Tax Foundation - Commentary

Double Taxation of Hospital Services Pushes Patient Bills Up

Sun, 15 Jun 2008 00:00:00 EDT

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

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

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

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

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

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

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

Seven Tax Everything

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

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

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

Tennessee Hospital Sues

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

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

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

Business-to-Business Taxes

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

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

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

Unique Opportunity Is at Hand for Far-Reaching Federal Tax Reform

Fri, 06 Jun 2008 00:00:00 EDT

This commentary appeared in the July 1, 2008, issue of Budget & Tax News, published by the Heartland Institute.

For the first time since 1986, the stars may be aligning for a grand bipartisan compromise on fundamental federal tax reform.

Regardless of who wins in November, the next president and Congress will have to deal with the collision of two cataclysmic tax events: The 2011 expiration of the Bush tax cuts and the growing irritation of the Alternative Minimum Tax (AMT).

The seeds for compromise lie in the fact that both sides have something to gain by addressing these problems at once. Naturally, Republicans want to avert the largest tax hike in history by maintaining the lower tax rates on income, capital gains, dividends, and married families with children. Meanwhile, Democrats will be brought to the table by the fact that the AMT is largely a Blue State problem, mostly affecting those living in high-tax and high-income states such as California, Massachusetts, New Jersey, and New York.

43 Million Pay Nothing
The first land mine is the distribution of the tax burden itself. The 2001 and 2003 tax cuts knocked millions of lower-income people from the tax rolls. When Bill Clinton left office, some 29 million tax filers had no income tax liability after they took advantage of their credits and deductions. Today, the number of "non-payers" has grown to more than 43 million, or one out of every three Americans who file a tax return.

And since so many lawmakers see the IRS as a giant ATM dispensing "refundable" credits, such as the Earned Income Tax Credit, it will be very difficult to convince them to support fundamental tax reform.

With the nation's tax burden now so concentrated at the top--the top 20 percent of taxpayers pay about 86 percent of all the income taxes—any tax reform plan is caught in a rhetorical Catch 22; tax reform equals "tax cuts for the rich." Enter land mine number two: AMT and the interests of Democrats.

Although the vast majority of households affected by the AMT earn between $100,000 and $500,000, Democrats have masterfully positioned it as a middle-income issue. Wrapping fundamental tax reform around AMT reform could inoculate the debate from the predictable class warfare diversions.

Considering these land mines, how do we craft a politically realistic tax reform plan?

Step 1: Eliminate tax exemptions and deductions.

More than 80 percent of the benefits of these tax deductions flow to households earning more than $80,000, and more than half of the benefits flow to those making more than $118,000.

Eliminating these deductions would solve several problems. It would free up dollars for marginal rate cuts to keep effective rates down, and it would add greater simplicity and equity to the tax code.

Affluent taxpayers may be the initial beneficiaries of these tax exemptions and deductions. But in the end, the real economic subsidies flow to well-heeled interest groups such as the housing industry, state and local governments, and public employee unions.

In particular, the state and local tax deduction allows local politicians and school districts to shift as much as one-third of the cost of any tax hike along to Uncle Sam—and thus other taxpayers.

Step 2: Make any tax reform a tax cut and tax simplification.

Next, one must recognize that tax cuts will always generate more support than a revenue-neutral tax shift. A 2007 Tax Foundation/Harris Interactive Poll found about half of all American adults would give up their credits and deductions for an across-the-board cut in their income tax rates.

The repeal of deductions, as outlined above, would fund significant marginal rate cuts. However, the task of mobilizing the other half of Americans who said they were not sure or who rejected the idea will require the sweetener of a lower tax bill as well as the promise of a simpler 1040 form.

Step 3: Continue to shield low-income earners with a super-deduction.

Politicians are not likely to put the non-payers back on the tax rolls by shrinking the value of the personal exemption, standard deduction, or child credit. With the political consensus that some low-income people should be protected from income taxes, the practical solution is to collapse the various credits and deductions into a super-deduction that accomplishes what current policies already do inefficiently: Eliminate the income tax bill for a family of four earning up to about $42,000.

Continuing to protect low-income taxpayers in this way will help earn goodwill from the left without actually creating any new programs.

Step 4: Make everyone a stakeholder.

An ideal plan would take this process a step further (as did the 1986 act) by slashing all tax rates equally, giving every taxpayer a stake in the reform. Better yet, the plan could condense the number of brackets to no more than two, as existed in 1988.

