Tax Foundation - Commentary

Local roads are overused because they're 'free'

Fri, 04 May 2012 00:00:00 EDT

Letter to the editor published in the Washington Examiner

Re: "Va., Md. punt on billions needed for roads," April 30

As a Virginia native, I have had intimate experiences with the horrid traffic in the D.C. metro area. However, contrary to popular opinion, traffic is not a symptom of a limited supply of roads. Rather, the roads we have are overused because they are not priced.

In a free market, prices steer resources to their most valued uses. Our current road funding system is broken because it does not take cues from the market. We just clumsily tax everyone and then provide roads free of charge.

A much better way to provide roads would be to use tolls wherever possible. That way, drivers would bear the cost of driving, traffic would decrease, and the funding of roads would be aligned with the number of people that actually drive on them.

Scott Drenkard

economist,

the Tax Foundation

Tax Freedom Day Still Two Weeks Away

Mon, 02 Apr 2012 00:00:00 EDT

This op-ed was published in the Daily Caller on April 2, 2012.

Spring is here, but we’re still not free. Tax Freedom Day® — the day each year in which Americans have worked long enough to pay all of their state, local and federal tax bills — arrives on April 17 this year. That means Americans will work 107 days into the year, from January 1 to April 17, to earn enough money to pay this year’s combined 29.2% federal, state and local tax bill. That is four days later than last year and a full week later than it was in 2009, at the low point of the Great Recession.

As the economic recovery continues, individual incomes and corporate profits will rise, increasing tax revenues and pushing Tax Freedom Day later in the year. The latest-ever Tax Freedom Day was May 1, 2000 — meaning Americans paid 33.0% of their total income in taxes. A century earlier, in 1900, Americans paid only 5.9% of their income in taxes, meaning Tax Freedom Day came on January 22. Americans now pay more in taxes than they spend on food, clothing and housing combined.

For nearly 40 years, the Tax Foundation has calculated Tax Freedom Day, which has become America’s most recognizable measure of the cost of government. However, this marks the eleventh year in row in which the federal government will spend even more than it takes in. If the federal government raised taxes enough to close this year’s budget deficit — an additional $1.014 trillion — Tax Freedom Day would come 27 days later, on May 14. That is just one week shy of the latest date on record for this deficit inclusive measure, which occurred at the peak of World War II, on May 21, 1945.

Putting aside these future obligations, let’s look at the breakdown of the current tax burden. First, the federal government will cost us almost twice as much as all state and local governments combined. It will take 69 days to pay federal taxes versus 38 days to pay state and local taxes. In 1932, it took just 10 days to pay federal taxes, and 46 days to pay state and local taxes.

The federal tax burden is dominated by individual income and payroll taxes. Of the 69 days Americans will spend on this year’s federal tax burden, 32 days are from individual income taxes and another 23 days are from payroll taxes. Extension of the payroll tax holiday this year took about 3 days off the burden. Corporate income taxes are the third largest federal tax burden, and will take 9 days to pay this year. Corporate taxes are ultimately passed on to individuals in the form of higher prices, lower wages or employment levels, or lower share value.

The state and local tax burden is dominated by property taxes and sales taxes, which each take about 12 days to pay off. Individual income taxes at the state and local level add another 8 days to the burden.

The Tax Foundation also calculates Tax Freedom Day by state. The total tax burdens borne by residents of different states vary considerably, not only due to differing state tax policies but also because the steep progressivity of the federal tax system means higher-income states like Connecticut, New Jersey and New York face a significantly higher total federal tax burden than lower-income states. Residents of Tennessee will bear the lowest average tax burden in 2012, with Tax Freedom Day for them coming on March 31. Also early are Louisiana (April 1), Mississippi (April 1), South Carolina (April 3) and South Dakota (April 4).

For more information, including historical charts showing how Tax Freedom Day has changed over the years, please see our website at: TaxFoundation.org/TaxFreedomDay.

Will McBride is an economist at the Tax Foundation.

Internet Taxation Trends and Options

Sat, 11 Feb 2012 00:00:00 EST

These remarks were presented at the 2012 Conservative Political Action Conference in Washington, D.C., on February 11, 2012.

Who knows what these states have in common? Alaska, Delaware, Montana, New Hampshire, and Oregon.

Correct! Those are the states that do not have a sales tax.

Citizens of these states have decided to do without one of the major tax sources. They have achieved it in different ways. New Hampshire, for example, does it with a reduced size and scope of government. Oregon does it with higher taxes on other things, like income.

But that's the beauty of federalism and the 50 states. Different states can have different mixes of taxes, services, and opportunities, and compete for all of us. And we can choose what works best for us as individuals.

Now there's one group that hates that there are states with no sales tax. And that's states WITH a sales tax. What I consider competition, they call tax cheating. So every state with a sales tax has adopted a "use tax" - a tax on any item purchased tax-free.

So take me. I live in Virginia. If I travel up to Delaware and buy some shoes tax-free, and bring them back to Virginia, under Virginia law I owe Virginia a 5% tax on those shoes. So Virginia asserts that it can tax a transaction between me in Delaware and a Delaware retailer. That's the use tax, and every state with a sales tax has one, and the Supreme Court upheld them as constitutional 7-2.

Now almost no one pays their use tax. States don't bother to try to collect it because they know you would have a few words if they tried, and because it's hard to do so.

Now there is one limitation on the states. They can't force the collection of use tax from someone who is not physically present in the state. So a retailer with all its property and employees outside the state is beyond the state's jurisdiction, and can't be forced to collect tax for the state. This is what's known as the physical presence rule, or the Quill rule, after the latest of a long line of constitutional cases that limited state tax powers.

Why does the Constitution allow the Congress and the Supreme Court to prevent states from extending their taxing powers beyond their borders?

Well, one reason is because it'd be a mess. State sales taxes are a mess. We have nearly 10,000 different sales taxes in the U.S., growing a couple hundred a year. I work for a tax research organization, and we have trouble keeping up, and we're not trying to run our small business.

Also, each taxes different things differently. Here in DC, bottled fruit juice at CVS is tax free, a bottle of soda at CVS is 6%, a glass of fruit juice or soda in a restaurant is taxed at 10%. In Minnesota, fur clothing is taxed differently than regular clothing, while in New York, clothing is taxed only if it's over $55. That changes to $110 in April. 16 states have sales tax holidays, temporary tax reductions for some items. These change every year. And so on.

In the period of the Articles of Confederation, the Founding Fathers saw states tax whatever they want, wherever they want, and saw it harm interstate commerce and damage the national economy. So they included in the Constitution protections to make sure it didn't happen.

If the states got their way (and some are trying, with so called "Amazon" taxes that go far beyond just Amazon purchases) we face new questions. Who gets to tax an online sale? Where the customer is located? Where the seller is located? Where the Internet server is located? Where the truck passes through? Where the warehouse is? All of them? Some of them?

Now, I have a lot of sympathy for brick-and-mortar retailers. They say that they're selling the exact same product to you and me as an online company, and you and I pay the sales tax when we buy it from them but not when we buy it from an online company. And they're right that there's no economic reason why one should be taxed and the other is tax-free.

So if we are going to change the system, we ought to make sure that it's something simple, understandable, and fair across the board. Whatever burdens the tax system puts on online businesses should be borne by brick-and-mortar. And states shouldn't be allowed to collect until they accept basic rules about what gets taxed and where. I'd love to hear your thoughts and ideas and reaction. The bill before Congress now achieves this better than previous bills.

We also have handouts: testimony I presented to Congress on this issue, a USA Today front-page story from last week on the topic, and a postcard of sales tax rates. You can also keep up with the issue at TaxFoundation.org.

Thank you.

The GPA of the GOP: Do taxes matter?

Thu, 19 Jan 2012 00:00:00 EST

This op-ed was published in the Washington Examiner on Jan. 19, 2012.

Heading into Saturday's South Carolina GOP primary, it is worth taking note of the perplexing disparity between what voters claim as their No. 1 issue (the economy) and how they have implicitly voted on tax policy.

The key drivers of a strong U.S. economy are consumer spending, industry investment, the export/import ratio, and government spending.

Tax policy, for better or for worse, affects each one of these. Yet the tax reform proposals that have been put on the table by GOP presidential candidates appear to matter very little to voters.

This year's GOP presidential caucuses in Iowa yielded the following results:

1. Mitt Romney (25 percent)

2. Rick Santorum (25 percent)

3. Ron Paul (21 percent)

In the Tax Foundation's Presidential Candidate Tax Plan Report Card, Mitt Romney, Rick Santorum, and Ron Paul received grades of C-, D+ and B-, respectively.

If the GOP were taking three college classes, this would result in a 1.9 grade-point average. The Iowa GPA is helped most by the corporate tax rate cut to 15 percent proposed by Paul. Still, a 1.9 would put the student on academic probation at most institutions.

The situation didn't look much better for the GOP in the New Hampshire primary. The state's top three vote-getters were:

1. Mitt Romney (39 percent)

2. Ron Paul (23 percent)

3. Jon Huntsman (17 percent)

On the report card, these three candidates' tax plans received a C-, B- and B+, respectively. The GOP student in this scenario would have achieved a 3.0 GPA.

However, if one weights the grades according to the percentage of votes the candidates received, the results are largely driven downward by the C- and B- of Romney and Paul.

Using this methodology to account for the higher variance of results in New Hampshire, the GOP student sees its GPA sharply decline to a 2.3. Likewise, if the current poll standings in South Carolina hold up, the student will have produced a 2.2 GPA.

What's mystifying about these results is not who the most popular candidates are. It is the underlying disparity between what voters claim is their No. 1 issue, the economy, and their willingness to accept timid tax plans that would keep the complexity and litany of tax preferences in the tax code.

GOP voters certainly have the right to choose their preferred candidate for any reason they wish: treatment of social issues, eventual electability, or even looks.

But if the party, like the rest of the country, wants an economic turnaround, taxes must play a major role. In that vein, many may wish to read economist Will McBride's "How to Judge a Tax Plan," in which he delineates the criteria that make certain tax reforms are good, satisfactory or harmful.

In his guide, McBride says cutting individual tax rates, thereby reducing the progressivity of the current code, is essential. "High personal income taxes are second only to corporate income taxes in their harmful effects on long-term economic growth."

He's definitely onto something here, as America is already saddled with the most progressive tax system in the industrialized world.

In addition, McBride suggests that cutting rates on capital gains and dividends taxes, as well as the estate tax, is essential. The ideal elimination of such taxes would have the beneficial effect of ending the double, triple and quadruple taxation of earnings. Doing so would also incentivize investment, therefore boosting economic growth.

It is certainly true that a number of college dropouts have gone on to do great things -- in some cases boost U.S. gross domestic product almost single-handedly (Bill Gates, Steve Jobs, Mark Zuckerberg, etc.).

But the U.S. cannot afford a sophomoric tax plan with a GPA that would place the country on academic probation. It needs one that would make the Dean's List.

David S. Logan is an economist with the Tax Foundation.

About that renewed talk of taxing financial transactions

Wed, 07 Dec 2011 00:00:00 EST

This op-ed was published on the website of the Washington Examiner on Dec. 7, 2011.

The congressional Joint Economic Committee held its "Joint Hearing on Tax Reform and the Tax Treatment of Financial Products" earlier this week.

The hearing came soon after the Section of Taxation of the American Bar Association (ABA) sent a letter to the Senate Committee on Finance and the House Committee on Ways and Means entitled "Options for Tax Reform Relating to Financial Transactions."

Though the lengthy paper contained within the ABA's letter does not attempt to examine the economics of Financial Transactions Taxes (FTT's), it brings back discussion on a subject, which was last seriously advocated on Capitol Hill by Rep. Nancy Pelosi, the former speaker and current Democratic Minority Leader.

The hearing also came on the heels of a European Union proposal to tax financial transactions and will undoubtedly stir up some dormant talking points for U.S. legislators.

However, even at a time when fiscal consolidation is desperately needed, such taxes should never be seriously considered as a panacea, and here is why:

High transaction volumes provide liquidity necessary for price discovery.
Much of short-term transactions are done to hedge and mitigate risk.
An increase in transaction costs will increase short-term volatility.
People can easily circumvent an FTT and the tax will be cumbersome to structure.

