Tax Foundation - Publications > Overview

How Much Does President Obamas Budget Redistribute Income?

Thu, 25 Jun 2009 00:00:00 EDT

Special Report No. 168

Key Findings:

• Families' share of tax burdens is compared to their share of government benefits, by income class, yielding a comprehensive measure of income redistribution. Customarily, only tax burdens are analyzed by income class. We apply this framework to President Obama's Fiscal Year 2010 Budget released in May.

• In FY 2012, when President Obama's policies have taken effect, income redistribution from the top-earning 1 percent of families will rise by an average of $64,000 per family. Families in the 95th-99th percentiles would pay slightly more, almost $2,000 per family.

• On average, a family in the top 5 percent would have an additional 1.8 percent of its market income redistributed as a result of President Obama's policies (compared to baseline); for the top 1 percent only, that figure is over 3 percent.

• President Obama's policies would reduce the amount of income redistribution from families in the 60th-95th percentiles.

• President Obama's policies would increase the amount of income redistribution to families in the bottom 60 percent of the population, especially the bottom 20 percent.

Introduction

Throughout last year's presidential campaign and continuing through President Obama's first two quarters in office, income redistribution has been a hot-button topic among policymakers, the media, and the general public. The issue was explicitly brought to the forefront of the campaign debate during the now infamous exchange between then-candidate Obama and "Joe the Plumber," who asked why the candidate wanted to tax people like him who own a business that makes $250,000. Obama replied, "... I think when you spread the wealth around, it's good for everybody."

How much should the nation's tax and spending programs move money down the income scale? Unfortunately, the basic questions needed to inform that debate have not been answered: "How much are we actually redistributing right now?" and "How would President Obama's proposals change the amount of redistribution?"

Answering those questions is the purpose of the Tax Foundation's fiscal incidence project, whose initial products are this Special Report and the accompanying working paper. Here we focus on 2012 because that is the first fiscal year (Oct. 1, 2011 - Sept. 30, 2012) during which the full Obama policy agenda is scheduled to be in effect, including his treatment of the expiring Bush tax cuts. That is also the first year in which Obama wants significant tax revenue deposited into his proposed health reform reserve fund. It is also when his climate revenues proposal kicks in. The projected budget deficit for FY 2012 is large, $557 billion, but it is actually much smaller than what the administration's budget predicts for fiscal years 2009 and 2010, both of which exceed $1 trillion.

In the matter of income redistribution, we conclude that President Obama's proposed budget lives up to his campaign promise to collect more tax revenue from high-income people and redistribute it down the income spectrum—what he would call a more even distribution of the economic pie.

On the paying end, we find that during FY 2012, if the new budget's policies are enacted, the amount redistributed from the top-earning one percent of U.S. families will increase by $64,000 per family up to a total of $432,000 per family. That is up from $368,000 per family, the redistribution that would prevail in 2012 even if none of Obama's major new initiatives were enacted. The upper-income families in the 95th through the 99th percentile of earners will lose only slightly more of their income. The large swath of so-called upper-middle-income families, those in the 60th through the 95th percentiles, will continue to have their income redistributed to other families lower on the income spectrum, but Obama's policies will actually decrease the amount they lose.

On the receiving end, Obama's policies will redistribute more income to families in the bottom 60 percent of the income spectrum, with most going to the bottom 20 percent, approximately $1,000 per family. Income redistribution to families in the 40th-60th percentiles would essentially remain unchanged.

Tax Watch, Summer 2009

Tue, 23 Jun 2009 00:00:00 EDT

Tax Watch is the Tax Foundation's quarterly tax policy newsletter, presenting our economic research and analysis in a simple, non-technical format—ideal for the non-economist looking for a clear explanation of current tax issues.

Highlights from the Summer 2009 issue include:

Video, Study Warn Against Obama Plan on Tax Deferral
Poll: Americans Say Taxes Complex, Need Reform
Cap and Trade: What Would Climate Policy Cost Americans?
Hawaii Adopts "Millionaire's Tax"

Click here for a free subscription to Tax Watch.

Illinois Tax Plan Would Sacrifice Its Only Tax Advantage Over Other States

Tue, 23 Jun 2009 00:00:00 EDT

News Release

Excellent Personal Income Tax Would Lose Some of Its Luster; New Corporate Income Tax Rate Would Rank Fourth Highest in Nation, Hurting Wages

Washington, DC, June 23, 2009 - As Illinois legislators gather in Springfield for a special session called by Governor Pat Quinn (D), a Tax Foundation expert warned that Quinn's proposal to increase individual and corporate income taxes would sharply reduce Illinois's state business tax climate ranking, moving it from the top half to the bottom half in the nation when it comes to "business-friendliness."

"Illinois has high property taxes and high sales taxes," said Tax Foundation Director of State Projects Joseph Henchman. "Currently, those taxes are partly offset by a low personal income tax. With a 50% increase in the income tax rate, Illinois legislators would give up the state's one tax climate advantage."

Quinn's plan would raise the personal income tax rate from 3% to 4.5% and the corporate income tax rate from 7.3% to 9.7%. The plan would also increase the personal exemption on the individual income tax from $2,000 to $3,000.

"Quinn's proposed new top corporate tax rate would be the fourth highest in the country, behind only Minnesota, Pennsylvania, and the District of Columbia," Henchman said.

The Tax Foundation annually produces a State Business Tax Climate Index, which measures how well a state's tax system encourages investment by maintaining a broad tax base and low rates. Based on current tax law, Illinois ranked 23rd out of 50 states for business-friendliness at the beginning of this fiscal year. With Quinn's plan in effect, Illinois's ranking would have sunk to 31st.

Henchman also criticized efforts by Illinois to claim its corporate rate is lower than it actually is.

"Illinois imposes a 4.8% corporate income tax, plus a 2.5% 'replacement tax,' for a total of 7.3%. Quinn's plan would raise that 4.8% rate to 7.2% while retaining the replacement tax, for a total rate of 9.7%," Henchman said.

"Corporate tax burdens are ultimately borne by individuals, as businesses pass these costs onto their employees, customers and shareholders," Henchman explained. "A growing body of scholarly evidence finds that increasing corporate taxes leads to depressed wages as businesses try to stay competitive. The proposed corporate tax increase would hurt Illinois's ability to attract investment and create jobs."

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

The Pine Tree State Chops Down Income Tax: Maine Enacts Major Tax Reform

Tue, 23 Jun 2009 00:00:00 EDT

Fiscal Fact No. 174

Summary
Maine passed the most sweeping changes to their tax code since the establishment of the income tax in 1969. This reform moves the state to a much flatter income tax at a highly reduced rate. The reform is revenue neutral, so the revenue loss from the reduced income tax rate will be made up for with an expanded sales tax base (i.e. more items will be subject to the sales tax). This Tax Foundation Fiscal Fact will examine the reform process and provide a critique of the newly overhauled tax system.

Background on the Reform Efforts
This reform effort was created through two different bills, LD 1088 and LD 1495. The first was under the design of the legislature in the form of LD 1088. This bill was revised at the urging of the governor and became LD 1495. It was signed into law on June 12, 2009.

LD 1088¹
LD 1088 was passed by the House on June 4th and by the Senate the next day. It was a partisan bill with only one Republican in the House voting in favor and none in the Senate. This bill had two major components: a reduction in the income tax and an expansion of the sales tax.

LD 1088 was designed to replace the income tax brackets and rates with a flat 6.5% rate. This bill amounted to a significant income tax cut of 24% for those with taxable income over $19,450. Everyone with taxable income greater than $9,700 would see a reduction in the amount of income tax owed. Additional credits were created for the two lower brackets to prevent an increase in the tax burden of filers in those brackets (see table for details on the previous rate structure).

In order to recover the funds lost through the income tax reduction, the state sales tax would be expanded to include a number of new services. These services would include activities such as entertainment and rentals. In addition to broadening the sales tax to include a number of additional services, the sales tax on prepared food and lodging would rise from 7% to 8.5%.

LD 1495²
Governor Baldacci expressed concerns with the bill, and the legislature proposed a revised bill, LD 1495. It was passed by both the House and Senate on June 11. Baldacci signed the bill into law on the following day.

The creation of a second bracket with a 6.85% tax on income greater than $250,000 through a tax surcharge is one of the major changes. These sorts of taxes on the rich have been increasingly popular in recent years. The most recent example was in Oregon, where the legislature established an additional tax bracket of 11% for individuals earning over $250,000. Maine's 6.85% seems more palatable in contrast, but still results in a more complex tax code.

