Tax Foundation - Commentary

Remarks to the Tax Analysts Conference on the State Fiscal Crisis

Fri, 30 Oct 2009 00:00:00 EDT

(Click here for video of this event. Joe's remarks begin at 36:40.)

The Current State Budget Situation

I want to start out by echoing three things that have already been said, and I'm going to say them again just to reiterate.

First is that state budgets historically recover after the general economical recovery. The "lag." So, even if the economy is recovering right now, we're not going to see that recovery in state budgets for some time. The state budget crisis that we are currently going through will continue for the foreseeable future.

The second thing is that because every state has to either constitutionally or statutorily balance its budget, the options are that they must raise revenue, cut spending, or some combination. States can't print money, as Scott said, California IOUs notwithstanding. So those are the options they have to face. I know it sounds like common sense, but so many politicians, so many state legislatures try their hardest to find some other option besides raising revenue, cutting spending, or some combination, and we've seen any number of sort of absurd examples. Chris mentioned a few of them in his opening of some of the ways, and I'm sure Doug from COST will be going over some other ways that states are trying to find other options to solve their budget shortfalls. But ultimately, that what it comes down to, and ultimately those are the decisions that need to be made.

The third point that I think bears reiterating is that the stimulus money bought time, and that's really all it bought, and it's running out. It was a finite pot of money, and it basically tided over the states. Some states took that opportunity to use the money for one-time purposes, put their fiscal house in order and move ahead; some states just put it right in their budget and kicked the can down the road. Regardless of what they did with it, it's running out and states are going to be back facing the hard decisions again.

So, we're talking about causes, and we're talking about what states should do. A point I would want to make is that not all state tax revenue is created equal. Different states are of course in different stages of state fiscal crisis. California, of course, is the poster child for everything that's gone wrong. I'm originally from California, so I'm not terribly proud of what its come to represent.

The really first time I really remember a state budget issue, reading in the newspaper in California, was back in 2000 when there was extended debate about what to do with the enormous state budget surplus -- multi-billions of dollars generated from capital gains revenues from the dot-com boom. I was in college at the time, so it was sort of a firsthand experience out of college in the Bay Area, and since then, of course, California has probably not balanced its budget legitimately once since then.

And so the question is why states like California are different from other states? Why is it so much worse there than for others?

A lot of it has to do with volatile revenue sources. Some revenue sources are exaggerated by the boom-bust cycle more than other revenue sources. The research seems to indicate that some revenue sources like taxes on high-income earners, taxes on corporate profits, taxes on capital gains -- these tend to soar very highly in boom times and then plummet to almost nothing in bust times, and we've seen that reflected in state budgets by revenue sources in the current situation. Those states that depended very heavily on taxes on high-income earners, taxes on corporate profits, taxes on capital gains -- they got a whole lot of revenue in the boom times, and as states are wont to do, they spent it. And, unfortunately, a lot of them spent it on -- not on one-time things but, rather, on ratcheting up their base of ongoing year-to-year operations. So now when those revenue sources have disappeared or plummeted, we're left with this overhang, and that's where these budget shortfalls have come from.

I certainly won't disagree that the recession is no mere coincidence in the severity of this, but I think we have to recognize that revenue volatility and dependence on volatile revenue sources is a major contributing factor. Even in California they've recognized this with the current reform commission. They're debating about the appropriate approach for dealing with volatile revenue sources, but everyone seems to agree that it's a big contributing factor.

Trends in State Budgets and Taxation

So, with the boom-bust cycle, it's a question of what do we do going forward, and of course there's a lot of solutions out there, so I'm just going to talk about a few of the tax trends we've seen in state budgets this year so far.

One note on the stimulus, which I don't think was brought up that much, was the stimulus had a lot of strings attached to it. I mean, a lot of people kind of snickered at Governors Perry and Sanford for taking or not taking the stimulus money, but the strings attached to it were quite substantial. They cordoned off whole areas of state budgets from reductions -- probably one of the largest moves of state budgeting power from state capitals to Washington we've seen in decades, as part of the stimulus package. And that precluded a lot of cuts from happening to some core governmental services, services that might need some re-evaluation.

In times of recession, it is true there is increased demand for some governmental services -- unemployment insurance, Medicaid, shelters. But that also means that it's a time to start reevaluating some other things the government is spending money on that maybe it's not a priority for right now. I mean, I can come up with a few absurd examples. There's the Michigan film tax credits. They have a program giving iPods to school children. I mean, there's a lot of things that maybe sounded -- I don't know if it would have been a good idea even in good times, but it's certainly not -- it's something we could probably do without in bad times right now.

There are some other trends going on right now. Millionaire's taxes, half-millionaire taxes, quarter-millionaire's taxes are things that we're seeing at the state level. These are a bad idea, because they essentially create a short-term gain for long-term harm. It is true that if you impose one of these high-income tax surcharges on high-income earners, you know, they're usually for a temporary period to -- if you impose them, you'll likely see a revenue increase, but what you see is your long-term ability to generate income in the state drop off, because people see that as a sign that that's how you view people that create jobs, the entrepreneurs in your state, so people are less likely to move into your state, people are less likely to create jobs in your state. That's the message that that sends.

We unfortunately see a lot of states doing more and more job creation credits and incentive programs. These usually don't work. A lot of business location decisions are made for reasons other than a giveaway package negotiated. It's usually an added plus that a business will be all too happy to take, but it's not one that usually drives decisions. It just uses up a lot of politicians' and bureaucrats' time, as well as taxpayer money, in order to pursue these programs.

In the mid-2000's in North Carolina there was a package of tax incentives for Dell that involved a long bitter argument at the state level. It went all the way up to the state Supreme Court. We were working with a group there on fighting this incentive package but it made its way through. The politicians ushered it through: everybody was glad-handing and shaking hands, cheering that they got Dell there for millions and millions of dollars. Earlier this month, Dell announced that they're closing the plant. I certainly can't be celebratory in a moment like that, because there are real people that are losing their jobs, and it's going to be very hard for their economy there. But ultimately that just shows the futility of this approach of economic development.

The better approach is to sort of lay out a welcome mat for all businesses, not picking and choosing winners and losers to bestow on certain favors. And if your state's tax code and your state's economy is so bad that you basically have to bribe people to move into the state to create jobs, that's a sign that that's what you need to fix. You need to fix your state's tax code and your economy, not just create exemptions to it for particular individuals.

Another trend we're seeing is these so-called Amazon taxes. Amazon.com itself really dislikes having a tax named after them, but that's the name, unfortunately, that's stuck. We've seen these now in North Carolina, Rhode Island, and New York, where it's currently under constitutional challenge. It went through the trial-level court in New York, which upheld it, and it's now on appeal to the Court of Appeals in New York, and I think it was being argued yesterday or today, but the trial-level court upheld it. Unfortunately, as those of us who watch Law and Order know, the trial-level court in New York is called the Supreme Court of New York. So, we saw a lot of news headlines that said "Supreme Court of New York Upholds Amazon Law," and state legislators read that and they took it to view that the highest court in New York has blessed this tax law, which certainly isn't the case.

This is just another example of states continuing to push to tax beyond their borders, to reach out and grab tax revenue from other states. Ultimately it is the residents of a state that get the benefit of public services, and they're the ones that should be paying for those public services. To the extent that states try to export their tax burden to other states and to companies, out-of-state companies and so forth, it's just a way of allowing their state residents to buy more government than they're willing to pay for, and that sets up problems down the line when that revenue source runs out.

We're seeing a lot of excise tax proposals not only on the good old tobacco and alcohol -- except beer, never beer -- but also now new categories -- plastic bags, and soda and fatty foods. Historically, excise taxes are taxes on things that the majority finds distasteful for some reason. They don't usually tend to be big money raisers, but you can have a whole multitude of them and they can raise up certain amounts of money, and usually it's entirely random what they choose. A lot of economists like to point to excise taxes as being a way of paying for public goods or externalities, but I can assure you that no government official, no legislator ever looks at it in terms of that question. It's just a question of how much money will it raise.

And then the last point I would want to raise is tax amnesties, which we're seeing in quite a few states. These raise one-time amounts of money -- cash in hand for states -- which is what they're after right now. They're problematic, because they're essentially an exemption from the state's tax code to people that have broken it, and it sends the signal that, hey, you know, next time around you don't really need to pay anything because we'll set aside a time in which you can just cough it up and we'll call it even. There's also a lot of penalties associated with them. So, if you miss the tax amnesty and then you're caught later on, you have to pay not only the back taxes plus the interest plus the fine but the new post-amnesty penalty for not having taken advantage of the amnesty.

I think Virginia had one of those previously, but they're now having another amnesty, so in this amnesty they're waiving the previous amnesty penalty, but if you miss this one, you will have to pay another amnesty penalty on top of the previous one. It gets kind of absurd, but it shows the problem associated with not just having a simple, neutral, transparent tax system and instead having to constantly be giving exemptions and waivers and one-person-only deals for it.

So in some we see a lot of big problems out there. Unfortunately, there's not a lot of effort going on to tackle some of these big issues. There are a lot of possibilities out there -- for fundamental tax reform, pension reform. I mean, probably one of the biggest drains on state finances right now is bloated, defined benefit government pensions, which are out of control. A lot of them were indexed to grow at almost absurd levels -- 8, 9, 10, 11 percent a year. A lot of them crashed pretty hard when the stock market dropped, and state budgets are expected to backfill that. There's a lot of opportunities in spending restraints. There's a few on the ballot this year. Corrections and school choice and so forth. But unfortunately, these are not the things that are being debated yet but we hope will be, because that's where salvation will lie in some of these spending and tax reform ideas.

Thank you.

Oh, give me a home without a subsidized loan

Fri, 02 Oct 2009 00:00:00 EDT

This op-ed appeared in the Christian Science Monitor on October 2, 2009.

The American dream means different things to different people. For some, it looks like a house on a leafy cul-de-sac with weekends spent mowing the lawn and planting shrubs. For others it's a rented apartment in the big city with a building engineer to handle such tasks.

The government should not subsidize one dream at the expense of another. Sadly, though, that's just what has happened. And as history so clearly demonstrates, one-size-fits-all policies don't work very well.

During much of the last century the heavy hand of government has been used to turn the US into a nation of homeowners. It all began in 1913 with the inclusion of a deduction for mortgage interest when the federal income tax was enacted.

Two decades later, with the economy in the throes of the Great Depression, federal intervention exploded. Herbert Hoover signed the Federal Home Loan Bank Act in 1932. Over the next two years his successor, Franklin Roosevelt, created the Federal Home Owners' Loan Corporation and the Federal Housing Administration. Fannie Mae was established in 1938.

Centralization of housing policy in Washington gave rise to interest groups representing home building, mortgage lending, and the real estate industries that pressured politicians to shower a never-ending stream of subsidies on owner-occupied housing.

So successful was this effort that by the late 1990s it became difficult to subsidize homeownership anymore, short of loosening lending standards on federally backed loans. Under unrelenting pressure, those, too, eventually wilted, and a torrent of unqualified buyers flooded the market, fueling a bubble that sent home prices into the stratosphere.

When the bubble eventually burst in 2006, home prices plummeted and many faced financial ruin. The economy slipped into a severe recession and Americans lost some $14 trillion in household wealth. Big Housing, which had pocketed enormous gains during the boom, dumped tremendous losses on taxpayers.

In addition to having different dreams, Americans also have widely varying housing needs. Consider those whose jobs require frequent moves. Because agent fees and closing costs typically exceed any short-run appreciation in value, it makes no financial sense for such people to buy a home.

Yet government policy encourages them to do just that.

Indeed, the current recession has shown what an albatross a home can be. People who have lost jobs often need to move for new ones. But having bought houses they can't sell, many face the unattractive choice of remaining unemployed or abandoning their homes. By creating this labor market rigidity, housing subsidies have deepened and prolonged the downturn.

What have policymakers learned from all this? Apparently not much.

There is growing pressure to extend and expand Washington's latest housing boondoggle: The $8,000 first-time home buyer tax credit. This new giveaway, passed as part of the stimulus bill and due to expire Nov. 30, is designed to lure even more people who are either not financially qualified or for whom buying a home is an unwise investment into the housing market, paving the way for more foreclosures and bailouts down the road.

Even if it is not extended, the provision will likely cost taxpayers more than twice what they were told it would in February.

Politicians must stop meddling in Americans' housing decisions.

The way out of the housing mess is not billions more in subsidies. It's dismantling the existing ones so that individuals can decide for themselves how to best attain shelter.

Doing so would protect taxpayers from the poor decisions of others and give the economy a much needed boost by steering investment away from the construction of McMansions and into those things that raise workers' wages like modern factories equipped with high-tech machines.

To be sure, those with a vested interest in the status quo will fight tooth and nail to keep their handouts. The experience of the past year, however, should teach us that subsidizing homeownership comes at a very high cost and places our economy at considerable risk.

Governing a nation of more than 300 million people poses immense challenges. Keeping the nation safe from attack, policing our streets, proving a basic safety net - these are important and difficult tasks. Our elected leaders should focus on truly public matters and let citizens make personal decisions like how to best put a roof over our heads.

Patrick Fleenor is chief economist of the Tax Foundation.

The "Green Jobs" Myth Behind Cap and Trade

Wed, 09 Sep 2009 00:00:00 EDT

(This op-ed was published in the Detroit News on Sept. 9, 2009 under the title "Benefits of cap and trade legislation too costly.")

Facing growing skepticism over his support of the costly Waxman-Markey cap-and-trade bill, President Barack Obama has decided to recast it as a path to economic prosperity and green jobs.

"We've seen that other countries realize a critical truth," he said in a Rose Garden speech. "The nation that leads in the creation of a clean energy economy will be the nation that leads the 21st century global economy."

"Make no mistake," he continued. "This is a jobs bill."

Gov. Jennifer Granholm echoed these sentiments recently: "The old argument that anything that helps the environment has to hurt the economy is over."

