratch would produce anything remotely like this.

Finally, there's no indication that the $1 million threshold is indexed for inflation. This is a problem with the current AMT; none of its parameters are indexed, so Congress passes temporary "patches" each year to avoid an effective tax increase. This is often a politically contentious (and occasionally farcical, at least with regard to the budget math) process, with the side effect that CBO's "Current Law" budget outlook is rendered more or less meaningless. There's the risk that the same problem with the Buffett Rule might cause similar absurdity to become another permanent fixture of the annual budget process, as well as the possibility of effective automatic tax increases every year if it's left alone.

Reasonable people can disagree over the merits of a progressive tax system, but there are good ways and bad ways to tweak progressivity. Rather than adding yet another minimum tax, we should focus on either fixing the current AMT or, better yet, getting rid of it entirely and fixing the problematic deductions and preferences that motivated its creation in the first place. Let's fix the tax code we already have, rather than patching over it with a new layer of complexity.

Pennsylvania Debates Proposed Natural Gas Impact "Fee"

Posted on January 31, 2012 by I. Harry David

Pennsylvania's House and Senate are considering competing proposals to assess so-called impact fees on natural gas drillers. All versions would either permit, or mandate, that county governments charge drillers an annual fee for each well. They differ on the rate, whether the decision to impose the charge be left to the counties or not, how much power the state would have to override local zoning ordinances, and how much revenue could be kept by the localities. The table highlights some of the essential differences between the proposal supported by the House and the Governor, and the Senate's proposal:

Supporters of the impact fee say its purpose is to recoup the state's costs in drilling, including the upkeep of roads, emergency management, and environmental protection. This suggests that the charge is really a tax, as a fee is distinguished from a tax depending on whether revenues are put into a general fund or only used to fund the provision of services to people who pay the fees. Gov. Corbett, in defense of his proposal, noted that none of the money would go into the Gen­eral Fund.

This issue matters in Pennsylvania, with its large reserves of natural gas. The Marcellus Shale gas industry has grown in recent years, to the point where it has become a large source of tax revenues ($1 billion over the last five years). Large though it is, falling prices have led some drillers to shut down wells. In a shrinking industry, regulatory and tax change is more likely to influence a driller's decision of whether or not to shut down a marginal mine. Chesapeake Energy is currently planning to shut down many wells, for example. So while Pennsylvania is at present alone among gas-producing states in assessing no impact fee, some in the business are concerned that the tax goes too far. David Spigelmyer of Chesapeake Energy, for one, says the fee would add to the already-excessive burden of regulations.

A tax that charges individuals according to the value that they place on publicly provided services better fits the norm of neutrality and decreases the hazards associated with higher taxes. Under this norm, governments should strive to make the revenue that government agencies receive proportional to the expense.  To the extent that the assessments are fees and not taxes, they treat businesses in all industries neutrally: without different subsidies or taxes.

However, it's not obvious whether the revenues distributed to each of the agencies it funds are the "right" amount of compensation for expenditures. The agencies incur expenses, to be sure, but do these expenses go toward providing services that are socially valuable, and more valuable than their cost? And even assuming that the value is greater than the expense, how well do the fees charged approximate the additional cost of providing services to the drillers?For instance, does State Fire Commissioner provide services at least as highly valued as the 10% of revenues that the governor's bill assigns to it?  Such an estimate cannot be made if prices are not voluntary payments.

On that note, it is worth noting that although the services provided by the government may in some cases be public goods valued by the drillers, they need not be financed coercively. A county official has attested that a driller voluntarily pays to fix the roads it uses. He also fears that an impact tax will cause the driller to cut back its contribution.

An unfortunate side note: it appears that the state believes that what it doesn't tax, it should subsidize. A new bill would offer millions in tax breaks to Shell Oil to develop its new plant in-state.

The proposals in Pennsylvania should be questioned on several issues: fiscal and regulatory federalism; redistribution; government provision of services; and tax neutrality.

For more on states' business tax climates click here.

For more on Pennsylvania's tax climate, click here.

Higher Cigarette Taxes and Convenience Store Success

Posted on January 30, 2012 by Joseph Henchman

A study released last year by Dr. Jidong Guang and Dr. Frank Chaloupka of impacTeen attempts to see what impact higher cigarette taxes have on convenience stores. The conventional logic is that higher cigarette taxes mean lower economic success for convenience stores, and they wanted to test that hypothesis.

That is easier said than done, apparently, as their paper states that they couldn't find good data on convenience store profits. So instead, they decided to see what impact higher cigarette taxes have on "number of convenience stores per 1 million people." They seem to gloss over the obvious fact that the number of stores per one million people is not a logical proxy for the stores' financial success. Big stores count as much as little stores; hugely successful stores count as much as marginally successful ones. So the result is bizarre: they conclude that "an increase in the tax rate of $1 per pack will be associated with an increase in the number of convenience stores per 1 million people by 11."

They wisely hide this in their conclusion, merely asserting that their data show that "higher cigarette taxes...have had no negative economic impact on convenience stores." That's smart on their part, as even the most vehement anti-smoking advocate would be hard-pressed to claim that higher cigarette taxes have a hugely positive impact on convenience store profits. But the study leaves the close reader hanging as to why this might be the case. They suggest that this could happen because retail profits rise as stores shift away from higher-taxed cigarette sales to lower-taxed consumer goods. This assumes, however, that the number of stores rising is equivalent to rising profits, which may not be the case. It also is another way of saying that stores' profits are in fact hurt by higher cigarette taxes, but that convenience stores find new ways to make up the revenue loss. The chart included on page 30 of their study (reproduced below), showing the number of convenience stores per capita oscillating wildly over the study period, suggests that the relationship is not as clean as they suggest.

Ultimately, this study simply shows that their metric (convenience stores per capita) is not well-connected to convenience store economic success. If higher cigarette taxes reduces the number of legally-purchased cigarettes, that definitely impacts convenience store revenue. 

New Podcast: National Taxpayer Advocate Nina Olson

Posted on January 30, 2012 by Richard Morrison

This week on the Tax Policy Podcast we're lucky to have Nina Olson, the National Taxpayer Advocate, as our guest. As head of the federal Taxpayer Advocate Service, she keeps an eye on what the Internal Revenue Service is up to and looks out for the interests of taxpayers year in and year out.

In her most recent report to Congress, Ms. Olson highlights a number of problems affecting U.S. taxpayers, including insufficient funding for customer service at the IRS, the lack of a federal Taxpayer Bill of Rights, and identity theft. Listen to the episode here.

Michigan-Subsidized Film Studio Fails; State Pension Fund Had Guaranteed Loan

Posted on January 27, 2012 by Joseph Henchman

We've extensively covered states' infatuation with using taxpayer dollars to subsidize film and television production, despite such production companies being some of the most profitable enterprises in modern America. While in 2000 a mere four states spent $2.7 million subsidizing film and TV, by 2011 that had reached 40 states and $1.4 billion.

Michigan was among the most generous, offering to cover 40 percent of qualified expenses, an outlay that cost Wolverine State taxpayers nearly $100 million a year. Acting on numerous reports from a variety of sources concluding that the incentives were wasteful and ineffective, new Governor Rick Snyder (R) managed to get the incentives pared back to only $25 million a year going forward.

Unfortunately, during the time of free-flowing state money, a little industry had popped up. While supporters talked about how they were building a permanent new Hollywood, in reality the whole thing depended entirely on ongoing state subsidies. Their reduction kicked the legs out from under the lie that it was ever going to be self-sustainable. Hence:

Michigan's largest film production studio will likely default on a bond payment due in two weeks, sticking the state's pension funds with the $630,000 obligation.

Sources close to Raleigh Studios in Pontiac told me Wednesday that the owners have not made their required monthly escrow set-aside payments since October, and won't have the money to meet their biannual bond obligation when it comes due Feb. 1.[...]