Table 1
Income Tax Rate Comparison between LD1088 and LD1495

Before Reform		LD 1088		LD 1495
Rate	Income	Rate	Income	Rate	Income
2.0%	>$0	6.5%	>$0	6.5%	>$0
4.5%	>$4,850			6.85%	>$250,000
7.0%	>$9,700
8.5%	>$19,450

Additionally a number of entertainment services were removed from the taxed list including skiing, swimming, bowling and golf. An earned income tax credit was added for low-income families while a transfer tax for homes over $500,000 was eliminated.

In Praise of the Reform
The reform effort has a number of appealing qualities that are worth highlighting here.

One of the principles of sound tax policy is neutrality: decreasing the number and size of tax credits and exclusions makes the tax system more neutral. LD 1088 is a partial attempt to do just that. Expanding the sales tax to cover services allows the rates to be lowered in other areas—in this case, income. LD 1495, although retaining this general idea, creates a number of additional exceptions and exclusions.

This reform also aims to stabilize tax revenue. The revenue from income taxes is known to be correlated with the ebbs and flows of the economy. This means that the state can experience high levels of revenue fluctuation with economic booms and busts. Broadening the sales tax base and lessening the reliance on income tax will lead to greater tax revenue stability.

The reform is scheduled to take effect on January 1, 2010. This means that individuals will be able to plan for the effects of the tax. This helps to ensure the stability of contracts and transactions.

Criticism of the Reform
The reform has a number of downsides that need to be considered as well.

New Hampshire is a famously low-tax state, with no tax on general sales. By extending its sales tax to previously untaxed services, Maine would improve the fairness and efficiency of its own sales tax, but it would also lengthen the list of services that are less expensive in New Hampshire.

Maine is attempting to shift some of the tax burden off their citizens and onto out-of-state residents. The list of newly taxed services include numerous items specifically designed to disproportionately tax "out-of-staters" such as rentals, entertainment and recreation services. (Not that Mainers never purchase these products.) This tax-your-neighbor strategy is likely to draw retaliation from neighboring states and distort economic decision making. The most egregious example of taxing the tourist is the raising of rates on lodging and prepared food from 7% to 8.5%.

Additionally, the statutory 6.5% rate does not represent the full effect of all the new tax provisions. Many Maine families would lose part of fthe new credit and so their effective marginal tax rate would be 8%³, still better than the status quo but not as big an improvement as it seems.

The current bill is being touted as revenue neutral by its proponents. There is a concern that the services targeted for the sales tax will recover faster than the rest of the economy. As these services recover they will produce greater tax revenue.

Moving Forward
The Maine legislature has attempted broad and far-reaching reform of their tax system. Ultimately the reform effort is a positive step forward. It would have been better if LD 1088 had been enacted into law instead of LD 1495. However, both represent an attempt to simplify and stabilize the Maine tax system. LD 1495 loses some of the simplicity of the flat tax and creates specific exemptions for certain industries. This represents partial failure to broaden the base and lower the rate.

The Maine legislature should remain focused on creating a tax code that pushes for simplicity, neutrality and stability. Whether this marks the beginning of larger tide of beneficial tax reform or the high watermark is yet to be seen.

Notes

1.http://www.mainelegislature.org/legis/bills/bills_124th/billpdfs/HP075001.pdf.

2. http://www.mainelegislature.org/legis/bills/bills_124th/billpdfs/HP105101.pdf.

3. J. Scott Moody, "LD 1088: The Illusion of Tax Reform" Path to Prosperity 7, April 16, 2009.

Justice Souters Tax Opinions Show Steady Erosion of Respect for Commerce Clause

Wed, 03 Jun 2009 00:00:00 EDT

Fiscal Fact No. 173

Retiring U.S. Supreme Court Justice David Souter will be remembered for many things: being President George H.W. Bush's "stealth nominee," a propensity to dissent, and his controversial deciding vote to approve the use of eminent domain for private purposes in Kelo v. City of New London. In cases involving taxation Justice Souter will be remembered for his antipathy. When asked why he sang along with the late Chief Justice William Rehnquist at the Court's annual Christmas party, he responded, "I have to. Otherwise I get all the tax cases."¹ It is not surprising, then, that Justice Souter's contribution to tax jurisprudence is not as significant as those of his colleagues. However, as he leaves the bench it is worth reflecting on his votes and opinions in key tax cases.

He was a frequent dissenter in other areas of the law, but in tax cases Justice Souter often sided with the majority. In West Lynn Creamery, Inc. v. Healy (1994),² Justice Souter joined a 7-2 majority holding that the dormant Commerce Clause limits the power of a state to adopt regulations that discriminate against interstate commerce. The case concerned a Massachusetts law that imposed an assessment on all milk sold by dealers to Massachusetts retailers; the proceeds were distributed to Massachusetts dairy farmers. The majority found that such "premium payments" are effectively a tax that made milk produced out of state more expensive. Although the tax also applied to milk produced in Massachusetts, its effect on Massachusetts producers was entirely offset by the subsidy provided exclusively to Massachusetts dairy farmers. In joining the majority, Justice Souter showed respect for the dormant Commerce Clause, reining in states' abilities to tax activity which had an effect beyond their borders.

Another Commerce Clause/tax case on which Souter found himself in the majority was Camps Newfound/Owatonna, Inc. v. Town of Harrison (1997).³ In that case, Justice Souter was the deciding vote in the Court's 5-4 decision, which held that a state impermissibly discriminates against interstate commerce when it "distinguishes between entities that serve a principally interstate clientele and those that primarily serve an intrastate market."⁴Thus, Maine could not have a property tax exemption for charitable organizations but deny that exemption to charities that principally serve nonresidents (in this case, out-of-state campers staying at a Maine camp site). The Court reasoned that this type of tax exemption is discriminatory and a violation of the Commerce Clause, notwithstanding the states' general authority to legislate on subjects relating to the health, life, and safety of their citizens.

After these early-career opinions in which he joined the majority in limiting a state's ability to tax, Souter seemed to shift in his approach to dormant Commerce Clause and state tax issues. The first case worth noting was Oklahoma Tax Comm'n v. Jefferson Lines,⁵ a 1995 case in which Souter wrote for the majority. The case concerned an Oklahoma sales tax on bus tickets between Oklahoma and other states. In his opinion, Souter concluded that while income taxes can be discriminatory and burden interstate commerce, a more lenient standard should apply for sales taxes. Rejecting reliance on earlier cases striking down state laws that taxed income without apportioning it by state, Souter wrote, "A sale of goods is most readily viewed as a discrete event facilitated by the laws and amenities of the place of sale, and the transaction itself does not readily reveal the extent to which completed or anticipated interstate activity affects the value on which a buyer is taxed."⁶ In other words, because sales occur in one state and are unconnected to interstate commerce, there can be no such thing as a sales tax that burdens interstate commerce.

He went on: "We have therefore consistently approved taxation of sales without any division of the tax base among different States, and have instead held such taxes properly measurable by the gross charge for the purchase, regardless of any activity outside the taxing jurisdiction that might have preceded the sale or might occur in the future."⁷

In concluding that a sales tax cannot burden interstate commerce, Souter seemingly ignored the sales that occur across state lines, from mail orders to cross-country deals to Internet purchases. Congress subsequently overruled the Court's decision with the enactment of section 14505 of the Interstate Commerce Commission Termination Act (ICCTA), which prevents states from collecting or levying taxes on bus fares for interstate travel.

Two years later, Souter again sided with state taxing power in General Motors Corp. v. Tracy.⁸ Writing for the majority, he found that Ohio's differential tax treatment of regulated and unregulated sellers of natural gas did not violate either the Commerce Clause or the Equal Protection Clause. He wrote, "We conclude that Ohio's regulatory response to the needs of the local natural gas market has resulted in a noncompetitive bundled gas product that distinguishes its regulated sellers from independent marketers to the point that the enterprises should not be considered 'similarly situated' for purposes of a claim of facial discrimination under the Commerce Clause."⁹ In other words, the two types of sellers are so different as to be incomparable for discrimination purposes. It is as if a judge ruled that an employer showing favoritism to one group of employees is not guilty of favoritism because the employees were so different that they could not be compared. Had a traditional Commerce Clause analysis been employed, the tax would have been invalidated for taxing out-of-state sellers while not taxing in-state sellers. However, Souter (as well as seven other members of the Court) saw two different markets: an unregulated market in which GMC made its purchases, and a regulated market where the individual consumer is buying.