If these bold claims -- that cap-and-trade will lead to a booming "clean energy economy" and create "green jobs" -- sound too good to be true, it's because they're not true.

Many prominent scientists believe that rising carbon dioxide (CO2) levels in the atmosphere are causing temperatures on earth to rise. Other, equally eminent scientists dismiss this notion.

Obama has embraced the global warming view and argues that the root of this problem stems from our failure to adequately take into account the cost of emitting CO2 when we consume energy. Energy production from coal, gasoline, natural gas and other so-called "fossil fuels" is a major source of CO2.

The president's solution is to limit (or cap) these emissions. As with any restriction on energy output -- i.e. the Arab oil embargo of 1973 -- this will drive up energy prices.

Because energy is used in the production and distribution of virtually all goods and services, the impact of these hikes will be felt economy-wide. Some will be readily apparent. The price of electricity (70 percent of which is produced by burning fossil fuels), for example, will rise. Other effects will be less obvious. Food prices will rise because energy is used extensively in the production and transportation of agricultural products.

The Waxman-Markey plan tries to minimize these costs by granting "rights" to pollute and allows them to be traded. Such rights are most valuable to firms that would find it very expensive to reduce their CO2 emissions and less so to those that can cut their pollution at little cost. The exchange of pollution rights among firms will ensure that those who can cut their CO2 emissions most cheaply do so first. This reduces the costs to the economy of complying with the cap.

While Waxman-Markey lowers the costs of limiting CO2 emissions, it does not eliminate them. Higher prices will mean that consumers' paychecks do not go as far and economic well-being will decline. This reduction may be worth it. After all, we may stave off the extinction of our species. Or it could be a colossal waste of money. There is no free lunch, however. The cost of reduced CO2 emissions is lower economic output, not economic nirvana.

The claims about this plan creating jobs are also misleading. The high levels of unemployment we are currently experiencing are transitory and due to the ongoing recession. A cap and trade program will do virtually nothing to alleviate this problem.

When the economy returns to full employment levels, so-called "green energy" jobs will simply replace those lost in the conventional energy sector. It's hard to say whether there will be more or fewer jobs in that sector. If the production of green energy was more labor-intensive there might be more jobs. If it were more capital-intensive, there might be fewer. In any case, the cap and trade bill is not the panacea for our employment woes.

All of this talk about "a clean energy economy" vaulting the U.S. to the front of the global economy and creating millions of jobs is a canard. The Waxman-Markey bill should be judged on its merits. Citizens should study the issue and ask one simple question: Are the potential benefits of reducing CO2 emissions likely to exceed its costs? If they believe that they are, they should embrace the plan. If they do not, they should reject it.

Patrick Fleenor is chief economist of the Tax Foundation.

Interview with Governing Magazine on Tax Cuts

Wed, 19 Aug 2009 00:00:00 EDT

(Note: This interview conducted by Penelope Lemov originally appeared in the August 2009 issue of Governing Magazine.)

Should states cut taxes in a recession like this one?

It depends. Different states have different situations. Some states - California, for instance - ran up their spending beyond anything sustainable during the boom years. So, in their case, cutting spending is preferable to cutting taxes. There may be example on the other side where cutting spending would cut into bone.

Can you cut spending and taxes in times like these?

It would be tough to get political support for that, but there's no inherent reason you couldn't do it. The idea behind cutting taxes or spending is that you don't do it for the sake of doing it. You cut so that spending will go down and you can reduce the involvement of government in society. It's a means to an end.

Given the states' desperate need for revenue, why isn't raising taxes a sound idea?

There are distortions created by high taxes that are true any time. Higher taxes mean less incentive for productive activity, and you need to have incentives whether or not you're in a recession. The Keynesian view is that you cut taxes and increase spending in a recession and do the reverse in good times. So there is that school of thought.

Several states that have raised income taxes have targeted the highest brackets, passing so-called "millionaire taxes," the idea being that it doesn't effect spending the way a tax increase on lower income people would. What's your take on the millionaire tax?

It's bad public policy for a couple of different reasons. First, there's the long-term picture. The tax increase may be effective at raising revenue this year or next, but what it does is reduce incentives to earn over time. To get a short-term benefit, you're imposing long-term harm. We saw that with New Jersey. That state has had a millionaire tax for a while. When they imposed it, revenue went up but the economic performance of the people who were taxed went down. I expected that to happen, but people acted surprised when it did. Maryland also has a millionaire tax, but there's not been a study done there - the tax passed only a year or two ago - but anecdotal evidence is that the same thing is happening there.

The other big problem is fairness: You're providing programs that benefit everyone, but you're funding them from a small group of people. That undermines support for these programs. When there's a downturn, you find taxpayers unwilling to keep these programs going. California relied so heavily on high earnings, such as personal income and capital gains that were soaring in good times. When the recession hit, those revenues dropped off. The money to pay for these programs dried up and now people are saying, "We're not going to pay for it anymore." So it makes support for these programs very shallow. We'll see what happens on the federal level if we fund health care reform with a millionaire surtax.

Some states have begun to talk seriously about extending the sales tax to services. What's your reaction to that?

Politically, that's harder to pass than other solutions because there are vested lobbies that benefit from a zero sales tax on their services. The base of service taxes would be legal, medical and real estate. These are the things that, if you wanted to raise real money, you would have to extend the tax to those things. But they have strong lobbies and they fight hard. The net result is what we've seen in many states: A plan starts out broad and services get picked out one by one and you end up with a couple of services and that doesn't raise much money. In 2007, Maryland started with a long list and ended up with only computer services, which then felt singled out for an attack. That got repealed.

It's unfortunate. Services should properly be subject to sales tax. The idea is to expand the base and lower the rate.

As parents get their kids ready to go back to school, many states - nearly a third of them - have sales tax holidays. How good an idea are those?

Sales tax holidays are a political gimmick. They don't provide significant tax relief. They are not an effective way to help low-income consumers or consumers generally. They are a way for politicians to pretend they care about tax cuts without doing anything about them. Historically, the holidays have been favored by high-tax states. Their consumers go to another state to buy, so the holidays are used to try to keep consumers shopping in-state. That's why New York and Massachusetts adopted theirs (though Massachusetts dropped their holiday this year). The holidays kind of work on that level, but as more states adopt the holidays, they becomes less effective. The real problem, though, is high sales taxes.

In the tax-versus-spending continuum, how do you see things shaping up for states in the coming year?

This past fiscal year, it was a question of how states used the federal stimulus money. Some used it to keep their current level of service, hoping for the best. Some used it to reorganize services or pay down debt, but in the process created structural balance. Indiana did that. The serious problems for those that used it to pad the budget and keep current services levels is that this coming year, they'll face structural deficits.

A lot of states have exhausted rainy-day funds - that's how severe this recession is and how serious spending constraints are. We're seeing a lot of states go through their spending column by column to find things to cut. That's the first I've heard of states doing that. When times are good, they don't spend time making sure all their spending is right.

Second Amendment holiday misses target

Sun, 09 Aug 2009 00:00:00 EDT

This op-ed appeared in the Shreveport Times on August 9, 2009.

Fifteen states will have sales tax holiday weekends this year, most of them tied to back-to-school or hurricane-preparedness savings. But not all sales tax holidays are created equal. A new trend has emerged in sales tax holidays recently as Louisiana Gov. Bobby Jindal enacted a "Second Amendment Weekend" that exempts all state and local sales taxes for rifles, handguns and a litany of hunting-related supplies for the first weekend of September. While South Carolina was the first to implement such a plan, other states, including Texas and Kentucky, are considering introducing similar gun sales tax holidays.

The tax breaks are pitched as a way to spur economic activity. Supporters argue that the holiday will increase the number of guns purchased. Since the 1980s, politicians have been claiming that a sales tax holiday, through increased economic activity, will "pay for itself." While it is true that general sales go up during holidays, overall retail sales for that month might not.

The New York State Department of Taxation and Finance conducted a study on the value of its own sales tax holidays. The study found that while sales increased during the holiday period, sales for the year were almost unchanged. Shoppers didn't buy any more goods; they simply shifted the timing of their retail purchases. This trend, which includes a dip in sales the weeks before and after the tax holiday, has been seen in other states with similar tax holidays and is expected in Louisiana.

It has been argued that this holiday increases recognition of the importance of the Second Amendment. However, it is absurd to think that tax policy should encourage individuals to exercise a specific right. Should the government give tax incentives to use Miranda rights? If so, then more people should start pleading the fifth.

Tax policy should be neutral to economic decision-making. Jindal is supporting a bill aimed at micromanaging the economy. The government of Louisiana, by deciding which items and industries are exempt, is attempting to determine the winners and losers in the market. The government, by targeting a singular sector for the holiday, is essentially subsidizing an industry.

Sales tax holidays and other tax gimmicks often end up being nothing more than a superficial political photo-op. It is unfortunate that Jindal chose to sign a bill that narrows the sales tax base, introduces unnecessary complexities for small businesses, and creates instability in the tax code when there is a wealth of better options for lowering taxes elsewhere.

At first glance, sales tax holidays sound like a taxpayer's dream come true. And for politicians who are always clambering toward a few more points in the polls, the gimmicks might give them a slight edge. However, these supporters' claims are myopic. Good, solid public policy should take into account long-term results instead of short-sighted political pandering. Some states and localities, including Florida, Maryland and the District of Columbia, have cancelled their holidays this year due to revenue shortfalls. Other states—including Louisiana—should take notice instead of adding to the list of popular sales tax holiday items.

Sales tax holidays introduce costly economic distortions into the economy by favoring some industries and products over others; broadly based and permanent tax cuts, on the other hand, can reduce distortions. It is important to provide tax relief without hindering the efficiency of the economy or distorting the decision making of individuals or firms. Taxes should be neutral to consumer spending patterns and decision making. Buying a gun is a personal decision best made in an efficient and nondistortionary market.

Micah Cohen is a summer fellow at the Washington, D.C.-based Tax Foundation, a nonpartisan research and educational organization that has monitored fiscal policy at the federal, state and local levels since 1937.

Solving California's budget problems

Thu, 30 Jul 2009 00:00:00 EDT

This op-ed appeared in the San Diego Union-Tribune on July 30, 2009.

Gov. Arnold Schwarzenegger and legislators are touting a compromise reached last week as a solution to the state's $26 billion budget shortfall, but the deal is woefully short of solving all of their problems. California is now so deep in mud that it is still issuing IOUs. So why is California, the state whose gross domestic product rivals that of entire nations, scrambling for stable ground? The answer is structural, and the solution is here.

The California Commission on the 21st Century Economy, better known as the Parsky commission for its chairman, businessman Gerald Parsky of Rancho Santa Fe, has crafted a winning proposal that includes a net receipts tax to replace the corporate income tax and the general fund sales tax, and a single-rate, progressive personal income tax. Enactment of such a bold plan would vault California into the national spotlight and start a wave of state tax reform that the country hasn't seen since Proposition 13 was adopted 30 years ago.

California now relies heavily on volatile tax revenue sources. The extremely progressive structure of the tax code creates business cycle "bracket creep." That is, during economic booms individuals move up in tax brackets and during recessions they move down. The result is the state's $26 billion budget crisis.

Personal income tax reform is politically feasible, as Maine showed recently by simplifying from four brackets to two. If California follows one expected suggestion from the commission—to go from seven brackets to one—its personal income tax would still be progressive and yet provide much steadier revenue.

The net receipts tax is like a traditional value-added tax on business. As a replacement for both the sales and corporate income tax, it would greatly simplify tax administration and eliminate many economic distortions. Regular corporations, so-called C-corporations, will be taxed at the same rate as non-corporate businesses in their various incarnations: limited liability companies, limited liability partnerships, S-corporations, etc. This would begin to make firm structure and decision-making less about taxes and more about efficiency and quality. A competing proposal put together by Fred Keeley, a member of the Parsky commission, is called the Blue Proposal and includes some bold reforms such as reversing the state's constitutional provision against applying the sales tax to services, and creating a substantial "rainy day" fund. First enacted in 1933, California's sales tax was logically limited to consumption goods. Now, service industries are the majority of California's economy yet retain their exemption. The Blue Proposal would undo this constraint, thus broadening and stabilizing a narrow tax.

Rainy day funds are budgetary institutions that have improved the fiscal systems of many states. Whenever California's revenue exceeded the official revenue estimate by more than 5 percent, the Blue Proposal would funnel the excess into the rainy day fund. Also earmarked for the rainy day fund would be one-third of capital gains tax revenue, in recognition of that tax source's particularly wild fluctuations. Another third of capital gains revenue would be earmarked for debt resolution, leaving the remaining third for the general fund. Effectively putting aside two-thirds of this volatile revenue source is a positive step away from California's current roller coaster revenue ride, which all parties agree must end.

One part of the Blue Proposal that is sure to make drivers and homeowners wince is a "pollution tax" on carbon-based fuels. Really a global warming tax, it broadly attempts to discourage the "bad behavior" of using energy for driving or home heating. Even in proposal form, it is overly complex: It suggests a gas rebate and a fluctuating tax rate depending on the daily price of oil. It is also an open invitation for political manipulation, explicitly suggesting exemptions for some industries or businesses. It seems unlikely to achieve the commission's overall goal, curbing the volatility of gas tax revenue. California wants to be a leader in environmental policy, but a state in budgetary crisis needs a less controversial and complex proposal to raise revenue.

Overall, the main proposal is a superior fundamental tax reform, but it would be wise for the commission to listen to all the reform ideas, and not get stuck on party lines. If enacted, these tax overhauls could succeed in providing more stable tax revenue in California and begin an important nationwide debate on which tax systems have staying power in good and bad times. The commission is still finalizing its proposal to be handed to the governor in September. For the sake of California's shaky economic future, let's hope for fundamental change to the state's fiscal system.