[F]ormer Gov. Jennifer Granholm in 2009 made the state employee pension funds the guarantor of the $18 million in bonds sold to help build the $80 million studio, located inside the abandoned facilities of the old General Motors Centerpoint truck complex.

If the studio can't pay, the pension funds have to.

The state also contributed an additional $15 million in tax incentives. 

Sounds like a big mess. Maybe we can all learn a lesson from Michigan's mistakes: offer a good tax system to all comers, but don't use the tax code to prop up one industry. It fosters dependency on the support and is costly for a long time.

“Buffett Rule” Will Boost Top Dividend Rate to Over 62%, Highest in OECD

Posted on January 27, 2012 by Scott A. Hodge

Lost in the intense scrutiny of the 15 percent tax rate that Mitt Romney paid on his capital gains and dividend income is the fact that capital gains and dividend taxes are a second layer of tax on corporate profits. In other words, before a company distributes $1 of profits to its shareholders, it must pay the 35 percent federal income tax on that profit. Individual shareholders, then, must pay the 15 percent personal tax rate on that dividend income.  

When both of these taxes are added together, along with state-level taxes, the U.S. currently has the fourth-highest overall tax rate on dividend income among the leading economies at 52.1 percent, according to the OECD. As the table below indicates, this is actually an improvement over 10 years ago when the U.S. had the second-highest dividend rate at 67.3 percent. The improvement is the result of the Bush-era tax cuts that lowered the tax rate on dividends from 39.6 percent - equal to the top individual tax rate in 2000 - to 15 percent, equal to the tax rate on capital gains.

Ten years ago, the simple average dividend tax rate for OECD nations was over 49 percent. Today, the simple average has fallen to around 41 percent. This is largely due to the dramatic decline in corporate income tax rate across the OECD. These figures for 2011 do not account for the most recent corporate rate cuts in Canada, the United Kingdom, nor the forthcoming cut in the Japanese corporate rate.

President Obama's proposed "Buffett Rule" would undo the modest improvement the U.S. has made in lowering the total cost of capital over the past decade. The Buffett Rule would effectively raise the tax rate on dividend income for millionaires from 15 percent to 30 percent. As the chart below illustrates, this policy would give the U.S. the highest overall dividend rate at 62.1 percent.

Capital is the most mobile factor in the global economy and highly sensitive to tax rates. The Buffet Rule would surely make the U.S. a less attractive place for investment and undermine our competitiveness. Other nations will gladly accept the capital that is unwelcome in the U.S.

Customers Receive Tax Forms for Airline Miles Rewards

Posted on January 27, 2012 by Joseph Henchman

Are airline frequent flyer miles taxable? By the strictest definition, they are compensation: instead of airlines paying customers with cash, they give them miles. Since such a cash award would be taxable, it's unusual that the miles wouldn't be. However, this is one of those things that hasn't been treated by the IRS as taxable, so suddenly changing policy would upset quite a few flyers who earn miles (including yours truly).

Thus, in 2002, the IRS issued a circular reserving their future authority to go after airline miles but indicating that they would not for now, due to "numerous technical and administrative issues relating to these benefits on which no official guidance has been provided, including issues relating to the timing and valuation of income inclusions and the basis for identifying personal use benefits attributable to business (or official) expenditures versus those attributable to personal expenditures." So, for now, the miles aren't taxable income.

Hence the surprise by some Citibank customers who signed up for an account and received 25,000 miles as a reward to get a 1099 statement from the bank, letting them know that they were reporting the miles as income, on their behalf, to the IRS:

Larry Fechter, 66, of Palm Springs was among numerous Citi customers who received a Form 1099 in recent days. He opened a checking and a savings account with the bank last summer after being promised 25,000 American Airlines miles.

"The mileage was a very strong inducement," Fechter told me.

He said there was nothing in the original sales pitch that warned of the tax consequences of accepting the miles. As such, Fechter said it was a big surprise to get the form in the mail informing him that he has to pay taxes on $645 worth of miles.

Citibank points to the IRS's instructions that "prizes and awards" are taxable income that must be reported by the bank, and although the IRS has given no official word, the Los Angeles Times concludes that the IRS still stands by its 2002 pronouncement. A clarification may be in order.

Update: The IRS has issued a statement: "When frequent flyer miles are provided as a premium for opening a financial account, it can be a taxable situation to reporting under current law."

Media Citations of the 2012 State Business Tax Climate Index Within 24 Hours

Posted on January 26, 2012 by TF Staff

The Tax Foundation's 2012 State Business Tax Climate Index is tool for business leaders, government policymakers, and taxpayers to gauge how their states' tax systems compare. The 56-page report evaluates 118 different aspects of state taxes and provides a roadmap for improving business tax climate in each state.

Below are the print and electronic media citations received within 24 hours of the Index's release on January 25, 2012. The report was also downloaded 9,811 times and public responses to their Index rankings were given by the Governors of California, Illinois, Montana, Nebraska, New Jersey, and Ohio. The 2011 Index was downloaded 487,000 times, received 320 media mentions, and was cited in 4 State of the State addresses.

Albuquerque Journal: "The Tax Foundation, a Washington, D.C., tax policy study group, has released its annual assessment of state business climates. As usual, New Mexico ranks in the lower half of all states, at 38th. And as usual, some of the states with the best performing economies show up as having bad business climates when it comes to taxation."

Associated Press: "A new report says Wyoming has the best tax policies in the nation for spurring job growth. Report author Mark Robyn says the state is especially attractive for prospective employers because it does not levy personal income and corporate taxes."

Asbury Park Press: "New Jersey's businesses have the nation's heaviest tax burden, according to a survey released Wednesday, a week after Gov. Chris Christie proposed cutting income taxes by 10 percent. The survey was done by the Tax Foundation, a Washington, D.C.-based group that advocates low taxes. It looked at five categories - corporate taxes, individual income taxes, sales taxes, unemployment insurance taxes and property taxes."

Austin American-Statesman: "Texas' lack of an income tax helped the state create one of the best business climates in the country, according to a Tax Foundation report released Wednesday. But the state's complicated and much-maligned 'margin tax' that is paid by businesses weighs down the state, the report's authors said. They recommended the state adopt instead a broad-based net income tax for businesses, an option that was recently deemed constitutional by the Texas Supreme Court."

Austin Business Journal: "Texas ranks as having the ninth-best tax climate in the U.S. for businesses, according to a new report by the Tax Foundation. Texas received a relatively low score on the corporate and sales tax components because of its gross receipts margins tax and intangible property tax, but ranked high in other components, partially because it does not levy an individual income tax."

Bloomberg Businessweek: "New Jersey Governor Chris Christie, the Republican who has sought to roll back taxes, battled with public employee unions and was courted to run for president, can't shake one distinction: His state again ranks last in business climate. The Washington-based Tax Foundation, which advocates for simpler tax codes with lower rates, today released its annual Business Tax Climate Index, which ranks the 50 U.S. states based on how welcoming their tax law is to businesses. New Jersey placed 50th, a position it also held in 2011."

Business Review: "New York once again ranks near the bottom in terms of business friendliness, according to the Tax Foundation's annual State Business Tax Climate Index. According to the index, New York ranks No. 49, beating only New Jersey, which ranked No. 50."

Chicago Tribune: "Let's talk climate change. Not weather, but taxes. When the Tax Foundation issues its annual State Business Tax Climate Index for 2012 on Wednesday, it will show Illinois underwent the most dramatic shift of any state in the union, tumbling a dozen places since its 2011 report from No. 16 in the relative standings to No. 28 this time around."

The Columbian: "Washington state improved its standing in a national assessment of how friendly state tax systems are to businesses, moving from No. 8 last year to No. 7 this year, according to a report released Wednesday by the nonpartisan Tax Foundation. "The Washington D.C.-based tax research group, which has analyzed fiscal policy at the federal, state and local levels since 1937, said the absence of an individual income tax in Washington puts it among the 10 states with the best tax systems under which to attract new companies and to expand existing ones."