Souter's most recent, and perhaps last, state tax case came in Department of Revenue of Kentucky v. Davis.¹⁰The Tax Foundation had filed an amicus brief supporting the Davises, but the Court supported Kentucky in a 7-2 decision written by Souter. Kentucky, like most other states, exempts from its income tax the interest earned on Kentucky state and local municipal bonds, but interest earned on other states' bonds is taxable. The practice was challenged in Kentucky state court, and the Kentucky Court of Appeals ruled that the practice discriminated against interstate commerce.

The Supreme Court reversed, with Justice Souter's opinion straying once more from a line of Commerce Clause cases that permitted states to encourage in-state investment but prohibited them from creating laws that punished out-of-state investment. Souter confused the state's role in setting interest rates on its bonds with its role of granting the tax exclusion, strangely writing that the state was acting as a "market participant" like any other bond issuer. "[T]here is no forbidden discrimination because Kentucky, as a public entity, does not have to treat itself as being 'substantially similar' to the other bond issuers in the market," the majority opinion read.¹¹ On the contrary, as we wrote at the time, Kentucky's simultaneous taxation of out-of-state activity and exemption of identical in-state activity protected its economic policies from interstate competition, creating an unconstitutional "exit toll," not a permissible welcome mat.

Over the course of his 19 years on the Supreme Court, Justice Souter has been accused of transforming from a moderate "conservative" to a reliable "liberal" vote. Insofar as his views on discriminatory taxes go, there has been a shift. A justice who was once eager to question states' protectionist use of their taxing authority (to the detriment of the national market) has become over time a justice willing to twist the precedents to uphold such laws. Having begun on one side of the issue, Justice Souter will retire on the opposite side.

Notes

1. 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).

2. 512 U.S. 186 (1994).

3. 520 U.S. 564 (1997).

4. Id. at 576.

5. 514 U.S. 175 (1995).

6. Id. at 176.

7. Id. at 186.

8. 519 U.S. 278 (1997).

9. Id. at 310.

10. 128 S.Ct. 1801.

11. Id. at 1803.

New Jerseys Gubernatorial Race, Part II: Governor Corzines Challengers Call for Lowering Tax Burdens

Wed, 27 May 2009 00:00:00 EDT

Fiscal Fact No. 172

(See Fiscal Fact No. 171 for a discussion of Gov. Corzine's proposals and New Jersey's current economic crisis.)

Lonegan and Christie Debate Income Tax Cuts
The two major candidates for New Jersey's Republican gubernatorial nomination are former U.S. Attorney Chris Christie and former Bogota, New Jersey, Mayor Steve Lonegan. Polls show a close race between the two, and between each challenger and current governor Jon Corzine (D). Both Christie and Lonegan have made taxes a centerpiece of their platforms.

Lonegan's more defined tax proposal centers on a flat income tax rate with no exemptions or deductions at a rate of 2.9% beginning with the first dollar, falling to 2.5% in the second year, and 2.1% in the third year. Lonegan argues that the economic growth induced by the sharp cut in income tax and elimination of distortive tax preferences will enable revenues to remain stable after the first year even as the rate drops.

A flat income tax of the type Lonegan proposes is ambitious but attainable. Nine states have flat income taxes: Colorado, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, Pennsylvania, Tennessee, and Utah. However, all of these states either incorporate some federal deductions by having state taxpayers use adjusted gross income or taxable income from the federal form, or provide a standard deduction or personal exemption. Both would have the effect of shielding some low-income individuals from paying income tax, providing all taxpayers with a minimal tax reduction, and making the system mildly progressive.

Lonegan's flat tax proposal is precisely that: flat in rate, in progressivity, and in the scope of things subject to taxation. On one hand, not offering a basic threshold below which one does not owe income tax could hurt poor workers disproportionately compared to the current tax system. Christie argues that 70% of households would pay increased income tax under Lonegan's flat tax plan. It is probably true that taxpayers currently in the bottom two tax brackets would pay more under the proposal, since Lonegan's flat rate exceeds the rates they currently pay (if they pay anything at all). Lonegan also states that the dramatic tax cut would produce long-term economic benefits that would exceed those costs.

Lonegan has also targeted the problematic Abbott ruling of the New Jersey Supreme Court, whereby the state is mandated to increase education funding under a dubious constitutional rationale. The Tax Foundation reviewed Abbott and other cases like it across the United States and estimated the tax impacts of the spending mandates, in its publication Appropriation by Litigation.[1]

Table 1: Lonegan Flat Tax Idea Similar but not Identical to Existing State Flat Taxes

State	Flat Tax Rate	Notes
Lonegan Plan: New Jersey	2.90%	No deductions; tax applies on first dollar earned
Colorado	4.63%	Piggybacks on federal deductions by applying rate to federal taxable income
Illinois	3.00%	$2,000 personal exemption; piggybacks on some federal deductions by applying rate to federal adjusted gross income with modifications
Indiana	3.40%	$1,000 personal exemption; piggybacks on some federal deductions by applying rate to federal adjusted gross income with modifications
Massachusetts	5.30%	$4,400 personal exemption; higher rate applies to some earned investment income
Michigan	4.35%	$1,000 personal exemption; piggybacks on some federal deductions by applying rate to federal adjusted gross income with modifications
New Hampshire	5.00%	$2,400 standard deduction; tax applies to interest and dividend income only
Tennessee	6.00%	$1,250 personal exemption; tax applies to interest and dividend income only
Utah	5.00%	$2,625 personal exemption

Christie has been less definite about his tax proposal, but has emphasized that it would involve an across-the-board cut to all state taxpayers, and that it would retain many of the targeted tax credits that Lonegan's plan eliminates. (Christie has also noted that the timing of the cuts is dependent on the state's revenue situation.) Christie has also called for the reduction of New Jersey's corporate income tax, which at a top rate of 9.36% is one of the highest in the country.

The corporate tax cut would be an important move for New Jersey's competitiveness. In Fiscal Year 2007, New Jersey raised $332 per capita in corporate income taxes, behind only Alaska, New Hampshire, and Delaware. (Each of those states does not have one of the major taxes.) However, Christie's reliance on both tax cuts and tax incentives (credits or subsidies) as a way of encouraging business is in stark contrast to Lonegan's view that such incentives should be eliminated in favor of broad tax cuts.

A state that faces economic decline and an exodus of population has two choices. One is to ramp up state spending on education and infrastructure and offer targeted tax incentives for selected industries, and hope that these inducements will lure people back. All state governments do this to some extent, notwithstanding the risk. At best, however, these investments will take decades to pay off. At worst, the fate of Michigan could become more common: people take their degrees from the excellent state schools and use the excellent roads to drive to other states where there are jobs.

The other choice is to reduce reliance on burdensome and volatile revenue sources, prioritize state services and pare back on the non-essential, and set out a welcome mat of a simple, transparent, neutral, and stable state tax system for all. If tax increases have to occur, states should structure them in a way that spreads the burden and addresses spending growth.

Finally, both Lonegan and Christie support requiring a two-thirds vote by the legislature to increase taxes. And both candidates have referred to Tax Freedom Day, the day of the year when Americans have earned enough to pay taxes and can start working for themselves. Tax Freedom Day is calculated annually by the Tax Foundation for the nation as a whole and for each state. New Jersey's Tax Freedom Day this year fell on April 29, 16 days after the national Tax Freedom Day and second-to-last in the country.

Conclusion
New Jersey is facing a crisis in its state budget, tax system, and the economy as a whole. It is thus surprising to see significantly different approaches to addressing New Jersey's economic performance. Governor Corzine has proposed deferring some expenses, limiting eligibility for a troubling property tax rebate program, and hiking taxes on high-income earners. New Jersey was an early adopter of such a "millionaires' tax" several years ago, and its budget situation is now worse than that of other states.

Chris Christie and Steve Lonegan both aim to cut taxes, although Christie would preserve the bracket progressivity and the array of credits and deductions. Lonegan, while eliminating them, would create the nation's first completely flat tax (although several states have flat taxes with a standard deduction or personal exemption) and the one with the lowest rate. Christie would cut the state's high corporate income tax but also rely on tax incentives to spur development and employment, a policy that New Jersey has tried for years and that has not worked in other states. Lonegan, on the other hand, hopes that favorable tax policy would be sufficient to bring jobs and business back.

Both plans are serious and attainable, with strengths and flaws. For those who deny that high tax rates and heavy tax burdens lead to a bad economy, one need only look at New Jersey. It remains to be seen which plan New Jersey residents think will make the Garden State bloom again.