Such a tax code would be simpler, fairer, and closer to the kind of efficiency economists have long called for. It would reduce the compliance costs for families and small businesses. It would almost certainly strengthen the American economy and help move the tax code back to its proper purpose of revenue-raising and away from its current distorted function of social policymaking.

Step 5: Fend off the special interests.

None of this is to say that fundamental tax reform will come easily or cheaply. With absolute certainty, every interest group and lobby will line the halls of Congress demanding their interest have protections carved into the new legislation. Advocacy groups of every stripe will take to the airwaves bemoaning the plight of their specific interest. They will scream that this new tax bill will evict people from their homes, leave children hungry on the street, and force seniors into destitution.

Of course, like most cries from special interests, none of this would be true. What would be true is that the United States would enjoy one of the best and most effective tax systems the world over. The new tax code would still show compassion for the poor and take a hefty chunk from the rich, while becoming considerably more fair and equitable.

Scott Hodge (hodge@taxfoundation.org) is president of the Tax Foundation. An earlier version of this essay appeared in the February/March 2008 issue of The Ripon Forum, www.riponsociety.org. Reprinted with permission.

Cigarette Taxes Are Fueling Organized Crime

Wed, 07 May 2008 00:00:00 EDT

This commentary appeared in the Wall Street Journal on May 7, 2008.

Cigarette Taxes Are Fueling Organized Crime

Last month, New York law enforcement authorities announced the arrest of Queens resident Rafea al-Nablisi for smuggling 12,000 cartons of cigarettes a week. It was not the first such arrest, and thanks to New York's latest cigarette tax hike, it will not be the last.

On April 23, less than two weeks after Mr. Nablisi's arrest was made public, Gov. David Paterson signed into law a $1.25 per-pack tax hike on top of the state's $1.50 per-pack tax. That's in addition to New York City's own $1.50 per-pack tax. Come July 1, New York City's smokers will be paying on average $9 a pack for legal cigarettes.

But if history is any guide, most cigarettes sold will actually be trucked up from Virginia, or shipped in from China, by "butt-leggers" who can make over $1 million on each tractor-trailer load of smuggled smokes. The blunt fact, which politicians of both political parties are determined to ignore, is that high cigarette taxes in New York have led to a bloody, decades-long smuggling epidemic.

While the problem first surfaced during the Great Depression, tax hikes in the early 1960s created a major profit opportunity for smugglers and kicked the epidemic into high gear. By 1967, a quarter of the cigarettes consumed in the Empire State were bootlegged. New York City's finance administrator labeled cigarette smuggling the "principal stoking facility of the engine of organized crime."

Crime rapidly spread beyond New York's borders, as trucks carrying cigarettes across the country were hijacked and businesses selling them robbed to supply New York's black market. In 1972, the chairman of a New York commission told Congress that retailers and other workers were "confronted almost daily with the risk and dangers of personal violence which are now inherent in their industry."

State and city officials responded with mandatory prison sentences and expanded police powers of search and seizure. But in 1973 a state commission found the crackdown to be "completely ineffective and a failure." Desperate state officials formed a special task force that proposed abolishing the city's cigarette excise. Gov. Malcolm Wilson embraced the idea, explaining: "One major incentive to organized crime is the high New York City cigarette taxes, piled on top of the state tax, which have made that city the promised land for cigarette bootleggers."

Fuhgedaboutit. Parochial politics scuttled any possibility that the tax would be abolished. But a series of homicides, including witness murder, discouraged lawmakers from further tax hikes in the late 1970s and early '80s. High inflation in those years drove cigarette prices up, but the fixed excise tax—the smuggler's profit margin—declined by more than 40%, greatly reducing bootlegging and related crime.

Lawmaker memories are short, however, and the state again began raising the cigarette tax in the 1980s. As a state tax enforcement official noted, it soon became "literally more profitable to hijack a cigarette-delivery truck than an armored truck." More tax hikes followed in the 1990s. City and state records of tax-paid cigarettes show sales plummeting, despite stable smoking rates. This signals the resurgence of smuggling and large-scale tax evasion.

As the Bureau of Alcohol, Tobacco and Firearms said in September 2002 of New York's cigarette smuggling, "Traditional organized crime is involved, terrorist groups are involved, and street gangs are involved." Rivalry among these groups has resulted in numerous shootings and homicides.

The connection to terrorism is no exaggeration. When New York police cracked another smuggling ring in 2005, they uncovered a multimillion dollar flow of funds from New York City to unknown individuals in the Middle East. Police Commissioner Raymond Kelly gave voice to the obvious conclusion: Terrorists probably got the money.