Even FTT proponents must, at the very least, concede that the academic literature on the subject is totally ambiguous. A survey of 11 articles published between 1989 and 2010 shows that the literature is completely divided, with four articles arguing against FTT's and three arguing in favor of them. The legitimacy of any policy taxing financial transactions would be absolutely undermined by this division.

In addition, revenue estimates from FTT's range from $17 billion to $360 billion (in 2010 dollars). Though the low figure does not account for the large increase in trading volume since 1989, doing so still yields a very large gap in estimates.

This fact should prevent legislators from justifying the implementation of such policy by claiming that FTT's will be a certain and stable revenue source.

Patrick Honohan and Sean Yoder put it best in their 2010 World Bank paper on the subject, Financial Transactions Tax: Panacea, Threat, or Damp Squib.

"Certainly not a panacea, and more likely a damp squib in terms both of revenue and efficiency gains (and perhaps more likely to result in efficiency losses), financial transactions taxes could be a threat to fiscal stability," Honohan and Yoder wrote.

A threat to fiscal stability-the absolute last thing American solvency needs.

David Logan is an economist with the Tax Foundation.

An Economic Loser in the Long Run

Fri, 02 Dec 2011 00:00:00 EST

This op-ed was published in U.S.News & World Report on Dec. 2, 2011.

There has been more than the usual amount of rhetoric, noise, and confusion regarding the Senate Democrats' bill that pairs a payroll tax holiday with a permanent surtax on millionaires. This bill would make the tax code more complicated, more unstable from year to year, and more redistributive—all damaging to long-term economic growth.

It is essentially the 2012 version of cash for clunkers. Economists claim that the payroll tax holiday would stimulate consumption spending, and it very well might in the short term. But just as cash for clunkers merely shifted car sales from the future into the present, this too will merely shift future consumption into 2012. We would basically be borrowing from ourselves and future generations.

This redistribution would occur not only across time and generations but also across income groups. The payroll holiday would cut taxes for one year on wages up to $106,800, while the surtax would be a permanent tax increase on millionaires.

The effect would be to increase the progressivity of our tax code, meaning high-income earners would pay an even greater share than they currently do. As it is, the top 1 percent of filers pay more in income taxes than the bottom 90 percent combined, giving us the most progressive income tax system in the industrialized world, according to the OECD.

There are real economic costs associated with such a progressive tax system. First, high-income earners do a great deal of the saving, investing, entrepreneurship, and high-productivity labor necessary for economic growth. Second, the U.S. is unique in that most business income is actually taxed through the personal code, and a large share of that accrues to high-income earners—about 39 percent to millionaires, as does 18 percent of all small business income.

Lastly, economic growth is suffering right now in large part due to various uncertainties, including an exceptionally uncertain tax environment. Our tax code is in constant flux, which prevents long-term economic planning. There are some 65 so-called tax extenders due to expire at the end of this year, and the Bush-Obama tax cuts are due to expire next year, meaning the majority of our tax code is a perpetual political football. This bill only adds to these uncertainties.

On Starving the Beast with No Tax Increases

Tue, 29 Nov 2011 00:00:00 EST

This piece was included as part of distributed materials for an American Enterprise Institute (AEI) event.

"Starve the Beast" Not Effective at Federal Level

Before the first decade of the twentieth century, many smart people believed that "starve the beast" could work at restraining federal spending growth. After cutting taxes, or at least not raising them, as Milton Friedman explained, "[r]esulting deficits will be an effective restraint on the spending propensities of the executive branch and the legislature." The much harder job of rolling up sleeves and cutting spending by terminating ineffective programs and confronting entrenched interests could thus be avoided.

After a decade of experience, we know now that "starve the beast" does not work at the federal level. Instead of creating pressure to reduce expenditures to a smaller revenue total, spending exploded. After the 2001-03 tax cuts, federal spending under the George W. Bush Administration grew 55 percent (29 percent after adjusting for inflation). Defense spending grew 6.8 percent a year even after adjusting for inflation, other discretionary spending grew 5.4 percent a year (again, after adjusting for inflation), and the federal debt rose to 66 percent of GDP.

Why? The best theory I've heard is "fiscal illusion": that tax cuts without spending cuts just reduces the apparent cost of government to the taxpayer. Instead of paying $1 in taxes to get $1 in services, the taxpayer is apparently paying only 70 cents to get $1 in services. Taxpayers thus demand more services. (Some argue that something similar is happening with nearly half of Americans paying no federal income tax, in that they will demand more in services but paid for by other people.) While tax increases lead to increased government spending, so apparently do tax cuts. The only thing that leads to spending cuts iscutting spending.

How You Tax is Just as Important as How Much You Tax

Some advocates of limited government believe that any reduction in government revenue is effective to this end because it puts money in consumers' hands. However, if the ultimate policy goal is to reduce government involvement in individual and market decisions, tax credits are a poor choice. These credits are often complex, administratively burdensome, use government policy to distort behavior, create damaging uncertainty, and are the result of political micromanaging. Even as a tax credit modestly drops government revenue, it increases government meddling in the economy and resultant harmful outcomes.

One recent example is the ethanol tax credit, which has heavily distorted domestic gasoline prices and foreign food prices (causing hunger overseas, as found by 17 studies) and warped economic decisions by just about everyone who uses energy, for the benefit of a small group of politically-connected insiders. Stopping this unconscionable policy and its harmful outcomes should supersede in importance the relatively small amount of additional revenue the government would gain from ending the tax subsidy. Serious analysis of this and other tax incentives should look not just at the revenue but also other economic costs.

Tax Foundation analysis is guided by the principles of economically sound tax policy: simplicity, transparency, neutrality, stability, and growth-promotion. These principles originally derive from Adam Smith's "maxims" about taxes from The Wealth of Nations. While we look at revenue impacts, we also look at other costs to taxpayers, such as administrative and compliance costs (Americans now spend 7 billion hours per year complying with the federal tax code), and reduced economic activity caused by a badly designed tax system. We analyze not just whether a tax change would increase or reduce revenue, but also whether it moves us towards a simpler, more sensible tax system.

Conclusion

I don't like paying taxes but if there are to be taxes, they should be as simple and sensible as possible. Tax policy should be used to raise revenue, not micromanage a complex economy by trying to pick winners and losers in the market. Everyone should kick in a bit, to avoid fiscal illusion. "Starve the beast" has not worked at the federal level, so we should recognize that there is no way out of the hard work of pursuing genuine tax reform.

The Emerging Debt Ceiling Deal

Mon, 01 Aug 2011 00:00:00 EDT

The emerging deal between congressional leaders and President Obama on the debt ceiling is nothing if not confusing. We'll try and give you the basics here.

Stage 1: Effective Immediately

-The debt ceiling is raised by $900 billion dollars. That's only enough to finance the cost of government until sometime next summer.

-Spending cuts go into effect that save $1 trillion dollars (or $1,000 billion dollars) over ten years, for an average of $100 billion in savings per year.

Stage 2: The next few months

Here's where things get interesting. Pretty much everyone agrees that $1 trillion dollars in savings over ten years isn't going to put much of a dent in the deficit (which currently stands at around one and a half trillion dollars per year), so the deal essentially leverages the urgency of the current situation (the treasury runs out of cash literally tomorrow) to force additional cuts to be decided later on. Here's how that works.

By November, a bipartisan congressional committee must come up with recommendations for additional deficit reductions of $1.5 trillion dollars over ten years (or an average of $150 billion per year), and Congress must pass them. If it fails in this task, then automatic "triggers" kick in, which force cuts in defense spending (which Republicans will hate) and in Medicare (which Democrats will hate). If it succeeds, the debt ceiling gets automatically increased by a further $1.5 trillion (which is enough to last until 2013). The idea here is that the prospect of such unattractive cuts, combined with the desire to avoid another fight over the debt ceiling next year, will force the bipartisan committee to make a deal.

The $1.5 trillion that the bipartisan committee is tasked with finding is subject to certain restrictions, most notably that it must be scored relative to "current law" (as opposed to "current policy"). The distinction between current law and current policy is at the root of an incredible quantity of confusion over what counts as a tax cut or tax increase.

In a nutshell, under "current law," any law which is scheduled to automatically expire is assumed to do so, whereas under "current policy," policies are assumed to exist in their current incarnations in perpetuity, even if it takes congressional action to maintain that status quo. For fiscal policy, some particularly relevant laws are the Medicare "doc fix," the Bush-era tax cuts, and the AMT (the Alternative Minimum Tax—an alternate way of calculating one's income tax). Under "current law," the Bush-era tax cuts expire at the end of next year, and certain AMT parameters revert to levels which substantially increase the number of taxpayers subject to the AMT.

The practical effect of this is that the bipartisan committee will be unable to make any recommendations regarding the Bush-era tax cuts. For example, let's say the committee proposes, among other things, raising the top marginal tax rate three percentage points, from 35% to 38%, which would bring in some amount of revenue that counts towards their $1.5 trillion assignment. "Hold on," says the Congressional Budget Office, "According to our current law baseline, that rate is set to go up to 39.6% in 2013 when the Bush-era tax cuts expire, so this is actually a tax cut, and it makes the deficit worse."

The bipartisan committee is therefore unlikely to touch any aspect of tax law that is directly affected by the Bush-era tax cuts (which includes marginal rates, the child tax credit, and various other credits and deductions), or any parameters that are routinely changed by AMT patches. If the committee wants to reduce the deficit by, say, increasing the top marginal rate by three percentage points, it has to explicitly say, "We'll make the rate 38% (35+3) in 2012, and 42.6% (39.6+3) in 2013 and beyond." That's not likely to be a popular move, and that's why Boehner said in his presentation to his caucus that the current law requirement "effectively [makes] it impossible for the Joint Committee to increase taxes." (For similar reasons, the committee will find it difficult to touch physician reimbursements under Medicare because they have to assume the end of "doc fix" patches for any change to count as deficit reduction.)

It should be said, however, that this doesn't preclude the bipartisan committee from recommending other kinds of tax increases (such as a national VAT or tax expenditure reductions) nor does it preclude Congress from extending the Bush-era tax cuts separately from the bipartisan committee. It simply means that any deficit reduction measure recommended by the bipartisan committee that raises taxes by changing rates and parameters associated with the Bush-era tax cuts has to explicitly assume their expiration (and thus a substantial tax increase) in order to score as reducing the deficit. As a result, the committee is unlikely to pursue any such changes.

In any event, in order to prevent the triggered defense and Medicare cuts, the bipartisan committee must come up with $1.5 trillion in deficit reduction, which Congress must then pass, by November. The only other way to prevent the unpopular "trigger" from taking effect is for Congress to pass a balanced budget amendment to the U.S. Constitution and send it off to the states. It's not entirely clear how likely this is. Constitutional amendments require two-thirds support in both the House and Senate to pass, and it's hard to see Senate Democrats voting for it. However, if the bipartisan committee is unable to reach its $1.5 trillion goal, and the alternative is triggered unpalatable Medicare cuts, Democrats may vote to pass the amendment despite their dislike of it, knowing that it would never get ratified by 38 state legislatures.

[Correction 11/21/11: Passing a Balanced Budget Amendment would not, by itself, prevent the "trigger" from being enacted, although it would allow for the full additional $1.5 trillion debt ceiling increase, instead of a reduced $1.2 trillion increase, which is the most allowed if the bipartisan committee fails.]

It was inevitable that the final compromise was going to have all sorts of complicated political maneuvering, though the intricacies of this particular deal are confusing even to those of us who observe Congress on a regular basis. We can at least be glad that the U.S. has, for now, avoided defaulting on its debt.

Details on the Different Debt Ceiling Plans

Thu, 28 Jul 2011 00:00:00 EDT

By law, the national debt of the United States cannot exceed $14.294 trillion dollars, which it reached on May 16. This limit is set by Congress and is usually referred to as the debt ceiling. A law setting an overall hard limit on the amount the federal government can borrow was first established in 1917 and was originally $11.5 billion dollars; Congress has obviously raised the limit a number of times over the past century since.