Florida Trend: "Florida, at number five, is in the top 10 states in the Tax Foundation's list of "2012 State Business Tax Climate Index." Leading the list is Wyoming, South Dakota, Nevada, Alaska and then Florida. At the bottom of the list is New Jersey, New York, California, Vermont and Rhode Island."

Global Post: "New Jersey is the worst state for business, according to the latest Business Tax Climate Index from the Tax Foundation, a Washington-based group that advocates for simpler tax codes and lower rates, Bloomberg Businessweek reported. The other states on the bottom of the list were New York (No. 49 out of 50) and California (No. 48)."

GoLocalProv: "Rhode Island's business tax climate is still among the worst in the country, according to a new report by the Tax Foundation. The state ranked 46th overall -up one from last year - ahead of only Vermont, California, New York and New Jersey, respectively. The bottom ten also included Iowa (#41), Maryland (#42), Wisconsin (#43), North Carolina (#44) and Minnesota (#45), respectively."

Honolulu Star-Advertiser: "The Washington D.C.-based Tax Foundation ranked Hawaii in the bottom third of states in terms of the tax burden faced by businesses. The nonpartisan think tank ranked Hawaii 35th out of 50 states in the 2012 State Business Tax Climate Index, unchanged from 2011. A rank of 1 is considered most favorable to business while 50 is least favorable."

Insurance Journal: "New Jersey and New York have the worst tax climates in the nation for business, according to a new report by the Tax Foundation, a Washington, D.C.-based research firm. Two other Northeastern states, Vermont and Rhode Island, also scored poorly. Vermont was ranked as fourth-worst state and Rhode Island was fifth-worst."

Knoxville News Sentinel: "Tennessee is the 14th best state for taxes on business, according to the Tax Foundation's analysis of state tax policies. Not surprisingly, Tennessee's ranks best - 8th - in the income tax category and worst - 43rd - in the sales tax category. Tennessee does not tax individual wages or salaries. However, the report notes that Tennessee has the highest combined state and local sales tax rate of 9.4 percent."

Lincoln (NE) Journal Star: "[Gov. Dave] Heineman said Nebraska's tax climate improved from 45th to 30th since 2006 in the Tax Foundation's state rankings. However, there is more work to be done, he said. "'Some will say we can't afford tax relief, but I say we can't afford to miss this opportunity to help hard-working Nebraskans,' stated Heineman."

Los Angeles Times: "California's combination of business, sales, income and other taxes ranks it close to the bottom of the 50 states for being business-friendly, according to a conservative Washington think tank. California placed 48th, ahead of New York at 49th place and New Jersey at 50th, said a report released Wednesday by the Tax Foundation. 'Even in our global economy, a state's stiffest and most direct competition often comes from other states,' Tax Foundation economist Mark Robyn said. 'State lawmakers need to be aware of how their states' business climates match up to their immediate neighbors and to other states in their region.'"

Los Angeles Times: "California's combination of business, sales, income and other taxes ranks it close to the bottom of the 50 states for being business-friendly, according to an index put out by a conservative Washington think tank. California placed 48th, ahead of only New York at 49th place and New Jersey at 50th, said a report released Wednesday by the Tax Foundation. The findings are likely to become an issue in a campaign by California Gov. Jerry Brown to put an initiative on the November ballot to temporarily raise the state sales tax and the individual income tax for people who make over $250,000 a year. Brown wants the money to pay down state debt, boost school spending and balance the budget."

MaineBiz: "Maine is 37th in the nation for its business tax climate, a slight improvement over last year's No. 38 spot, according to an annual report from Washington, D.C.-based Tax Foundation."

Memphis Business Journal: "Tennessee is among the 'tax friendliest' states for business in the U.S., coming in at No. 14 for 2012 on a list created by the Tax Foundation. Tennessee, which has no state income tax, ranked higher than all of the other nine states that touch it. Broken down, Tennessee ranked 13th for its corporate tax burden, 8th for individual income tax, 43rd for state sales tax, 27th for unemployment insurance tax and 48th in the property tax ranking."

Missoulian: "Montana has the eighth best business tax climate in the U.S., a national study has concluded. The Tax Foundation, a nonpartisan educational organization based in Washington, D.C., issues its rankings each year. Montana dropped a spot from seventh place in 2011 to eighth place in 2012. "'Montana does have a good tax climate,' said Gov. Brian Schweitzer, a Democrat. 'It's not new.'"

Montana Watchdog: "Montana ranks No. 8 for its tax climate for business - dropping a notch from seventh place in 2011 - according to a 2012 report released Wednesday by an organization that monitors fiscal policies. Wyoming ranked No. 1, according to the eighth edition of the State Business Tax Climate Index put out by the Washington, D.C.-based Tax Foundation. 'The lesson is simple, the state that raises sufficient revenue without one of the major taxes, will, all things being equal, have an advantage over those states that levy every tax in the state tax collector's arsenal,' economist Mark Robyn wrote."

NJ.com: "The Tax Foundation, a conservative, D.C.-based group that advocates for simple tax laws and low rates, yesterday released its eighth annual State Business Tax Climate Index. Gov. Christie told reporters in Trenton that the state will make a much stronger showing in the rankings next year. 'When that income-tax cut comes in, I'm willing to bet you that we won't be 50th again next time,' Christie said."

NJBiz: "New Jersey again ranks last in the United States with the worst overall tax environment for business, but the state has achieved a slightly higher corporate tax ranking, inching up to 39th in the nation from last year's 40th spot, according to a report that by the nonprofit, nonpartisan Tax Foundation. 'New Jersey is ripe for what we call fundamental tax reform, broadening the base and lowering the rate, whether it's corporate income tax, personal income tax, meaning get rid of tax preferences and lower the tax rate,' said Mark Robyn, the report's author and an economist at Tax Foundation. 'In New Jersey, it's not about fiddling around on the edges, it's really about having to make some really big changes.'"

NCNN.com: "A new report comparing state business-tax climates shows that North Carolina has a lot of room for improvement.  The reports was released by the nonpartisan Tax Foundation in Washington, D.C. In the report, North Carolina ranks 44th overall in terms of business taxes, compared with 41st a year ago. The report says Wyoming has the nation's best business-tax climate; New Jersey, the worst."

NewsOK: "Oklahoma ranks 33rd in the nation in terms of business taxes, according to a report released Wednesday by the nonpartisan Tax Foundation in Washington, D.C. The state's ranking is down from 29th for fiscal 2011. Wyoming has the nation's best business-tax climate, while New Jersey has the worst, according to the report."

Omaha World-Herald: "The conservative Tax Foundation this week dropped Nebraska to No. 30, from 29th, in its national 'business tax climate' rankings. That ranking, though, is up from 45th from 2006. [Gov. Dave] Heineman and state business leaders feel that an even higher ranking will make the state more attractive to new companies."

Orange County Register: "California's business tax climate is the third worst in the United States, according to a new report from the Tax Foundation. Even though California's temporary income surtax and sales tax hike expired in 2011, the state didn't improve in the standings for 2012 because its taxes were so high already, said Tax Foundation economist Mark Robyn."

Orlando Business Journal: "Florida ranks No. 5 on a new Tax Foundation report that compares state tax systems. Coming in at No. 1 was Wyoming, followed by South Dakota, Nevada, Alaska, Florida, New Hampshire, Washington, Montana, Texas and Utah."

Orlando Sentinel: "Here's some good news for Gov. Rick Scott - though it does tend to undermine the GOP talking point that Florida businesses have been saddled with crushing levels of taxation. A new report from the Tax Foundation says Florida is again among the top five states in the country when it comes to offering businesses low tax burdens. The state ranked fifth, finishing behind Wyoming, South Dakota, Nevada and Alaska."

Panama City News Herald: "[T]he annual State Business Tax Climate Index ranks Florida fifth in the lowest business tax burden, behind only Wyoming, South Dakota, Nevada and Alaska. The Sunshine State also placed fifth in 2011. Note that Florida is by far the largest state on that list, and it finishes well ahead of Texas (ninth), which it often competes with. Neighboring Alabama ranks 20th, Georgia is 34th and Mississippi is 17th."