[1] See Chris Atkins, "Appropriation by Litigation: Estimating the Cost of Judicial Mandates for State and Local Education Spending," Tax Foundation Background Paper No. 55 (Jul. 2007), at http://www.taxfoundation.org/research/show/22505.html

New Jerseys Gubernatorial Race, Part I: Governor Corzine Proposes 10.75% Income Tax Rate

Wed, 27 May 2009 00:00:00 EDT

Fiscal Fact No. 171

(See Fiscal Fact No. 172 for a discussion of Corzine's challengers' proposals.)

Executive Summary
As the only two states electing governors this year, New Jersey and Virginia can expect to be in the spotlight for the rest of 2009. Mirroring the national concern with revenue and spending, candidates in the New Jersey gubernatorial race are talking taxes.

Like 40 other states, New Jersey faces a mismatch between declining revenues and desired spending, and revenues have fallen faster than in other states. On May 19, the state Office of Legislative Services reported that income tax revenues are down 19% ($2.4 billion) from last year, and another $1 billion drop is expected next year. The National Conference of State Legislators (NCSL) estimated in April that New Jersey's budget shortfall is $7.1 billion for Fiscal Year 2010 out of a $29 billion general fund budget, with the shortfall continuing into Fiscal Year 2011.[1] (New Jersey officials now say that the shortfall is up to $9 billion, after income tax collection for April 2009 turned out to be 38% off.) NCSL notes, "This is the most dire fiscal situation in the state's recent history."

Fiscal policy in the Garden State reads like a "what not to do" for policymakers and stakeholders. The corporate income tax combines a high rate, onerous rules, and lavish subsidies for the politically connected. The sales tax is one of the highest in the country. The state is one of five to adopt a heavy individual income tax on high-income earners, which has reduced economic activity in the state. New Jersey residents also pay more property tax per capita than residents of any other state.

It's hard to imagine New Jersey could do much worse. The state's faltering economic performance is convincing evidence that taxes matter. Specifically, New Jersey's experience shows that complex, burdensome, opaque, and volatile taxes undermine long-term economic growth.

How New Jersey Ranks Against Other States

Table 1: New Jersey Among Highest Top Income Tax Rates
(excludes states that permit deduction of federal income tax)

Rank	State	Top Income Tax Rate
1	Hawaii	11.0%
2	California	10.55%
3	Rhode Island	9.9%
4	Vermont	9.5%
5	New Jersey	8.97%
5	New York	8.97%
7	Maine	8.5%

Table 2: New Jersey Has Highest 2008 State-Local Tax Burden in U.S.

Rank	State	State-Local Tax Burden
1	New Jersey	11.8%
2	New York	11.7%
3	Connecticut	11.1%
4	Maryland	10.8%
5	Hawaii	10.6%
6	California	10.5%
7	Ohio	10.4%
8	Vermont	10.3%
9	Wisconsin	10.2%
10	Rhode Island	10.2%

Source: Tax Foundation State-Local Tax Burdens, 2008
http://www.taxfoundation.org/taxdata/show/336.html

Table 3: New Jersey is Least Business-Friendly State in 2009

Overall Rank	State	Corporate Tax Rank	Individual Income Tax Rank	Sales Tax Rank	Property Tax Rank
41	Minnesota	44th	39th	40th	17th
42	Nebraska	32nd	33rd	42nd	48th
43	Vermont	31st	45th	15th	42nd
44	Iowa	46th	46th	26th	33rd
45	Maryland	14th	50th	31st	34th
46	Rhode Island	40th	42nd	30th	43rd
47	Ohio	33rd	47th	39th	46th
48	California	45th	49th	43rd	15th
49	New York	22nd	43rd	49th	45th
50	New Jersey	39th	48th	41st	50th

Source: Tax Foundation State Business Tax Climate Index, 2009, http://www.taxfoundation.org/research/show/22658.html

As the campaign heats up, each major candidate has developed a tax plan, seemingly out of recognition that taxes are a significant factor in the state's economic performance.

Governor Corzine Limits Property Tax Rebate Program, Spends Down Rainy Day Fund, and Looks Again to High-Income Earners
Due to unfunded mandates imposed by the state on several byzantine layers of local government, New Jersey property taxes are among the highest in the country. Their unpopularity has led to calls for action, and the state's response has not been to address the underlying mandates or redundancy. Instead, the state chose to shift tax revenue from local property taxes to state sales and income taxes, by offering state-level tax rebates and income tax deductions for the payment of local property taxes.

The rebate program, around since 1977 but greatly expanded under Gov. Jon Corzine (D) in 2007, has sent out $2.2 billion in checks per year. In 2008, the rebates were restricted to households that make under $150,000 per year.

Corzine proposed in March as part of his Fiscal Year 2010 budget to eliminate the income tax deduction for property taxes for all filers, except senior and disabled citizens, and scale back the property tax rebate even further to households that make under $75,000 per year. Additionally, he proposed raising the top income tax rate from the current 8.97% to 9.72%. The "double whammy" of eliminating both the property tax rebates and deductions proved unpopular, and the proposal was recently modified.

Now, Gov. Corzine's revised proposal eliminates the property tax deduction only for taxpayers who earn more than $150,000 in income, but eliminates the rebate checks for all except senior and disabled citizens (some 500,000 households would lose the rebates). However, the top income tax rate would go to 10.75%, with new 10.25% and 8% brackets as well. (See Table 4.) 61,300 filers out of 4 million would pay more, and officials estimate the income tax increases would raise $400 million. Payroll tax increases may also be a possibility.

Table 4: Gov. Corzine's Income Tax Proposal
(new brackets and rates bolded)

Income Brackets	Current Tax Rates	Corzine Proposed Tax Rates
>$0	1.40%	1.40%
>$20,000	1.75%	1.75%
>$35,000	3.50%	3.50%
>$40,000	5.525%	5.525%
>$75,000	6.37%	6.37%
>$400,000	6.37%	8.00%
>$500,000	8.97%	10.25%
>$1,000,000	8.97%	10.75%

To balance the 2009 budget, Corzine has proposed spending $450 million from the state's $700 million rainy day fund, cutting spending by $150 million in part by postponing a new preschool program, cutting $150 million in payments to the state's pension fund, and shifting approximately $450 million in expenses (including business subsidies) into the next fiscal year. A tax amnesty program is now projected to collect $200 million, twice as much as previously expected.

Some New Jersey residents endorse Corzine's decision to go after high-income earners, arguing that those who can afford to pay "a little more" should. The idea that a tax on high-income earners would save the day should not be new to New Jersey residents: just such a tax was enacted in 2004 to fix the state's budget. Following neighboring New York in June 2004, then-Governor James McGreevey signed into law the 8.97% tax rate on income over $1 million, retroactive to January 1, 2004. Since then, California, Maryland, and Hawaii have joined New York and New Jersey in imposing a new top rate near or above 10% on a small subset of high-income earners.

To evaluate Corzine's proposed rate increases, one need not even look at New Jersey's economic performance since the adoption of its "millionaires' tax" five years ago; double-digit state income taxes have been tried before and failed as fiscal policy. Through the early 1990s, several states maintained double-digit income tax rates, including California (11% until 1996) and Hawaii (10% until 1998).[2] These rates came down due to a combination of booming tax revenues from all sources, and growing expert understanding that location decisions of highly mobile entrepreneurs are sensitive to state income tax rates, particularly in the interstate context. To attract and keep good talent, create jobs and drive economic growth, legislators knew that state tax systems had to be competitive with their neighbors.

We still see elements of that today. Even in adopting its millionaires' tax, New York did not let its rate go above neighboring New Jersey's, and other states are wary of crossing the 10% psychological barrier. The California Franchise Tax Board has taken pains to deny that their 10.3% top tax rate is in the double digits, referring on their website and on tax forms to a 9.3% top rate and elsewhere noting that there is a 1% surcharge.[3](California's top income tax rate has now gone to 10.55%.)