In the past, increasing the debt ceiling was a relatively routine procedure that Congress performed once or twice a year, sometimes with some political theatre criticizing congressional and presidential irresponsibility. However, the current House of Representatives has a particularly high number of strong fiscal conservatives and has shown itself unwilling to raise the ceiling beyond the current $14.294 trillion dollars, either not at all or without some strong concessions that may address historically large deficits. The Treasury cannot borrow beyond this limit, and has relied on borrowing off-the-books against federal pension funds and other programs since May 16. However, on or about August 2, this source runs out, and the federal government will be unable to pay all of its bills without additional borrowing, and may eventually be forced to default on some of its obligations. It's unclear what will happen then - predictions range from nothing at all to economic Armageddon.

The current crisis is centered on disagreements over whether any debt limit increase should be tied to a deficit reduction deal, and if so, how large that reduction should be, and whether it is composed of only spending cuts or also includes revenue increases.

Here are some possible outcomes:

1. Congress and the President make a deal

There are a variety of approaches that have been proposed, which I'll summarize here:

a)"Cut, Cap, and Balance." This is the plan favored by the Republican Study Committee and many of the more conservative House freshmen, and has already passed the House. It would cut the federal deficit in half as soon as the next fiscal year, accomplished entirely through spending cuts, and limits future spending to 18% of GDP. It also requires the House and the Senate to vote on a Balanced Budget Amendment to the Constitution by the end of the year. Despite its success in the House, the plan was tabled by the Democratic-controlled Senate and is unlikely to pass, and President Obama has indicated that he would veto it should it reach his desk. The plan also introduces a supermajority requirement to pass tax increases, which critics charge will make the deficit worse.

b)The Coburn Plan. Sen. Tom Coburn (R-OK) has introduced legislation which raises the debt ceiling, in return for reducing the deficit by $9 trillion over the next ten years (or an average of $900 billion a year)-by far, the most far reaching and dramatic proposal. $1 trillion of that $9 trillion comes from new revenue generated by eliminating certain tax expenditures, and the other $8 trillion is spending cuts, of which $2.6 trillion comes from Medicare and Medicaid changes, and another $1 trillion comes from the defense budget. A significant number of House members oppose any revenue increases (even if they come from eliminating tax expenditures), and political reluctance to reduce spending for Medicare, Medicaid, and defense cuts, make it a plan that has something in it for everyone to hate and unlikely to pass in the near term.

c)The McConnell Plan. This approach, proposed by Sen. Mitch McConnell (R-KY) and receiving heavy criticism for its political nature, establishes in law a procedure by which the debt ceiling can be raised over the next couple of years. First, the president submits to Congress a formal request to raise the ceiling. Congress then votes to approve or disapprove the request, but the President is allowed to veto Congress's disapproval and raise the debt ceiling anyway. Democrats dislike it as it is designed to embarrass them politically during an election year, and conservative Republicans do not like it as it does not reduce the deficit.

d)The Reid Plan and the Boehner Plan. These two competing plans are the most recent attempts at a compromise and are actually more similar than many people realize. Both are composed entirely of spending cuts rather than tax increases, and are similar in size and scope. My colleague Ryan Rosso has a post up explaining their similarities and differences, but the main difference is with the politics and the timing: Boehner's plan raises the debt limit in two steps and requires a second vote prior to the next presidential election, whereas Reid's plan raises the limit enough to get us past 2012. Reid also counts savings from winding down operations in Afghanistan and Iraq, while Boehner refuses to count such a wind-down as savings since it will happen anyway. Boehner's plan looks as if it will pass the House, but its prospects after that are uncertain.

e)Some other compromise. President Obama has expressed his desire for a "balanced approach" that includes both spending cuts and revenue increases, but a sticking point is a number of Republicans that have taken a firm stand against any proposal that includes tax hikes. If history is any guide, unusual events can lead to unusual congressional actions. For example, during the 2008 financial crisis, the House initially rejected the bank bailout bill, but after the Dow Jones average dropped 777 points the next day, Congress reversed course and passed the same bill only a few days later. Other possibilities might involve abolishing the debt ceiling entirely, exempting Social Security from the debt limit (which would provide a few trillion in breathing room), or reinstating the president's power to impound appropriated funds. Critics of the debt limit argue that it is redundant to require Congress to approve borrowing to pay for spending it has already approved, and that creates uncertainty and makes it ineffective in reducing spending.

2. The Validity of Public Debt Clause. Section 4 of the 14^th amendment states that "The validity of the public debt of the United States, authorized by law... shall not be questioned." Some commentators have argued that this clause makes any default unconstitutional and renders the debt ceiling meaningless. Under this theory, President Obama could instruct the Treasury to borrow above the limit by making the argument that the Constitution requires it. Most experts, however, are skeptical of this line of reasoning, and the White House has ruled it out of consideration.

3. Default. Opinions differ on how catastrophic a default would be but it is important to realize that "default" can happen on a number of obligations and not necessarily for interest payments on the federal debt (something which might truly cause economic Armageddon). Tax revenue comes into the Treasury year-round and, while not nearly enough to pay for the entire cost of government, can still pay for a significant portion of it. The government may have the leeway to prioritize certain payments over others (although this is disputed), but if they could, interest payments could be prioritized over other spending. The practical effect of default is likely to be similar to a government shutdown: among other things, nonessential government employees will stay home (or be paid in IOUs) until the crisis is resolved.

4. More exotic solutions. There's no shortage of creative ideas floating around. One solution involves the U.S. Treasury minting trillion-dollar coins, which it technically has the authority to do. Such a move is not likely to be politically popular.

Motion Picture Association Attacks Tax Foundation Critique of Film Tax Subsidies

Wed, 29 Jun 2011 00:00:00 EDT

Earlier this month, we reported that 37 states will offer film tax incentives in 2011, a drop from 40 states in 2010 and the first such drop since the trend began over a decade ago. The aggregate dollars paid out by states has also dropped, from $1.396 billion to $1.299 billion. I made the prediction that 2010 will remain the peak year, which was noted approvingly by, among others, The Economist magazine.

Why is this happening? I think it's a mix of two reasons: (1) every impartial study of film tax incentives has indicated that they are ineffective economic development tools, have a poor return for job creation, and do not pay for themselves, and (2) legislators are weighing priorities in tight state budgets, and are willing to let go of a program that is being hammered by experts on the left and the right. Even Michigan, which was leading the pack by paying 42 cents to qualified film and television productions for every dollar they spent, has thrown in the towel. Eight other states zeroed out their programs, and eight states made moves to scale back their programs. (On the other hand, our report noted, six states renewed or expanded their programs.)

Within a day of our study's release, the Motion Picture Association of America (MPAA) responded on their blog:

Pure and simple: film and tax incentives create jobs, expand revenue pools and stimulate local economies. That's why a study released by the Tax Foundation yesterday strained credulity and provided a host of prejudged conclusions about the value of film and television tax credits in bolstering jobs and local economic development.[...]

Two recent studies that performed cost/benefit analyses confirmed the economic benefits of production tax incentives to New York and Michigan. Michigan's report, sponsored by the Detroit, Ann Arbor, Traverse City and Grand Rapids Convention & Visitors Bureaus indicated that the incentive created nearly 4,000 full-time equivalent jobs for Michigan residents in 2010 at an average salary of $53,700 per year, and generated roughly $6 per dollar of net credit cost. The New York report showed a 1.9 return on the state's investment (ROI).

In locations with uninterrupted film tax credit programs there have been continuing investment and job growth. In Massachusetts, for example, only 10 films were produced over seven years with $67 million of direct investment. Once the credit was enacted the Commonwealth had 26 films in three years with a startling $676 million of direct investment to the state.

I cut part of it out in the quote above, but their first four paragraphs were an attack on our motivations in putting out the report (yes, this rather dry report is the one they claim is full of bias). I thus feel justified in noting that most or all of the benefits of these film tax incentive programs accrue to the film and television production industry. Hence, the MPAA's panicked denials that there is any downward trend or any legitimate argument against their subsidies. I also put aside their implication that we did not report on states expanding or renewing their credit programs, because we did.

I now turn to specific critiques.

Michigan Film Incentive Costs $90,000+ Per New Job

Their Michigan study, conducted by Ernst & Young but commissioned by and paid for by state economic development officials that push the film tax incentive program, found that the credits cost $73 million in 2009 and created 797 full-time equivalent (FTE) jobs, for a cost of $91,593 per new job. In 2010, the study found the incentives cost $117 million and created 1,039 full-time equivalent jobs, for a cost of $112,800 per new job. Only by taking credit for all economic activity remotely related to film production can you reach the numbers the MPAA cites, and even then, the Ernst & Young study finds a net cost of $34 million in 2009 and $60 million in 2010, unrecouped by higher tax collections from ancillary activity or reduced unemployment costs.

Note that Michigan's film office was essentially forced against its will to report cost-per-FTE-job figures, after a 2010 study commissioned by the bipartisan Senate Fiscal Agency criticized them for not doing so. That study, by the way, concluded that "film incentives represent lost revenue and do not generate sufficient private sector activity to offset their costs completely." Michigan recently scaled back its film tax incentive program.

New York Study's Astounding Return on Investment Ignores Opportunity Costs

The New York study, conducted by Ernst & Young but commissioned by and paid for by the New York film office and the MPAA itself, reaches its positive numbers only by taking credit for all economic activity remotely related to film production. This is problematic because it ignores the concept of "opportunity cost"—the fact that the money used for film subsidies, and the labor and resources used by them, would have been used for something else in the absence of the program.

Even if the displaced activity is less productive, it still means there's some amount of economic activity that would occur without the incentive program. E&Y's studies attribute all economic activity remotely related to film production to the film incentive program's existence. This is especially problematic for New York (and California), as they draw a significant number of film and television productions even without incentives. (A just released study from the Los Angeles County Economic Development Corporation makes the same critical error.)

Even those fanciful assumptions don't prepare the reader for E&Y's conclusion, which is more optimistic than what any on the left ever said about the stimulus or any on the right ever said about the Bush tax cuts. The report unbelievably calculates that $214 million in credits in 2007 resulted in $1.7 billion in production spending (and $2.1 billion in indirect spending, for a total spend of $3.8 billion), which in turn generated $403 million in new tax revenue (190% of the credits). Put another way, the E&Y report claims that $1.00 in credits generates $17.75 in new economic activity, which in turn generates $1.88 in new tax revenue. This means that if we gave $1 trillion a year in subsidies to the MPAA's members, we could solve our long-term budget problems.

In reality, it sounds like E&Y's report assumes what it is supposed to calculate. It's unclear whether the multipliers that they cite (that is, the ratio of dollars of activity generated to dollars spent) are calculated from the data, or assumed to produce the data. My guess is that it's the latter, as this is a common practice (and was used for the stimulus to show how, for example, many new jobs would be created for a given dollar of government spending). E&Y assumes that film production has an incredible multiplier in its calculations (2.77 for new job creation, 2.52 for new income, 2.26 for new productions), so the conclusion that proponents draw from it - that film production has an incredible multiplier - should be taken with a grain of salt.

Subsidizing Film Productions Leads to More Film Productions

The MPAA notes that states that pass new tax credit programs see a burst of new activity. There is no dispute between us here, for it is a truism. Subsidizing anything gets you more of that thing. The question is whether the benefits of a given amount of net new job creation and the net new investment exceed the cost. (I would note, however, that states must continuously increase the generosity of their programs or risk losing productions. It's a never-ending escalation that no state can truly win, making it unlikely that any permanent industry will result from it.)

One measure of that is whether the tax credit pays for itself in induced tax revenue collections, or more than $1 generated for every $1 spent. Aside from E&Y's studies paid for by economic development authorities and the MPAA, every other study has found film tax credits generate less than 30 cents for every $1 of spending:

• Arizona's Department of Commerce calculated 28 cents on the dollar.

• Connecticut's Department of Economic Development found a 7 cent return on every $1 spent.

• Two studies in Louisiana found between 13 and 18 cents on the dollar.

• Massachusetts' Department of Revenue found it got 16 cents on the dollar.

• Michigan's Senate Fiscal Agency found 11 cents on the dollar.

• New Mexico's Legislative Finance Office found 14 cents. (E&Y did a New Mexico study too, calculating $1.50 on the dollar, but having the same problems as their Michigan and New York studies.)

• Pennsylvania's Legislative Budget & Finance Committee found 24 cents on the dollar.