Patch.com: "According to the Tax Foundation, a nonprofit educational foundation advocating for sound tax policies, New Hampshire businesses are now among the most highly taxed in the country (46th worst corporate tax rank as reported in the Tax Foundation's recently released 2012 Business Tax Climate Index)."

Philadelphia Business Journal: "The Tax Foundation has released its 2012 State Business Tax Climate Index. Delaware and Pennsylvania were among what the Tax Foundation considers the best states, ranking in the top half of the survey. Delaware was No. 12 and Pennsylvania came in at No. 19. New Jersey? Well, let's just say its ranking qualified it for this slideshow countdown - from No. 41 through the worst, No. 50 - on the 10 worst business tax hells."

Phoenix Business Journal: ""Arizona falls in the middle of the pack when it comes to the "business friendliness" of state tax systems. According to the State Business Tax Climate Index for 2012, created by the Tax Foundation, Arizona ranks 27th overall. The best ranking belongs to Wyoming. The worst belongs to New Jersey."

Providence Business News: "Rhode Island has ranked among the "worst" for its business climate tax on the Tax Foundation's annual index ... again. 'Rhode Island made fundamental changes to its individual income tax in 2011. The state formerly had five tax brackets, with rates starting at 3.75 percent and topping out at 9.9 percent. This system also included an optional 6 percent flat tax with few tax preferences,' the report noted."

Puget Sound Business Journal: "[A] Tax Foundation report ranks Washington seventh in the nation when it comes to business-friendly state tax systems. The foundation's eighth annual State Business Tax Climate Index focuses on how various elements of a state's tax system harm or enhance the competitiveness of a state's business environment."

Salt Lake Tribune: "Utah has the 10th best business tax climate among the U.S. states, according to the Tax Foundation, a Washington-based watchdog group. The foundation maintains an index measuring how states' tax systems compare in promoting business competitiveness. 'Even in our global economy, a state's stiffest and most direct competition often comes from other states,' Tax Foundation economist Mark Robyn said."

St. Louis Business Journal: "A new report ranking states' desirability for their business tax climate saw Illinois fall 12 places this year from last year after a significant income and corporate tax increase, according to the Tax Foundation. Missouri was rated worst this year for sales tax, coming in 26th, and best for its property tax, coming in at No. 7."

STLToday: "Last year's big tax hike in Illinois drove the Land of Lincoln down sharply in the latest rankings of state business climates by the Tax Foundation. "The Washington think tank - a Washington think tank that generally advocates for lower taxes - dropped Illinois from 16th to 28th in its annual index of tax climates in the 50 states. Missouri slipped one spot, from 14th to 15th."

StateImpact Idaho: "According to the Tax Foundation's annual report on state business tax climate, Idaho ranks in the middle of the pack.  The Foundation looks at corporate, individual income, sales, property and unemployment insurance tax rates to compare states."

Wichita Business Journal, "Governor Brownback might have a point. When he released his proposal for state tax reform earlier this month, he said the state is 'no longer content to be in the middle of the pack' on issues like taxation and economic growth. His assessment of Kansas' tax climate was just about right, according to the Tax Foundation's annual ranking of state business tax climate. Kansas ranked 25 this year."

Wisconsin State Journal: "Wisconsin is one of the 10 worst states in terms of taxes on businesses, according to the State Business Tax Climate Index, released Wednesday by the Tax Foundation. It rates Wisconsin No. 43, down from 41 a year ago. Wyoming, South Dakota and Nevada were rated the top three states for business taxes while the lowest three were California (48), New York (49) and New Jersey (50)."

The Buffett Rule: Lessons from the Recession on Taxing Millionaires

Posted on January 26, 2012 by Scott A. Hodge

President Obama's proposed "Buffett Rule" reminded me of a blog I wrote a few months ago on the impact of the recession on millionaire incomes and the taxes they pay. It may sound circular, but if you are going to tax millionaires, you need millionaires to tax. But recent IRS data for 2009 indicates that the recession did more to reduce the number of millionaires than any surtax.

Comparing the 2009 data to the pre-recession data for 2007 shows that not only did the number of millionaires fall by 40 percent, but the overall income of millionaires fell by 50 percent. The result for the U.S. Treasury was that 54 percent of the total drop in tax revenues during this period was due to the falling tax collections from millionaires.

Table 1 shows the total number of tax returns by income group. In 2007, there were 392,220 tax returns reporting $1 million or more in adjusted gross income (AGI). In 2009, by contrast, there were 233,435 millionaire returns, a drop of nearly 159,000, or 40 percent.

Of the total number of tax returns filed each year, millionaires' share of returns declined from 0.3 percent to 0.2 percent.

Table 2 compares the amount of AGI reported by each income group in 2007 to 2009. Overall, American's incomes dropped 12 percent from 2007 to 2009. However, millionaires' income dropped 50 percent during this period to $702 billion from $1.4 trillion. While the total amount of AGI for all taxpayers dropped by roughly $1.04 trillion, the reduction in millionaires' income comprised 67 percent of that total loss in AGI.  

The AGI of taxpayers earning over $10 million fell 61 percent, the biggest decline in AGI of any group. Their incomes dropped $342 billion in two years, from $561 billion in 2007 to $219 billion in 2009. Their lost income comprised roughly 33 percent of the overall fall in AGI over those two years.

Table 3 shows the amount of income taxes paid by each income group for 2007 and 2009. Overall, income tax revenues declined by 22 percent in those two years, or $247 billion. However, collections from millionaires dropped 43 percent, or $133 billion. Collections from those earning over $10 million collapsed even more, falling by 54 percent or roughly $60 billion.

In 2007, millionaires contributed 28 percent of the roughly $1.11 trillion in tax revenues collected that year. By contrast, in 2009, their share of income tax burden fell to 20 percent.

Overall, the lost revenues from millionaires comprised 54 percent of the total drop in tax collections between 2007 and 2009.  

The lesson from this IRS data is that we don't need higher tax rates on millionaires to collect more tax revenues from them. We need economic growth to create more millionaires. Once we have more millionaires, the tax collections will take care of themselves.

Unemployment Drops in 46 States: Exceptions are Hawaii, Illinois, Mississippi, North Carolina

Posted on January 26, 2012 by Joseph Henchman

The U.S. Bureau of Labor Statistics recently reported some good news: unemployment rates have dropped in 46 states from January 2011 to January 2012. There were four exceptions:

• Illinois, which in January 2011 enacted a 67% increase in individual income taxes and a 30% increase in its corporate income tax. While applauded by progressives at the time, the tax increases are increasingly viewed across the spectrum as having severely harmed the state's business climate. A series of hearings and high-profile targeted tax incentive packages to retain jobs led to some modest changes that mostly nibble around the edges. Illinois's sharp rise in unemployment (+0.8%), while most of the country and all of their neighbors saw drops, suggests that the tax increases are a contributing factor.
• Hawaii, which in 2009 raised income taxes with three new brackets. Their 11% rate on income over $200,000 is now tied for highest among the states. Unemployment rose +0.3% over the past year.
• Mississippi, which also rose +0.3%. A tax commission in 2008 considered a number of ambitious changes (including some submitted by us) but ultimately did nothing except raise the cigarette tax.
• North Carolina, which rose +0.1% and in 2009 raised income and sales taxes. The income tax increase expired at the end of 2010 and the sales tax increase during 2011, although Gov. Bev Perdue (D) has said she wants to re-raise the sales tax. (She also announced this morning that she will not seek re-election this year.)

South Carolina Governor Calls for Reducing Individual and Corporate Taxes

Posted on January 26, 2012 by Joseph Henchman

In her State of the State speech, South Carolina Gov. Nikki Haley (R) discussed the importance of broad-based tax reform:

Tax reform is critical to our state - every conversation we have with CEOs at some point drifts to our tax structure, and we have been communicating with Representative Tommy Stringer and his tax reform committee on how we move forward with real changes this year.