Sheffrin and Cohen are California residents interning with the Washington, D.C.-based Tax Foundation. Sheffrin, a Davis resident, is a student at Wesleyan University in Connecticut. Cohen, a San Diego resident, attends George Washington University in Washington, D.C. A more detailed analysis of California's tax structure was released this week and can be found at taxfoundation.org.

Game Misconduct: St. Louis Widens Jock Tax

Tue, 14 Jul 2009 00:00:00 EDT

This op-ed was published in the Boston Herald on July 14, 2009.

As the 80th anniversary of the All-Star Game comes to Busch Stadium, the city of St. Louis has publicly rolled out the red carpet and privately sent each All Star a special tax bill.

The city always charges a "jock tax" of 1 percent on the daily income of visiting athletes, and that's on top of almost 6 percent that the state of Missouri collects. It is hard to sympathize with a tax on millionaire ballplayers, but this tax also targets any employee who travels with the team. Even these non-jocks—scouts, trainers or other support staff lugging the ballplayers' equipment around—have to pay the jock tax.

Fourteen of the 17 states with a pro baseball team levy a jock tax, and Massachusetts is among them. Visiting players to Boston have to pay the state income tax on their daily earnings, but the tax rate is lower than Missouri's, and Boston has no city wage tax.

Jock taxes are not new, but St. Louis has added a new twist. As Jake Wagman of the St. Louis Post-Dispatch has reported, the city is not following the state's lead in how to calculate the tax owed during All-Star weekend. Instead of lumping the players' bonuses in with their salaries and demanding a share of daily earnings, the city is demanding 1 percent of the entire bonus, implying all of the bonus is earned during All-Star weekend.

Even if a player is chosen but does not go to St. Louis, or if he's benched the whole game, he will still owe St. Louis 1 percent of his bonus.

Shouldn't the city apply the same principles to every All Star? Should President Barack Obama, who will throw the first pitch, and Sheryl Crow, who will sing, be treated similarly—a portion of their income taken as well? Are the tax collectors really going to enforce a rock 'n roll tax and a Barack tax?

All-Star bonuses are modest by Major League Baseball standards. Some of the players' contracts don't include an All-Star bonus, and for those lucky enough to have one, the average amount is only $50,000. That means the tax revenue St. Louis collects will be roughly $500 apiece and total about $20,000.

Compared to revenues from concessions, parking or even taxes on the tickets themselves, this additional revenue is a pittance. It would not even be enough to pay the salary of the tax collector who thought it up!

Our own Red Sox All Stars will have to pony up for the privilege of playing in St. Louis. Kevin Youkilis earns a $50,000 All-Star bonus, so he'll shell out an extra $500 for no good reason. Jonathan Papelbon receives a $25,000 All-Star bonus, so he'll pay $250 of that to St. Louis.

The point is not whether the players can afford the extra $250 or $500. It is whether St. Louis has pushed its tax collection too far with this grab for a minor purse.

Kiran Sheffrin is a Sox fan and athlete studying economics and global relations at Wesleyan University. She is interning at the Tax Foundation in Washington, D.C.

Wind Power: Good Enough Not to Need Subsidies

Wed, 01 Jul 2009 00:00:00 EDT

This commentary appeared in the July 2009 issue of Illinois Business Journal.

In March, I had the good fortune to see 20 impressive windmills just off the Danish coast. Looking out over the water at such a sight, it is easy to understand the attractiveness of wind power. It's renewable, no-carbon, and no-pollution, and is probably the best use of a wind-swept expanse of water that is still close to a large city. Also, Reason magazine recently compared the costs of different energy sources and found that the cost of windpower (9.3 cents per kilowatt-hour) is not too far off from the national average of (9.6 cents).

So why subsidize it?

Economists use the term "rent-seeking" whenever makers and sellers of a product ask politicians to pass laws that give them an advantage over their competition. Most of us call it corporate welfare. It is damaging to the overall economy because it changes incentives. Instead of creating the best products for the lowest cost, companies curry favor to get the best deal from federal, state and local officials.

It is hard to deny that wind power advocates have been very successful at that. Much of the reason our federal and state tax systems are so complex and unclear is because they are littered with all sorts of special exemptions, deductions, exclusions, and credits for particular activities. Rather than just using the tax system to raise the revenue needed to fund the programs society wants, politicians have adopted the "Michigan model" and turning the tax code into a tool to manipulate the economy and pick winners and losers.

There are few sectors of our economy with more profit potential than energy innovation. No one today can know what great energy innovations will be made over the next few decades, and no one today can know what investments will be duds and which ones will pay off tremendously. The ones who get it right will probably see an enormous payoff. Energy innovators should take the risks of their investments just as they take the profits, without relying on corporate welfare.

Nevertheless, Illinois residents may decide that funding wind power development is an important goal deserving of taxpayer dollars. If that is the case, it should be done after open debate, and through the normal budget appropriation process. Unfortunately, that is not what has happened. Tax credits like the 8-year wind tax credit are rarely scrutinized as closely as direct appropriations, and proponents know it. Once in the state's tax code, they can line their pockets with little threat of repeal. And the state's decision to grant sales tax exemptions to any industry that state officials deem to be "high-impact" is almost an open an invitation to make large political donations.

Wind power does have some limitations. There are not many windswept sites near large cities that can accommodate the land footprint that windfarms need, so remote sites are usually chosen, necessitating transmission lines and their expenses and inefficiencies. Wind is intermittent. There are also environmental impacts associated with turbine blades killing birds.

The risk of granting subsidies is that they will waste taxpayer dollars by encouraging development of wind energy in unsuitable and otherwise unprofitable sites. Wind power has proven that it can be an environmentally friendly and successful part of a local power grid. But it is unlikely that wind will be replacing oil and coal anytime soon, and trying to do so could turn into an expensive mistake. Every dollar that federal and state incentives push into wind power development means one less dollar that could have been used for a more successful alternative energy solution, or for some other important government priority.

For its own reasons, the wind industry has taken any number of government handouts, including tax credits, funds filtered through other government agencies, and state mandates designed to tilt the market in their favor. That's a shame, because there's ample evidence that wind is doing okay without corporate welfare being needed. If the wind industry's growth is dependent on continued subsidies, that's another way of saying that further investment is uneconomical.

Taxpayers have two choices for Illinois. They can trust the suits in Washington and Springfield to pick the next winning energy technology, and risk the future of the Illinois economy on that bet (just as Michigan bet on the auto industry). Or, they can stand down their government and all of its "incentives," and let inventors, retailers, and consumers decide what works and what doesn't.

Investment should flow to the projects that makes the most sense to consumers and investors, not to the projects with the best lobbyists. Illinois residents will be better off if they empower scientists and consumers instead of politicians, and keep the hot air out of wind.

Joseph Henchman is tax counsel and director of state projects at the Tax Foundation, a nonprofit tax research group in Washington, DC. Go to www.TaxFoundation.org.

Higher cigarette taxes: unhealthy and unfair

Mon, 29 Jun 2009 00:00:00 EDT

(This op-ed appeared in the Los Angeles Times on June 29, 2009.)

Raising the tax isn't as simple as 'the state needs money, and smoking is bad.'

Nicholas Goldberg's "How and why taxes go up, in smoke" (June 14) reads more like press release from the anti-smoking lobby than an objective question-and-answer backgrounder: Smoking is bad and the state needs more money, therefore hiking the cigarette tax is good. If smokers quit, so much the better. It's a win-win!

Oh, if life were only so simple.

Is smoking "bad"?

An overarching theme of the article is that smoking is simply a bad thing. Yet we live in a diverse society in which tastes vary widely. For some, total bliss is a pack of Marlboros and a day at the monster truck show; for others, it's a bottle of Cabernet and a night at the opera. There is no reason one group should be subject to punitive taxes while the other is praised for its sophistication.

The fact that something is risky doesn't make it bad. Some people ride motorcycles and sunbathe; like smoking, these are risky activities. Are they therefore bad? No. As long as people understand the risks of what they are doing and bear all of the costs, there is no reason for the government to threaten to impoverish them if they don't live their lives in the way some bureaucrat demands.

Life in a free society requires tolerance of activities that have little or no effect on others, even those we don't personally approve of. If government or interest groups have information about risks that are not widely known, they should disseminate it. Otherwise, adults should be left alone to live their lives in accordance with their own dreams and values.

Are cigarette taxes "good"?

Goldberg also points out that "smoking is unpopular, and smokers are politically weak," so why not raise tobacco taxes? Is tyranny of the majority, the classic danger of democracy that Alexis de Tocqueville warned about, really something Californians want to embrace? Of course not. Instead, we should ask, what is an equitable division of the tax burden? Presumably we all benefit from government services. Then we should all pay for them.

A special tax on cigarettes could be justified if smokers were foisting some costs onto their fellow citizens. This subject has been studied extensively by some of the nation's leading economists, who have found that there is indeed a small "externality" associated with smoking—about 35 cents per pack. However, because federal and state cigarette taxes are far in excess of this amount, the current fiscal system transfers billions of dollars from relatively low-income smokers to higher-income nonsmokers. If anything, tax fairness calls for a reduction of the cigarette tax, certainly not a higher one.

Ancillary costs

Goldberg spends much of his time discussing how the law of demand—the common-sense idea that as the price of something rises the quantity demanded by consumers falls—can be used to snuff out smoking. Unfortunately, he glosses over another economic concept, the notion of a substitute good—in this case, bootleg cigarettes—that undermines his argument.

Right now, it is possible for bootleggers to earn more than $400,000 on every truckload of cigarettes smuggled into the Golden State. Those from a foreign source can fetch five times that amount. These illicit profits are the reason the California Board of Equalization estimates that the state loses more than $275 million annually to tobacco tax evasion.

It doesn't take a Nobel laureate to know what would happen if the cigarette tax were doubled or tripled. The marked rise in bootlegging would mitigate any health benefits of the hike. Moreover, as commerce migrates from the corner store to the street corner, youth access to tobacco products would probably increase.

A higher tax would also probably trigger a wave of cigarette thefts, a problem that has plagued the state in the wake of past tax hikes. The increase in such lawlessness coupled with the rise in the crimes traditionally associated with black markets—murders from deals gone bad, gun battles over turf and so on—would adversely affect smokers and nonsmokers alike.

Conclusion

There are no easy answers to California's budget woes. These problems have been building for decades. Perhaps it's time for citizens to fundamentally reappraise exactly what they want the state government to do and devise a fair and efficient tax system for collecting revenue. Hiking what is already one of the most unfair and disruptive taxes on the books will only increase the harm to smokers and nonsmokers alike.

Patrick Fleenor is chief economist at the Tax Foundation.

The tyranny of taxing 'sin'

Thu, 14 May 2009 00:00:00 EDT

(This op-ed originally appeared in the Christian Science Monitor on May 14, 2009.)

Scrambling for revenue, politicians are pursuing higher taxes on junk food, alcohol, and tobacco - a clear threat to individual liberty.

Washington - Sin is big, at least in the minds of federal and state lawmakers. The US Senate is currently considering a soda tax to help pay for healthcare reform. In New York, Gov. David Paterson (D) wants a sin tax on non-diet sodas, and West Virginia Delegate Margaret Staggers (D) supports "a heckuva junk food tax." Nationwide, Democrats and Republicans have proposed higher taxes on alcohol and especially tobacco.

Such politicians are often called "nanny-staters" because they think the proper role of the state is to scold the people in the same way a nanny scolds children. Don't touch that chocolate!

But it's probably not politicians' love of scolding that keeps these tax hikes coming - it's their love of money. They want to spend more, and they'll take whoever's money is easiest to grab.

Sin taxes are easy to get enacted for several reasons, but the biggest is that each allegedly sinful product is consumed by a minority of the public. So it's the classic danger of democracy that Alexis de Tocqueville warned about two centuries ago: the tyranny of the majority.

Fleecing the minority is made much easier by an army of busybodies who make a comfortable living feeding "studies" to the media, proclaiming that Americans eat the wrong foods, drink the wrong beverages, don't exercise enough, and are generally sinful. These modern-day Carrie Nations' denunciations of nearly every commonplace pleasure - from Girl Scout Cookies to movie theater popcorn - are fodder for the nightly news.

To dispel the notion that their sin taxes go too far, the nanny-staters rely on a clever sleight-of-hand: Instead of pitching the tax as a punishment for sin, they claim they're merely compensating society for costs imposed by bad habits. These claims are often unsupported by science, but many media repeat them without question.

Take cigarettes. It's often asserted that smoking costs society more than $100 billion. Peer-reviewed studies from economists such as Vanderbilt University's Kip Viscusi and Willard Manning of the University of Chicago, however, demonstrate that nearly all of the costs of smoking - healthcare, higher insurance premiums, lower productivity at work - are borne by smokers themselves, not the larger society. Some experts even calculate that smoking yields net cost savings. Yet higher cigarette excises keep coming - exceeding $5 per pack in some locations - far more than could be justified as a corrective tax.

Even President Obama - a man known to have indulged an occasional smoke himself - couldn't resist the temptation to ally himself with the nannies and grab some cash to fund his pet programs. He has more than doubled the federal cigarette excise, breaking his campaign promise not to raise taxes on people making less than $250,000.

To maintain fairness, and protect minorities, society should rely on broad-based levies on income, property and sales. All who benefit from government services would pay for them.

Remember: one man's sin is often another's little piece of heaven on earth. Our ability to control the personal details of our lives is rare and precious. What a shame if the Statue of Liberty no longer held up a torch of liberty but instead a ruler to whack citizens across the knuckles when they reach for a treat.

Patrick Fleenor is chief economist of the Tax Foundation.

Remarks to the Shaftesbury Society Luncheon hosted by the John Locke Foundation, Raleigh, North Carolina

Tue, 05 May 2009 00:00:00 EDT

(Click here for video of this event.)

Good afternoon. Thank you for coming and for inviting us. North Carolina has been the state I've come to the most since I started working at the Tax Foundation because there is always something going on down here. (Laughter.) It's always a pleasure to come down here and the see some good friends.