Of the above studies, only Massachusetts's study did not assume that all film and television production occurred because of the credit. So all the other numbers should be considered on the high end.

The MPAA blog closes with the statement that "[n]ew investment in film and digital media production is, on balance, revenue positive." The evidence does not support that statement.

Film tax credits do not pay for themselves. While some benefits accrue to in-state filmmakers and suppliers, on the whole they are a net transfer from taxpayers to out-of-state production company beneficiaries.

For more information on film tax incentives, please see our larger report on the topic.

Mitch Daniels Sets the Example

Tue, 17 May 2011 00:00:00 EDT

This op-ed was published in the New York Times on May 17, 2011.

State officials are now adjusting to a "new normal," realizing that expecting revenues to grow 6 or 7 percent a year is as much a phantom as the dot-com and housing profits upon which those expectations were built.

In some states, like Indiana and Arkansas, governors and legislatures have come together to recognize that spending must be prioritized to fit within expected revenues.

Indiana's governor, Mitch Daniels, deserves special praise for ensuring that long-term expenses match long-term revenues, and for building on his predecessors' work to ensure that government outcomes are measured and incentives for better performance are put in place. Arkansas, too, prioritizes expenditures as part of its legislative process, and if there's no money left, the lower priorities do not get funded. The state cannot run a budget deficit.

In too many states, however, the attitude has been to put temporary patches on the budget in hopes that the economy will recover enough to avoid the pain of cutting spending back down to earth. These states have tried combinations of gimmicks like moving the last payroll into the next budget year, reliance on one-time revenue sources like federal stimulus aid or tax amnesties, temporary tax increases, and borrowing to pay operating expenses. These states need to understand that their tax collections will never return to the growth levels reached at the peak of the boom. The more they kick the can down the road, the worse the eventual correction will be.

California has excelled at this for over a decade, but even it did not go as far as Illinois, which conserved cash by not paying six months' worth of bills. Earlier this year, Illinois's Gov. Pat Quinn (D) and Connecticut's Gov. Dan Malloy (D) pushed through large across-the-board tax increases that bridge this year's gap between revenue and spending. But without structural changes, those budget gaps will reappear.

As part of a budget prioritization process, easy targets for cuts are targeted tax incentives. Although these tax breaks are politically popular because they enable officials to cut ribbons at a shiny new facility or take credit for a handful of new jobs created, the evidence suggests that they do more harm than good.

They work only if politicians are effective venture capitalists, picking winners and losers correctly. Existing businesses that pay their taxes year-in and year-out are usually not eligible, and the new facilities and jobs have a habit of disappearing as soon as the credits stop.

One example, and perhaps the most egregious of targeted incentives, is the tax credit for film and television production. Forty states offered $1.4 billion in credits to such production companies in 2010. Fortunately, the trend seems to be on the wane; this year 37 states will offer $1.3 billion.

New Jersey's Gov. Chris Christie (R) and the former Iowa governor Chet Culver (D) both eliminated their states' film tax credit programs, and New Mexico's Gov. Susana Martinez (R) and Michigan's Gov. Rick Snyder (R) have sought to cap the spending on their otherwise open-ended programs.

Low Corporate Tax Rates: A Win-Win For Everyone

Thu, 17 Feb 2011 00:00:00 EST

This op-ed appeared in Investor's Business Daily on February 17, 2011.

Polls show that the top three issues on the minds of Americans today are jobs, the economy and the deficit.

Yet our ability to create jobs, boost the economy and, ultimately, cut the deficit is being undermined by the fact that the U.S. imposes the second highest corporate income tax rate of any industrialized country at nearly 40% (combining the federal and state rates).

To make matters worse, Japan—which holds the top spot in corporate taxation—will be cutting its rate as of April 1, bestowing the U.S. with the undignified rank of No. 1 corporate taxer in the world.

In tax terms, the U.S. is a Hummer when the market is demanding Hondas.

While we have stood still, nearly 60 countries have cut their corporate taxes over the past four years as a means of luring jobs and investment from high-tax nations like the U.S.

The obvious solution is to cut our corporate tax rate and make the U.S. a more attractive place to do business in and do business from.

We should be doing everything possible to roll out the welcome mat to companies—foreign and domestic—who want to invest here and create jobs.

The good news is that President Obama seems open to addressing America's high corporate tax rate.

The bad news is that many lawmakers in Washington are suspicious of all businesses and believe that foreign-owned firms use tax "loopholes" to rob the Treasury of revenues in the same manner that domestic companies use tax "loopholes" to ship jobs overseas.

Under the guise of reducing tax avoidance, Rep. Lloyd Doggett, D-Texas, has introduced two bills that would make America more unwelcome to foreign investment and possibly put U.S. firms at risk to retaliation by other nations.

The bills—H.R. 62, the International Tax Competitiveness Act of 2011, and its companion, H.R. 64—would dramatically change the way foreign-owned companies are taxed in the U.S.

The main way that Doggett's legislation would do this is by changing how our tax code treats foreign-owned firms for tax purposes. The bill would treat foreign firms as if they were "domestic" corporations if they locate any major global operations or top level executives in the U.S.

Why should being designated a U.S. firm matter? Because the U.S. corporate tax system taxes American corporations on their worldwide income, while it taxes foreign-owned companies on the profits they earn in the U.S.

Obama Should Cut The Corporate Tax Rate

Mon, 22 Nov 2010 00:00:00 EST

This op-ed was published on Forbes.com on November 22, 2011.

After taking a shellacking at the polls on Nov. 2, President Barack Obama was hoping to find some success abroad pushing for trade deals for the very same U.S. companies who he has spent the past two years bashing as tax cheats and exporters of jobs. Instead, he took another shellacking at the hands of our major trading partners. Perhaps he will learn a lesson from this drubbing as well.

Despite Obama's esteemed status as a world citizen, he has demonstrated a mercantilist view of America's role in the global economy. He professes to increase U.S. trade, but his policies would actually punish American firms with higher taxes if they do business on foreign soil and are fortunate enough to earn profits there.

Obama's is an antiquated, zero-sum notion of global trade that sees U.S. firms only as makers of stuff here—preferably in unionized factories—to be shipped to foreign markets. In his mind, when U.S. firms compete on-the-ground in foreign countries and make products near where their customers live, they have, by definition, killed domestic jobs in doing so.

If Obama and his advisors are looking for a Clintonesque opportunity to move back to the center in a way that would make a real difference to the economy, he should partner with Republicans to cut the corporate tax rate and reform how we tax the foreign profits of U.S. companies. The evidence suggests that such reforms would not only be good for the long-term growth of the economy, but would improve workers' wages and living standards over time. This would be a win-win in the same way "ending welfare as we know it" was good for taxpayers and welfare recipients who went to work.

A dramatic cut in the corporate tax rate could be the best tonic for the ailing economy. As is now well known, next to Japan, the U.S. imposes the highest corporate tax rate of any industrialized country at nearly 40 percent (combining the federal and state rates). Perhaps an explanation why both economies are in the doldrums lies in a 2008 report by economists at the Organization for Economic Cooperation and Development (OECD), who measured the relationship between different taxes and economic growth. They determined that the corporate income tax is the most harmful tax for long-term economic growth.

High personal income taxes were found to be the second-most harmful tax for long-term growth, which would argue for not allowing the Bush cuts to expire on the "rich" as Obama proposes. The least harmful taxes for growth, according to OECD economists, are consumption taxes and property taxes.

Mobility is the key to the OECD's tax-harm hierarchy. Capital and income are the most mobile factors in the global economy and, thus, the most sensitive to high tax rates. Consumers and property are less mobile and, therefore, less sensitive to tax rates.

This leads us to the next reason to cut the corporate tax rate, that workers will be the biggest beneficiaries. Economic research also finds that because capital is mobile but workers are not, labor bears a disproportionate share of the economic burden of corporate taxes—as much as 70% by some estimates. Economists such as Kevin Hassett at the American Enterprise Institute have found that workers in countries that have cut their corporate rates have seen faster growth in wages than workers in countries that have not cut their corporate taxes. (A recent Tax Foundation study found a similar relationship in our 50 states, so governors take note).

Thus, Obama can legitimately sell a deep corporate rate cut as being pro-labor because not only will it lead to an increase in wages and living standards, it will most likely lead to an increase in jobs because America will be a more attractive place for inbound investment. The OECD report found that, "Lower corporate and labor taxes may also encourage inbound foreign direct investment, which has been found to increase productivity of resident firms."

Lastly, Obama and the Republicans should take the advice of the recent Bowles/Simpson report and change the way the U.S. taxes foreign profits away from a world-wide base to a system that taxes only domestically generated profits—known as a territorial tax system. This is the manner in which most of our major trading partners tax their multinational firms, the most recent converts being Japan and the U.K. Such a move would U.S. multinationals on a level playing field with their global competitors.

But to make the U.S. truly more competitive, lawmakers will have to cut the federal corporate tax rate much lower than the 26% rate suggested in the Bowles/Simpson report, perhaps as low as 20%. A 26% federal rate combined with the average of the state rates will still leave the U.S. with an overall corporate tax rate over 30%, still higher than France, which currently has the third-highest corporate tax rate in the OECD. But a 20% federal rate would give the U.S. the lowest overall rate of any G-7 nation and a rate roughly on par with China's 25% corporate rate.

To his credit, Obama has signaled a openness to cutting the corporate tax rate, so long as it is accompanied by "closing loopholes." However, there are simply not enough corporate loopholes to close to finance lowering the rate down to 20% While some might argue that the new investment generated by a 20% corporate rate would "pay for itself," a deficit-neutral option would be to pair the rate cut with cuts in spending targeted to business—so-called corporate welfare. This approach delivers the twin benefits of economic growth and lower government spending.

In 2006, Martin Sullivan, the economics writer for the trade publication Tax Notes, predicted that "some forward-looking Democratic candidate will follow the lead of the European left and propose a major cut in the corporate tax rate" as a means of preserving the corporate tax base. Left-of-center governments in Europe had come to the practical realization that lower corporate tax rates accompanied by broader bases tend to keep more profits at home, which turns out to produce higher tax revenues. Thus, he argued, a Democrat would lead the charge for a lower corporate tax rate in this country when they come to the same realization.

Perhaps Barack Obama is that Democrat.

The Republicans Will Have To Cut Some Lemons

Mon, 08 Nov 2010 00:00:00 EST

This op-ed was published on Forbes.com on Nov. 8.

Now that Republicans have convinced American voters to give them another try, how do they reestablish their bona fides as the party of smaller government and less spending? While they will no doubt get a lot of advice in the coming weeks, they should try stealing a cost-cutting page from Southwest Airlines.

Last year Southwest Airlines announced with great fanfare that they would no longer serve lemons with drinks during flights. And by doing so, they would save $100,000 a year.

Now why would a major airline—or any huge company, for that matter—make such a big deal out of saving $100,000 a year? It sent an important message to its two key audiences: its customers and its own employees.

For customers Southwest's announcement provided a visual symbol of the lengths the company would go to—even denying passengers a garnish with their drinks—to save money and be the low-cost airline. But the announcement also sent the same message to Southwest's own employees as to the lengths they are expected to go to keep costs low.

For Republicans this will mean taking on a sacred cow or two to signal to both the American people and federal employees that the era of profligate spending is over.

In Washington parlance, of course, taking on sacred cows typically means going after major entitlement programs such as Social Security and Medicare. To be sure, those programs need fixing for the long term, but anyone who thinks that those are the only sacred cows in Washington doesn't understand how obsolete programs such as the Wool and Mohair program, the Appalachian Regional Commission, Rural Utilities Service (formerly the Rural Electrification Administration) and the Corporation for Public Broadcasting continue to benefit from taxpayer subsidies.

Remarkably all of these obsolete programs survived the "Gingrich revolution" and the government shutdown in 1995. But they should not be allowed to survive the Boehner/Tea Party revolution if Republicans are to reestablish their reputation as prudent fiscal stewards.

It won't be easy. As Ronald Reagan once said, "A government bureau is the nearest thing to eternal life we'll ever see on this earth." Once begun, a program's beneficiaries and stakeholders refuse to allow it to die. As a result, the federal budget is littered with programs that time has made irrelevant.