Our budget includes almost 140 million dollars in tax cuts for the people and businesses of South Carolina.  These cuts will flatten the individual income tax from six brackets to three, reduce taxes for the citizens of our state by almost 80 million dollars, and phase out the corporate income tax over a four year period, injecting much needed dollars back into our businesses and giving us an unbelievable economic development tool.

The tax relief we ultimately adopt must be broad-based, offering relief to as many South Carolinians as possible.  And these tax cuts should mean lower rates - not more credits, exemptions, and loopholes that only benefit a chosen few.  

What we have laid out in the budget is a blueprint for how we believe the dollars available for tax reductions can best be spent.  Together, I believe we can agree to a set of tax cuts that make South Carolina more competitive and send more dollars back where they belong - in the pockets of the people and businesses of our state.  

Here's more detail from her budget on those proposals:

Governor Haley's tax reform proposal consists of four key components:

1. Phase-out the Corporate Income Tax over a four-year period;

2. Consolidate six Individual Income Tax brackets into three, while cutting rates;

3. Amend the Constitution to establish Property Tax rates by statute; and

4. Require that the Board of Economic Advisors and the Department of Revenue publish biennial reports on the number of beneficiaries of each tax credit, deduction, and exemption, along with the impact on the State Treasury.

Corporate Income Tax. Although South Carolina's Corporate Income Tax generates a relatively small portion of the state's overall receipts, eliminating this tax would send a strong signal that we want to attract jobs and businesses.  Under this plan, a four-year phase-out would begin on January 1, 2013 with a reduction in the Corporate Income Tax rate from the current 5% to only 3.75%.  Businesses would save $61.6 million in the first year, which they could then reinvest in jobs and infrastructure.

Individual Income Tax. Collapsing six brackets into three would leave South Carolina with a fairer and flatter tax system and would provide an estimated annual income tax cut of $84 for filers with at least $5,600 per year of taxable income.  Individuals currently in the 4%, 5%, or 6% bracket would all see their marginal rates reduced to 3.75% under the proposed model.  In the plan's first year, this would represent a $78.2 million tax cut.

South Carolina's individual income tax brackets are indexed for inflation under SC Code Section 12-6-520.  Under the Governor's plan, the transition between the current 3% and 4% brackets would be frozen in place at $5,600 and filers in the existing 3% bracket (with taxable income between $2,800 and $5,600) would be protected by a "hold harmless" provision to keep them from being subjected to the new 3.75% rate.  Over time, inflation will continue to raise the income level that serves as the ceiling of the 0% bracket until ultimately, it reaches $5,600, and the  "hold harmless" provision is no longer required.  This would leave South Carolina with three brackets, set at 0%, 3.75%, and 7%.

Property Tax. Property tax rates are established in Article X of the South Carolina Constitution, making it a difficult and timeconsuming process to reduce rates, such as for the crushing 10.5% Manufacturer's Property Tax.  This plan proposes to begin by amending the Constitution so as to allow these rates to be set in statute, making it easier to reduce them in the future.

Tax Credits, Deductions, and Exemptions. The State's current patchwork of tax credits, deductions, and exemptions often rewards targeted individuals, businesses, or classes at the expense of all other taxpayers.  Extending preferential treatment to one segment of society reduces the overall tax base, driving up rates for those who are unable to obtain special status for themselves. Regular reporting on the number of beneficiaries for each tax expenditure, along with the impact on the State Treasury, would provide key decision-makers with the information they need to regularly reassess the merits of these incentives.

Here's South Carolina's current individual income tax rates and what they would be if the proposal took effect:

Note: Brackets and rates are for 2012. Filers currently in the 3% bracket would be "held harmless" from a rate increase, until inflation over time increases the income threshold for the 0% bracket to that level.

The total tax reduction on the individual side would be approximately $78 million, and on the corporate side would be $61 million in the first year. (The proposal lowers it by 1.25 percentage points in the first year, and continues lowering it by the same amount each year until the tax is eliminated.)

The individual tax is a modest tax reduction that simplifies the tax system. Coupled with a review of tax incentives, it could lead to significant improvement in South Carolina's tax climate.

The corporate tax change is ambitious but can have a big impact. If fully eliminated, South Carolina would join just Wyoming, South Dakota, and Nevada with no corporate income tax or other broad-based business tax. With America having one of the highest corporate income tax rates, that would be noticed globally.

More on state tax policy here.

Scott Hodge on Fox Business: What Mitt Romney's Tax Returns Tell Us

Posted on January 26, 2012 by Richard Morrison

Obama’s “Buffett rule” Equivalent to Raising Top Marginal Rate on Millionaires to 44%

Posted on January 25, 2012 by David S. Logan

In his State of the Union address last night, President Obama proposed the latest version of the "Buffett rule."  But he got more specific this time around.

The rule would require all individuals reporting at least $1 million in income to pay an effective tax rate of no less than 30 percent.  He did not say how this would be implemented, nor did the White House release more specifics on the rule today. 

For the moment, let's think about this in the context of the term with which most Americans can identify: top marginal rate.  This is the tax rate you pay on your last dollar earned.  How big of an increase to the top marginal rate is the "Buffett rule" equal to for million-dollar earners?

Nine percentage points.

If the rest of the tax code remained untouched, the top marginal rate would need to be raised from 35 percent to 44 percent on the average million-dollar earner (someone making $3.1 million annually, calculated using table 1.2 of IRS data) to ensure the 30 percent effective rate of the proposal.

The United States already "boasts" the most progressive individual tax code in the industrialized world.  Combine that with the fact that the OECD has found individual taxes to be the second most harmful to economic growth and this policy spells disaster for the 100 percent, not just the one.

Follow David S. Logan on Twitter @Loganomix

Unanswered Issues on the "Buffett Rule"

Posted on January 25, 2012 by Scott A. Hodge

Last night, President Obama said that American needs a new tax system, but one that is only for people who make more than $1 million in a year. According to Obama:

"Tax reform should follow the Buffett Rule.  If you make more than $1 million a year, you should not pay less than 30 percent in taxes.  And my Republican friend Tom Coburn is right:  Washington should stop subsidizing millionaires.  In fact, if you're earning a million dollars a year, you shouldn't get special tax subsidies or deductions."

Basically, the President is proposing a new "Super Alternative Minimum Tax" of 30 percent for anyone making over $1 million. So if your income is above $1 million, you have to pay 30 percent of your income in taxes, even if that income came from capital gains or dividends, which is normally taxed at 15%.  Like the regular Alternative Minimum Tax - which was enacted in 1969 to prevent a handful of millionaires from paying less on their taxes but now impacts over 3 million Americans - this new Super AMT would reduce any deductions that might reduce your effective tax rate below 30 percent.

Tax Foundation economists estimate that the Buffett rule is equivalent of raising the top marginal rate from 35 percent to 44 percent. In other words, the average effective tax rate for millionaires is 25 percent. So, based on the current amount of deductions millionaires take, in order to raise their effective tax rate to 30 percent you would have to raise the top marginal tax rate to 44 percent. On a very static basis, we roughly estimate that this policy would raise $40 billion, assuming that taxpayers don't change their behavior.  Compared to a $1.1 trillion deficit next year this is a drop in the bucket.