The purpose of the Tax Foundation's state program is to provide data, research, and analysis from a disinterested national perspective to stakeholders and influential people like yourselves about tax policy. In this, we're eager to work with everyone we can to provide the tools and information to make informed decisions, particularly about trends in other states and around the world, how you compare to other states, and where you can go from here.

Now we start from the assumption that you want wealth and jobs and productivity and entrepreneurship and rising standards of living. Now I understand not everybody shares those basic assumptions. (Laughter.) But assuming that, our argument is an important way of achieving that is having a tax system that exists to raise revenue without interfering in individual economic decisions, that doesn't have politicians and bureaucrats picking winners and losers, and that provides opportunities for ideas to succeed or fail.

Now of course, other things than taxes matter. It's pretty important that you have an educated population, that people who want a job can find one, that people have access to health care, and that you have good infrastructure. Our message at the Tax Foundation, though, is that tax policy is a part of this equation. Michigan has great universities, good public services, and decent infrastructure, but people flee the state because there are no jobs there. Michigan has designed a tax system that shifts resources from unpopular groups to popular ones. So they have a terrible business tax and all these transfers from existing businesses to favored ones-a credit for this, subsidies for that, and for all of it they have stagnation. They have no seen a year of net job creation since 2000; the recession is not new for Michigan.

Normally this is where I would talk about a success story to compare, but it's pretty hard this year. State revenue is down and a lot of state budgets are hurting. North Carolina of course is included in this. I understand there is a protest today at the state capital over state workers being asked to not work without pay, as opposed to not working with pay. (Laughter.)

A big part of this state budget crisis is that when revenues were booming, spending boomed up with them, and so there were some states that thought double-digit growth in revenues would last forever and went ahead with double-digit spending increases. California, my home state, is the biggest example of this; again in the year 2000, that year capital gains tax collections made up 15% of their state budget, which is not sustainable in any long term growth. They relied on volatile revenue sources like capital gains, corporate income taxes, taxes on the high-income earners—very mobile people. Doing that makes your state budget much more likely to yo-yo sharply between bad and good times. We have a report on state budgets which you all have that goes over this.

Our message to legislators this year has been: yes, it's a tough time, but it's also an opportunity. These volatile revenue sources like capital gains taxes, corporate income taxes, and taxes on high-income earners—they are at their lowest ebb this year, with the state is getting almost nothing from them. It's the perfect time to reduce or eliminate them and fix your state tax systems. States need to be looking for that edge Scott outlined. In New York and across the country, a lot of very smart and very young and very mobile people are thinking about what to do with their lives next. Where will they take their ideas and their entrepreneurship and their productivity?

Part of that is state spending. You can't get taxes under control unless you get your spending under control. This year, state government spending growth nationwide is basically nil after accounting for inflation and this is years after years of exceeding inflation and population growth. If North Carolina is thinking about some modest reforms, there are lots of options. Colorado of course has it famous spending caps, the TABOR. There's also New Hampshire with has a very limited government tradition.

A surprising one is Arkansas—one of the few states this year with a budget surplus—and this is not a red state thing. Democrats control both houses of the legislature by wide margins and the governorship, and yet they have a budget surplus this year. The reason they do is because they have mechanisms to requiring legislators to rank all their appropriations into "must have" and "nice to have" categories, and nothing in the "nice to have" category can be funded into the "must have" categories funded, and you can only fund the "nice to have" to the extent that revenues are available. Imagine that! (Laughter.)

And of course California has its Proposition 13 tax controls and they're voting this month on some ambitious spending controls too. If Arkansas and California can tackle meaningful tax and spending reforms, there is no reason that North Carolina cannot. And of course other states that have emulated North Carolina's excellent constitutional provision requiring tax legislation to be read three times, going through multiple readings in legislature. John mentioned the Heatherly lottery case which allowed me to become intimately familiar with the North Carolina Constitution. It's an excellent document; I think you should be proud of it and proud that other states have looked to part of it as a model.

And as I said, part of how you attract and keep people depends on education, services and transportation. But taxes matter too. It's a very hard sell to try to get somebody to open a new business in Hoboken or Pittsburgh or Detroit. But people say Raleigh or Charlotte or Durham or Winston-Salem and they don't close their ears. Now you've got to think of how you can close that deal. What tax reform can you do that will one-up the other states and offer a simple, transparent, neutral, and stable tax system that will be a benefit to existing and new businesses alike, and will lay the groundwork for long-term economic growth after this recession?

Before we go into that, and before I offer my thoughts on the tax proposal swirling in the Legislature right now, let me talk about how you compare to your neighbors as a whole, neighbors and to the nation as a whole.

We have a couple different rankings that we do in the Tax Foundation. One is Tax Freedom Day, the day of the year in which Americans have earned enough to pay their taxes and start working for themselves. That arrived on April 9 in North Carolina, 4 days earlier than the national day but a bit below the regional average.

We have our Tax Burdens report, which evaluates how much North Carolinians pay in taxes. North Carolinians pay 9.8% of their income in taxes, higher than the U.S. average of 9.7%. Not bad, but not good.

North Carolina has the 11th highest top personal income tax rate in the country. Income tax collections are 13th highest in the country. Corporate tax collections are 21st highest in the country. Interestingly, your gas taxes are 14th highest in the country.

On the other hand your sales taxes and property taxes are lower than your average state. You don't target cigarette smokers to fund all your state services, which is a good thing because it doesn't create the situation where people demand more government because they're making someone else pay for it. Although, I understand that in the legislature's plan they are going to fix that problem. (Laughter.)

Each fall, the Tax Foundation digs into every state's tax code and ranks them all on how business friendly they are. We weigh over a hundred variables in income, business, property, sales, and unemployment taxes, and apply the principles of sound tax policy to them. In our 2009 State Business Tax Climate Index, North Carolina ranked 39th best business climate out of 50, or in other words 12th worst business out of 50. That's the worst in the south. You improved a bit over the previous year, thanks to that cut of your top individual income tax rate, but it's still pretty high. To attract and keep entrepreneurs and companies, especially against neighbors that are more hungry for jobs and business than ever before, this may be a good time to tackle some real tax reform.

So I've outlined a few areas you might want to look at. Only you can decide what the end goal should look like, and there will probably be different ways to get there. Should you have a flat income tax with no sales tax? Should you have a broad sales tax with a low rate or none at all? Should you dump the corporate income tax? Should you tax capital gains at a lower rate? How much should state government spend each year, and on what? These are questions I hope North Carolinians will be able to debate and hash out, you should think big.

But allow me to suggest some things that you should stay away from. I've mentioned the dangers of taxes on capital gains, corporate income, and high-income earners. I'd also avoid taxes designed to punish certain activities or shift disproportionate tax burdens to unpopular or unrepresented groups, like smokers, or tourists like me, or car renters like Scott. (Laughter.) I'd also be very careful about franchise fees on LLCs: these are highly mobile businesses that have already paid taxes through the individual income tax code. Imposing a franchise tax on them is double taxation. They may just all go to Delaware. My roommate has a LLC in Delaware and it's very easy to do: you just print out a form, fill it out, send it, they stamp it, they send it back to you and you have a Delaware LLC.

I'd also avoid keeping tax provisions designed to reward certain activities, like film tax credits and R&D tax credits and mortgage tax credits and new investment tax credits, and so forth. Studies have looked this and found that most of the activity would have occurred anyways. So it's just a drain on state revenues at the expense of existing businesses who watch as their state rolls out the red carpet for new business while they end up having to pay and open the checkbook for everyone but them. I'm glad Scott mentioned Dell moving to Ireland and from Ireland to Poland because of course Dell has a history here in North Carolina. That incentive package they got, I don't think you needed it, and I don't know how many on this room will disagree with me on that, but is not the way to long term economic growth. Your governor and state legislators are smart people (laughter), well, maybe that's debatable, but no one wants them playing venture capitalist with our money. It's risky and the market should be deciding what business gets to succeed or fail, not a bureaucrat.

Sales tax reform is a little tougher. Sales taxes were first adopted during the Great Depression. North Carolina, for example, adopted hers in 1933 as property tax revenues plummeted and unemployment swelled. Back then, the 3% tax applied only to goods and not services, since services made up a small part of the total economy and it was hard to tax them. But as our goods-based economy has steadily transformed into a service-based economy, that the tax now covers a smaller and smaller share of total goods and services because it doesn't tax most services. So the rate has had to go up every now and then, and today it's somewhere between 6% and over 8% in some places. Your state line average it's about 7%.

The ideal sales tax should tax all consumption once and only once. Services should be taxes just as much as goods. Business inputs, like raw materials or equipment, shouldn't be subject to sales tax because consumers will pay the tax when they buy the finished product. Taxing it again at the production stage just leads to double taxation and disturbs the price, ends up encouraging businesses to consolidate for no reason other than to avoid double taxation. Washington State does that and it's a mess there

In your sales tax, now you tax some of these inputs and for all the Legislature's plan talks about it, it doesn't address that problem. You will still be taxing manufacturing machinery and office equipment, while exempting those services like legal and medical services. You also exempt gasoline and groceries from the sales tax, which are huge parts of the taxable base. So you have a good opportunity here: you can get rid of those taxes on inputs, extend the tax to everything, and lower the rate dramatically.

Unfortunately, as you probably know, the plan doesn't tax all services, just a bunch of politically unpopular ones. Maryland tried that. They started with this big long list of services and then the lobbyists picked it apart, and at the end, there was just one service left taxed: computer services. That was the one industry that didn't have a lobbyist in Annapolis. They quickly hired four lobbyists and got that thrown out. (Laughter.) So you've really got to go for everything or that'll happen.

I'm also kind of confused why are the rate reduction in the left plan it's so small. Right now, North Carolina's sales tax applies to only about 37% of your goods and services. If you got that up to just 60% of goods and services, you could slash the sales tax rate to 2.5%. So that this proposal cuts the sales tax to merely 4% to 5% is, well, yawn. Not going to cut it for interstate competitiveness.

2009 and 2010 present great opportunities. The tax system is in flux. Everyone agrees it's on the table. Taxes matter and North Carolina already excels at some of the basics that many states have yet to achieve. One big oomph—slashing rates while eliminating distortions, or maybe even junking a whole tax altogether in this year when it raises little revenue anyway—can do wonders for laying the groundwork to ensure North Carolina enjoys long-term economic growth. You're first in flight. Aim to be first in tax policy too. Thank you.

(Thanks to Maria José Toledo for transcribing the remarks.)

Opportunity for Tax Reform is Here: Will Obama Squander It?

Fri, 03 Apr 2009 00:00:00 EDT

(The following commentary originally appeared in the April 3, 2009 edition of the D.C. Examiner).

On February 26, 2009, President Obama unveiled his federal budget proposal. The 10-year outline sharply increases spending and borrowing from previous projections, with a total of over $9 trillion in new debt. The federal government's share of the economy will hover around 25 percent, up from the last few decades' average of somewhere between 18 and 20 percent. Nearly $1 trillion in new revenues will be raised over the next decade beyond the projected baseline, primarily (but not exclusively) from those making more than $250,000 per year.

That the proposal eliminates or reduces some deductions should not be mistaken for a move toward "broad base, low rate" fundamental tax reform. As The Economist succinctly put it a month ago:

"Mr Obama's scattershot tax increases are a poor substitute for the wholesale reform America's Byzantine tax code needs. Limiting high earners' deductions for mortgage interest, local-government taxes and other things is certainly more efficient than raising their marginal tax rates even more. But it would be better to replace such deductions for everyone with targeted credits, abolish the alternative minimum tax (an absurd parallel tax system that ensnares a sizeable chunk of the upper middle class), and implement a broad sales tax. Rather than simply eliminating the sheltering of corporate income from abroad, Mr Obama could have broadened the corporate tax base and lowered the rate. In sum, Mr Obama could simultaneously raise more revenue and make the tax code simpler and more conducive to growth. But he hasn't."

We at the Tax Foundation have lots of ideas for broadening bases and lowering rates, which can help close the budget gap while moving toward a simple, neutral, transparent tax system. We will soon produce a report on the distributional impacts of the Obama budget, which we hope will inform a debate this country needs to have regarding how much income the federal budget should be transferring from one group to another. We also have much to say on the practical effects of trying to impose punitive taxes on high income earners, who tend to be entrepreneurial, highly mobile, and sensitive to hefty tax increases.

President Obama is not alone in insisting that high-income earners pay most of the cost of expanding the size and role of government. When President Obama's budget came out, there were more than a few editorials who heralded a New Liberal Order (of proactive government and progressive taxes) that involved the death of the Reagan Revolution (of limited government and low taxes). Many state governors, struggling to close their own budget shortfalls, are turning to taxes on millionaires (and more recently, several-hundred-thousand-aires):

To seal a $132 billion budget, [New York Governor David] Paterson has called for raising the marginal tax rate to 7.85% for three years for single filers who earn $200,000 to $500,000 as well as married couples whose combined earnings total $300,000 to $500,000. A new 8.97% tax bracket would be levied on filers with $500,000 of taxable income. The state's tax rate is 6.85% for everyone who earns more than $40,000. New York City levies a 3.6% marginal rate for earnings over $90,000.

A handful of states already had in place so-called millionaire's taxes, but New Jersey is considering boosting for one year the tax on top earners to 10.25% from 8.97%. The proposal would provide an estimated $620 million to help close a $7 billion shortfall, said Thomas Vincz, a spokesman for the state treasury.

California already has a 10.3% tax on incomes above $1 million. The governor and Legislature agreed in February to raise the tax on all brackets by 0.25 percentage point in an effort to close a $42 billion deficit.

Last year, Maryland added a new 6.25% tax bracket for those with incomes of over $1 million. Other states are taking note: Wisconsin's governor has pitched a new tax bracket for individuals making more than $225,000 a year or couples making $300,000. Delaware's governor has suggested raising taxes on those who make more than $60,000 by one percentage point, to 6.95%.