The Wool and Mohair program, for example, is a relic from World War II, when airmen's flight jackets had wool linings. The Depression-era Rural Utilities Service was obsolete 40 years ago when 98% of rural America was electrified and had telephone service. The Corporation for Public Broadcasting, of course, was created when America had three TV channels, no cable service, no remote controls, no Internet, no iPods, no Netflix and apparently no other entertainment options.

Republicans should terminate one or more of these programs immediately to show people that life can go on without them—n the same way people can survive a flight from Nashville to Reno without lemon wedges.

But cutting government down to size will require more than just killing obsolete programs. Because programs never die, redundancy is rampant. For example, according to the Government Accountability Administration, the federal government currently funds nearly 70 domestic food assistance programs, the 18 largest of which spend more than $60 billion per year.

Speaking of food, the federal food safety system is based on 30 different laws that are administered by 15 agencies, says the GAO. And the 44 job training programs administered by nine federal agencies at a cost of $30 billion annually have done wonders for the 9.5% of Americans out of work (hat tip to Sen. Tom Coburn). Needless to say, redundancy is a target-rich environment for cost savings.

Republicans should also put their federalism money where their mouth is by cutting federal funding of purely local projects. Why should the federal government (in this case, the Economic Development Administration) give $1 million to the Bee Development Authority in Beeville, Texas, to support renovation of two existing airplane hangars? Or give $663,375 to the city of Kendallville, Ind., to fund construction of infrastructure improvements in the Kendallville Eastside Industrial Park?

Or how about the $500,000 to downtown West Plains, Mo., to fund the historic preservation and renovation of a 1918 building adjacent to the West Plains historical district? These projects, and thousands more like them, have purely local benefits and should be funded by state and local taxpayers—if at all.

But the government also owns a lot of stuff that should be sold off to raise cash to retire debt or pay down liabilities, in the same way the Feds forced AIG and General Motors to divest themselves of various assets to pay back their bailouts. For example, billions of dollars could be raised by privatizing government-owned businesses, including utilities like the Tennessee Valley Authority and the Western Power Marketing Administrations, the passenger rail service Amtrak and even the air traffic control system. Even more billions could be raised by selling some of the estimated $1 trillion worth of federal land and buildings, $400 billion in mineral rights and $280 billion in inventories.

Speaking of privatization, the supposed guardians of free enterprise should get government out of the business of subsidizing business, whether it is SBA loans for Subway franchises or the 21st Century Truck Partnership program at the Department of Energy. If Nixon can go to China, Republicans can cut corporate welfare. Except in this case, they should use the savings to cut the corporate income tax rate rather than lower the deficit. That will do more to stimulate long-term economic growth than trimming a few billion off the national debt.

House Speaker-elect John Boehner, R-Ohio, has already promised a moratorium on congressional earmarks. That is a first good step in retraining his colleagues that they can curry favor with voters by not delivering pork.

Next, however, Boehner and his leadership team must convince their colleagues that slaughtering a number of small sacred cows--such as the Wool and Mohair program--can not only make a dent in the deficit, but more import, can earn them the credibility to take on the big sacred cows of Medicare and Social Security. It all begins by cutting a few lemons.

Scott A. Hodge is president of the Tax Foundation, a nonprofit tax research organization in Washington, D.C.

Big question left for 2010: What about the tax cuts?

Sun, 07 Nov 2010 00:00:00 EDT

This op-ed was published in the New York Post on Nov. 7.

Roast turkey with all the trimmings—that's usually the biggest thing on the plates of Congress during a lame-duck session. But this fall features around 70 lame ducks and a lot of unappetizing legislative work on the menu, including the biggest tax question in a decade.

Set to expire on Jan. 1 are the 2001 and 2003 Bush tax cuts, plus the Obama tax credits enacted in the stimulus bill. Both expirations would immediately lower workers' paychecks in January, so the congressional Democrats' last majority hurrah will be important.

And there's even more tax action. Tax provisions that expired at the end of last year need attention. Without retroactive changes for tax year 2010, these provisions would raise the amount many taxpayers send in with their 2010 tax returns this spring. The alternative minimum tax (AMT) is the biggest of these already-expired tax provisions, but another group of provisions called "tax extenders" (because they're extended in law one year at a time) are politically important to certain constituencies. The R&E tax credit is big for many companies; the property tax deduction for non-itemizers is a recent, popular add-on; and the deduction for general sales taxes paid is big for people in states that levy high sales taxes but low income taxes (like Florida and Texas).

Due to the chance that some tax rates may go up in January, workers and investors, especially those with high incomes, should have the phone numbers of their tax advisors and stock brokers handy as the lame ducks deliberate. If investors see capital gains tax rates going up in January, many should take gains before New Year's Day. Also, should workers expect higher wage tax rates for 2011, those in a position to do so should accelerate work and invoices in 2010. Then there's the morbid question of timing one's death. Wealthy, terminally ill people and their families are facing the question of whether or not to shift deaths from 2011 into 2010 to avoid a big estate tax bill in 2011. (Estate tax is zero in 2010.)

Republicans favor extending the expiring Bush tax cuts for everyone in addition to enacting a permanent AMT patch. Making the Bush tax cuts permanent is their ideal, but Republicans are mum on the fate of the tax cuts in the Obama stimulus bill, many of which came in the form of refundable tax credits that disproportionately favor low-income Americans. In his 2011 budget, President Obama pushed for extending all the tax cuts in the stimulus bill for at least another year, as well as pushing for a permanent patch for AMT and a permanent extension of the Bush tax cuts for those with incomes below $250,000.

So if Vegas were taking bets on this question, where should you put your money? What are the odds that the lame-duck Congress will fully or partially extend the tax cuts? Could the lame-duck Democrats enact little or nothing, punting these tax headaches to the new Congress in January?

The annual AMT ritual is considered a pain by most legislators and taxpayers, but it could operate as a useful political spur to the lame ducks to do something about the entire tax mess. Most other action could conceivably be punted to the new Republican Congress - let them handle these headaches with retroactive legislation. However, the AMT and the extenders can't wait unless Congress wants one out of every five taxpayers to face a nasty surprise when filling out the 1040 this spring.

The Democrats can't allow that, especially because blue-state residents are disproportionately hit by the AMT. So "something" will be done on taxes, with two scenarios on the Bush tax cuts likely taking shape: (1) a one- or two-year extension of all the Bush tax cuts and some of the stimulus provisions (probably not making-work-pay); or (2) the same extension but with higher tax rates for people earning over some high threshold such as $500,000 or $1 million.

I would not bet on full, permanent extension despite the big Republican wins last week. In fact, political gridlock leading to total expiration of the Bush tax cuts is still more likely than full permanent extension, but the odds of both are slim.

Looking beyond the lame-duck session, where could liberal President Obama and a conservative House compromise on taxes? Here are two possibilities.

President Obama and the Democratic majority in the Senate may be willing to swallow a cut in corporate taxes to get climate legislation (or at least a gas tax increase) through the Republican House. Or maybe Republicans could accept a tax increase in the form of a reduced mortgage interest deduction in exchange for Fannie and Freddie reform.

Such compromises will now be essential for almost anything to pass, and there is some recent precedent for bipartisan compromise on major tax legislation. The Democratic Congress that came together with President Reagan in 1986 to pass tax reform included such liberal lions as Bill Bradley and Dick Gephardt. And in 1997, President Clinton and the Gingrich Congress compromised on capital gains taxes and education credits. Hopefully after the lame-duck Congress enacts some temporary fix, the new Congress will find areas of agreement in making the tax system simpler, fairer, and more pro-growth.

Gerald Prante, Ph.D., is senior economist at the Tax Foundation, a nonpartisan think tank in Washington, DC.

The Estate Tax Is Foolish, Wasteful, Ineffective

Sun, 19 Sep 2010 00:00:00 EDT

This op-ed was published in the Richmond Times-Dispatch on Sept. 19, 2010.

Washington, D.C. -- People are supposed to become more popular when they die, but Yankees owner George Steinbrenner and Houston oilman Dan Duncan both became targets of political invective for being billionaires who died during 2010, the only year since 1916 when no federal estate tax is due.

Virginia billionaire John Kluge has been spared by tax-envious pundits and has gotten the rave reviews he deserves since his recent death at his home in Albemarle County.

Kluge had donated more than $63 million to the University of Virginia during his lifetime, and the college will also receive his Albemarle estate, valued at $45 million in 2001.

Thanks to the Bush tax cuts enacted a decade ago and a disorganized Democratic Congress at the end of 2009, the heirs of all three of these titans are spared the monumental chore of filing a federal estate tax return and paying up to 45 percent of the estate in tax (the top rate in 2009).

There will still be a minefield of estate tax complexity for them to navigate, made worse by the temporary nature of the repeal, but they can avoid the tax unless Congress acts in the next few months to apply the estate tax law retroactively to all of 2010. That is the intention of Max Baucus, chairman of the Senate Finance Committee, and the Obama administration.

The executors and heirs would be better off if the repeal had been permanent, and here's a surprise: so would every other taxpayer. Why?

Not just because of the usual anti-"death tax" talking points: that it can prevent small businesses and farms from being passed on to the next generation; and that it's preposterously complex and economically damaging to savings and entrepreneurs.

In light of the federal government's massive deficits, those arguments have not been enough to convince most congressmen to repeal the estate tax permanently.

But a paper by economist J.D. Foster has pointed out two other persuasive arguments for permanent repeal.

The estate tax siphons away income tax revenue.

Taxes are interactive. When Congress raises, lowers, or repeals one tax, it changes the revenue flows of the others. So even though the estate tax has been officially collecting about $25 billion a year in revenue, its repeal would not make such a big dent in federal coffers. The estate tax robs the income tax three ways:

• by shifting wealth into nonprofits that pay no tax;

• by boosting income tax deductions for tax planning; and

• by imposing wasteful compliance costs on taxpayers and the IRS.

Charities love the estate tax because most wealthy people would rather give their money away while they're alive than leave it to Uncle Sam's estate tax collectors. And while that sounds fine, those huge transfers sap income-tax revenue in the long run.

For example, consider a $100 million charitable gift made shortly before death in 2009 to avoid paying about $40 million in estate tax. The charity could be the National Rifle Association or Handgun Control, the Catholic Church or Planned Parenthood. If the charity invests the gift, it will earn about $8 million annually, tax-free.

But this year, thanks to estate tax repeal, people like Duncan, Steinbrenner, and Kluge are more likely to leave their assets in the hands of taxpaying people, probably their spouses and children, who continue earning taxable income. When the heirs earn that $8 million, it won't be tax-free; they'll pay about $3 million to Uncle Sam.

And if they reinvest the balance, 10 years of tax payments will exceed $40 million. After 20 years, the income tax payments would exceed $100 million.

So in this example, Uncle Sam gets more tax money from permanent repeal of the estate tax than he does from keeping it in law.

Permanent estate tax repeal would also boost income tax revenue by cutting back on tax planning, which is expensive and tax deductible. Wealthy individuals would shift their spending to non-deductible expenses or invest more, boosting current and future income-tax receipts.

Tax collectors would cheer, too. Not only would taxpayers avoid complex planning costs and massive paperwork, but the IRS could devote more collection efforts to areas that have historically been much more profitable.

We replace our wealthy families every year.

The estate tax supposedly cuts down on the concentration of wealth, and many people consider any tax on the nation's wealthiest people, dead or alive, as the best sort of tax. But income inequality is, as even progressive economist Paul Krugman admits, not a big problem if Americans move rapidly up and down the income spectrum during their lifetimes.

Krugman doesn't think our income mobility is adequate, but we do have a dynamic economy. The wealthiest people are almost never the same from year to year as new American entrepreneurs constantly emerge and soar past older fortunes.

IRS data back this up. The highest-earning 400 tax returns filed between 1992 and 2007 included only seven people who appeared continuously. One-timers were numerous: 2,515 people popped up into the top 400 once in that 16-year span.

One argument for permanent repeal, then, is that our dynamic economy has solved the concentration-of-wealth problem far better than the estate tax ever did or could.

Alas, this foolish tax is soon to be reinstated, possibly even retroactively. The tombstone should read "Federal Estate Tax, 1916-2009, RIP" but instead it will almost certainly rise from the dead and haunt our economy for many years to come.