If states are still concerned about interstate tax competition, what has really changed? The short answer is priorities. States that adopt new taxes on high-income earners are ones where policymakers are persuaded to ignore concerns about long-term economic growth in favor of a short-term budget fix that avoids deep spending cuts. In New Jersey, while the new millionaires' tax raised revenue for the state and helped reduce a budget shortfall, it also reduced the state's overall economic output and harmed its ability to grow during and after the recession.[4]

This is the tradeoff that proponents of taxes on high-income earners usually fail to acknowledge. Yes, such taxes will generally raise revenue in the short term without a sudden exodus of wealthy people fleeing to the state next door. But over the medium term, the taxes will negatively impact location decisions. People expanding old businesses or creating new ones will incorporate the higher cost of doing business into their decision-making and steer clear of the state. California currently faces an enormous brain drain of dynamic individuals after five years of double-digit income taxes, and it seems that New Jersey may now be seeing the evidence of a brain drain from its millionaires' tax. Hawaii has long been accused of chasing out its best and brightest, and it can only be exacerbating that problem with its new top tax rates.[5]

Conclusion

Most Americans gripe about property taxes, but New Jersey residents genuinely have a broken property tax system. But unless spending and mandates are addressed, the rebate programs and deductions just shift the same tax burden. At some point, even the popularity of the rebate checks may be undermined as more and more people are excluded from the program. Preserving the program by raising tax burdens on the New Jersey residents most needed for economic recovery is short-sighted.

Governor Corzine has proposed deferring some expenses, limiting eligibility for a troubling property tax rebate program, and hiking taxes on high-income earners. New Jersey was an early adopter of such a "millionaires' tax" several years ago, and its budget situation is now worse than that of other states. For those who deny that high tax rates and heavy tax burdens lead to a bad economy, one need only look at New Jersey. It remains to be seen which plan New Jersey residents think will make the Garden State bloom again.

Notes

[1] National Conference of State Legislatures, State Budget Update: April 2009, at http://www.ncsl.org/bookstore/productDetail.htm?prodid=0151010159pdf.

[2] Some states had double-digit income tax rates since the 1990s but also permit deduction of federal taxes from the state income tax. In these states (such as Montana in the 1990s and Iowa today), the high marginal tax rate on personal income is not immediately comparable to other states because of deductibility.

[3] See William Ahern, "California Legislators Push for More Double-Digit Income Tax Rates," Tax Foundation Fiscal Fact No. 134 (Jul. 14, 2008), at http://www.taxfoundation.org/research/show/23370.html.

[4] See Gerald Prante, "Did People Flee New Jersey After 2004 Income Tax Hike?," Tax Foundation Tax Policy Blog (Apr. 14, 2009), at http://www.taxfoundation.org/blog/show/24618.html.

[5] See, e.g., "Brain Drain has Many Casualties" Honolulu Star Bulletin, April 16, 1999, available at http://archives.starbulletin.com/specials/braindrain.html; University of Hawaii at Mānoa, Alumni Outcomes Survey 2003 available at http://www.hawaii.edu/offices/app/opp/alumni/alumni03.pdf (finding that more graduates are moving out of state); University of Hawaii at Mānoa, Discussion Brief, 2008-4 v.4 available at http://vcafo.org/support_bulletin/2008-4.pdf (finding that large percentages of public school graduates leave the state).

A Golden Opportunity: Californias Budget Crisis Offers a Chance to Fix a Broken Tax System

Mon, 18 May 2009 00:00:00 EDT

Fiscal Fact No. 170

Executive Summary
On May 19, Californians will go to the polls to vote on six statewide ballot propositions related to the state's budget problems. The headline initiative is Proposition 1A, which will extend a series of tax increases due to expire in 2010 and institute a rainy day fund.

No one observing California's fiscal situation has suggested that its enormous short-term budget deficit results from a reluctance to tax. Rather, it is a result of trying to keep spending commitments that were based on naïve assumptions about tax revenue growth from the boom. Ultimately California will need to reprioritize those commitments. The tax increases in Proposition 1A can be viewed as buying time for this reprioritization, or more likely, they can be viewed as buying time to put off the hard choices.

These tax increases are on top of what were already high taxes, especially for the individual income tax, corporate income tax, and sales tax. The high rates and collections from these taxes harm California's long-term competitiveness and economic growth. With respect to the so-called millionaires' tax on individuals, the idea of paying for broadly available public services through disproportionate taxes on high-income earners raises serious equity questions. More pragmatically, such taxes are highly volatile and contribute to the boom-and-bust cycle of California's state budget.

Policymakers and stakeholders in California and other states considering reform of their tax systems should raise these concerns and resist efforts to substitute damaging short-term fixes for real long-term, pro-growth tax reform.

California Faces Extension of Increases in Income, Sales, and Car Taxes
The tax increases in question are:

Personal Income Tax. The budget agreement tacked on an additional 0.25% to each bracket, retroactive to January 1, 2009 and expiring on December 31, 2010.¹ If Proposition 1A passes, the increase will be extended two years until December 31, 2012.

Table 1 California Personal Income Tax Table, Singles
Bracket	Previous Rate	Rate Effective January 1, 2009
>$0	1%	1.25%
>$7,168	2%	2.25%
>$16,994	4%	4.25%
>$26,821	6%	6.25%
>$37,233	8%	8.25%
>$47,055	9.3%	9.55%
>$1,000,000	10.3%	10.55%

Sales Tax. The budget agreement included a 1% increase in the state sales tax, effective April 1, 2009 and due to expire on June 30, 2011. If Proposition 1A passes, the increase will be extended one year until June 30, 2012.

Table 2 California Sales Tax (State and Key Cities)
City	Previous Rate	Rate Effective April 1, 2009
(State Base)	7.25%	8.25%
Los Angeles	8.75%	9.75%
San Diego	7.75%	8.75%
San Jose	8.25%	9.25%
San Francisco	8.50%	9.50%
Long Beach	8.25%	9.25%
Fresno	7.975%	8.975%
Sacramento	7.75%	8.75%
Oakland	8.75%	9.75%
Santa Ana	7.75%	8.75%
Anaheim	7.75%	8.75%
Bakersfield	7.25%	8.25%
Riverside	7.75%	8.75%
South Gate	9.75%	10.75%

Car Tax. The budget agreement raised the vehicle license tax back to where it was prior to the 2003 recall election, from 0.65% to 1.15%, beginning May 19, 2009 and due to expire on June 30, 2011. If Proposition 1A passes, the increase will be extended two years until June 30, 2013.

Table 3: California Vehicle License Tax	Current Rate	New Rate
Statewide	0.65%	1.15%

Note: An earlier proposal to increase the state gasoline tax did not meet legislative approval. The state gas tax rate remains unchanged at 18 cents per gallon.

These tax increases are estimated to raise $10 billion, with the extensions from Proposition 1A generating a further $6 billion. California has been struggling to close a $40 billion budget gap between desired spending and expected revenues in its $92 billion 2009-10 budget.

California's Budget Has Grown at an Unsustainable Level
As we detailed in our state budgets report in February, California has been the worst offender of relying on volatile tax revenues that soar excessively in boom times but sour excessively in recessions.² Compounding this instability is California's decision to ratchet up spending to match boom-time revenue growth, resulting in a spending trend line that is ultimately unsustainable.

For example, in 2000, 15% of California's budget came from state income taxes on capital gains, in retrospect an unsustainable proportion. (It was in February 2000 that hopeful officials projected a $6 billion state budget surplus, the last time the state's budget was balanced without resort to borrowing or accounting tricks.) Because California heavily taxes high-income earners, and because high-income earners have incomes that are more volatile than incomes of other individuals, revenue growth from this source is heavily exaggerated. The figure below, reproduced from our state budgets report, illustrates the volatility of some revenue sources over more stable ones (like sales and gasoline taxes).

Figure 1
Unstable Revenue Sources in California's Budget over Time

Since 2000, year-over-year growth in capital gains income tax revenue ranged from minus 56.6% to plus 60.5%; year-over-year growth in corporate income tax revenue ranged from minus 22.7% to plus 27.6%. The new income tax bracket on those earning more than $1 million (enacted by proposition in 2004 effective January 1, 2005) is following a similar pattern, with year-over-year growth since then ranging from minus 35.1% to plus 10.0%.³

These wild swings in revenue are difficult enough for budget planners trying to find ways to pay for services that steadily increase in cost. Adding to this, however, are increases in spending that accompany the temporary increases in revenues during booms. Each year between 1999 and 2003, California general fund spending ranged between $71 billion and $75 billion. Buoyed by revenues, spending grew dramatically mid-decade, and by 2007 general fund spending had reached $99 billion. This is a 31% increase over 2003, during a period in which inflation increased 12% and the state population grew just 5%.

Once increased, it is difficult to bring state spending down. For all the discussion of budget cuts, the state's budget for 2009 is projected at $92 billion, a 23% increase over 2003 when Governor Schwarzenegger took office. In running in that year's recall election, Schwarzenegger seemed to recognize spending as a key driver of the state's fiscal woes, promising to restrain spending growth to a sustainable level. Key to this has been his push to create an effective state rainy day fund.