Just a few weeks before that 2005 bust, Buffalo-area businessman Aref Ahmed had been sentenced to three years and a month for cigarette smuggling. The feds said he'd used the racket to fund "scholarships" at terrorist training camps in Afghanistan during the spring of 2001. Going back to 1993, counterfeit cigarette stamps were found in the apartment of the first World Trade Center bombers.

Politicians continue to use the health of smokers as their excuse for higher cigarette taxes. This view is myopic. As Gov. Wilson argued three decades ago, high cigarette taxes are bad public policy because of their effect on the rest of us. In the 1960s and '70s, organized crime exploited high cigarette taxes at our expense. Today we face an even deadlier adversary.

****

Mr. Fleenor is chief economist of the Tax Foundation and author of "Cigarette Taxes, Black Markets, and Crime: Lessons from New York's 50-Year Losing Battle" (Cato Institute, 2003).

Beacon Hill's Gift to the Black Market

Sat, 26 Apr 2008 00:00:00 EDT

This commentary appeared in the Boston Globe on April 26, 2008.

According to police, Richard "Pops" Picardi, a 76-year Revere man who hobbled about on a prosthetic leg, was a purveyor of many vices. For drug addicts he supplied OxyContin, Percocet, and other narcotics, investigators say. To smokers he supplied cheap, tax-free cigarettes out of a Chelsea taxi office.

This operation came to an end last week after police and Suffolk County prosecutors closed in on him. Yet such busts do little to stem the flow of illegal smokes into the Bay State. Massachusetts is awash in bootleg cigarettes.

High state cigarette taxes have turned packs of cigarettes into pots of gold for criminals, spawning a massive black market supplied by both smugglers and thieves who can quickly unload stolen cigarettes for cash.

Legislators on Beacon Hill are now planning to almost double the criminal profit margin by hiking the state cigarette tax by another buck a pack. This will only place more citizens in harm's way.

The Bay State is no stranger to cigarette tax-induced crime. Soon after the state tax was enacted in 1939, legal, tax-paid sales fell, as cigarettes were smuggled in or diverted from tax-free stocks and sold in the ordinary market. Merchants in neighboring states also began advertising the tax-free prices available in their stores.

Massachusetts tax authorities responded by stationing agents in neighboring states to photograph border shoppers lured by bargain smokes. That failed, and so did more frequent audits of wholesalers and retailers. The criminals proved to be wily, and, like the famous liquor bootleggers during Prohibition, these "butt-leggers" sometimes outran enforcement agents in souped-up cars.

Over the next quarter century a stalemate of sorts set in between tax-enforcers and tax-evaders. Taxes increased slowly, only at about the rate of inflation, so evasion remained more or less constant.

The Surgeon General's famous report on smoking and health in 1964 changed everything. Lawmakers reacted by more than doubling cigarette excises over the next decade, causing cigarette bootlegging and related crime to explode.

By the mid-1970s, the state's highest-in-the-nation tax created horrendous evasion problems. A 1977 federal report found that Massachusetts smokers were buying 76 million untaxed packs annually, and labeled the state's bootlegging problems as "serious." A subsequent state report agreed, and state officials concluded that profits in the illegal cigarette trade were large enough to attract professional criminals who also supplied this vast, illicit market by hijacking cigarette trucks and robbing retail or wholesale locations.

At a 1977 congressional hearing on the national cigarette bootlegging problem, Senator Edward Kennedy noted that the Mob's entry into the racket had led to "increasing violent crime: extortion and bribery, truck hijackings, armed robberies, serious assaults, and even murder."

State officials made the usual futile gestures, forming task forces with federal authorities and nearby states. Nothing made a dent. In 1980, combined federal and state enforcement efforts netted just 5,800 cartons of illegal smokes, about the number smuggled in three hours on a typical day.

The emergence of this large illicit market, coupled with the inability of enforcement officials to do much about it, helped discourage additional large tax hikes for more than a decade and a half. This allowed inflation to gradually whittle down the excise to levels not seen since the early 1960s. By the early 1990s, this de facto tax reduction had largely eliminated the state's problems with large-scale evasion.

But lawmakers' memories are woefully short. At the beginning of 1993, the state cigarette excise nearly doubled to 51 cents per pack. Smoking in Massachusetts dipped slightly, following the nationwide trends. You would never know the effect was so modest from looking at the state's records of tax-paid cigarettes—sales of those plummeted. But smuggling boomed.

Additional tax hikes in 1996 and 2002 have pushed the tax to its current level of $1.51 per pack. The resulting increase in border activity has helped push sales of tax-paid cigarettes to unprecedented lows.