Connecticut Gov. Jodi Rell, a Republican, has vowed not to raise taxes, but she is facing pressure from unions and advocates for the poor who have been pressing the Democrat-controlled Legislature to squeeze more revenue from residents earning more than $200,000 a year.

This revolution, if that is what it is, is built on sand. Again, The Economist put it better than I could:

"[B]y asking only the richest 2% of Americans to pay more, Mr Obama is building his vision of a more activist government on a shaky foundation.... [T]he recession is already undoing some of the rise in inequality as the capital gains, bonuses and Wall Street profits that fuelled much of the gains in top incomes turn to dust. This could further imperil Mr Obama's revenue projections, if the rich people he is relying on to pay virtually all his bills end up a lot less rich than they were. Much as Mr Obama would like to shield the middle class, he needs to level with Americans: if they want a bigger government, one that will help them in all sorts of ways, they should be prepared to pay for it."

Commentators sometimes shake their heads at how Americans seemingly demand low taxes but also lots of government services. Our complex, non-transparent, non-neutral tax code promotes that by transferring income simultaneously from poor to rich, rich to poor, poor to poor, and rich to rich, with direct and indirect taxes, some of which are paid by employers directly, and some of which are hidden in prices through business taxation. Who can accurately say what they pay in taxes?

With the costs hidden, dispersed, and sometimes shifted outright onto a minority of people, it's no surprise Americans sometimes embrace expansion of government services. But as the federal and state governments begin relying more and more on high-income earners to fund programs and services for everyone, that Well will eventually run dry and we will be caught with lots of spending and no way to fund it. To avoid this, officials should consider this to be a golden opportunity to switch to a tax system that focuses just on raising revenue in the least distorting way possible.

Joseph Henchman is the director of state projects and tax counsel for the Tax Foundation, a nonpartisan, nonprofit organization that has monitored fiscal policy at the federal, state and local levels since 1937.

Letter to the Oklahoma Tax Commission on Cigarette Taxes

Tue, 27 Jan 2009 00:00:00 EST

UPDATE: The Oklahoma Tax Commission has notified us that they will be correcting their regulations.

The following letter was sent to the Oklahoma Tax Commission.

As part of a research project on state cigarette taxes, we have discovered a regulation issued by the Oklahoma Tax Commission that may be beyond the power of the authorizing statute. We believe that it is likely the result of a drafting error, but its correction is important for transparency and compliance purposes. If the error is deliberate policy, it likely represents a violation of the statute and a punitive tax unjustified by adopted policy.

Pursuant to 68 Oklahoma Statutes § 302 et seq., cigarettes sold, used, received, possessed, or consumed in the state are subject to a tax, to be evidenced by stamps provided by the Commission. The statutes set out the tax as follows:

§ 302 4.0 mills per cigarette

§ 302-1 2.5 mills per cigarette

§ 302-2 2.5 mills per cigarette

§ 302-4 2.5 mills per cigarette

§ 302-5 40.0 mills per cigarette

Total 51.5 mills per cigarette

Consequently, the Commission properly adopted OAC 710:70-2-9(c), setting the non-tribal cigarette tax rate as $1.03 per pack (51.5 mills X 20 cigarettes).

However, in OAC 710:70-2-9(a), the Commission regulations state:

Rates for packages of twenty-five (25) cigarettes are One Hundred Twenty-five percent (125%) greater than the rates for the twenty-unit packages.

Since the statute specifies a tax rate per cigarette, the Commission is empowered only to impose a rate on a 25-cigarette pack that is 25% greater than (or put another way, 125% the rate of) a 20-cigarette pack. "125% greater than" is substantially different from "25% greater than." The regulations, as they currently read, would impose a tax of $2.3175 per 25-cigarette pack, or 92.7 mills per cigarette.

As mentioned, we believe that this regulatory problem is likely the result of drafting error. Left uncorrected, however, the regulation could lead to enforcement problems in the future and compliance problems in the present. To prevent confusion about the taxes collected by the Commission on 25-cigarette packs, it may be advisable to address the regulatory language. Its current form states a tax that the Commission is not empowered to collect.

CBPP Report Confuses Two Issues; Ignores Budget Reform Opportunity

Thu, 08 Jan 2009 00:00:00 EST

Yesterday, the Center on Budget and Policy Priorities released a report rejecting a suggestion by Sen. Mitch McConnell (R-KY) on Sunday that any stimulus package providing funds for state infrastructure spending be in the form of loans, not grants. Here are McConnell's words:

Congressional Democrats have talked about sending hundreds of billions of dollars to the states. If we loan these funds, rather than give them away, states will be far less likely to spend it frivolously. And the taxpayer would have greater assurance their money is well spent.

McConnell is worried (as are many people, including Democrats) that the latest stimulus/bailout bill will become a giant Christmas tree on which every congressman hangs pet pork projects, ones that would never pass muster in ordinary times. The packed-with-waste 803-page "wish list" submitted by the U.S. Conference of Mayors illustrates that danger.

The reason "shovel-ready" has now become part of our everyday language is that according to even the most avid fans of economic stimulus through infrastructure spending, the spending surge has to be immediate or it won't work.

The CBPP report confuses the infrastructure-spending part of the proposed stimulus package with the bailout-of-state-governments part. These are two very different proposals, each with different pros and cons. For example, CBPP warns that states could not accept loans because most forbid accepting loans to balance their operating budgets. This is true, but irrelevant: the loans could only be for infrastructure spending, not budget shortfalls. McConnell's statement could have been clearer, but the context indicates that he was referring to the infrastructure.

CBPP also makes the broad statement that state budget shortfalls (which total around $93.7 billion over the next year and a half, according to the National Conference of State Legislatures, much lower than CBPP's eye-popping $350 billion over 2-1/2 years) "stem from the recession, not from fiscal mismanagement." It's surprising that serious analysts would make such a blanket statement absolving state officials of any responsibility for their plight.

As we've covered on our Tax Policy Blog, the circumstances vary widely by state. Ten states are still in surplus, and not all of them are oil- or coal-producing states. Those states in the worst positions are those with the worst business tax climates, the biggest run-up in spending during the boom, the largest emphasis on using the tax code to pick winners and losers, the smallest commitment to rainy day funds, and the heaviest reliance on volatile revenue sources like capital gains, high-income earners, and corporate profits. Perhaps "mismanagement" is a too strong word for such failures, but it's not just the recession at work here. Does the CBPP seriously allege that California, which hasn't de facto balanced its budget in a decade, isn't in its tough situation because of a failure by its citizens to equalize the amount of taxes they're willing to pay and the amount they want to spend on state services? And Michigan: when a budget shortfall is the same size as a foolishly generous tax subsidy for film production, isn't that mismanagement?

Of course, whether the money's a federal loan or grant, it's more government spending that taxpayers will have to make up, but loans help ensure that the projects are worthwhile because a repayment obligation will keep cost-effectiveness criteria in the minds of state and local officials.

Our criticism of states now in trouble could be likened to Monday morning quarterbacking. But if a bailout of the states is what it's come down to, how about requiring states to do some fundamental tax reform? Unlike the blank check that CBPP evidently wants to write, I propose that states should only get bailed out if they commit to fixing what broke in the first place:

Reduce reliance on volatile sources of revenue like capital gains, high-income earners, and corporate profits
Set up a mandatory rainy day fund (to be filled after the present crisis)
Strict spending controls
Eliminate targeted tax credits in the income, corporate, and sales taxes

We recognize that recessions are tough for state governments, with their combination of dropping revenues, increased demand for services, and balanced budget requirements. Yet most states are handling it by reprioritizing spending and drawing down rainy day funds. That's sound management. Whether these strategies can continue working into 2010 remains to be seen. But a bailout without strings attached just rewards the worst offenders of state fiscal practices.

Give police a break: Leave the cigarette tax alone

Thu, 11 Dec 2008 00:00:00 EST

This op-ed was published in the Orlando Sentinel on December 11, 2008.

Florida lawmakers face a budget shortfall of more than $2 billion, and the siren song of the cigarette tax once again can be heard.

"A dollar of additional tax on cigarettes could add $1.1 billion in new revenues," says state Rep. Richard Krisemen.

Kriseman and others bemoan the fact that Florida's cigarette tax hasn't been raised since 1990. But history shows there is good reason for this. When the tax was higher than in other states, it proved nearly impossible to administer, bogging down law enforcement in an endless battle with bootleggers.

Criminals seized the opportunity to smuggle when the tax was enacted in 1943. North Carolina had no tax at the time; so smugglers started trucking in untaxed cigarettes. Florida was inundated with newspaper ads and fliers offering smokers tax-free cigarettes from mail-order houses out of state. State legislators responded with more enforcement and a plea to Washington to curb mail-order cigarette sales, none of which proved effective.

During the next two decades, tax enforcers and evaders were mired in a stalemate. Tax rates remained somewhat constant, and so did evasion. Florida's legal, tax-paid cigarette sales remained low despite large influxes of tourists.

This situation changed in the 1960s when politicians used the growing concerns over smoking and health as an excuse to raise cigarette taxes. A tax hike in 1963 caused sales to drop sharply compared with national levels as more bootleg cigarettes began flowing into the state. According to authorities, one source was commercial fishermen, some of whom began augmenting their incomes by smuggling from Puerto Rico and the Panama Canal Zone.

In 1968, Florida achieved the distinction of levying the highest state cigarette tax in the nation after the tax was raised to 15 cents per pack. The only place with a higher tax was New York City where smuggling-related crimes were ravaging the city. This prompted the head of the Tobacco Tax Council to point out it was now possible for bootleggers to "live in New York in the summer and Florida in the winter. Quite a nice life!"

By the early 1970s, evasion problems were horrendous. A major federal report found that Floridians were buying more than 200 million packs of untaxed cigarettes annually. The chairman of the state House Committee on Finance and Taxation said the situation "attracts criminals and generates a major source of crime."

Florida's response? Throw more resources at the problem. But nothing worked. Frustrated, Jackson Walter, the state's chief cigarette tax collector told Congress, "[T]he smuggling problem takes up a lot of resources; frankly it diverts a lot of resources from jobs that the Legislature in our state otherwise intended these people to do."

At the height of the smuggling epidemic in 1970, the state seized only 20,572 packs of illicit cigarettes, less than the number smuggled into the state each hour of the typical day.

This large illicit market, coupled with the inability of officials to enforce, helped discourage tax hikes for nearly two decades. This allowed inflation to decrease the excise to levels not seen since the early 1960s. By 1990, this de facto tax cut had greatly reduced large-scale evasion.

Unfortunately, lawmakers' memories are woefully short. In 1990, the state again hiked its cigarette tax by more than a third. They were quickly reminded of the perils of excessive taxation when a predictable resurgence of smuggling caused sales of tax-paid cigarettes to drop by nearly 8 percent during the next two years. Since that time, inflation again has eroded the tax, and the state's problems with smuggling have declined sharply.

Politicians like cigarette taxes for one reason: The burden falls on an unpopular minority, namely smokers. But as history so vividly demonstrates, this view is myopic. The corrupting influence of a large black market and the diversion of scarce law-enforcement resources into a protracted battle with bootleggers harm all Floridians.

Patrick Fleenor is chief economist of the Tax Foundation in Washington, D.C., and author of "Cigarette Taxes, Black Markets, and Crime" (Cato Institute, 2003).

Pros and Cons of the Maryland Slots Proposal, from a Tax Policy Perspective

Mon, 03 Nov 2008 00:00:00 EST

Tomorrow Marylanders will vote on a constitutional amendment to allow slot machines—also know as video lottery terminals, or VLTs—in five locations around the state to raise money for public education. Slots opponents and advocates have been fighting bitterly for years, and the issue will finally be decided.

Many opponents of this plan argue that VLTs are more likely than traditional lottery games to lead to compulsive gambling. Some call them "video crack" because they allow players to bet repeatedly in a short period of time, providing the fast-paced, instant gratification that other lottery games generally don't provide. Others oppose the games, and gambling generally, on moral grounds. Still others talk of voting for the slots plan to bolster Maryland's horse-racing industry. However, there are tax policy considerations that most of these discussions overlook. Below are two opposing-yet-not-so-different sides of the slots argument, from a tax policy perspective.

Reasons to Support the Slots Plan, by Gerald Prante

The question surrounding government-run slots in Maryland is similar to many policy debates that come down to questions of second best and baselines. Under an ideal fiscal system in Maryland, slots would be permitted to operate freely and the rate of return in the marketplace would be close to competitive (or close to a normal rate of return). Price, as measured by the "take" of the slot owner, would not greatly exceed marginal cost (including opportunity cost). Policymakers could then internalize any negative externality of gambling by levying a proper Pigouvian tax (based, perhaps, on the amount gambled).

Unfortunately, such a policy isn't up for discussion and so we are left with two alternatives: prohibition (status quo) and a government-run monopoly that earns economic rents (and is likely inefficient relative to a privately-run monopoly, and definitely less efficient than a free market due to X-inefficiencies of monopolies in general).

The first point that needs to be made is that the current policy of prohibition is actually an implicit tax whereby the tax equals the expected fine of being caught gambling and providing gambling services. This "tax" raises very little revenue, and its benefits are largely viewed as paternalistic and/or protecting the property of others in society (i.e. the negative externalities are so great that it justifies an exorbitant tax that is essentially equivalent to prohibition). I personally see little justification for a prohibition tax that is levied at such an exorbitant rate. The optimum tax is obviously less than the status quo; and in fact, government revenue will actually increase if this tax is decreased. This is one of the rare cases in which we are indeed on the right side of the Laffer Curve. Those who oppose such a policy by arguing that it amounts to an increase in tax burden are ignoring the fact that there are two components to a tax burden: the revenue portion and the excess burden. While revenues may increase, that doesn't mean the overall burden has increased because consumer choice has actually been expanded, which means that well-being can only increase assuming a rational consumer (and absent externalities).