Proposition 1A is the culmination of these efforts. To resolve the short-term budget crisis, Schwarzenegger and legislative Democrats reached an agreement whereby broad-based taxes would be increased temporarily. Down the line, in order to avoid slashing spending, voters can choose to extend the taxes, but must in return agree to the creation of a rainy day fund. (The May 19 propositions do not contain any meaningful limit on spending, aside from depositing above-average revenues into the rainy day fund, and prohibiting their use for ongoing programs.)

Californians Faced High Tax Burdens Even Before the 2009 Increases
Prior to the early 2009 tax increases, Californians already paid some of the highest state-local taxes in the United States. As reported in the 2008 edition of the Tax Foundation's State-Local Tax Burdens study, Californians paid 10.5% of their income on state-local taxes, the sixth highest burden in the country; the national average was 9.7%. That translated into a payment of $5,028 per capita in state-local taxes.

Table 4
Top 10 State-Local Tax Burdens as Percent of State Income, FY 2008

State	Tax Burden	Rank
U.S. Average	9.7%	--
New Jersey	11.8%	1
New York	11.7%	2
Connecticut	11.1%	3
Maryland	10.8%	4
Hawaii	10.6%	5
California	10.5%	6
Ohio	10.4%	7
Vermont	10.3%	8
Wisconsin	10.2%	9
Rhode Island	10.2%	10

Structurally, California's tax system is not business-friendly. Anecdotal stories about a brain drain underscore the danger that intelligent and innovative people will leave or at minimum not enter if tax burdens are excessive. The Tax Foundation's annual State Business Tax Climate Index evaluates tax structures for business-friendliness, and the 2009 edition ranked California 48th, or third worst. The individual income tax ranked second to last, corporate income tax ranked 45th, and sales tax ranked 43rd. (Property tax structure was a bright spot, ranking 15th in the country.)

Corporate Income Tax
California's 8.84% flat corporate income tax rate is one of the highest in the United States (and combined with the 35% federal rate, in the world), and the state ranks 6th in the country in per capita collections from the tax. It is worth noting that neighboring Nevada has a 0% state corporate income tax, with Arizona at 6.968% and Oregon at 6.6%.

Table 5
Top 10 States, Per Capita Collections from State Corporate Income Tax, FY 2007

State	Collections Per Capita	Rank
U.S. Average	$178	--
Alaska	$1,196	1
New Hampshire	$453	2
Delaware	$352	3
New Jersey	$332	4
Massachusetts	$327	5
California	$307	6
West Virginia	$298	7
New York	$281	8
Connecticut	$236	9
Kentucky	$234	10

Nationwide, states' reliance on the corporate income tax has been falling over time, from a high of 9.5% in 1977 to about 5 percent today.⁴ The nightmarish administrative complexity associated with apportioning income from multistate companies to the various states, combined with a mess of inconsistent apportionment and nexus rules designed by each state to maximize tax revenue, results in a tax that raises very little revenue while imposing enormous costs on the economy.

California has been among the most aggressive states in attempting to squeeze more out of its corporate income tax. Besides its high rate, California officials have sought to extend tax obligations to LLCs, which already pay taxes through the individual income tax code. That action and attempts to reach income beyond California's frontiers have been stopped by the courts, but they give the impression that California is hostile to business. Dramatic reduction of the corporate income tax could reverse this impression, reduce administrative costs of doing business in the state, and reduce reliance on a volatile tax that is increasingly not worth the revenue it produces.

Individual Income Tax
Even prior to the recent increase, California's individual income tax was one of the highest top rates in the country. Unlike other states with high top rates, California's kicks in at a rather modest level of income. The now 10.55% rate applies to income of $1 million or up, but the second-highest 9.55% rate applies to all income over $47,055.

It should be remembered that much business income is taxed under the individual code (such as from LLCs, partnerships, and sole proprietors). By contrast, both Nevada and Washington State have no individual income tax, and Arizona's individual income tax reaches just 4.54% of income over $150,000.

Just before California enacted its "millionaires' tax," New Jersey implemented one in June 2004, when then-Governor James McGreevey signed into law an 8.97% rate on income over $1 million, retroactive to January 1, 2004. While the millionaires' tax raised revenue for the state and helped reduce a budget shortfall, it reduced the state's overall economic output and harmed its ability to grow during and after the current recession.⁵

Yes, new taxes on high-income earners will generally raise revenue in the short term without a sudden exodus of many wealthy people fleeing to the state next door. But over the medium term, the taxes will negatively impact location decisions. People expanding old businesses or creating new ones will incorporate the higher cost of doing business into their decision-making, and steer clear of the state. California currently faces an enormous brain drain of dynamic individuals after five years of double-digit income taxes.

Sales Tax
California's sales taxes have high rates and a narrow base, the opposite of what fiscal experts generally recommend. Different sources calculate California's sales tax at different rates, primarily because even the rates are a complicated mess. The state portion of the sales tax is (as of April 1) 8.25%, consisting of:

5.00% for the state general fund
0.25% for the state general fund effective 2004 (shifted from Bradley-Burns local tax)
0.50% distributed to local health/welfare programs
0.50% distributed to local public safety programs
0.75% Bradley-Burns tax, returned to the local jurisdiction where the sale occurred (this tax was 1% prior to 2004, when 0.25% was shifted to the state)
0.25% Bradley-Burns tax returned to the county where the sale occurred for transportation purposes
1.00% increase effective April 1, 2009, to the state general fund

Additionally, local governments can add up to 2% in local add-on sales taxes; a 0.5% transportation sales tax is quite common. Prior to April 1, 2009, the average local add-on sales tax was 0.71%, leading to an average state sales tax of 7.96%, the fifth highest state-local average in the country. With the increase, California has the second-highest state-local average sales tax rate in the country, behind only Tennessee (see Figure 2).

Figure 2
Combined State and Local Sales Taxes by State

Notwithstanding the high rate, California sales tax collections are comparatively low. In Fiscal Year 2007, California brought in just $897 per capita in state sales tax revenue, behind twelve other states (Hawaii, Washington, Wyoming, Nevada, Florida, Tennessee, Mississippi, Arkansas, New Jersey, New Mexico, Arizona, and South Dakota).

Considering that California has a higher sales tax rate than most of these states and arguably more economic activity per capita than many of them, the low collections are a sign that California's high rate applies only to a narrow category of items. A 2003 study on sales tax breadth by Professor John Mikesell estimated that California's sales tax applies to just 34.7% of goods and services, below the national median of 43.3%.⁶

Rather than just increasing the rate, California should consider fundamental reform of its sales tax. At present, California exempts whole categories of consumption while taxing a few categories of business-to-business transactions. The latter harms transparency because it creates taxes passed to consumers but hidden in the price, while also punishing products that require multiple purchases in the production chain. If California broadened its sales tax base to that national median (by taxing all goods and services but exempting business-to-business transactions to prevent multiple hidden taxes), the state rate (pre-increase) could drop from 7.25% to 5.8% with no loss in revenue. Even after including local sales taxes, the combined average rate of around 6.5% would be lower than most nearby states (except for neighboring Oregon, which has no sales tax).

Conclusion
A state that faces economic decline and an exodus of population has two choices. One is to ramp up state spending on education and infrastructure and offer targeted tax incentives for selected industries, and hope that these inducements will lure people back. All state governments do this to some extent, notwithstanding the risk. At best, however, these investments will take decades to pay off. At worst, the fate of Michigan could be more common: people take their degrees from the excellent state schools and use the excellent roads to drive to other states where there are jobs.

The other choice is to reduce reliance on burdensome and volatile revenue sources, prioritize state services and pare back on the non-essential, and set out a welcome mat of a simple, transparent, neutral, and stable state tax system for all. If tax increases have to occur, structure them in a way that spreads the burden and addresses spending growth. Such a choice will not generate billions of dollars immediately to recover from years of borrowing and spending beyond means. But it will lay the groundwork for long-term economic growth and ensure that the Golden State's tarnished decade will not continue forever.

Notes

1. The budget agreement raised every tax rate by 0.25 percentage points. The bill contained language to cut the increase to 0.125 percentage points if California received at least $10 billion in federal stimulus funds. On March 27, 2009, Treasurer Bill Lockyer certified that the state would receive only $8.6 billion in stimulus funds, resulting in the 0.25 rate increase.

2. See generally Joseph Henchman, State Budget Shortfalls Present A Tax Reform Opportunity, Tax Foundation Special Report No. 164 (Feb. 2009), at http://www.taxfoundation.org/publications/show/24321.html.