There are lots of unanswered issues here:

• Which deductions would be effected? The White House cites only "tax subsidies for housing, health care, retirement, and child care." But the biggest tax deductions for the wealthiest tax returns (the "Fortunate 400") are the charitable deduction (comprising 50% of their itemized deductions), taxes paid deduction (30% of their deductions) and the interest paid deduction (17% of deductions). The Buffett tax rule would effectively cap all of these deductions.  
• Most of these high income taxpayers are business owners - LLCs and S corporations. They are already paying the 2^nd highest business tax rate in the industrialized world. Locking in this 30 percent rate would immediately make them uncompetitive globally. Also, since top earners have a lot of business income, they can take advantage of various credits such as the Foreign Tax Credit, the R&D tax credit. The Domestic Manufacturing Deduction and the Bonus Depreciation are also important to many S corporations and LLCs.  Will all of these be denied too?
• Research shows that 50 percent of "millionaire" taxpayers are only millionaires once. Meaning, they are millionaires in one year because the sold a business, cashed out stock, or won the lottery. A Super AMT would have a chilling effect on people selling their businesses or stock - effectively locking in assets for a long time. That would be bad for the economy by reducing its dynamism.
• The history of the current AMT shows how these class warfare policies eventually trickle down to the middle class.
• The U.S. already has the fourth-highest overall tax rate on dividend income among the 34 largest economies at more than 52 percent according to the OECD. Only France, Denmark, and the United Kingdom have higher combined rates (corporate level plus individual level). The Buffett rule would likely push this rate up to 61.2 percent for millionaires. What effect would that have on stocks and the cost of capital?

These are only a few of the issues the While House has not addressed - or simply overlooked - in their zeal to tax the rich. 

Scott Hodge on Fox Business: Are the Wealthy Paying More than Their Fair Share in Taxes?

Posted on January 25, 2012 by Richard Morrison

2012 State Business Tax Climate Index Released

Posted on January 25, 2012 by TF Staff

Today we release our new 2012 State Business Tax Climate Index.

Each year we produce the Index to enable business leaders, government policymakers, and taxpayers to gauge how their states' tax systems compare. While total taxes paid is a relevant measure, another is how the elements of a state tax system enhance or harm the competitiveness of a state's business environment. The Index looks at over 100 variables in individual income tax, corporate income tax, sales tax, unemployment insurance tax, and property tax to reduce these many complex considerations to an easy-to-use ranking.

The 10 best states in this year's 2012 Index are Wyoming, South Dakota, Nevada, Alaska, Florida, New Hampshire, Washington, Montana, Texas, and Utah. Many of these states do not have one or more of the major taxes, and thus do not have the associated complexity and distortions.

The 10 lowest ranked, or worst, states in the 2012 Index are Iowa, Maryland, Wisconsin, North Carolina, Minnesota, Rhode Island, Vermont, California, New York, and New Jersey. While the bottom three states remained steady compared with 2011, Rhode Island improved modestly by implementing a revenue-neutral income tax reform. The states in the bottom ten generally have complex, non-neutral taxes with comparatively high rates.

Illinois moved most dramatically in its Index rank over the past year, falling twelve places after a significant income and corporate tax increase.

We hope that providing this information to you helps gauge how your tax system compares and provides a roadmap for improving the business tax climate. In 2011, the Index report was downloaded 487,000 times and referenced in 320 major media articles and 4 State of the State addresses. The rankings are used in other organization's rankings as the tax component, and recent academic evidence found correlation between Index component ranking and state wage and economic growth.

The 2012 Index reflects state tax systems as they stood on July 1, 2011, the start of the 2012 Fiscal Year in most states. Read the 56-page Index report and the results at http://www.taxfoundation.org/research/show/22658.html. (Download a PDF version here.)

Facts About Redistribution Obama Failed to Acknowledge

Posted on January 25, 2012 by Scott A. Hodge

During last night's State of the Union address, President Obama argued that government should do less for the rich and more for the middle class. The insinuation here is that government tax and spending benefits are not progressive enough and don't do enough to redistribute incomes from the top to the bottom.

What Obama failed to do, however, was present any facts on how progressive the current system is so that people could judge whether they would like more or less redistribution. In 2009, Tax Foundation economists did such a "fiscal accounting" to see how much families at different income levels received in all government spending benefits relative to how much they pay in all federal taxes.

We found that federal tax and spending policies are already very progressive and redistributive. As the charts below indicate, the bottom 60 percent of families - those earning under about $85,000 in 2010, receive more in total spending benefits from government than they pay in all taxes combined. In other words, the benefits they receive from government - from education and roads to national defense and welfare - greatly exceed all the federal taxes they pay - from income and payroll taxes to gasoline and corporate income taxes.

Indeed, the lowest-income Americans paid less than $1,700 in total taxes, but received $17,617 in spending benefits. In other words, they received more than $10 in spending benefits for every $1 they paid in taxes of any kind. Remarkably, middle-income families - whom Obama says government does not do enough for - got $1.15 in spending benefits for every $1 they pay in taxes.

By contrast, the top 40 percent of families pay far more in taxes of all kinds than they receive back from government in benefits. For example, families earning between roughly $86,000 and $110,000 paid an average of $23,289 in total taxes, but received $22,938 in benefits - equal to about 0.98 cents on the dollar. The wealthiest families, those earning over $712,000, paid more than $660,000 in taxes but received $283,000 in spending benefits - equal to about 0.43 cents on the dollar.

Our study actually tilted the spending to favor the rich by assuming that they benefit from public goods - such as national defense and public health - in proportion to their income. Meaning, the more you earn the more you benefit from defense spending and so forth. Had we assumed that public goods benefit everyone equally, the rich's ratio of spending to taxes would have shrunk to 0.05 cents on the dollar while the poor's ratio of spending to taxes would have grown to $14.75.

Even before Obama's policies were put in place, we estimated that federal tax and spending policies served to redistribute more than $826 billion annually from the top 40 percent of families to the bottom 60 percent.

The president says that is not enough. That's fine, but he should be honest about what amount of redistribution he thinks is enough. Then the American people can decide with all the facts before them.

Tax Policy References in the State of the Union

Posted on January 24, 2012 by Joseph Henchman

Tax policy is a hot topic and featured prominently in tonight's State of the Union address given by President Obama, and in the Republican response delivered by Indiana Gov. Mitch Daniels. Here are the references.

From the State of the Union:

We should start with our tax code. Right now, companies get tax breaks for moving jobs and profits overseas. Meanwhile, companies that choose to stay in America get hit with one of the highest tax rates in the world. It makes no sense, and everyone knows it.

So let's change it. First, if you're a business that wants to outsource jobs, you shouldn't get a tax deduction for doing it. That money should be used to cover moving expenses for companies like Master Lock that decide to bring jobs home.

Second, no American company should be able to avoid paying its fair share of taxes by moving jobs and profits overseas. From now on, every multinational company should have to pay a basic minimum tax. And every penny should go towards lowering taxes for companies that choose to stay here and hire here.

Third, if you're an American manufacturer, you should get a bigger tax cut. If you're a high-tech manufacturer, we should double the tax deduction you get for making products here. And if you want to relocate in a community that was hit hard when a factory left town, you should get help financing a new plant, equipment, or training for new workers.

My message is simple. It's time to stop rewarding businesses that ship jobs overseas, and start rewarding companies that create jobs right here in America. Send me these tax reforms, and I'll sign them right away.[...]

When kids do graduate, the most daunting challenge can be the cost of college. At a time when Americans owe more in tuition debt than credit card debt, this Congress needs to stop the interest rates on student loans from doubling in July. Extend the tuition tax credit we started that saves middle-class families thousands of dollars. And give more young people the chance to earn their way through college by doubling the number of work-study jobs in the next five years.[...]

After all, innovation is what America has always been about. Most new jobs are created in start-ups and small businesses. So let's pass an agenda that helps them succeed. Tear down regulations that prevent aspiring entrepreneurs from getting the financing to grow. Expand tax relief to small businesses that are raising wages and creating good jobs. Both parties agree on these ideas. So put them in a bill, and get it on my desk this year.[...]

Our experience with shale gas shows us that the payoffs on these public investments don't always come right away. Some technologies don't pan out; some companies fail. But I will not walk away from the promise of clean energy. I will not walk away from workers like Bryan. I will not cede the wind or solar or battery industry to China or Germany because we refuse to make the same commitment here. We have subsidized oil companies for a century. That's long enough. It's time to end the taxpayer giveaways to an industry that's rarely been more profitable, and double-down on a clean energy industry that's never been more promising. Pass clean energy tax credits and create these jobs.[...]