William Ahern is director of policy and communications at the Tax Foundation, a nonprofit think tank in Washington, D.C. Contact him at ahern@taxfoundation.org.

Don't raise taxes on job creators

Fri, 17 Sep 2010 00:00:00 EDT

This op-ed was published on CNN.com on Sept. 17.

Editor's note: Scott A. Hodge is president of the Tax Foundation, a nonprofit tax research organization in Washington that has advocated for what it considers economically sound tax policies since 1937.

Washington (CNN) -- Imagine the media and public outrage if President Obama had said at the outset of the BP oil spill, "Since Louisiana comprises less than 2 percent of the nation's population, the spill's impact on the entire economy is likely to be trivial."

Or the uproar he would cause by justifying budget cuts at the National Institutes for Health "because the 1.5 million Americans who will be diagnosed with cancer this year represent only 0.5 percent of the population so we are spending too much to benefit too few."

Preposterous examples, yes, but this is exactly how Treasury Secretary Tim Geithner recently justified allowing the tax cuts to expire for upper-income taxpayers.

In response to widespread concern, even among Senate Democrats, that the tax hike will hurt private business hiring, Geithner dismissed the worry as "a political argument masquerading as substance" because only 3 percent of business owners are profitable enough right now to have to pay the higher rates.

The administration hasn't always been so cavalier over the fate of small groups of Americans. Indeed, it spent some $60 billion to bail out General Motors and Chrysler, roughly 0.7 percent of the nation's civilian work force. Not to mention the $814 billion stimulus bill that the administration now claims "saved or created" 2.5 to 3 million jobs. While many were skeptical of that claim, even if it were true, that's less than 3 percent of the nation's work force.

The political argument that is masquerading as substance is Geithner's.

In the debate over what tax rate high-income individuals should pay, he cites a trivial factoid: the percentage of taxpayers who immediately have to pay more.

What he stays mum about is economically important: The vast majority of all private business income is generated by individuals who will be paying substantially higher taxes.

Over the past 30 years, the number of what are known as "pass-through" businesses such as sole proprietorships, S-corporations, LLCs and partnerships nearly tripled, from 10.9 million to 30 million. They are called pass-throughs because the business profits pass through to the owners who pay the business taxes on their individual tax form.

The most numerous type is sole proprietorships; they grew from 8.9 million to more than 23 million. S-corporations and partnerships grew the fastest, from 1.9 million to more than 7 million. As a result, more business income is now taxed under the individual income tax code than the traditional corporate code.

According to the most recent IRS data for 2008, taxpayers with a positive tax liability reported $864 billion in business income. Overall, individual taxpayers earning more than $200,000 and married couples earning more than $250,000 -- the group that President Obama has targeted for higher tax rates -- reported 68 percent of all pass-through business income, a total of $588 billion in all.

The largest share of private business income, some 35 percent, was reported on tax returns of filers earning more than $1 million, successful firms that likely began as mom-and-pop shops. But, by contrast, just 16 percent of all pass-through business income was reported by taxpayers earning less than $100,000. There may be more of these taxpayers but they generate a lot less business income.

This distribution of private business income explains why Congress's Joint Committee on Taxation determined that should the tax rates go up in 2011, 50 percent of the roughly $1 trillion in private business income will be earned by taxpayers hit by the highest tax rates of 36 or 39.6 percent.

The Obama administration estimates that their proposals to raise tax rates on income, capital gains and dividends while limiting deductions will generate $629 billion in revenues from high-income taxpayers over 10 years.

The question is how much of that tax hike will come from taxpayers with business income?

A recent Tax Foundation study determined that 39 percent of the expected new revenues generated by Obama's tax proposals would come from business income, an estimated $246 billion over 10 years. Hardly trivial.

Administration officials should understand the effects of higher taxes on business activity. After all, they raised cigarette taxes to reduce smoking, they proposed a cap-and-trade tax to reduce carbon usage and they recently proposed higher taxes on oil companies to reduce oil consumption.

So they should know that the surest way to get less entrepreneurship and less private business income is to tax it. So if the top income tax rate goes up to 39.6 percent from the current rate of 35 percent, we should expect these business owners to invest less, expand less and hire less.

As Joe the Plumber suspected, "spreading the wealth around" appears to be more important to this administration than growing the economy. The No. 1 priority for any Treasury Secretary should be growing the nation's wealth, not redistributing it.

The opinions expressed in this commentary are solely those of Scott A. Hodge.

Five Myths about the Bush Tax Cuts

Thu, 16 Sep 2010 00:00:00 EDT

This op-ed was published in the Fiscal Times on Sept 15, 2010.

Myth on the Left: The Bush tax cuts were only for the rich.

For the past ten years, Democrats have convinced a large fraction of the public that the tax cuts only benefited high-income people. The talking point has been repeated so often that it seems as if it must be true. But it never was. Everyone saved, and if all the tax cuts expire at the end of this year, everyone will pay.

The quickest way to prove this point is to compare the official "score" of the president's tax proposal—letting the Bush tax cuts expire only for high-income people raises $630 billion over 10 years—with the official score for letting all the tax cuts expire, which raises $3 trillion over 10 years.

That means some pieces did benefit those at the top of the income spectrum: changes to itemized deductions and the estate tax, and the rate cuts on high wages, dividends and capital gains. And measured in nominal dollars, a high-income taxpayer saved more than a low- or middle-income taxpayer.

Nevertheless, the Bush tax cuts sent trillions of dollars in tax relief to those beneath the president's so-called middle-class cutoff of $200,000, and when the tax cuts are measured as a percentage of their income, or as a percentage of their previous tax payments, the Bush tax cuts provided comparable benefits to all income levels.

The most damaging result of this myth is that Democratic Party spokespeople have convinced much of the electorate that all government funding needs can be solved by just raising taxes on the rich; a dangerous misconception, especially as our nation moves ever closer to a fiscal cliff whose avoidance will require hard choices on spending and taxes that hit all Americans.

Myth on the Right: The Bush tax cuts caused revenues to go up.
Republican spokespeople and other tax-cut enthusiasts have asserted that the tax cuts passed in 2001 and 2003 actually increased revenue. They often point to rising revenues from 2004 through 2007 following the tax cuts in May 2003. Unfortunately, as any Economics 101 student will tell you, correlation doesn't prove causation. Yes, revenue did rise, but we have to answer the question: Would it have risen anyway?

We can never be absolutely sure how the economy would have reacted if the tax cut legislation had failed for some reason in 2001 and 2003, but the consensus among experts is that the economy would have grown in the mid-2000s with or without the Bush tax cuts. That doesn't mean the tax cuts had no feedback effect at all—people reported more taxable income than they would have—but those beneficial effects were not so great that the tax cuts could have "paid for themselves."

The most damaging result of this myth is that Republican lawmakers feel less pressure to propose spending cuts. Why bother when cutting a tax rate will raise more revenue?

Myth on the Left: The Bush tax cuts caused the financial crisis and/or the recession.
Many Democratic leaders like to paint with a broad brush when it comes to the economic policies of the previous administration. They blame the real estate bubble, the financial meltdown and the recession on Bush administration policies generally, and then conveniently lump the Bush tax cuts in as part of the cause. As in the Republican myth above, this is a failure to distinguish correlation from causation. No authority on the economy would say that the banking crisis and the recession could have been averted by holding off on tax cuts in 2001 and 2003.

If one seeks to fix blame on the Bush administration, it's more honest and productive to focus on the administration's regulations (or lack thereof) pertaining to housing and banking, although even there, the Bush policies were more like a continuation of policies that go back decades.

Myth on the Right: President Obama is proposing the largest tax increase in U.S. history.
As part of their election strategy, Republican spokespeople are pretending that President Obama favors allowing the Bush-era tax cuts to expire for all taxpayers. Often that expiration is called the largest tax increase in U.S. history. Both charges are false.

In his budget, President Obama proposes extending the tax cuts for taxpayers earning less than $250,000 for married couples ($200,000 for singles). When confronted with this documentary proof, some on the right respond that the President had two years to address this expiring tax cuts issue but chose not to do so because he actually wants them all to expire. But by the same argument, Republicans could be accused of preaching spending restraint when they have no intention of cutting spending.

So is Obama's actual tax plan—to allow tax cuts to expire for high-income people—a historically huge tax hike? No: At $630 billion over 10 years (0.4 percent of GDP), the Obama proposal raises less revenue than many past tax enactments when measured as a share of the economy. If Congress ignores the President's request and allows all of the tax cuts to expire, will that be the largest tax hike in U.S. history? Such historical comparisons are fraught with technical difficulties, but as a percentage of GDP, total expiration would indeed be historically massive, probably bigger than any tax hikes except two enacted during World War II.

But is allowing a scheduled expiration to take place even a "tax increase" at all? All of the big tax increases in history have required explicit action by Congress. In this case, the "tax increase" was set in law by Congress in 2001 as part of the tax cut due to Senate reconciliation rules. By traditional "current law" comparisons, the Obama budget proposes a historically large tax cut, not a tax hike at all, because it raises less revenue than current law would.

On the other hand, even the president calls his plan a tax hike. That's because his budget team adopted a "current policy" baseline. Instead of comparing its proposals to current law (the expiration), he compares it to what the policy was last year. By this measure, the Obama proposal to let high-income tax rates go up is a $630 billion tax increase over ten years, and that is significant but not huge, historically speaking. This is mostly a matter of semantics.

A Bipartisan Myth: Tax changes we like are "tax reform."
Democratic partisans might say that the few provisions of the Bush tax cuts they supported in 2001 constituted "tax reform" because the dictionary defines "reform" as an amendment that improves some law or policy. The Democratic favorites 9 years ago were the establishment of a 10-percent tax bracket for the first few thousand dollars of taxable income, the doubling of the child tax credit from $500 to $1,000; and expansion of the earned income credit for couples.

Republican partisans say any tax cut is "tax reform" - that's the basic principle advocated by the Americans for Tax Reform. And some academics on the right say that the true tax-reform provisions from the Bush era were the 2003 cuts to the dividend and capital gains tax rates because those reduced the double taxation of capital income.

However, "tax reform" has a more specific meaning in tax policy, expressed in the mantra "broad base, low rate." True, the Bush tax cuts lowered rates, but they narrowed the base instead of broadening it. That is, instead of exposing previously untaxed income to taxation so that the system would be fairer, and rates could be lowered even more, the Bush tax cuts exempted even more income from taxation.

In 2005, the Bush team finally got around to fundamental tax reform, calling together a group of scholars. They published two smart tax reform proposals that would have lowered tax rates and broadened the tax base, but like the recommendations of almost every tax reform commission since 1986, the year of the last true tax reform, they were ignored by those in power. If by some movie magic, Congress could have enacted in 2001 either of the two plans proposed by the 2005 commission, the nation's economy and tax system would be much better off.

Gerald Prante, Ph.D, is senior economist and Bill Ahern director of policy and communications at the Tax Foundation.

The Unkindest Cuts

Sun, 22 Aug 2010 00:00:00 EDT

This article appeared in the New York Post on August, 22, 2010.

Perhaps the biggest issue going into the fall's midterm elections is the elimination, extension or modification of the so-called Bush tax cuts. It affects our wallets, of course, but also our nation's financial future, as government debt continues to expand to immense proportions While the argument is sometimes framed as tax cuts for the rich, the truth is if Congress does nothing before January, virtually all Americans' paychecks would shrink.

The tax cuts passed under the Bush administration, mostly enacted in 2001 and 2003, substantially lowered what every taxpayer, poor and rich, owes each year. Among the dozen major tax changes, the single biggest provision was a new 10% bracket for the first several thousand dollars we earn, which benefited all taxpayers, including low-income households who also received bigger refundable credits. Middle-income households got marriage penalty relief, and when the per-child tax credit doubled from $500 to $1,000, they got most of the benefit.

High-income households got their full itemized deductions back and estate tax relief, and investors got a lower rate on capital gains and dividends. Across the board, the marginal tax rates on wages fell from 28%, 31%, 36% and 39.6% to 25%, 28%, 33%, and 35%. In short, virtually every American's paycheck got bigger.