Backers of the current hike argue that it will raise needed revenue while discouraging smoking. The first claim is myopic, since the tax imposes costs on society in terms of lawlessness. The widespread availability of cheap cigarettes via the black market also undermines the second.

Patrick Fleenor is chief economist of the Tax Foundation and author of "Cigarette Taxes, Black Markets, and Crime," published by the Cato Institute.

A Modest Proposal for Raising Education Revenue in Arkansas Without a Lottery

Tue, 11 Mar 2008 00:00:00 EDT

Lieutenant Governor Halter recently revived the idea of starting a state lottery to raise money for scholarships. While state-run lotteries are certainly popular (42 states and D.C. have them), it might just make sense for Arkansas to take a different approach. A lottery would require quite a bit of work to start up, so why not just take over a business that already exists in the state: selling cigarettes?

The legislature could ban the sale of cigarettes by private vendors and open government-run and owned tobacco stores throughout the state, with a massive tax to raise scholarship money.

This plan would require widespread advertising, just like the advertising in states with lotteries. We would like to suggest the following catchy jingle for the new Arkansas State Cigarette Advertising and Merchandising (A-SCAM) Agency:

Buy Arkansas Cigarettes
and your ash will become cash!
For the students who want to read,
a puff is enough
to buy the books that they need!

Or perhaps a simpler slogan would suffice: "Buy Arkansas State Cigarettes and light up a student's education!"

We understand that some people will oppose this plan—people who don't care about education, obviously. The naysayers might argue that tobacco sales and marketing is not an appropriate activity for state governments. Arkansas policymakers should respond with the same arguments that are used to defend state lotteries. Smoking is unhealthy, so why shouldn't the state raise money from people stupid enough to engage in such a dangerous activity (just like gambling)? Sure, the state already raises a small fortune from tobacco excise taxes, but why not go a step further? If the state has a monopoly on tobacco sales and advertises smoking heavily, imagine the revenue it could raise!

After all, if the tax code can't be used to make moral judgments about which consumer goods are "stupid" or "wrong" and to punish citizens who purchase those goods, then what is it for?

Some goody-two-shoes might whine that the state would then actually need people to smoke. But the Arkansas treasury is dependent on cigarette sales as it is. Most legislators have already learned to walk the fine line between encouraging citizens to participate in an unhealthy activity to generate revenue and discouraging the activity through punitive taxes. Policymakers in lottery states know plenty about this paradox.

Another benefit of this plan is that legislators will not have to call the revenue raised "tax revenue" or even acknowledge that the cigarette taxes are taxes. Since cigarettes will be sold only by the government, the state can call the revenue whatever it likes. After all, states with lotteries call their lottery revenue "miscellaneous revenue" or "profits," even though it's actually implicit tax revenue; why should it be any different for State Cigarettes? This means that legislators who want to raise taxes without their constituents' knowledge will now have a handy way of doing so (and without violating that pesky no-new-taxes pledge!).

Best of all, since people who buy State Cigarettes will purchase them voluntarily, they will not realize they are being taxed and will not demand transparency in the tax system. Everyone knows that an item that's purchased voluntarily cannot be taxed, because taxes are mandatory. That's how it works with state lotteries, according to lottery proponents, so the same logic will most certainly apply to State Cigarettes.

Opponents of this plan, just like opponents of lotteries, will no doubt claim that the revenue raised will be a form of regressive taxation disproportionately burdening the poor. They may also claim that a high tax rate on an item enjoyed by a subset of the population is unfair, since taxes pay for public services enjoyed by everyone. They might even have the audacity to allege that the revenue from State Cigarettes might not be used entirely for education since earmarked revenue is fungible, including lottery revenue.

Pro-State-Cigarette policymakers should simply attack their opponents for not caring about education, which is the only thing that matters. Anyone who cares about raising money for Arkansas students will enthusiastically support any plan that lets the state run and advertise a monopoly business with a high, regressive tax (not accurately labeled a tax) on one particular, potentially unhealthy consumer good.

Relying solely on cigarette smokers might be a gamble, but isn't it the only way to "light up a student's education"?

Supreme Court Backs Railroad, Throws Out Tax Assessment

Sat, 01 Mar 2008 00:00:00 EST

(The following article originally appeared in the February 2008 edition of the Heartland Institute's Budget & Tax News).

In a decision establishing stronger protection for railroads from discriminatory state taxes, the U.S. Supreme Court has ruled in favor of CSX Transportation, a national railroad company that was hit with a huge jump in property taxes in Georgia. In December the court ruled unanimously for the railroad.