Even if one wants to justify the existence of an externality (such as higher crime rates, etc.), the current Pigouvian tax that is set at a level of prohibition is likely far in excess of the tax level that would reflect the true externality (how bad is it in Nevada?). With regard to the internality argument that says people are acting irrationally by gambling (and could become addicted) and therefore that a barrier to gambling improves their well-being, it becomes less clear. The main problem with gambling from a paternalistic perspective is the lost income that results from it, and therefore a government-run monopoly that has a higher "take" than the free market could actually make the problem worse. Therefore, under an assumption of a high degree of irrational economic actors, it is possible that a government-run monopoly is inferior to prohibition. But, a priori, I find this argument especially weak given that other options for gambling already exist for Maryland residents, such as internet gaming, lotteries and out-of-state gambling.

One final possible justification for opposing the current Maryland initiative is the existence of a public choice problem. If government becomes involved in operating slots, does that make it more likely for government to take existing free-market industries and convert them to government-run enterprises that earn rents? Similarly, it is possible (yet in my view highly unlikely) that absent this initiative, Maryland would have eventually let a free market for slots play out. On the contrary, it could even be a stepping stone for a free market end that at least raises tax revenue in a more efficient method.

In summary, the arguments that have been made in opposition to the slots initiative have not only failed to convince me that the optimum policy is prohibition, but they have failed to convince me that even a second best policy is prohibition compared to a government-run monopoly.

Reasons to Oppose the Slots Plan, by Alicia Hansen

Many people on both sides of the debate fail to realize that video slot machines would be run by the State Lottery Commission and, for all intents and purposes, would constitute a significant expansion of the state-run lottery. Therefore, to evaluate the slots plan, we need to examine the merits of the lottery as a whole in addition to the specifics of adding VLTs. Here are some reasons that I consider the slots plan—and any expansion of the state-run lottery—poor tax policy.

Transparency

Sound tax policy requires transparency, which means that policymakers should not try to hide the true nature and cost of taxes, and taxpayers should be aware of the types and amounts of taxes they pay. State governments keep a portion of lottery revenue after they award prizes and cover operating costs, and that portion is used to fund programs entirely unrelated to lotteries or gambling (public education in many states). If this revenue were simply put back into the lottery agency and used to continue providing lottery games, then it would be a user fee; however, since this revenue is used for other government programs, or put into the general fund in some states, it is tax revenue, plain and simple.

However, most people are unaware that they are paying taxes when they play the lottery. They reason that since playing the lottery is voluntary and taxes are mandatory, lottery revenue cannot possibly be tax revenue. But they're confusing the purchase of a product, which is always voluntary, with the payment of a tax on that product, which is mandatory. A lottery player cannot buy a ticket or play a VLT without paying the full purchase price—including the portion kept by the state—just as one cannot voluntarily buy a bottle of wine without paying the mandatory excise taxes or a book without paying the mandatory sales tax.

Lawmakers are quite happy to allow lottery players, taxpayers and voters to hold onto this inaccurate view of the lottery, and refuse to correctly label the revenue "tax revenue," instead calling it "miscellaneous revenue" or "profits." They know that if they call it tax revenue, voters will be less accepting of the lottery. Hiding the true nature of lottery revenue allows policymakers to have their cake and eat it too: they get to claim credit for raising more money for worthy causes without having to admit to raising taxes.

The lack of transparency is bad enough with traditional lottery games, such as lotto and Powerball. But it's even worse with VLTs, which often resemble casino games so closely that players probably don't even realize they're playing a game that's run by the state, let alone that they're paying implicit taxes on that game. When we think of playing the lottery, we think of buying a ticket at the convenience store and scratching off a few circles or waiting days to find out if we won; we don't think of going to the racetrack to play slots.

Regressivity

The implicit lottery tax is a regressive one, meaning that the poor pay a disproportionate share of their income in implicit lottery taxes. While it is true that the poor spend a disproportionate amount of their income on many recreational activities and goods, those goods are not provided and heavily marketed by the state. There is less research on the regressivity of VLTs than on traditional lotteries, and it's possible that VLTs will prove somewhat less regressive. However, we must still ask whether the state should be in the business of providing, advertising and heavily taxing a good on which the poor are known to spend a disproportionate amount.

Neutrality

Another reason to oppose state-run lotteries is their lack of neutrality. Since taxes provide government services enjoyed by everyone, taxes should also be paid by everyone. They should be levied at the same rate on all goods and services, not at higher rates on goods deemed unnecessary or unhealthy to the consumer ("sin taxes"). The implicit tax rate on lotteries, however, is extremely high—much higher than any state's sales tax rate. While it is true that Maryland VLTs would have a lower implicit tax rate than the state's other lottery games, there is still no reason for the rate to be any higher than the state's sales tax. And, since VLTs will simply be part of the state lottery, although they will lower the overall implicit tax rate of the lottery, it will still remain much too high, violating the principle of economic neutrality. The very fact of the government monopoly inherently makes the lottery non-neutral.

What's Next?

In 1963, no state allowed lotteries, Today, 42 states and the District of Columbia have them, and they're all run by the state. Many states enacted them in large part to prevent residents from spending money on neighboring states' lotteries. This domino effect has now created a game of one-upmanship in which states compete for revenue not only by selling lotto tickets, but also by exempting lottery agencies from some of the regulations that other government agencies must follow, joining multi-state lottery games, raising their ticket prices to exorbitant levels, creating digital lottery tickets, installing VLTs, attempting to sell lottery tickets on the internet, and so on. We must wonder where the competition will end. Competition among private companies in a free market is healthy; competition among state governments for the most revenue spent by residents on gambling is not.

Maryland's HB17 contains the following assumptions regarding the slots revenue predictions:

Other Assumptions
VLTs will operate 365 days a year, once operational.
Virginia and Washington, DC do not authorize VLT gambling.
West Virginia and Delaware do not expand VLT operations, either by adding additional VLT facilities or authorizing casino-style gambling.
Pennsylvania does not expand gambling beyond VLT facilities authorized in 2004.

What will happen if these assumptions are unfounded? In five years, if West Virginia and Delaware have expanded VLT operations, and DC and Virginia have indeed installed VLTs, and Maryland residents are spending large sums of money in those states, how will Maryland policymakers up the ante to bring that money back into the state? A lottery in every town? Roulette wheels on every street corner? Half-price lottery tickets for schoolchildren? At some point the state must say enough is enough and turn to transparent, honest methods of taxation for additional revenue, such as the state income tax or sales tax.

Unreliability of Earmarking

The slots plan is being sold to voters as a way to finance public education. But there's no guarantee, no matter what legislators say, that all the money raised from VLTs will be spent on education. Since earmarked money is fungible, policymakers can simply shuffle finds and spend the lottery revenue on whatever they please. Even in states with "lockboxes" to safeguard lottery revenue for education, there's nothing to prevent legislators from spending less non-lottery revenue on education than they otherwise would have; as long as the education budget exceeds available lottery funds, the use of the earmarked revenue cannot be guaranteed. Some voters, however, might support the slots plan simply because they believe the education funding predictions they hear. "We must do this for the children" is a common refrain among lottery supporters, but often the children benefit far less than promised.

The Role of Government

It is true that the slots plan will increase consumer choice by providing another type of gambling in Maryland and another recreational activity. While consumers are generally better off when they have more choices, government involvement is not necessary to provide this choice. If the goal is to give consumers choice and end the prohibition on certain types of gambling, the solution is very simple. Policymakers can get the state out of the lottery business (they can even earn a large sum by selling the lottery to the highest bidder), allow private companies to compete to offer both traditional lotteries and video lotteries, and impose the state sales tax on the profits. It doesn't need to be anymore complicated than that, or damaging to the tax code.

State-run lotteries and state-run video slot machines make the tax system more complex, more bureaucratic, less transparent, more regressive, and less neutral. And they're simply unnecessary. If Maryland policymakers need more money in state coffers, then they can explicitly and honestly increase the rates of broad-based sales, income or property taxes.

Conclusion

Despite the differences in these two points of view, both authors conclude that the ideal solution would be free competition in the gambling industry, with the state's involvement limited to levying explicit, transparent taxes.

Read more Tax Foundation studies and blog posts on state-run lotteries.

Summarizing the Truth About the Presidential Candidates? Tax Plans

Wed, 29 Oct 2008 00:00:00 EDT

This commentary appeared in Google News' "Comments by People in the News" on October 29, 2008.

Near the end of every Presidential election, attacks from both sides saturate the airwaves, mailboxes and even voicemails of American voters. And in a year where the economy is the number one issue, Senators John McCain and Barack Obama have attacked each another over the emphases in their tax plans. McCain has attached labels of "welfare" and "socialism" on Obama's tax plan. Obama has attacked McCain's plan as extending a policy of George W. Bush that he claims only cares about the rich and will not in his view "trickle down" to other parts of the income spectrum.

The rhetoric on the campaign trail and in television ads has been about as honest as an Iraqi Information Minister under Saddam Hussein. Both campaigns should be ashamed when it comes to the misinformation spread throughout this campaign on the issues of tax policy. Rather than spending time fact-checking their falsehoods, let's focus on the two candidates' real priorities.

Obama's priority appears to be the distribution of the economic pie, raising taxes on upper-income taxpayers so that the government can transfer money to those in the bottom and the middle. Obama's plan could have positive effects on economic growth in the short run because he shifts income from upper-income households who are more likely to save money into the pockets of those who are more likely to spend the money. However, this isn't a free lunch; such a policy comes at the expense of savings and thereby long run economic growth. Obama's view appears to be that the loss in economic activity from the tax hikes would not be large enough to offset the good that is done by having a more equal distribution of the economy's resources.

McCain's tax plan appears to be focused more on growing the economic pie. He plans to keep the lower marginal rates for those at the top. (Obama keeps all the lower rates passed as part of the Bush tax cuts except for the top two rates, 33 and 35 rates.) He also plans to cut the top U.S. corporate income tax rate. Unlike Sen. Obama, these two aspects of McCain's plan are not related to any concern over the distribution of the economic pie. But it's ironic that McCain would be attacking Obama for wanting to "spread the wealth" when Sen. McCain's health care plan—a $2,500 refundable tax credit for individuals ($5,000 for families) for purchasing health insurance—is itself a heavy dose of redistribution, benefitting lower- and middle-income earners. Oddly enough, this is the part of his tax plan that has been most heavily criticized by the Obama campaign.

With only a few days left in this campaign, don't get brainwashed: mute the ads, throw away all of those mail pieces, and hang up on those "robocalls." Filter out the falsehoods and focus on the candidates' priorities.

Small Business and the Personal Income Tax Rates

Tue, 28 Oct 2008 00:00:00 EDT

This commentary appeared in The Hill's Congress Blog on October 28, 2008.

Throughout this Presidential election year, confusion has often reigned over the tax policy debate. In particular, the debate over small business taxation has been dominated by Joe the Plumber who for the last couple weeks has personified the issue. The political heat of the moment has obscured an important issue that Americans should understand: How and when do "business taxes" and "individual taxes" overlap?

An under-appreciated feature of the U.S. tax system is that most small businesses are not required to pay the corporate income tax. Instead, small business income "flows through" to the owners who report it on their individual income tax returns. About 35 percent of business taxes are paid in this manner by the owners of sole proprietorships, partnerships and S corporations.

So what have Sen. Obama and some Congressional leaders proposed? They want to restore the higher, Clinton-era tax rates on the top two individual income brackets, increasing the 33 and 35 percent rates to 36 and 39.6 percent. But these higher rates won't just hit high wages; they'll hit business income.

About 1.3 million tax returns would pay an extra $30.1 billion under Obama's plan to raise the top two tax rates. Depending on how we define "small business," these higher tax rates would raise taxes on 45 to 55 percent of small business income.

Using an inclusive definition of "small business"—every individual tax return with any business income (IRS Schedules C, E or F)—a majority of the nation's small business income, 55 percent, would see a tax increase, and the total additional tax collection would amount to $16.4 billion.

Using a more restrictive definition of "small business"—every individual tax return with business income greater than 30 percent of wage income—50 percent of small business income would see a tax increase, and the total additional tax collection would amount to $15.1 billion. If we restrict the definition of "small business" further—including only those tax returns where business income exceeds 50 percent of wages-even then, 45 percent of the nation's small business income would see a tax increase.

So why should we pay attention to the way our tax code treats small businesses? They are an important source of innovation and risk-taking, creating between 60 and 80 percent of net new jobs, employing over half the labor force, and generating more than one half of the nation's gross domestic product. Higher income tax rates reduce the investment spending of entrepreneurs and the likelihood that they invest at all, discouraging the growth or expansion of small businesses.

How will America's entrepreneurial sector fare under a new President and a new Congress? Good question.

Learn more about the Tax Foundation's study on the impact of the Presidential candidates' tax plans on small business here.

Almost Everyone Would Do Better Under the McCain Health Plan

Mon, 27 Oct 2008 00:00:00 EDT

This commentary was published in the Wall Street Journal on October 27, 2008.

His tax credit is larger than the current tax subsidy for insurance.

The McCain health-care insurance tax credit may well be one of the most misunderstood proposals of this presidential election. Barack Obama has been ruthless in his attacks. But the tax credit is highly progressive and will provide a powerful incentive for people to purchase health insurance. These features under normal circumstances should endear Democrats to the proposal.

There has been a lot of rhetoric and misstatements, but what exactly does Sen. McCain have in mind? He would replace the current income tax exclusion for employer-sponsored health insurance with a refundable tax credit—$5,000 for those who purchase family coverage and $2,500 for individual coverage. Mr. McCain would also reform insurance markets to stem the growth in health insurance premiums.

What many may not realize is that the federal government already "spends" roughly $300 billion to $400 billion through the tax code to encourage people to pay for their health care through employer-sponsored health insurance. This subsidy takes the form of the exclusion for employer-sponsored health insurance from both income and payroll taxes.