If the tax cuts were to fully expire, New Yorkers would be among the hardest hit, since their incomes are higher. For example, the average middle-income family in Carolyn Maloney's congressional district (NY-14) would face income taxes that are $3,066 higher.

The tax cuts were all temporary because Republicans could not get enough Democratic votes to gain a 60-vote Senate majority. Without that supermajority, no bill can pass if it adds to the deficit for more than 10 years. Well, the 10 years have passed, and it's a different world. Instead of budget surpluses on the horizon, a looming fiscal cliff is much closer than anyone would have thought possible. Extending the Bush tax cuts in full for another 10 years would add an estimated $3 trillion to the national debt. That is on top of the $8 trillion that is already set to be added to the debt under the president's proposed budget for 2011-20.

Tax cuts from the Bush years aren't the only tax laws set to expire on Dec. 31. President Obama's stimulus bill included temporary tax credits for higher education, more refundable tax credits for low-income households, and a new "making work pay" tax credit worth $400 per worker - those are expiring, too.

So what can we expect Washington to do before Jan. 1?

There is a chance that Congress will take no action and allow all of the tax cuts to expire. Most experts were shocked in 2009 when Congress did nothing to stop a scheduled repeal of the estate tax, so a similar scenario could play out this fall. And full expiration has academic support from renowned economists Alan Blinder and Alan Greenspan, who say a commitment to fiscal responsibility is worth any short-term economic harm.

But that is not the Democrats' plan. Instead, they propose extending about 80% of the Bush tax cuts. Only high-income taxpayers, defined as single people earning more than $200,000 and couples earning more than $250,000, will see their paychecks shrink in January. That threshold was set by then-candidate Obama on the 2008 campaign trail.

High-income people will lose many of their tax cuts under the Democrats' plan: they'll lose a large fraction of their itemized deductions including charitable gifts and mortgage interest. Their tax rate on qualified dividends and long-term capital gains will go from 15% to 20%, and the top two wage tax rates will return to 36% and 39.6% from their current levels of 33% and 35%. According to the administration, these restored higher tax levels would raise about $630 billion over 10 years, which is about only one-fifth of the $3 trillion price tag for making all the tax cuts permanent. In his budget, President Obama proposed cutting back further on the itemized deductions of high-income taxpayers, but Congress has ignored that idea for the second year in a row.

On the other end of the policy option spectrum is full extension of the tax cuts, which most Republicans favor. With a weak recovery faltering, they argue, higher tax rates on everyone would be disastrous, and even if limited to high-income people, the job-creating business sector would suffer. As for the benefit of deficit reduction cited by Blinder and Greenspan, Republicans scoff, predicting that government would just spend the additional revenue instead of paying down debt.

And the fate of the Bush tax cuts is not the only uncertainty. What will Congress do about the tax credits in the stimulus bill, worth about $70 billion per year? President Obama proposes extending all of them at least one year and some permanently. But when House Democrats recently publicized a tax plan officially scored by the Joint Committee on Taxation, none of the major Obama stimulus credits were included.

Over the next four months, Congress will be making the first of what will be many major decisions over the next decade concerning the future of US fiscal policy. So when the champagne corks pop 130 days from now on New Year's Day, what tax rates will each of us be paying?

Gerald Prante is senior economist at the Tax Foundation, a nonprofit, nonpartisan research and educational organization that monitors fiscal policy.

Ground new airline taxes

Sun, 15 Aug 2010 00:00:00 EDT

This op-ed was originally published in the Orange County Register.

As airline profits nosedived this past decade, new fees on headphones, seat selection and checked baggage have travelers flustered. Congressional Democrats are making a bad situation worse by declaring their intention to extend the tax on airline tickets to the new fees for extra onboard services.

Ironically, the newly imposed fees are an effort by airlines to lower the base-level ticket price. The cost of amenities was traditionally bundled into an all-inclusive ticket price, but now airlines are being more transparent, charging less for a bare-bones ticket but setting fees for extras. This is good news for bargain-hunting passengers, but new taxes are not good news for anyone.

The federal excise tax already adds 7.5 percent to the price of a ticket, with revenue earmarked to a trust fund supposedly dedicated to airport projects, employment and maintenance. Sen. Jim Webb, D-Va., last week introduced the so-called "Airline Baggage Transparency and Accountability Act," which would extend the FET to blankets, headphones and every other optional accessory on airplanes - an unjustified money grab by the federal government.

A passenger who decides to watch a movie, purchase headphones or buy a blanket does not use any more runway space or air traffic control services than the fellow in the next seat who doesn't buy any extras. Therefore both should pay the same tax to support airport operations.

The FET is not a general revenue raiser like a sales tax and shouldn't be applied like one. Especially if the add-on services "do not use the infrastructure that the tax is intended to pay for," Spirit Airlines Inc. President Ben Baldanza said in testimony at a House transportation subcommittee hearing last month.

Government taxes on airline travel have been accumulating for years. Three government agencies, the FAA, the EPA and the DHS already have their hands in the cookie jar with 17 "special aviation taxes." Fortunately, not every aviation tax is a shameless revenue grab, but that's what this new extension of the FET would be.

Airlines are trying to rebound from 2008's high jet fuel prices and low passenger demand. Major airlines American, Continental, Delta, United and US Airways lost a fortune in 2008 and 2009. They desperately need a robust national economic recovery.

In California, particularly, the airline industry is a major engine of the economy, accounting for 9 percent of total economic activity in the state and employing 1.7 million people. The July traffic statistics from Orange County's John Wayne Airport were gloomy. In the past year, the passenger count dropped by almost 2 percent, continuing a trend that started in 2007. Cargo is down over the same period, say FedEx and UPS.

Consumers want cheaper fares, and raising taxes is not the answer. If Congress is serious about focusing on jobs and the economy, it should help lay the foundation for a new takeoff strategy by holding off on its expansion of the airline ticket tax.

New cell phone taxes state

Fri, 16 Jul 2010 00:00:00 EDT

This commentary appeared in the San Diego Union-Tribune on July 16, 2010.

For "Ellen," who is too embarrassed to use her real name, it was back-to-back cell phone bills totaling $1,100 for her daughter's text messages and excess minutes. Such excessive cell phone bills are increasingly common in California thanks to taxation run amok.

Federal, state and local surcharges and fees are breaking the bank for wireless consumers. From June 2002 through June 2008, 22 California cities approved requests to extend their public utilities taxes to "modern forms of communication," i.e., wireless services such as cell phones, Internet access and text messaging services.

What caused this wave of new taxes at the state and local levels? Ironically, a federal tax cut.

In 2006, the IRS released Notice 2006-50 admitting that the previous 3.5 years of taxes it had collected on long-distance service were illegal. So-called bundled services -- flat-fee plans offered by wireless carriers that provide both local and long distance service -- were exempt from federal taxation.

When California cities realized their public utilities taxes no longer applied to bundled cell phone plans, they swiftly amended their statutes, not only to preserve their revenue streams, but to increase them. Take Sacramento, for example. In 2008, the city approved Measure O, allowing the local utilities tax to cover "modern and emerging technologies in communication." More recently, on April 13, El Segundo passed Measure M, which approved "updating and replacing the telephone tax regulations with modern communication services."

The trick behind this vague wording is that the suddenly untaxed bundled services are small compared to the size of the newly taxed "modern services." So cities including Sacramento and El Segundo were able to boast "tax reductions" by lowering the rate a bit while greatly increasing their revenue by taxing so many new things.

Covering Measure O in Sacramento, News10 ABC quoted Timothy Bittle of the Howard Jarvis Taxpayers Association, "Don't be fooled. When the city says vote 'yes' for this because it's a tax reduction, you need to realize what the city is trying to do is double, triple and even quadruple your tax."

In 2009, more than 1.56 trillion text messages were sent within the United States. Currently, 91 percent of Americans use cell phones, compared to 82 percent in 2007. This booming market looks like a cash cow to local governments, and they are lining up to milk it. In November, it is Chula Vista's turn, and the wording is similar to Sacramento's: The city's public utilities tax laws should be amended so that they "reflect recent changes in Federal tax law and to modernize the definition of technology communications so that it is technology neutral."

Staff members claims the city is only trying to close a "threatening loophole" found in the federal excise tax that jeopardizes the city's current ordinance and its ability to collect tax revenue

The measure will be on the November 2 ballot and advocates extending the utility user tax to Internet, texting and toll-free numbers.

The purpose of the public utilities tax is to compensate the government for building infrastructure to facilitate utilities such as water, gas and electricity. Cities do not subsidize wireless carriers or intervene in constructing cell phone towers and infrastructure. The important distinction to make is that wireless carriers like Verizon, Sprint and others are not public utilities, nor do they use public utilities. Therefore, local governments in California have no business placing a public utilities tax on a private good.

If cities in California continue passing measures that include broad terms like "modern and emerging technologies in communication," residents are making current and future cellular services fair game for taxation.

What are the chances Chula Vista will reverse such a perverse trend? The answer may hinge upon the turnout in the 51st Congressional District race between Republican Nick Popaditch and Democratic incumbent Bob Filner. One or both of them may take a stand on this issue, warning voters that an unjustified tax is sneaking up on them. After all, what politician in his right mind would support a tax on text-message donations to Haitian Relief or on cell-phone votes for American Idol?

Forster is a visiting scholar at the Tax Foundation in Washington, D.C., and a student at the University of San Diego.

State Jock Taxes: Is LeBron Better Off in Miami?

Thu, 08 Jul 2010 00:00:00 EDT

Tonight, at 9 p.m. on ESPN, LeBron James will sit down with America to tell us where he will be playing basketball for the next five or six years. So let's take a second amidst all of this NBA free agency madness to discuss what LeBron really should be concerned about, jock taxes. Those are the nonresident state income taxes that states and cities strictly enforce on athletes while letting almost everyone else go scot free.

Because of the Larry Bird Exception in the NBA salary cap, designed to help the home team keep its star players, the Cleveland Cavaliers can offer James roughly $100.2 million over 5 years while other teams can "only" offer him $96.1 million. Cleveland is also permitted to offer him an extra year on the contract, but as we compare the deals that he can get in various cities, we will consider only the first 5 years.

That extra $4.1 million that Cleveland can offer LeBron comes out to about an extra $10,000 more per game. But how much of that would he get to keep? Let's say LeBron has the choice to stay in Cleveland or go play with the Miami Heat. James may have a higher salary in Cleveland, but Florida has no state income tax. Ohio, on the other hand, has a top rate of 5.925%, plus Cleveland's own income tax rate of 2%, for a total of about 8%.

That makes Miami look like a clear winner because 8% of $100 million is $8 million, almost double the Cleveland salary advantage. But not so fast Florida. True, if James plays in Miami, none of his neighbors will be paying state income tax, but thanks to the jock tax, LeBron will.

While most people who travel in their jobs pay state income tax only to their home state, which is zero in Florida, athletes get special attention. In the NBA, each player's per-game salary is computed, and whenever a team is on the road, the players must pay whichever tax rate is higher, the home state's or the away state's.

How does this work out for LeBron if he chooses to play in either Miami or Cleveland? First let's consider all of his 41 home games in either city. Because Florida has no income tax, LeBron's home game income tax liability is zero. On the other hand, were LeBron to play in Cleveland, he would pay Ohio's progressive tax with a top rate of 5.925% plus Cleveland's flat income rate of 2% on all 41 home games. On LeBron's Cleveland salary of about $244,000 a game, LeBron would be paying $9,900 in tax on each game he plays for the Cavaliers, compared to zero playing for Miami. In other words, James would be losing almost all of his salary advantage for playing with Cleveland, and that is only for half of his games.

So now let's consider jock taxes paid on the road. There are 6 places that effectively have no jock tax: Florida, Texas, Washington D.C., Illinois, Toronto and Tennessee (Illinois has a jock tax but it is retaliatory and therefore doesn't apply to athletes from Florida, while Tennessee has a jock 'fee' and it cannot be credited on state income tax forms). Because of Ohio's income tax laws, LeBron would be forced to pay Ohio and Cleveland's income taxes for each game played in those no-jock-tax locations if he were to play for Cleveland. But Florida would charge him no income tax while he was there. So that's another Miami advantage for 10-to12 games per year, during which LeBron, as a Cav, would be forced to pay roughly $211,000 ($2,600 per game) in income taxes that he wouldn't have to pay if he joins Miami.