Supported by a friend-of-the-court brief from the Tax Foundation, a national tax research group, CSX successfully argued Georgia's assessment method effectively gutted federal law that protects railroads from discriminatory taxes.

Spurious Assessment Method

The case, CSX Transportation v. Ga. Bd. of Equalization, dates to 2002, when Georgia hired a new utilities property assessor. Using new assessment methods he calculated a 36 percent increase in CSX's assessed value over 2001, which led to a 47 percent increase in the firm's property tax bill even though there was little actual change in the property.

CSX argued the assessor's method was flawed, and an assessment expert testified other methods would have been more accurate.

CSX was able to bring a lawsuit because railroads are protected by a federal law--the "4-R Act"--from discriminatory state taxation.

The 4-R Act dates to the 1970s, when states punitively taxed captive railroads so badly that many were failing. The law prevents states from taxing more of a railroad's "true market value" than they do for other commercial property. If a state is taxing railroads at 80 percent of their value but other commercial property at only 40 percent, the tax violates federal law.

Threat to Protections

Both the trial court and the Eleventh Circuit Court of Appeals sided with Georgia. They held that nothing in the 4-R Act allows railroads to challenge the assessment method. In attempting to prove the existence of discrimination, the courts held, railroads are limited to "checking the math" and finding a calculation error in the state's chosen assessment method.

CSX appealed, and the Tax Foundation's brief in support argued the lower court's reasoning would eviscerate the 4-R Act's purpose, meaning, and text.

"Discriminatory assessment methods cannot be shielded from legal challenge because Congress has exercised its power to limit states' ability to use any conceivable method of assessing and taxing railroad transportation property," the brief stated. "Otherwise, states would get immunity for even absurd assessment schemes, like basing it on the property's height above sea level."

A unanimous Supreme Court reversed the lower courts and held for CSX. Chief Justice John Roberts, who delivered the Court's opinion, echoed the Tax Foundation's argument.

'Total Lack of Support'

"The total lack of textual support for Georgia's position is not surprising," the opinion states. "The dichotomy the State presses would eviscerate the statute by forcing courts to defer to the valuation estimate of the State, when discriminatory taxation by States was the very evil the Act aimed to ban."

The Tax Foundation's brief emphasized judges should be able to consider all available evidence in determining whether discrimination exists. Excluding evidence that the state's chosen method is skewed simply makes it more likely a discriminatory state taxation system can persist.

"Tax legislation should be based on careful economic analysis and transparent procedures," the Tax Foundation argued in the brief. "Permitting criticism and challenge can help ensure neutrality, simplicity, and fairness in our tax system."

The Court's opinion recognized that, noting "preventing courts from scrutinizing valuation methodologies would render [the 4-R Act] a largely empty command."

Similar Tax Discrimination

CSX is not alone in facing discriminatory property taxation. Florida's practice of imposing higher property taxes on out-of-state landowners is currently pending in the state courts, and a Pennsylvania judge recently held Allegheny County's property tax assessment scheme is so disproportionate as to violate the state constitution.

Joseph D. Henchman is tax counsel at the Tax Foundation, a national nonpartisan tax research organization in Washington, DC.

In For A Penny...: Book Review of "FairTax: The Truth - Answering the Critics"

Sun, 10 Feb 2008 00:00:00 EST

(The following book review originally appeared in the February 10, 2008 edition of the New York Post).

Mike Huckabee's success on Super Tuesday was a godsend for a new book by talk-show host Neil Boortz and Rep. John Linder of Georgia, "FairTax: The Truth."

This sequel to their 2005 bestseller, "The FairTax Book," once again urges the nation to repeal most federal taxes in favor of a national retail sales tax. Huckabee is the one major candidate who has embraced the idea and the new book claims that zealous FairTax supporters helped him win the Iowa caucus. He also won the primary in Georgia where Boortz and Linder are based and where support for the FairTax is strongest.

Like many movie sequels, the new offering spends too much time repeating the original. It's subtitled "Answering the Critics" and is written in Q&A form. But if Huckabee remains on the national stage, these arguments will soon graduate from tax journals to TV, so it doesn't hurt to hear the pros and cons in this format.

Boortz's talk-radio style makes for a fast read. But with it come exaggerations. The IRS could be abolished, the authors say, and they snidely assign the nation's tax collectors one final duty: "The IRS should be expected to stick around until it has completed its one remaining mandate: collecting taxes still due from the era of the income tax. Passage of the FairTax should not be viewed as an amnesty for past tax cheats."