Still, some 45 million Americans are uninsured; and the growth in health-care spending continues to outpace the growth in incomes and the economy, which portends further increases in the number of uninsured. The employer-based system itself is eroding. Voters should be wondering whether there is a better approach than this subsidy.

Consider the current exclusion. Its value rises with how much someone spends on health care, and how much of this spending is funneled through employer-sponsored health-care coverage. This creates an incentive for people to purchase policies with low deductibles, or which cover routine spending. These policies look a lot less like insurance and more like prefunded spending accounts purchased through employers and managed by insurance companies. Consider homeowners and auto insurance policies. Do these cover routine spending on cleaning the gutters or tuning up a car?

The subsidy encourages people to buy bigger policies that cover more, and leads to greater health-care spending. Moreover, lower deductibles and coverage of routine spending dulls consumers' sensitivity to price. Reducing the tax bias should result in insurance that is more focused on catastrophic coverage and less on routine spending.

By replacing the income tax exclusion with a fixed, refundable credit, the McCain proposal reduces the tax bias for large insurance policies. Because the credit is for a fixed amount, regardless of how much you spend on health care, it helps break the link between the existing tax subsidy and how much is spent on health care. This improves incentives in the health-care market by reducing the bias that has contributed to such a high level of health-care spending.

Moreover, the credit provides a powerful incentive for people to purchase insurance. The two tax provisions—the new credit and the repeal of the income tax exclusion—on net provide a substantial tax cut of $1.4 trillion over 10 years. Not only do most Americans receive a tax cut under the McCain proposal, but the tax cut is directed toward low and moderate income taxpayers.

Consider the family of four shown in the chart nearby, assumed to purchase a $14,000 health insurance policy. The straight line reflects what the family would get under the $5,000 McCain tax credit. The lower line shows the value of the current income tax exclusion, which rises and falls with a taxpayer's tax rate.

What is striking about this picture—and contradicts Mr. Obama's public comments—is that the McCain tax credit for the purchase of health insurance exceeds the value of the current exclusion for all income levels shown. Indeed, it generally provides more resources to purchase health insurance than the existing exclusion. The total subsidy for health care would rise from about $3.6 trillion over 10 years today to roughly $5 trillion under his proposal.

How large an effect does this proposal have on the number of uninsured? Based on estimates by career economists in the Treasury Department's Office of Tax Analysis of similar proposals discussed in the Washington Beltway several years ago, the McCain health-care tax credit can be expected to increase the number of insured by 15 million and probably more. The Lewin Group, a respected private health-care research outfit, recently estimated that the McCain credit would increase the number of insured by as much as 21 million. It is true that many may no longer get their insurance through their employer, but they will be given the resources to purchase insurance on their own.

Will the insurance that is purchased be a generous plan with first dollar coverage or low deductibles? It is much more likely to be a plan with higher deductibles that is more focused on providing true insurance against catastrophic losses rather than a more generous plan that includes a lot of prepayment for routine and predictable medical expenses. But this is precisely one of the objectives of the policy: to reduce the current tax bias that encourages people to funnel routine health expenses through insurance policies.

Finally, the credit has important implications for the nation's finances down the road. This is perhaps the most important aspect of the proposal.

There is an enormous unfunded liability associated with the major entitlement programs of Social Security, Medicare and Medicaid. If left unchecked, the growth in these programs will nearly double the size of the federal government by 2040, consuming roughly 40% of the nation's output rather than the 20% today. While the growth in Social Security is largely the result of demographics, the growth in Medicare and Medicaid is also driven by the rapid growth in health-care spending. This is where a proposal like Sen. McCain's can be so important.

The elimination of the income-tax exclusion should reduce private health-care spending; to the extent this reduces the cost of health care, it should also put downward pressure on the growth of Medicare and Medicaid costs. Thus, by removing the tax bias for more generous health coverage, the McCain health credit also has the potential to provide important dividends to the entitlement problem down the road.

Mr. Carroll served as deputy assistant secretary for tax analysis at the U.S. Treasury. He is now vice president for economic policy at the Tax Foundation, and an executive-in-residence with American University's School of Public Affairs.

Business Taxes Increasingly Out Of Line

Mon, 27 Oct 2008 00:00:00 EDT

This commentary was published in the Worcester Business Journal on October 27, 2008.

This November, folks in Massachusetts will be voting on an initiative that would repeal the state's 5.3 percent individual income tax.

There are legitimate concerns about increasing tax burdens, declining business climates, and out-of-control spending in many states.

Yet, no matter how one votes on the initiative, Massachusetts, and the rest of this nation, need to start thinking beyond its borders when it comes to tax policy.

Study Hall

A study from the Organisation for Economic Co-Operation and Development (OECD) last month shows that the U.S. corporate tax rate is now 50 percent higher than the average among our friends in the industrialized world. Only Japan has a higher rate than us.

If each of the 50 states were treated as countries, 23 of them would have a higher combined federal-state corporate tax rate than Japan. Massachusetts would have the fourth highest corporate tax rate in the world, behind Iowa, Pennsylvania and Minnesota.

Last month, KPMG released its annual survey of corporate and indirect tax rates for 2008, showing that 23 countries have lowered their corporate tax rates this year, and no nation has raised its rate since last year. Sweden, for instance, announced a series of proposals to improve its business climate, including a plan to cut its corporate tax rate from 28 percent to 26.3 percent to help Swedes return to the job market instead of living off of subsidies.

This comes on the heels of another study from the OECD, showing that corporate taxes are the single most harmful tax to economic growth, more so than personal income or sales taxes.

America has become increasingly uncompetitive not because of any action we have taken but because we have done nothing while the rest of the world has moved ahead.

The Tax Foundation has launched CompeteUSA, a campaign to raise the public's awareness of America's high business tax rates and how those taxes have an impact on our competitiveness, wages, and living standards.

But why isn't there a louder call to reform our corporate tax system during these turbulent economic times?

In this election year, plenty of politicians like to make businesses appear unworthy of any tax relief. But there is a lack of understanding that workers and families ultimately bear the burden of our business taxes. In the form of higher prices, lower wages and poorer return on investment, the federal corporate income tax quietly tapped $3,190 per household. That's more than the average household spends on restaurant food, gasoline or home electricity in a year.

While Massachusetts should look at its own tax system, continued failure by policymakers to keep up with our top global economic competitors means that we should be very concerned about jobs, capital, and investments moving from high-tax countries to low-tax countries. America must focus not only on the short term fixes in the midst of this financial crisis; we must also revisit a stagnant business tax system that threatens our position within the global marketplace.

Scott Hodge is the president of the Tax Foundation, a nonprofit, nonpartisan organization that has monitored fiscal policy at the federal state and local levels since 1937.

Reforming a Broken Health Care System is No Joke: A Response to Brad Delong's Blog Post

Fri, 19 Sep 2008 00:00:00 EDT

I read Brad Delong's blog post "This Is a Joke, Isn't it?" on my recent piece "McCain's Health Credit: The Intersection of Health Policy and Tax Policy," Tax Foundation Fiscal Fact No. 144, September 16, 2008, with great interest. In my piece I tried to make it clear that the McCain health credit proposal is no panacea. It addresses important problems with the current tax treatment of employer-based health insurance. Improved incentives can help control health care costs. But the policy also increases the tax subsidy for health care from its current level of about $3.6 trillion over ten years to about $5.0 trillion over ten years. This large increase in the aggregate subsidy might well work in the opposite direction.

There are also concerns about the effect of the policy on the employer market. This is partly mitigated by keeping the payroll tax exclusion for employer-based health insurance (i.e., not completely leveling the playing field between the group and non-group markets). Usually, proposals to change the tax treatment of health care are accompanied by other proposals to reform insurance markets to ensure sufficient pooling and to increase subsidies for those with high risk/poor health status. But these proposals also more often than not take the form of objectives rather than well defined or articulated policies.

Delong's main point is that he does not see how the McCain health credit could possibly increase the number of newly insured by 15 million or more. The idea is simply that some, perhaps many, would have the means to purchase health insurance under the McCain health credit. Let's consider the size of the full subsidy under the McCain proposal. First, McCain provides the $5,000 and $2,500 credits for family and individual coverage. Second, he does not completely replace the existing tax subsidy for employer-based insurance. While repealing the income tax exclusion, he retains the payroll tax exclusion, which is about one-third of the existing $3.6 trillion subsidy (over ten years). The payroll tax exclusion lowers the price of health insurance purchased through one's employer from $1 to about 85 cents for those below the Social Security wage cap (and to just 97 cents for those above the wage cap). Consider a family purchasing a $6,000 policy. After payroll taxes, the cost of this policy would be $5,100. The McCain health credit would cover another $5,000, leaving the family with a $100 after-tax cost for the policy. At this low price, it seems likely that the family would purchase the insurance.

Now, the more important question is: Can someone really find family policies that cost in the neighborhood of $5,000? The answer depends on what the policy covers. Insurance at this price probably would not be a generous plan with first dollar coverage or low deductibles. Instead, it is much more likely to be a plan with higher deductibles that is more focused on providing true insurance against catastrophic losses rather than a more generous plan that includes a lot of prepayment for routine and predictable medical expenses. But this is precisely one of the objectives of the policy: to reduce the current tax bias that encourages people to funnel routine health expenses through insurance policies.

Searching www.ehealthinsurance.com, I found that the annual premium for the top ten picks for family coverage with two adults born in 1970 (i.e., in their late thirties) and two children ranged from $2,208 to $6,048 in Berkeley's zip code of 94720. The deductibles ranged from $500 to $7,000. The plans with a $3,000 and $5,000 deductible had annual premiums of $5,304 and $3,828, respectively. Obviously, this casual observation is not meant to suggest that everyone can get insurance at these rates, because clearly they cannot. Those with poor health status, with high risk profiles or in high cost areas would undoubtedly pay more, and possibly a lot more. The point, however, is that the level of subsidy provided by the McCain health credit is large enough to allow many to purchase real insurance that will provide a badly needed financial backstop in times of serious trouble. It would provide a substantial benefit to many. So, now, let's turn to where the estimate of 15 million came from.

The estimate of 15 million comes from work on similar proposals about the time the Administration put forward its proposal back in early 2007 for a new standard deduction for health insurance (SDHI) to replace the existing income and payroll tax exclusions for employer-based health insurance. At the time, estimates were produced from various sources for the original SDHI proposal and related credit proposals.¹ Estimates for the SDHI proposal were prepared by the Congressional Budget Office (CBO), the Joint Committee on Taxation (JCT), the U.S. Treasury Department of the Treasury, and the Lewin Group.

These organizations estimated that the SDHI proposal would increase the number of newly insured (net of any effects related to the group market) by between 6 million and 9.2 million. The JCT and Lewin Group were at the high end with estimates of 8.5 and 9.2, respectively. The Treasury came in with a more conservative estimate of 6 to 7 million (to the chagrin of the Administration, I might add).

Estimates were also produced by the Treasury for various proposals to replace the income and payroll tax exclusions for ESI with a credit. The estimates for the credit proposals' effect on the newly insured ranged from about 11 to 15 million. The estimates at the higher end of this range were for versions of the proposal with fewer strings attached to the excess credit (i.e., the credit amount in excess of the cost of health insurance). (Incidentally, another problem with the McCain health credit is that is requires the excess of the credit to be deposited into an HSA. I am not sure why this string needs to be attached. It would decrease the take-up and means that the link between the tax subsidy and health care spending is not completely broken, which seemed to be a key merit of the approach.)

Now, the McCain health credit differs from the proposals analyzed by the Treasury Department in one critically important respect: the McCain health credit retains the current payroll tax exclusion for employer-based health insurance. This difference should have two effects on the estimates of earlier credit proposals, both of which should lead to higher estimates.

First, by retaining the payroll tax exclusion, the McCain proposal does not fully level the playing field between the group and non-group markets. Indeed, roughly speaking, and pointed out in my piece earlier this week, it retains about one-third of the existing tax subsidy for employer-sponsored health insurance. Thus, the effects of the proposal on the group market should not be as great under the McCain proposal as compared to the earlier proposals analyzed by the Treasury Department. While this component of the Treasury estimates is not public, suffice it to say that depooling was perceived as a significant problem and was one of the explanations for Treasury's more conservative estimates.

Second, the credit proposals analyzed by Treasury were roughly revenue neutral, but the McCain credit is not. Because the proposal retains the payroll tax exclusion, it provides a large tax cut. This tax cut, in effect, increases the federal tax subsidy for employer-based health insurance from the current $3.6 trillion over ten years to $5.0 trillion over ten years. Indeed, as shown in Figure 1 in my piece earlier this week, the value of the McCain health credit exceeds the tax value of the current income tax exclusion (where I assumed an average family premium of $14,000, not the lower $12,000 as suggested by Delong in his posting) at most income levels. The greater generosity of the McCain health credit relative to the earlier credit proposals analyzed by the Treasury should translate into the McCain health credit having a larger effect on the number of uninsured.

Of course, these are very difficult estimates to make (as suggested by the large variance in the estimates cited above for the Administration's SDHI proposal), so it is difficult to put a precise number on the McCain health credit. But, if one finds the earlier estimates believable, then it is likely that the McCain health credit should have more potent effects simply because it is a more generous proposal and does less harm to the employer market.

Another point to emphasize in an analysis of the McCain health credit is that it is highly redistributive. That is, it redirects the tax subsidy for health care towards those with low and moderate income, which is where a lot of the uninsured happen to reside in the income distribution. I would think that many who are concerned with government aid to the less fortunate would find this, plus spending another $1.4 trillion (over ten years) on health care, to be attractive features of the McCain proposal.