3. Following the addition of the new millionaires' tax top bracket, the California Franchise Tax Board has taken pains to deny that their 10.3% top tax rate is in the double-digits, referring on their website and on tax forms to a 9.3% top rate and elsewhere noting that there is a 1% surcharge. See William Ahern, "California Legislators Push for More Double-Digit Income Tax Rates," Tax Foundation Fiscal Fact No. 134 (Jul. 14, 2008), at http://www.taxfoundation.org/research/show/23370.html.

4. See David Brunori, State Tax Policy 84 (2005).

5. See Gerald Prante, "Did People Flee New Jersey After 2004 Income Tax Hike?," Tax Foundation Tax Policy Blog (Apr. 14, 2009), at http://www.taxfoundation.org/blog/show/24618.html.

6. See John L. Mikesell, State Retail Sales Tax Burdens, Reliance, and Breadth in Fiscal 2003, State Tax Notes 125 (Jul. 12, 2004).

Bank Secrecy, Tax Havens and International Tax Competition

Wed, 13 May 2009 00:00:00 EDT

Special Report No. 167

Introduction

There is a growing perception in Washington, DC, that the U.S. corporate tax base may be eroding due to either the bank secrecy of "tax havens" or the so-called tax loopholes that are said to "encourage American businesses to shift jobs overseas."

Indeed, Congress recently held hearings to consider ways to modify bank secrecy rules so that taxpayers won't easily avoid paying tax by sheltering overseas income in low-tax countries. Meanwhile, President Obama's FY 2010 budget submission promises to raise more than $200 billion in new tax revenues from U.S. companies by restricting their ability to defer paying taxes on profits earned abroad and by modifying their ability to allocate various business expenses between U.S. and foreign subsidiaries.

Clearly, the U.S. government should demand that taxpayers follow the law and pay legally owed taxes. But lawmakers need to be careful not to confuse the act of wrongful tax evasion with the effects of global tax competition. U.S.-based firms are already at a competitive tax disadvantage compared to firms based in other major trading nations. Confusing tax evasion with tax competition could lead to policy changes that put the U.S. economy at an even greater competitive disadvantage.

While some lawmakers, such as Ways and Means Chairman Charles Rangel, have given a nod to the notion of cutting the corporate tax rate, the changes to the international tax rules proposed by the Administration would actually undermine the benefits of lower rates and make U.S. firms and employees less competitive abroad.

OECD countries such as Ireland, Poland, the Slovak Republic, and Switzerland have enjoyed an influx of foreign capital and investment not because they are "tax havens" but because they have dramatically lower corporate tax rates than the United States, France, Germany, Great Britain and Japan. Until these high-tax countries lower their corporate tax rates, they will continue to lose ground—investment and jobs—to lower tax competitors.

An increasing amount of economic evidence suggests that dramatically cutting the U.S. corporate tax rate while maintaining the current system of deferral (or, perhaps, moving in the direction of a territorial tax system) would make U.S. firms more competitive abroad while improving the wages and living standards of U.S. workers at home. This paper explains why the effects of global tax competition should not be confused with "harmful tax practices" or tax evasion, and how far out of step the U.S. corporate tax system—both the rates and international tax structure—has become in comparison to most other developed nations.

The Price of Paradise: Hawaii Becomes Fifth State to Adopt New Income Tax Brackets on High-Earners

Tue, 12 May 2009 00:00:00 EDT

New Top Rate of 11% on Income Over $200,000 is Highest State Rate in U.S.

Fiscal Fact No. 169

The Hawaii Legislature forced through several tax increases on May 11, including an income tax increase and tax increases on cigarettes and other tobacco products, among others. With the exception of the cigarette tax increase, all these tax increases were vetoed by Governor Linda Lingle on May 7 in Hawaii's first-ever public veto ceremony attended by nearly a thousand taxpayers and citizens. However, on May 11 the state legislature was able to override each of the vetoes and enact the tax increases.

The income tax increase is retroactive to January 1, 2009, and expires on December 31, 2015. The cigarette tax will go up on July 1, 2009 and increase again in 2010 and 2011. The hotel accommodations tax also goes up 1 percentage point on July 1, 2009 and again on July 1, 2010, temporarily through 2015. The conveyance tax increase permanently takes effect on July 1, 2009.

State Income Tax Increased, Brackets Added
The broadest tax increase and the one receiving the most attention is an income tax increase on higher-income earners. The legislation adds three income tax brackets on top of the current nine, at rates of 9% on income over $150,000 ($300,000 for joint filers), 10% on income over $175,000 ($350,000 for joint filers), and 11% on income over $200,000 ($400,000 for joint filers). By adding the 11% bracket, Hawaii will move from eighth to first in the ranking of top state income tax rates, passing Maine, New Jersey, Iowa, Oregon, Vermont, Rhode Island, and California. (See Table 1.)

The income tax increase makes Hawaii the most taxing state by some statistical measures. Not only does Hawaii now have the highest statutory income tax rate, 11 percent, but with the increase to twelve tax brackets they now have the most tax brackets of any state. The new bracket structure is rather clumsy in the sense that it is highly graduated for lower-income filers, then flat for middle-income filers, and then highly graduated again for high-income filers. There are nine different brackets between zero and $48,000 ($96,000 for couples) and rates that range from 1.4 to 8.25 percent. But once a taxpayer reaches this 8.25 percent bracket, the next rate takes effect only after taxable income has increased to $150,000 ($300,000 for couples).

The same steeply increasing liability could be achieved with half as many tax brackets or fewer, simplifying a tax structure that can be confusing for taxpayers and accompanied by a real economic burden that increases along with tax complexity.

Hotel, Cigarette, and Real Estate Taxes Also Increased
The hotel accommodations tax rate will rise incrementally from 7.25% to 9.25% by mid-2010. Hawaii relies heavily on tourism, and some tourism-related business owners and their employees are worried that the increase will hurt businesses and cost jobs. Those businesses are fighting against a national trend to foist new taxes on non-residents who have no political power within the state. From a policy perspective, this gouging of non-residents is the wrong approach to taxation. States should focus on enacting simple broad-based taxes without favoring one type of purchase or purchaser over another. Indeed, if every state taxes hotel rooms in a competitive fashion, then a race to higher rates is going on, with each state taxing other states' residents.

The cigarette tax hike is the only component of the tax package that the governor declined to veto. The increase from $2.00 to $3.00 per pack will occur in three increments, increasing to $2.60 on July 1, 2009; $2.80 on July 1, 2010; and $3.00 on July 1, 2011. This tax increase overrides Hawaii's previously scheduled cigarette tax increase which was designed to increase the tax in $0.20 increments until it reached $2.60 in late 2011. With the newly scheduled increase to $2.60 on July 1 of this year, Hawaii will move into third place in the cigarette tax ranking, behind only New York ($2.75 per pack) and Rhode Island ($3.46). In addition, the tax rate on smokeless tobacco has been increased from 40% to 70% of the wholesale price, an increase that the governor vetoed on May 7 but the legislature overrode.

The tax increases on cigarettes and other tobacco products, which are classified as excise taxes, are especially disconcerting. Excise taxes are taxes on specific products or activities, such as gasoline, beer, or cigarettes. Rates should be set at an amount that offsets the so-called negative externalities, or costs to society, associated with the use of such products. Unfortunately, most lawmakers instead view excise taxes simply as easy revenue raisers or a means of achieving their own social policy goals. This is especially true of excise taxes on cigarettes and other tobacco products whose political unpopularity makes them easy targets for tax increases, despite the low income profile of the smoking public.

The conveyance tax on the purchase of residential and commercial property was also part of the flurry of tax increases and a permanent enactment. Previously the highest rate was $0.30 per $100 of value on properties worth at least $1 million. The new legislation adds four brackets to the tax structure: $0.50 per $100 on property worth at least $2 million, $0.70 per $100 on property worth at least $4 million, $0.90 per $100 on property worth at least $6 million, and $1.00 per $100 on property worth at least $10 million.

Hawaii's New Income Tax Brackets Follow Similar Action by California, Maryland, New Jersey, and New York
With its new, dramatically higher income tax rates, Hawaii becomes the fifth state to adopt a so-called "millionaires' tax," joining California, Maryland, New Jersey, and New York. Such taxes are unique in that they impose a top rate near or above 10% on a small subset of high-income earners. The income level at which the new top rate applies is often a sharp jump from where the previous top rate applies, but with each new "millionaire's tax," the tax is kicking in on more and more people who are not millionaires.