And there are some personal accusations too: that the critics are just lobbyists or income tax scholars trying to protect their "natural habitat," that is, the inside-the-beltway environment where tax gurus manipulate peoples' income taxes for their own gain.

Boortz and Linder see themselves as having grabbed a tiger by the tail. No mere policy proposal to them, the FairTax is a movement that's opening the eyes of thousands of people every day, proving how much damage the federal tax system is doing to our economy, our privacy and our government.

The four taxes they aim to replace are the two income taxes, personal and corporate, plus the payroll tax and the estate tax. That's $2.5 trillion this year, which is no paltry sum to raise with a sales tax. But the current tax code sets such a low bar for the FairTax to clear that Boortz and Linder are able to tee off on its obvious flaws:

n Complexity and cronyism. Individuals and companies with identical incomes often owe dramatically different amounts of tax because of the credits, exemptions and deductions that litter the tax code. Lobbyists keep it that way.

n Economic waste. Economists have long believed that taxing people when they spend - not when they earn - is a better way for the government to raise money, so these "consumption taxes" like the FairTax have an economic advantage.

n Privacy. The IRS must intrude to enforce an income tax, but a payer of sales tax is anonymous.

Yet despite the dreadful status quo, there are serious criticisms of the Fair Tax. Economist William Gale at the left-leaning Brookings Institution took the lead with an assault on the published FairTax rate, 23 percent on almost all goods and services, asserting that it's unrealistically low. And from the right, President Bush's 2005 Tax Reform Commission explicitly rejected the FairTax for similar reasons.

Free-market economist Bruce Bartlett recently chimed in with an across-the-board denunciation, including an allegation that the FairTax movement was started by Scientologists.

Boortz and Linder dismiss Bartlett's claim out of hand, and they do an excellent job of skewering Rudy Giuliani's claim that we should preserve the income tax for the sake of its most popular loophole, the mortgage interest deduction.

To the common charge that people could easily evade the FairTax, Boortz and Linder say that large retailers would go along: "In America, 3.6 percent of all companies - 92,334 firms - collectively make 85.7 percent of all sales. It's more important for the owners of those companies to stay in business and out of jail than it is to help you avoid paying the FairTax."

Boortz and Linder, though, spend the bulk of the book rebutting charges that the FairTax would shift the tax burden down the income scale. The reading gets more academic here, as the authors lean heavily on the writings of Boston University economist Lawrence Kotlikoff, the FairTax's most prominent academic defender.

Would the FairTax hurt the poor by taking away income tax credits? No, Boortz and Linder brag, the FairTax system is better for the poor because it includes a monthly check for all expenses up to the poverty level, which they call a "prebate."

Won't taxing services fail, as it has in some states? Isn't it nonsensical to tax government purchases? Won't the "prebate" be a massive, corrupt government check-writing program?

The criticisms are numerous, and some of the answers are too glib. But the need for fundamental tax reform is undeniable, and the FairTaxers are committed to this worthy cause. If Huckabee's star continues to ascend, we're all going to need to know a little about the fundamental tax reform plan that he claims can turn the economy around.

William Ahern is communications director for the Tax Foundation.

State Property Tax Debates Heating Up

Tue, 01 Jan 2008 00:00:00 EST

(The following article originally appeared in the January 2008 edition of the Heartland Institute's Budget & Tax News).

With the recent rise in home values and property tax bills across the country, the property tax debate has heated up in several states.

According to a 2006 Tax Foundation poll, property taxes are the form of state and local taxation most loathed by the public. Current property tax discontent is reminiscent of the late 1970s and early 1980s, when property tax caps, including California's Proposition 13 and similar measures, were debated and passed in many states.

Three States Take Lead

Three states--Florida, Georgia, and Indiana--are leading the current push for some version of property tax reform.

Some lawmakers, including Indiana Gov. Mitch Daniels (R), are offering plans that would shift revenue collection from localities to state governments, thus moving the government entity that controls tax rates (and spending) farther from the people.

Daniels and his Commission on State Tax and Financing Policy are looking at both short- and long-term fixes to the state's property tax dilemma. Their plan, released in late October, would cap the residential property tax at 1 percent of assessed value and business properties at 3 percent by 2009. The plan also adds a homestead deduction of 35 percent in 2009, shifts some school costs to the state, and replaces elected township and county assessors with an appointed assessor in each county.

Although Daniels' plan would limit growth in local spending in accordance with a county's average personal income over a six-year period, it would also raise the state's sales tax from 6 to 7 percent.