Given the interest among some on the left for the credit alternative to the Administration's SDHI proposal at the time, I was a bit surprised that Senator Obama did not propose the credit himself. Indeed, a paper analyzing the Administration's SDHI proposal co-authored by Jason Furman (Policy Director for Senator Obama's Presidential campaign) and others saw some merit in the original SDHI proposal and suggested that a credit alternative would address some of its limitations. ²

Notes

1. These estimates are discussed in, Robert Carroll, "The Economic Effects of the President's Proposal for a Standard Deduction for Health Insurance," National Tax Journal Vol. LX(3) (September 2007): pp. 419-431. In particular, see tables 1 and 2 on pages 425 and 430.

2. Len Burman, Jason Furman, Greg Leiserson and Roberton Williams, "The President's Proposed Standard Deduction for Health Insurance: An Evaluation," Tax Policy Center, February 14, 2007.

CBPP Report Longs for a Poorer Country

Wed, 27 Aug 2008 00:00:00 EDT

The Sears catalog has throughout American history represented the dreams and accomplishments of our capitalist system. By 1973, a family flipping through the 1,500 page catalog would find the best-quality items on the market at affordable prices. Among their options were the latest electronic calculator for $89 ("Adds, subtracts, multiplies, and divides, even to negative answers"), a 650-watt microwave oven for $439.95, a "compact" record player with two 4" x 6" speakers for $187.95, and the most colorful, broad-legged, plaid polyester slacks for $15.95 each.

One need not even adjust for inflation ($1 in 1973 = $4.95 in 2008) to know that these products would be considered overpriced and obsolete today. Aside from eBay and estate sales, many of these items are unavailable because no one wants them. They've been replaced with better and less expensive items, and have been joined by products unavailable in 1973 at any price, such as portable music players, computers, VCRs, and cell phones. Throw in advances in other fields and one recognizes that in the last thirty-odd years, we have all benefitted from the vastly more productive and innovative American economy.

This week's release of Census data shows some of this accomplishment. Household income rose, the number of people without health insurance dropped, and the economy continued to grow (albeit slowly). There are, of course, worrisome issues out there, but Americans today can and do access the best economic opportunities, medicine, science, transportation, and virtually anything else, in the history of the world.

For some folks, though, flipping through the 1973 Sears catalog is a wistful look at how great things used to be, how much better off Americans were back then. They see that decade as a time when income inequality was low (focusing on relative differences, rather than absolute improvements in well-being, as if everyone being equally poor was a good thing). If only we could go back to that decade, of double-digit inflation, government-protected monopolies, heavy taxes, and 8 percent unemployment!

Just this week, the Center on Budget and Policy Priorities (CBPP) cast the latest 2008 Census data in stark terms. "Never before on record has poverty been higher and median income for working-age households lower at the end of a multi-year economic expansion than at the beginning." The alarmism echoes Sen. Joe Biden's first speech as the Democratic vice-presidential candidate last week, when he lamented the shrinking wages of American families.

These statements are both true and misleading. The narrow definition of poverty used by CBPP ignores the fact that poverty in 2008 means something very different than poverty in 1973, or even in 2000. Over 90 percent of American households have a color TV, telephone, automobile, microwave, and cell phone, and about 100 percent have electricity, a radio, a refrigerator, and a stove.

Biden's reference to wage income ignores two major measures of well-being. One is the enormous growth in employer-provided benefits since the 1970s, such as health insurance, time off, and retirement plans. When these are included, compensation is much higher today, even in inflation-adjusted dollars. The other major omission is that things are more plentiful, better, and lower priced today. The hours an average person must work to buy things have dropped substantially over the years. A laborer in 1895 had to work 24 hours to buy a cushioned chair; by 1997, it required just 2 hours. Ditto for a dozen oranges (2 hours vs. 0.1 hour), milk (2 hours vs. 0.25 hours), a set of encyclopedias (140 hours vs. 4 hours), a bicycle (260 hours vs. 7.2 hours), and even gasoline.

The CBPP report cherry picks bad-sounding statistics from a rather positive report. Employer-based health coverage dropped from 2007 to 2008, they report, overlooking the fact that Census reported a mild uptick in the number of Americans with health insurance. (It will get worse again "in 2008, and probably in 2009 as well," they reassure us.) They applaud the drop in the number of uninsured children, but reach back to the last year when the number was even smaller (2004) and shake their heads at the "trend." They hack people out of the population until they find some narrow subset where income didn't rise. They highlight the increase in children living in poverty (2008 poverty, not Oliver Twist poverty).

CBPP isn't being a Gloomy Gus for no reason. Their report concludes, "[S]ignificant pain may lie ahead for many Americans.... [T]he next President and Congress should consider setting a national goal to reduce poverty and acting upon it." Maybe digging so hard for worrisome statistics has led them to forget that the only way to end poverty in the long-term is to increase wealth. Instead of emulating the 1970s by using our tax code to pick winners, shift money around, and penalize success, as CBPP often advocates, how about we focus on making our tax code simple, transparent, stable, and neutral?

Tax Study Commission Can Improve Business Cimate

Tue, 19 Aug 2008 00:00:00 EDT

This letter was published in the Jackson Clarion-Ledger on August 19, 2008.

The Mississippi Tax Study Commission has issued a draft of its recommendations for improving the state's tax system. The best tax system is one with low rates on a broad base, treating all taxpayers equally while minimizing economic distortions. When I testified before the commission, I expressed the hope that it will work toward such a tax system, which would make Mississippi a more powerful economic performer.

Repealing corporate franchise and inventory taxes would attract more investment, while reducing a hefty cost borne by even unprofitable businesses. Businesses could then make decisions on economic factors, not tax liability concerns. Repeal would eliminate these distortions without the complexity of more tax credits.

Eliminating Mississippi's sales taxes on machinery would improve the state's business tax climate. Only 14 other states have this tax, and businesses are known to avoid states with it. Such taxes on business inputs are hidden taxes, since they are passed on to consumers in the price of goods.

The commission should also be careful about urging increased cigarette taxes. The poor bear a disproportionate share of such "sin" taxes, and they inequitably shift the burden of paying for government to a small group of people. Hefty taxes designed to reduce an activity should also not be relied on for revenue.

I commend Gov. Haley Barbour and the commission for taking a comprehensive look at Mississippi's tax system. I hope that the commission considers proposals that can provide Magnolia State residents with a simple, neutral, transparent and stable tax system.

Joe Henchman

Tax Counsel

The Tax Foundation

Washington, D.C.

Economic Growth Requires Bold Steps: Mississippi Should Consider Tax Reform Recommendations

Fri, 18 Jul 2008 00:00:00 EDT

It's almost August, and that means the Mississippi Tax Study Commission should be working its way toward final recommendations. In early 2008, Governor Haley Barbour announced the creation of the Commission, which is tasked with preparing a comprehensive study of the state's tax system and recommending improvements. Bringing together a wide range of business, legal, academic, and legislative expertise, the Commission must submit a report of its findings by August 31, 2008.

In March, the Tax Foundation presented Special Report No. 161: An Opportunity to Improve Mississippi's Tax Climate, analyzing Mississippi's tax system and making recommendations for improvements. In doing so, we relied on our principles of sound tax policy: that good state tax systems levy low rates on a broad base, and treat all taxpayers the same while minimizing economic distortions.

While it is true that Mississippi's tax system is about middle-of-the-pack regionally, mediocrity is no cause for celebration. States with the courage to undertake comprehensive review of their tax systems do so because they want better economic performance and to become a hub of business and consumer activity. States such as Mississippi should keep in mind regional, national, and international competition for capital, jobs, and entrepreneurs, and adopt a tax system that acts as a welcome mat to all players on a neutral basis.

The Commission responded positively to our presentation and we are hopeful that they keep our suggestions in mind, which we briefly reiterate here.

Consider Repeal of the Corporate Franchise Tax. This economically damaging part of Mississippi's tax code (imposing a $2.50 levy for every $1,000 in capital that is held, invested, or employed by a business) hits firms even when they are not profitable, and the burden of calculating it prevents Mississippi from attracting multi-state and multi-national corporations. Its abolition would give Mississippi a boost, even if the revenue were made up elsewhere.
Consider Repeal of the Inventory Tax. Inventory taxes, levied on the value of a company's inventory, exist in only 15 states. They are especially harmful to large retail stores and others that have large amounts of merchandise. They distort economic decisions because they force companies to make business decisions based on minimizing tax burdens, rather than economic activity. They create strong incentives to move inventory (such as warehouses and shipping facilities) to other states. An income tax credit is an insufficient solution, since it would maintain the economic distortions and the burden of calculating the tax, and less-profitable companies would be unable to take the credit. For these reasons, many states repealed their inventory taxes. If Mississippi joined them, it could enjoy a regional advantage over neighboring states that (for the moment) still have inventory taxes.
Consider Repeal of the Intangibles Tax. According to Mississippi Code § 1-3-41, § 27-35-31, and § 27-35-33, taxes on business and personal property also apply to intangible property, such as funds on deposit, promissory notes, rights of court judgments, stock certificates, and bonds. Only four states tax such intangibles, a tax that is highly harmful to businesses that hold large amounts of their own or other companies' stock.
Eliminate the Sales Tax on Machinery and Other Business-to-Business Transactions. Mississippi is one of only 15 states to impose sales tax on purchases of manufacturing machinery. Businesses have been known to avoid locating facilities or factories in states where the factory's machinery would be subject to state sales tax. Eliminating the tax would make Mississippi more attractive to such projects.
Conform Mississippi's Corporate and Individual Income Taxes to the Federal Tax Base, and Adjust Brackets for Inflation. Requiring businesses and individuals to calculate income twice under two different systems imposes a heavier tax compliance burden. Conforming Mississippi's tax base, as well as flattening income and corporate tax brackets, would considerably lower these costs. Similarly, indexing brackets for inflation would prevent individuals from being pushed into higher tax brackets each year even though their real income remains the same.
Avoid Cigarette Tax Increases. Mississippi should be careful not to rely on cigarette taxes as a long-term source of revenue because it puts the state in the position of relying on a tax on an activity imposed with the justification of reducing the activity. Numerous studies have shown cigarette taxes to be highly regressive, with the poor bearing a disproportionate share of the tax burden. Evasion and compliance costs undermine many of the asserted benefits of such tax increases. Mississippi should avoid such reliance on cigarette taxes.

These recommendations also do not consider bolder steps that Mississippi could undertake, such as repealing one of the major taxes (income, corporate, sales), that would greatly improve its competitive position. Such actions should be considered as part of a comprehensive analysis.

Serious tax reform in Mississippi should consider these recommendations and address the underlying concerns. Leaving problematic taxes such as the franchise tax, inventory tax, and sales tax on machinery unaddressed would preclude the move Mississippi hopes to make from middle-of-the-pack tax climate to growing hub of commercial activity.

Double Taxation of Hospital Services Pushes Patient Bills Up

Tue, 01 Jul 2008 00:00:00 EDT

This commentary was published in the July 1, 2008 issue of the Heartland Institute's Budget & Tax News. It references this earlier Tax Foundation study.

As medical costs continue to rise, an under-appreciated factor is states' double taxation of hospital services. In many states, hospitals must pay sales tax on purchases of medicine and equipment—taxes that get passed on to patients in the form of higher bills.

In a new report, "States Should Avoid Sales Taxes on Nonprofit Hospitals," the Washington, DC-based Tax Foundation found only seven states exempt all hospital purchases from the sales tax and six states impose sales tax on even nonprofit hospital purchases.

"Ideally, a sales tax should be levied on all goods and services sold at retail, and to prevent distortions and hidden taxes, it should be levied only once on each good or service sold at retail," the study points out. "Just as imposing sales tax on manufacturing inputs leads to hidden taxes and pyramiding on retail consumers, so too does imposing a state sales tax on hospital purchases lead to hidden taxes and pyramiding on patients."

The report reviews all 50 states and the District of Columbia to see which impose sales taxes on hospital purchases of medicine, equipment, and other materials.

Thirteen states have a generic sales tax exemption for purchases made by any nonprofit or charity, the study notes. Thirteen others have provisions specifically exempting nonprofit hospital purchases from the sales tax but not necessarily purchases by other nonprofits or charities.

Seven states exempt inputs purchased by all hospitals. Arkansas and North Carolina exempt certain purchases by nonprofit hospitals.

Seven Tax Everything

Seven states are the worst on taxing hospital inputs. Louisiana, Oklahoma, and West Virginia tax all inputs purchased by nonprofit hospitals, and Tennessee, Washington, and Wyoming tax all but medical equipment purchases. Oklahoma's tax is upside-down: It taxes hospitals' inputs but exempts retail sales.

Greg Barker, director of planning and business development with Touro Infirmary in New Orleans, estimated his facility spends $4 million annually in sales taxes on hospital inputs.

"This disadvantage in the marketplace is not good tax policy and does not offer fairness among area hospitals because the tax burden is not equally applied to all facilities," Barker said. "A $4 million savings goes a long way to improving the financial status of one of New Orleans' longest-serving hospitals."

Tennessee Hospital Sues

In the 1970s in Tennessee, Parkridge Hospital in Chattanooga brought a lawsuit after the state ordered it to pay sales tax on its business-to-business purchase of human blood for patient transfusions, even though Tennessee law limits the sales tax to retail sales. Tennessee legislators responded by enacting a specific sales tax exemption for blood purchased by charities.

While the "blood exemption" is still on the books, many other purchases of inputs by hospitals in Tennessee remain subject to the sales tax. Patients in Tennessee thus pay hidden taxes embedded in their hospital bills, and Tennessee's tax system is less transparent and neutral.

Even states that exempt nonprofit hospital purchases tax other business-to-business transactions that should be exempt.

Business-to-Business Taxes

Of those states that impose a state-level sales tax (45, plus the District of Columbia), many impose sales taxes on business-to-business transactions that do not involve a final retail sale, the study notes.

"[M]ore than half the states (27 plus D.C.) tax two or more inputs. 14 states and D.C. tax the purchase of manufacturing machinery, an especially distortionary tax, and Hawaii imposes sales tax on all but one examined business-to-business transactions," the report notes.

"For many states, exempting inputs from the sales tax should be a part of any tax reform effort," the study concludes.