Right now, our most immediate priority is stopping a tax hike on 160 million working Americans while the recovery is still fragile. People cannot afford losing $40 out of each paycheck this year. There are plenty of ways to get this done. So let's agree right here, right now: No side issues. No drama. Pass the payroll tax cut without delay.

When it comes to the deficit, we've already agreed to more than $2 trillion in cuts and savings. But we need to do more, and that means making choices. Right now, we're poised to spend nearly $1 trillion more on what was supposed to be a temporary tax break for the wealthiest 2 percent of Americans. Right now, because of loopholes and shelters in the tax code, a quarter of all millionaires pay lower tax rates than millions of middle-class households. Right now, Warren Buffett pays a lower tax rate than his secretary.

Do we want to keep these tax cuts for the wealthiest Americans? Or do we want to keep our investments in everything else- like education and medical research; a strong military and care for our veterans? Because if we're serious about paying down our debt, we can't do both.

The American people know what the right choice is. So do I. As I told the Speaker this summer, I'm prepared to make more reforms that rein in the long term costs of Medicare and Medicaid, and strengthen Social Security, so long as those programs remain a guarantee of security for seniors.

But in return, we need to change our tax code so that people like me, and an awful lot of Members of Congress, pay our fair share of taxes. Tax reform should follow the Buffett rule: If you make more than $1 million a year, you should not pay less than 30 percent in taxes. And my Republican friend Tom Coburn is right: Washington should stop subsidizing millionaires. In fact, if you're earning a million dollars a year, you shouldn't get special tax subsidies or deductions. On the other hand, if you make under $250,000 a year, like 98 percent of American families, your taxes shouldn't go up. You're the ones struggling with rising costs and stagnant wages. You're the ones who need relief.

Now, you can call this class warfare all you want. But asking a billionaire to pay at least as much as his secretary in taxes? Most Americans would call that common sense.

References to taxes in Governor Daniels's Republican response:

The extremism that stifles the development of homegrown energy, or cancels a perfectly safe pipeline that would employ tens of thousands, or jacks up consumer utility bills for no improvement in either human health or world temperature, is a pro-poverty policy.  It must be replaced by a passionate pro-growth approach that breaks all ties and calls all close ones in favor of private sector jobs that restore opportunity for all and generate the public revenues to pay our bills.

That means a dramatically simpler tax system of fewer loopholes and lower rates.[...]

It's absolutely so that everyone should contribute to our national recovery, including of course the most affluent among us.  There are smart ways and dumb ways to do this: the dumb way is to raise rates in a broken, grossly complex tax system, choking off growth without bringing in the revenues we need to meet our debts.  The better course is to stop sending the wealthy benefits they do not need, and stop providing them so many tax preferences that distort our economy and do little or nothing to foster growth.

State Sales Taxes on Clothing

Posted on January 24, 2012 by Joseph Henchman

A sales tax that best minimizes economic distortions is one that taxes all final retail sales once and only once. However, most states depart from this by not taxing services while taxing business inputs, meaning some goods have no tax on them while others have multiple sales taxes. And of course, in many states there is a tendency to avoid tax on "necessities."

Putting legislators in the awkward position of deciding which goods and services are luxuries and which are necessities-not to mention deciding which have educational, cultural or artistic value-can cause discord and confusion. The more things are exempt, the more special interests become determined to exempt their good or service, thus driving up the rate on everything else to maintain the same amount of revenue.

One example of this is clothing. 8 states partially or fully exempt clothing from the sales tax. Some clothing, however, is taxed, as not all clothing purchases can properly be considered necessities. Retailers and consumers thus face rules defining the difference, adding complexity to the tax code. At the same time, clothing purchases are a large part of retail purchases, meaning exemptions lead to large revenue reductions; states generally do not cut spending, so taxes are likely to rise elsewhere. Connecticut recently ended its exemption while New York has temporarily reduced theirs.

Table: Sales Tax Treatment of Clothing
as of January 1, 2012

Source: Tax Foundation; Commerce Clearing House.

More on state tax policy.

Massachusetts Governor to Unveil 2013 Budget Proposals

Posted on January 24, 2012 by Alex Raut and Scott Drenkard

As part of his 2013 fiscal budget to be proposed next week, Governor Deval Patrick (D) of Massachusetts will target soda, candy and cigarettes for additional revenue. According to a January 23 report by Tax Analysts, (subscription required) soda and candy will be added to the state's 6.25 percent sales tax base, and the cigarette tax will increase by 50 cents, totaling $3.01 per pack.  Though these "sin taxes" are the highlight of the proposal, Patrick's budget would:

• "Apply the motel/hotel excise tax to the full cost of a room, including the markup from internet resellers
• Change the calculation for corporate taxes so that Massachusetts companies that sell products out-of-state
• Change the tax treatment for subsidiaries of insurance companies that do not perform insurance-related business
• Make new investments in technology to better identify and collect uncollected and underreported taxes"

These changes are expected to generate $260 million in new revenue for fiscal year 2013.

If approved, the hike in cigarette prices would be the second during the governor's tenure, and would vault cigarette excise tax rates in Massachusetts to fourth highest within 350 miles. This increase could make greater opportunities for peddlers of smuggled cigarettes, which already made up 22% of cigarettes consumed in Massachusetts in 2010.

Cigarette Excise Taxes within 350 miles of Massachusetts (as of July 1, 2011):

Many of the states in the area would have significantly lower prices. At a mere 30 cent tax per pack, even the 350 mile drive from Virginia doesn't seem too bad if you'd like to make a quick profit. Of course, as with any other illegal trafficking, cigarette smuggling comes with a host of problems, and has even been linked to funding terrorism. Additionally, those selling cigarettes on the black market could very well be hooking the next generation of smokers. It seems unlikely that those selling smuggled cigarettes will check identification of their customers.

Follow Scott Drenkard on Twitter @ScottDrenkard.

Hawaii State of the State Address Seeks Wasteful Credits and Soda Tax

Posted on January 24, 2012 by Scott Drenkard

Hawaii Governor Abercrombie addressed the Hawaii legislature yesterday to offer his plans for the new year. Among his proposals was an effort to make Hawaii's Film Tax Credit program permanent as well as a plan to spend $1 million on a task force that will examine "solutions" to the obesity problem of Hawaii.

As we have noted on many occasions, film tax incentives do little to spur job growth, and the jobs they do are create are fleeting. Of course with any tax credit lawmakers must take into account the fact that revenue allocated to credits is money that cannot be spent elsewhere in the budget.

I'm personally convinced that many lawmakers and voters approve these generous benefits just because they think movies are sexy-they like to see their home state on the big screen. Abercrombie's speech gives credence to this notion: "the film industry also depends on showcasing the beauty and variety of our aloha state. We've seen what these islands can look like on big screen and television." The glamour of the movies shouldn't inform tax credit decisions.

As for soda taxes, I see Hawaii as a battleground state for a sugar-sweetened beverage tax in the coming years. In 2011, four bills were introduced in the Hawaii the legislature that proposed a 1 cent/ounce tax on sugary drinks with Orwellian names like the "Sugary Beverage Healthy Hawaii Fee" (by the way, it isn't a fee, it's a tax).

Abercrombie makes a misstep on his description of the science behind soda taxes though, saying, "the link between sugar-sweetened beverages and health is undeniable." As I noted in the Washington Post last weekend, the science is unclear about the link between soda consumption and obesity. Further, an excise tax on soda (which is almost certainly what the million-dollar task force will recommend) necessarily falls on all consumers of soda, even those that use soda in a moderate, appropriate manner.

The theme of Abercrombie's speech was "Pupukahi I Holomua," or, "Unite to Move Forward." If Hawaii wants to move forward, it needs to leave these backwards tax policies behind.

More on Hawaii here.

More on sugar and snack taxes here.

Follow Scott Drenkard on Twitter @ScottDrenkard.