House Speaker Pat Bauer (D-South Bend) worries an increase in the sales tax may hurt middle-income families and the poor. He told Indianapolis News 6 TV, "The big question whenever you increase a tax like sales tax is who wins and who loses." Nonetheless, Democrats in the state appear cautiously supportive of Daniels' plan.

Some Want Tax Abolished

Some policy advocates are going further than Daniels, calling for outright abolition of Indiana's property tax. Daniels has said he will not support eliminating property taxes because doing so would necessitate a large increase in income taxes.

Gerald Prante, an economist at the Tax Foundation, says eliminating the property tax would endanger the state's fiscal health. "While abolishing the property tax may sound good, if you want to reduce taxes you have to reduce spending," Prante said. "Unless spending is cut, eliminating the property tax will merely shift the tax burden onto some other tax, which may be worse than the property tax."

Prante added, "Furthermore, eliminating the property tax, which is relied upon by local governments, will transfer power to the state government on the issue of taxation, thereby reducing or even eliminating tax competition within the state, as well as reducing the chances that one's voice will be effective in changing tax policy."

Georgia May Dismantle Tax

Georgia, too, is considering legislation to dismantle the property tax system in the state.

Glenn Richardson (R-Hiram), speaker of the House, has proposed the GREAT (Georgia's Repeal of Every Ad Valorem Tax) Plan, a constitutional amendment under which property taxes would be replaced by extending the current 4 percent sales tax to services and by eliminating all sales tax exemptions.

The plan is projected to generate the same amount of revenue as the property tax, but the revenue would be remitted to the state and not directly to local governments. Richardson notes on the GREAT Plan's Web site, "It is not our intent to cut taxes, but rather, to reform the system of taxation in Georgia."

Because the plan is proposed as a constitutional amendment, it requires a two-thirds vote of the General Assembly and approval by the state's voters in a ballot measure.

Local officials have opposed the plan. "Decisions should be made at home, not at the Dome," Dr. Steve Smith, Lowndes County Schools superintendent, told the Valdosta Daily Times. "The state will be the financial winner and the local government will be the loser because the power will be given to Atlanta," he warned.

Florida Voters Have Say

In late October, Florida lawmakers passed a reform plan that will be on the January ballot for voters to approve.

The measure would double the $25,000 homestead exemption to $50,000, allow more portability of tax cap savings under the Save Our Homes initiative, and impose a 10 percent cap on assessments for non-homestead property. The plan is expected to save the average homeowner about $240 a year.

A proposal that would have eliminated property tax payments for lower-income senior citizens was dropped from the final plan by the Senate. Because Florida does not have an income tax, revenue at the state level may be made up by a sales tax increase, unless there is a decrease in spending.

Florida Tax Watch, a nonpartisan research group, said the plan does not cut taxes and therefore is not "true tax reform." In a statement on its Web site, the group notes, "heaping savings on homesteaders may naturally disincentive them from participating to try to keep local government spending under control."

Policy analysts largely agree that when control of taxation and spending is shifted from localities to the state, localities have less influence. To cut property taxes effectively, spending must be curbed as well, they say. Otherwise, the revenue is likely to be recouped through another form of taxation, and likely one that is not as visible to voters.

Tax Foundation's Wish List for Tax Policy in 2008

Thu, 27 Dec 2007 00:00:00 EST

The Tax Foundation staff has released its wish list for tax policy in the new year. Since 2008 is an election year in which a predicted economic slowdown could put pressure on some government budgets, reporters and politicians are likely to give the public a double dose of tax policy.

Special interests will, as always, push tax policies that favor themselves at the expense of other taxpayers. Social engineers will continue pushing tax policies that redistribute money based upon health, age, income, and other demographics. And finally, gimmicks like tax holidays and tiny, overhyped tax cuts will be featured in legislatures and political campaigns. Champions of sound tax policy like yours truly at the Tax Foundation will view all these policies with a skeptical eye.

Our Wish List for Tax Policy in 2008

1. Politicians will stop playing word games, and call taxes "taxes" and not "fees," "surcharges," or "profits." Any assessment that raises money in excess of what is needed to defray costs is a tax.

2. Politicians will stop using the tax code to give even more preferential treatment to sectors like housing and healthcare that are already tax-pampered. This includes using the tax code as a bailout for homeowners.

3. Elected officials in state governments seeking to give property tax relief to homeowners will not do so merely by shifting to some other source of tax revenue like sales or income (which usually ends up as a tax increase) or by shifting it all to commercial property owners.

4. Members of Congress will finally realize that two oceans can't protect us from the tax competition sweeping the rest of the world. China is now the latest country to cut its corporate tax rate.