Therefore, even though LeBron's salary would be $10,000 more per game if he stayed in Cleveland, he would be paying $12,500 more in taxes. The rest of the road games are pretty much a wash between the two cities. When playing in California, New York and other destinations, players from Ohio and Florida pay the same, the tax rate of the state they're visiting.

Of course these numbers are only estimates and do not account for the possibility of playoff games, possible increases in state tax rates or changes in the NBA salary cap. It should also be noted that if you include LeBron's 6th year as a Cavalier, the tax benefits of playing for Miami would only cut Cleveland's salary advantage by about two-thirds.

So Miami has a clear tax advantage, but what about some other possible destinations for LeBron, like Chicago, New York, New Jersey and Los Angeles? Although Illinois has a low, flat income tax rate of 3%, Chicago athletes are at a distinct disadvantage because Illinois is the only state that does not permit their resident athletes to credit jock taxes they've paid against their own state income tax liability. That means that these athletes pay 3% of their income to Illinois, plus any jock taxes levied against them. If LeBron were to go to Chicago, he would pay the same amount that he would pay in Miami, plus 3% of his earnings. At $234,000 a game, for 5 years, LeBron would be paying over $7,000 more per game in taxes for Chicago then he would for Miami. As far as New Jersey, Los Angeles and New York go, each state has a much higher state income tax than Cleveland, with the top rates being 8.97% in New Jersey, 10.55% in California, and 12.62% in New York City. Although, this may not matter much for the Knicks, who say that the city of New York would make LeBron a billionaire.

I have a bad feeling that amidst all of the free agent 'summits' LeBron has been attending and Family Guy episodes he has been starring in, he hasn't had time to calculate his income tax liability in each state and figure out which team can offer him the most money. Someone should really hurry up and inform him before he announces his decision tonight, in case he wants to change his mind.

For more on jock taxes, see http://www.taxfoundation.org/research/topic/1.html.

The Scope of State Taxing Authority

Fri, 02 Jul 2010 00:00:00 EDT

When a consumer buys something online, in many cases that consumer is not charged sales tax by the online retailer. The U.S. Supreme Court has ruled that, to prevent disruptions to interstate commerce, a state may force only those businesses with a "substantial connection" with the state ("nexus") to collect its sales tax. Otherwise, the Court held in its 1992 case Quill Corp. v. North Dakota, businesses would face an enormous burden of complying with over 8,000 separate sales tax jurisdictions, with ever-changing bases and rates. Thus, only businesses with employees or property in a state usually collect a state's sales tax, even if the employees or offices are not directly involved in soliciting sales in the state.

The Quill decision expands on another important state tax case, Complete Auto Transit, in which the Supreme Court articulated a four-part test to determine if a state tax violates the Commerce Clause. (Prior to Complete Auto Transit, state taxation of interstate commerce was unconstitutional.) The Complete Auto Transit test requires (1) Nexus, a sufficient connection between the taxpayer and the state to warrant imposition of state taxes, (2) Fair Apportionment, such that the state does not tax more than its fair share of the taxpayers' income, (3) No Discrimination, in that the state cannot unduly burden out-of-state taxpayers in a similar line of commerce as local taxpayers or favor local taxpayers to out-of-state taxpayers' detriment, and (4) Relatedness to Services, so that taxes are fairly related to services provided to the taxpayer by the state.

Simply put, the Supreme Court's current position is that Commerce Clause requires a substantial level of contact between the state and the thing or person to be taxed.

Compliance Issues with Sales Taxes

These decisions have been premised both on the geographic limit of state powers and on the difficulty of complying with thousands of ever-changing state sales tax bases, rates, and exemptions, which are, contrary to popular belief, not aligned with 9-digit or even 5-digit zip codes. Getting sales taxes wrong can be costly: undercollecting risks serious tax penalties and fines, while overcollecting risks class action lawsuits from customers.

Simple and uniform taxes can create economic certainty, fostering investment by businesses and individuals. However, tax rates and exemptions vary widely among states and within states. The Streamlined Sales Tax Project (SSTP) is a recent effort to simplify and harmonize state sales taxes in the hope that Congress or the Supreme Court will permit states to impose use tax collection obligations on out-of-state companies.

While the SSTP has made notable progress on adopting uniform sales tax definitions and procedures, meaningful efforts to simplify sales taxes (such as by reducing the number of sales taxing jurisdictions or aligning them with zip codes) have been actively avoided in the hopes of attracting more members. States who have joined the SSTP can continue to tax types of clothing differently, to tax types of food differently, to add special taxes to various products and services, and so forth. Even the SSTP website's compendium of state sales taxes has no web calculator for 10 states, and it includes the unhelpful disclaimer that the table "only reflects the general state sales tax rate. Some states have reduced rates on food and drugs. Please view their web sites to obtain the correct state rate for these products and other pertinent laws."

Similarly, in recent years several new online software programs have appeared to help retailers with sales tax calculation and compliance. Like any other tax calculation service, these can be costly and prone to error in the details as they try to keep up with constantly changing rates and exemptions. Rather than fix underlying problems with state sales taxes, SSTP has instead immunized users of those services it certifies from compliance actions, preserving underlying complexity. It also tries to cement an inequity: local "brick and mortar" retailers need only collect one sales tax based on where they are, while online businesses must collect sales tax from thousands of jurisdictions, based on where their customers are.

Frustrated by revenue demands and the slow pace of progress at the SSTP, a few states have turned to more aggressive actions, like new expansions of nexus, "Amazon" taxes, or draconian disclosure requirements. A drop in state revenues has contributed to this pressure.

Cigarette Excise Tax Compliance

Cigarette retailers can be prone to confusing and costly compliance procedures. For example, Arkansas recently decided to control cross-border shopping for low-tax cigarettes with a border zone cigarette tax, which authorizes a state-wide cigarette tax rate but enforces a lower, variable rate for certain towns and even certain stores located near the state's borders. Under this law, if an Arkansas consumer buys cigarettes across the border in Louisiana, Arkansas will collect a tax at Louisiana's rate plus 3 cents if the resulting rate is lower than Arkansas's standard rate for that area.

If Arkansas's variable cigarette tax rate structure proves successful at limiting cigarette tax evasion, and it likely will be, I predict other states may follow suit. Thus, the future likely means more cigarette tax jurisdictions with disparate rates.

Conclusion

The physical presence rule of state taxation should not be compromised by federal or state laws that permit states to overreach and tax businesses without any substantial nexus. Destination/customer-based sales taxes risk multiple taxation and burdensome compliance costs that contribute to substantially diminished market shares, and adopting an ambiguous "economic nexus" standard would introduce substantial uncertainty for taxpayers, unsettle expectations, endanger economic investments, and distort business decisions.

More on these topics:

Mark Robyn, "Border Zone Cigarette Taxation: Arkansas's Novel Solution to the Border Shopping Problem," Tax Foundation Fiscal Fact No. 168, April 9, 2009, http://www.taxfoundation.org/news/show/24599.html.
Joseph Henchman, Why the Quill Physical Presence Rule Shouldn't Go the Way of Personal Jurisdiction, 46 State Tax Notes 387 (Nov. 5, 2007), http://www.taxfoundation.org/news/show/22785.html.
Joseph Henchman, Testimony to the Maryland Legislatures on the Streamlined Sales Tax Project, Feb. 18, 2009, http://www.taxfoundation.org/news/show/24346.html.
Joseph Henchman, "SSTP is Not All It's Cracked Up to Be," Tax Foundation Tax Policy Blog (Jul. 23, 2009), http://www.taxfoundation.org/blog/show/24919.html.
Mark Robyn, "I'll Have Some Margarita Mix To Drink and a Packet of Lemonade Mix for Dessert," Tax Foundation Tax Policy Blog (Jul. 7, 2009), http://www.taxfoundation.org/blog/show/24827.html.
Joseph Henchman, "Nearly 8,000 Sales Taxes and 2 Fur Taxes: Reasons Why the Streamlined Sales Tax Project Shouldn't Be Quick to Declare Victory," Tax Foundation Tax Policy Blog (Jul. 28, 2008), http://www.taxfoundation.org/blog/show/23423.html.
Joseph Henchman, "Seneca Object to New York Cigarette Tax Law," Tax Foundation Tax Policy Blog (Dec. 18, 2008), http://www.taxfoundation.org/blog/show/24076.html.

Letter to Virginia Attorney General Cuccinelli Regarding His Office's Position in the FFW Property Tax Case

Thu, 01 Jul 2010 00:00:00 EDT

08-1521 McDonald v. Chicago (06/28/2010)

PDF Version of this letter

July 1, 2010

Kenneth T. Cuccinelli II
Attorney General of Virginia
Office of the Attorney General
900 East Main Street
Richmond, VA 23219

Dear Attorney General Cuccinelli,

I was disappointed to learn that your office filed a friend-of-the-court brief in opposition to our position in FFW Enterprises v. Fairfax County, pending before the Virginia Supreme Court. As I explain in our brief and other work on the case, the tax at issue violates principles of sound tax policy by perpetuating the myth that "business" can be forced to shoulder disproportionate burdens, even for a project whose benefits will be primarily enjoyed by residents and travelers.

As you know, this case involves newly-enacted special property taxes on property near what will be new Metrorail stations, with the revenue used to help fund the Dulles Metro extension. Such tax-benefit districts are common and justified under a "benefits conferred" approach whereby those who benefit from the spending are those who pay the taxes.

This case is different because Fairfax will impose the taxes only on commercial property. Residents and travelers will benefit at least as much, if not more, from the Dulles Metrorail improvements, so a tax only on commercial landowners within the geographic area surrounding the stations cannot be justified under a "benefits conferred" approach. Special district taxes for benefits from the Metrorail should be imposed uniformly over the taxing district, not arbitrarily on some types of property.

The Virginia Constitution limits policymakers' discretion in defining taxation categories in this context. Fairfax County and, unfortunately, your brief, argue that because the Uniformity Clause only requires uniformity "among the same class of subjects," the General Assembly is free to define the class however it wishes and survive any Uniformity Clause challenge. (Your 8-page brief does not even attempt to explain or justify the General Assembly's arbitrary action against taxpayers, instead pasting a page of text from the trial judge's opinion musing about possible rationales.)

If such a theory survived constitutional scrutiny, legislative classifications could routinely overburden select groups of private property to finance benefits enjoyed by the broader public. Such classifications could then be prone to a federal takings challenge because as a classification becomes increasingly specific to a certain type of property, a tax based on benefits conferred takes the nature of an arbitrary deprivation of property without due process.

The General Assembly's chosen route to raise revenues for the Metrorail construction may be administratively and politically convenient, but it creates exactly the type of discriminatory tax classification that the Virginia Constitution was designed to prevent. The General Assembly should not have the power to burden specific types of private property for public benefit under the guise of district-wide taxes. The state, and the state's Attorney General, has an obligation to protect taxpayers from such arbitrary actions.

Should you be interested in reconsidering your office's position in this case, I'm happy to be of help.

Yours Very Truly,

Joseph D. Henchman

Tax Counsel & Director of State Projects

Tax Foundation

For more on the FFW case, see here: http://www.taxfoundation.org/publications/show/26381.html

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

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To schedule an interview, please contact Natasha Altamirano, the Tax Foundation's Manager of Media Relations, at (202) 464-5102 or naltamirano@taxfoundation.org.

Get ready for the tanning tax

Wed, 30 Jun 2010 00:00:00 EDT

This article originally appeared on CNN.com.

Put away those plastic mini-goggles and grab your favorite tube of self-tanner. The first new tax to fund health care reform goes into effect Thursday -- a 10 percent excise tax on indoor tanning services.

The tanning industry is just the latest victim of government paternalism, putting it in the same category as cigarettes, alcohol, gambling, sodas, trans fats, junk food and other targets of so-called "sin taxes."

Desperate for revenue and lacking the guts to curtail big special-interest tax breaks such as the employer-provided health insurance exclusion or the mortgage interest deduction, congressional leaders and the president have singled out a politically vulnerable target. Kind of like a pride of lions singling out the weakest wildebeest. ...

Visit CNN.com to read the full commentary.