Presidential Tax Returns

Posted on January 24, 2012 by TF Staff

This morning Mitt Romney joined Newt Gingrich and Barack Obama in the group of presidential candidates who have released their 2010 tax returns. Ron Paul and Rick Santorum have not yet released theirs.

We'll have more to say about these returns later, but for now we wanted to collect them all in one place for easy side-by-side comparison.

Republicans

Newt Gingrich Tax Return (pdf)

Mitt Romney Tax Return

Democrats

Barack Obama Tax Return (pdf)

Vice President Joe Biden has also released his 2010 tax return (pdf).

Even at 14%, Romney Pays a Higher Rate than 97% of His Fellow Americans

Posted on January 24, 2012 by Scott A. Hodge

 The release of Mitt Romney's tax returns, which indicate that he paid an average tax rate of 14 percent after deductions, has once again prompted a great deal of confusion over marginal and average tax rates. For a moment, let's set aside the issue that most of Mr. Romney's income is in the form of capital gains and dividends, which are taxed at 15 percent rather than at the highest marginal rate of 35 percent, and look at the difference between marginal and average (or effective) tax rates.

Our income tax system is progressive, meaning we pay higher tax rates as our income gets higher. As the table below shows, there are six tax brackets for different bands of income. The "marginal" rate refers to the tax rate that is applied on that band of income.

Say, for instance, our income is $120,000. This would put us in the 25 percent bracket. If the U.S. had a flat rate tax system (and no deduction), we would pay 25 percent of $120,000 in tax, or $30,000.

However, under our marginal tax system we pay 10 percent on the first $17,000, or $1,700. We then pay 15 percent on the next band of income up to $69,000, or $7,800. We then pay 25 percent on the marginal amount over $69,000, for another $12,750 in taxes. When we total the taxes paid on these three bands of income it comes to $22,250, for an average (or effective) tax rate of 18.5 percent.

Of course, in our simplified example we have not taken account of all the exemptions, credits, and deductions that are available to us. These deductions reduce our taxable income. So instead of paying taxes on $120,000, the deductions for our children, mortgage, and charitable contributions could easily reduce our taxable income well below $90,000. At this taxable income we would owe a total of $14,750, for an average rate of about 12 percent.

Millionaires go through the same process, meaning they pay 10 percent on the first band of income, 15 percent on the next band, and so forth. As the chart below shows, based on the most recent IRS data for 2009, the average tax rate (after deductions) paid by all Americans is 11 percent. It is also clear that millionaires pay an average of 25 percent, while virtually every taxpayer earning under $100,000 pays an average rate of no more than 8 percent of their income in taxes. [Click here for more detail on the chart's data.)

There are roughly 123 million taxpayers who earn under $100,000, or about 88 percent of the 140 million Americans who filed a tax return in 2009. In other words, 88 percent of all taxpayers pay 8 percent or less of their income in income taxes.

Which gets us back to Mitt Romney's effective tax rate of 14 percent, after deductions. As the chart shows, this rate is still higher than the average rate paid by taxpayers earning up to $200,000. There are about 136 million taxpayers who have adjusted gross incomes less than $200,000, or 97 percent of all taxpayers. So even with an average tax rate of 14 percent, Romney paid a higher average rate than 97 percent of his fellow Americans.

Income Inequality went Up 12 Percent under Clinton, Zero under Bush

Posted on January 20, 2012 by William McBride

It is a good rule to question every study on income inequality by asking, "Why those years?"  

The latest version is from the Congressional Research Service (CRS), and the author concludes:

"Changes in income from capital gains and dividends were the single largest contributor to rising income inequality between 1996 and 2006. Changes in tax policy also made a significant contribution to the increase in income inequality, but even in the absence of tax policy changes income inequality would likely have increased."

And about those years:

"The years 1996 and 2006 are examined for several reasons.  First, both years were at approximately similar points of the business-cycle with moderate inflation (about 3%), a modest unemployment rate (about 5%), and moderate economic growth (3.7% in 1996 and 2.7% in 2006).  Second, 2006 was the year before the August 2007 liquidity crunch and the onset of the severe 2007-2009 recession.  Third, there were major tax policy changes between these two years.  Fourth, both 1996 and 2006 were three years after the enactment of tax legislation that affected tax rates and are unlikely to be affected by short-run behavioral responses to these changes."

In fact, 1996 and 2006 are not even close to similar points in the business cycle: 1996 was at the beginning of an economic expansion that lasted another four years, while 2006 was at the end of an economic expansion that ended the following year.    

It is deeply misleading to talk about income inequality without properly taking into account the business cycle.  The financial crisis of 2008 and ensuing recession has devastated personal incomes to a degree not seen since the Great Depression.  The most dramatic collapse has been in high incomes, as can be seen with the most recent IRS data.  For example, since 2007 the number of millionaires has dropped 60 percent, while income reported by millionaires has dropped in half.   

Much of this volatility is due to the collapse of capital gains, as the charts below indicate.  Based on IRS data, as a share of income, capital gains went from 9.5 percent in 2006 to 3.0 percent in 2009, and this while the tax rate on capital gains remained 15 percent.  The second chart shows capital gains in dollar terms and compares it to the S&P 500.  First, capital gains track the stock market - that should be obvious.  Second, capital gains realizations went from $771 billion in 2006, peaked at $896 billion in 2007, and then collapsed to $231 billion by 2009 - a drop of 74 percent in two years.

Why is this important?  The CRS acknowledges that capital gains mainly accrue to high-income earners, and this too can be seen from IRS data.  In 2009, it is in fact the largest source of income for those making $10 million or more.  Thus, the collapse of this income since 2007, as well as other sources of income such as business income, completely disrupts the story that income inequality has increased since 1996.

Lastly, the third chart below shows a standard measure of income inequality, the Gini coefficient, for the years 1986 to 2009, again based on the most recent IRS data.

It shows just how much measures of income inequality depend on the business cycle, and why 2006 or 2007 are terribly unrepresentative years.  They are in fact the two peak years for the Gini coefficient over this time period, at 0.567 in 2006 and 0.574 in 2007.  From there, the Gini coefficient falls 7 percent to 0.535 in 2009.  This is not quite as low as it was in the 2002 recession, but then we haven't seen 2010 data yet.  From the trajectory it seems likely that 2010 will be still lower.  As it is, the Gini coefficient in 2009 is lower than it was in 1998, and close to where it was in 1997.

It must be acknowledged that the Gini coefficient has an underlying upward trend between 1986 and 2000.  The steepest increase follows the 1986 tax reform, which dramatically lowered the top marginal rate on ordinary income (see the last chart below), and began a long trend of business income moving from the corporate code to the personal code in the form of pass-through entities such as partnerships and S-corporations.  This alone might explain much of the measured increase in income inequality over this period.   However, Clinton raised the top marginal rate in 1993 to 39.6 percent, and this also ushered in a long period of increasing income inequality.  The Gini coefficient went from 0.498 in 1993 to 0.555 in 2000 - an increase of 12 percent.

In contrast, the period since 2000 has exhibited no underlying trend in income inequality, but rather dramatic fluctuations resulting from the business cycle.  The CRS is right to connect this to capital gains, which have likewise cycled up and down, but wrong to conclude this represents an underlying trend.  Income inequality at the beginning and end of the Bush years was virtually unchanged, with the Gini coefficient going from 0.555 in 2000 to 0.557 in 2008.  In 2009 the Gini coefficient fell further, to 0.535, for a 4 percent drop since 2000.  There is therefore no evidence that the Bush tax cuts in either the top marginal rate or capital gains rate had any long term effect on inequality.

It may be the case that lowering the tax rate on capital gains created more volatility in the stock market and thus capital gains realizations and personal incomes.  More likely, the stock market moves for many reasons more important than the tax rate on capital gains, such as the internet revolution, war, monetary policy, demographics, and the housing bubble. 

Here is our earlier critique of a CBO study that claims income inequality increased between 1979 and 2007. 

Follow William McBride on Twitter @EconoWill