5. Politicians will stop raising taxes on arbitrarily targeted items like cigarettes, alcohol, bottled water, soda, tasty food, adult entertainment, gambling, etc. just because they want to raise revenue for some government program that is supposed to provide broad public benefits.

6. State officials will stop obstructing our national market by attempting to export taxes to "out-of-staters." States should attract investment with pro-growth policies, not by protectionist penalties on the productive.

7. At least one of the states that have recently considered lottery privatization will go through with a sale (not a lease!). That will reverse the domino effect of state governments going into the business of promoting gambling.

8. States will eliminate gimmicks like sales tax holidays and instead lower sales tax rates for the entire year.

9. TaxReformPanel.gov and TaxFoundation.org will be the most visited web sites of 2008, and our ultimate wish...

10. Congress will avoid another AMT ping-pong match in late 2008, instead acting in the public interest by passing fundamental tax reform that merges the good features of the AMT (a broader tax base and lower tax rates) into the regular tax code.

Don't Assume the U.S. Supreme Court Accepts Economic Nexus

Mon, 17 Dec 2007 00:00:00 EST

(The following article originally appeared in the December 17, 2007 edition of State Tax Notes).

To the Editor:

Andrew W. Swain and John D. Snethen suggest that the U.S. Supreme Court's refusal to hear four economic nexus appeals indicates that the Court "remains content to allow the states to develop...economic nexus."[i]

This conclusion is unwarranted. The Supreme Court receives over 7,000 appeals per year, and hears less than 100. This does not mean that the Court approves of the lower court ruling in 98.5% of cases appealed, but simply that they don't have the time to consider all of them. The Court itself has put it best: "The denial of a writ of certiorari imports no expression of opinion upon the merits of the case, as the bar has been told many times."[ii] The Court later explained further:

We have repeatedly indicated that a denial of certiorari means only that, for one reason or another which is seldom disclosed, and not infrequently for conflicting reasons which may have nothing to do with the merits and certainly may have nothing to do with any view of the merits taken by a majority of the Court, there were not four members of the Court who thought the case should be heard.[iii]

Further, the real problem may be that the Supreme Court often does not get fired up about tax cases. Paul Caron, now editor of TaxProf Blog, has summarized this:

The view that tax law is less interesting or important than other areas of law pervades even the Supreme Court. For example, one proffered explanation for Justice Marshall's productivity in the tax field is that the conservative Chief Justices under whom he served refused to assign him more important cases: "Justice Marshall was forced to write on federal income tax because he was given nothing better to do." Other members of the Court apparently share this view of tax law. For example, when asked why he sings along with the Chief Justice at the Court's annual Christmas party, Justice Souter replied, "I have to. Otherwise I get all the tax cases."[iv]

Quill held that the states cannot impose sales tax collection and compliance burdens on an out-of-state business merely for having customers in the state. Swain and Snethen applaud recent state moves to tax "income" (measured entirely by sales in-state, so really a tax on sales) on businesses with no property or employees in the state, and who pay taxes to other states where they are located. It's exactly the same as Quill-states attempting to damage interstate commerce as they pursue their own parochial interest. Such a formalistic tweak does not remedy the serious constitutional problem.[v]

Because there is real uncertainty out there as states embrace economic nexus and other schemes to boost tax revenues at the expense of our national economy, I hope the Supreme Court does reconsider its recent denials of certiorari in future nexus cases. But Swain, Snethen, state revenue departments, and other advocates of economic nexus are celebrating a bit prematurely if they treat silence as an endorsement.

Joseph Henchman

Joseph Henchman is Tax Counsel at the Tax Foundation, Washington.

[i] Andrew W. Swain and John D. Snethen, Paying Their Fair Share: The Hidden Lesson of Complete Auto and Quill, 46 State Tax Notes 749 (Dec. 10, 2007), at http://services.taxanalysts.com/taxbase/tbnews.nsf/Go?OpenAgent&2007+STT+238-2.

[ii] United States v. Carver, 260 U.S. 482, 490 (1923).

[iii] Brown v. Allen, 344 U.S. 443, 491-92 (1953).

[iv] Paul L. Caron, Tax Myopia, or Mamas Don't Let Your Babies Grow Up to Be Tax Lawyers, 13 Va. Tax. Rev. 517, 525 (1994).

[v] See generally Joseph D. Henchman, Why the Quill Physical Presence Rule Shouldn't Go the Way of Personal Jurisdiction, 46 State Tax Notes 387 (Nov. 5, 2007), at http://services.taxanalysts.com/taxbase/tbnews.nsf/Go?OpenAgent&2007+STT+215-4.