Beginning in 2003, New York adopted two new top brackets (the top rate of 7.7% applied to income over $500,000) as a three-year temporary measure, which expired in the midst of the property tax boom at the end of 2005.¹ In 2009, New York attempted to address its budget shortfall in part by adding back the top brackets as a three-year measure, with a top state rate of 8.97% on incomes over $500,000.

New Jersey followed its neighbor in June 2004 when then-Governor James McGreevey signed into law an 8.97% tax rate on income over $1 million, retroactive to January 1, 2004, raising the top rate from 6.37%. While this makes it the first true "millionaires' tax," it was still a lower rate than California's then-top rate of 9.3%, which applied to income over about $41,000. In November 2004, California voters narrowly approved Proposition 63 (53.8% to 46.2%), creating a 10.3% top rate on income over $1 million to fund mental services programs. As part of its 2009 budget agreement, California's top rate has gone to 10.55% for two years, and voters go to the polls on May 19 to decide whether to extend it through 2012.²

Also as part of a budget package, one that was designed to pay for expanded state services, Maryland in 2008 added four new income tax brackets, including a top rate of 6.25% on income over $1 million.³ Notwithstanding their tax increases on high-income earners, New Jersey, Maryland, and California continue to experience serious budget shortfalls that are actually comparatively worse than those in other states.⁴

Table 1
Income Tax Brackets in States with Special Taxes on High-Income Earners
Tax Rates for Singles, 2009

California

Rate	Bracket
1.25%	>$0
2.25%	>$7,168
4.25%	>$16,994
6.25%	>$26,821
8.25%	>$37,233
9.55	>$47,055
10.55%	>$1,000,000

Hawaii

Rate	Bracket
1.4%	>$0
3.2%	>$2,400
5.5%	>$4,800
6.4%	>$9,600
6.8%	$14,400
7.2%	>$19,200
7.6%	>$24,000
7.9%	>$36,000
8.25%	>$48,000
9.0%	>$150,000
10.0%	>$175,000
11.0%	>$200,000

Maryland
(Does not include county income taxes, which average 2.98%.)

Rate	Bracket
2.0%	>$0
3.0%	>$1,000
4.0%	>$2,000
4.75%	>$3,000
5.0%	>$150,000
5.25%	>$300,000
5.5%	>$500,000
6.25%	$1,000,000

New Jersey

Rate	Bracket
1.4%	>$0
1.75%	>$20,000
3.5%	>$35,000
5.525%	>$40,000
6.37%	>$75,000
8.97%	>$500,000

New York
(Does not include New York City income tax, which has a top rate of 3.648%.)

Rate	Bracket
4.0%	>$0
4.5%	>$8,000
5.25%	>$11,000
5.9%	>$13,000
6.85%	>$20,000
7.85%	>$200,000
8.97%	>$500,000

Taxing High-Income Earners Has Failed Before as Sound Fiscal Policy
The trend may be new, but the policy has been tried before. Through the early 1990s, several states maintained double-digit income tax rates, including California (11% until 1996) and Hawaii (10% until 1998).⁵ These rates came down due to a combination of booming tax revenues from all sources, and growing expert understanding that location decisions of highly mobile entrepreneurs are sensitive to state income tax rates, particularly in the interstate context. To attract and keep good talent, create jobs and drive economic growth, legislators knew that state tax systems had to be competitive with their neighbors.

We still see elements of that today. Even in adopting its millionaires' tax, New York did not let its rate go above neighboring New Jersey, and other states are wary of crossing the 10% psychological barrier. The California Franchise Tax Board has taken pains to deny that their 10.3% top tax rate is in the double digits, referring on their website and on tax forms to a 9.3% top rate and elsewhere noting that there is a 1% surcharge.⁶Now those rates are 9.55% and 10.55% (see Table 1).

If states are still concerned about interstate tax competition, what has really changed? The short answer is priorities. States that adopt new taxes on high-income earners are ones where policymakers are persuaded to ignore concerns about long-term economic growth in favor of a short-term budget fix that avoids deep spending cuts. In New Jersey, while the new millionaires' tax raised revenue for the state and helped reduce a budget shortfall, it reduced the state's overall economic output and harmed its ability to grow during and after the recession.⁷

This is the tradeoff that proponents of taxes on high-income earners usually fail to acknowledge. Yes, such taxes will generally raise revenue in the short term without a sudden exodus of wealthy people fleeing to the state next door, especially in Hawaii. But over the medium term, the taxes will negatively impact location decisions. People expanding old businesses or creating new ones will incorporate the higher cost of doing business into their decision-making, and steer clear of the state. California currently faces an enormous brain drain of dynamic individuals after five years of double-digit income taxes, and it seems that New Jersey may now be seeing the evidence of a brain drain from its millionaires' tax. Hawaii has long been accused of chasing out its best and brightest, and it can only be exacerbating that problem with these new tax rates.⁸

In Hawaii, the tourism industry bears a disproportionate tax burden in an already high-tax state, and the tax package seemingly left no stone unturned in exacerbating that. Officials were apparently convinced that Hawaii's location minimizes the economic impact of further tax increases. With hotel occupancy at a low and likely to go lower with the hotel tax increase, and with special funds raided and the state's commitment to provide tax incentives for high technology development ($130 million a year as of 2007), the revenue Hawaii hopes to see from the tax increase may be illusory.

New taxes on high-income earners have the best chance of success where policymakers are persuaded to focus just on short-term problems and minimize concerns about long-term economic growth. It is true that paying for unemployment benefits and state services is a bigger challenge in a time of recession. Officials from President Obama and Vice President Biden on down have talked about how high-income earners should pay "a bit more," with references to patriotism, duty or fairness.

But, as we noted in our state budgets report in February, such rhetoric does not address some major concerns. First, state budget shortfalls are a result of trying to keep spending commitments based on naïve assumptions about tax revenue growth from the boom; ultimately states will need to reprioritize those promises. Second, paying for broadly available public services through disproportionate taxes on high-income earners raises serious equity questions. Third, such taxes are highly volatile and contribute to the boom-and-bust cycle of state budgets because the incomes of such individuals are so volatile, more so than other types of tax revenue. Finally, such taxes can undermine long-term economic growth.

Policymakers and stakeholders in states considering taxes on high-income earners should raise these concerns and resist efforts to substitute damaging short-term fixes for real long-term pro-growth tax reform.

Notes

1. For New York City residents, the 7.7% state rate combined with the 3.648% city rate resulted in a double-digit income tax rate.

2. The budget agreement raised every tax rate by 0.25 percentage points. The bill contained language to cut the increase to 0.125 percentage points if California received at least $10 billion in federal stimulus funds. On March 27, 2009, Treasurer Bill Lockyer certified that the state would receive only $8.6 billion in stimulus funds, resulting in the 0.25 percent rate increase.

3. Maryland has uniquely high county income taxes which average approximately 3 percent of income, so the 6.25% state-level rate brings the tax rate over 9 percent of almost all high-income Marylanders.

4. See generally Joseph Henchman, "State Budget Shortfalls Present A Tax Reform Opportunity," Tax Foundation Special Report No. 164 (Feb. 2009), at http://www.taxfoundation.org/publications/show/24321.html.

5. Some states had double-digit income tax rates since the 1990s, but also permit deduction of federal taxes from the state income tax. In these states (such as Montana in the 1990s and Iowa today), the high marginal tax rate on personal income is not immediately comparable to other states because of deductibility.

6. See William Ahern, "California Legislators Push for More Double-Digit Income Tax Rates," Tax Foundation Fiscal Fact No. 134 (Jul. 14, 2008), at http://www.taxfoundation.org/research/show/23370.html.

7. See Gerald Prante, "Did People Flee New Jersey After 2004 Income Tax Hike?," Tax Foundation Tax Policy Blog (Apr. 14, 2009), at http://www.taxfoundation.org/blog/show/24618.html.

8. See, e.g., “Brain Drain has Many Casualties” Honolulu Star Bulletin, April 16, 1999, available at http://archives.starbulletin.com/specials/braindrain.html; University of Hawaii at Mānoa, Alumni Outcomes Survey 2003 available at http://www.hawaii.edu/offices/app/opp/alumni/alumni03.pdf (finding that more graduates are moving out of state); University of Hawaii at Mānoa, Discussion Brief, 2008-4 v.4 available at http://vcafo.org/support_bulletin/2008-4.pdf (finding that large percentages of public school graduates leave the state).

Tax Watch, Spring 2009

Wed, 22 Apr 2009 00:00:00 EDT

Highlights from the Spring 2009 issue include:

Federal Tax Reform on the Way?
State Budget Shortfalls May Spark Tax Reform
America's Tax Freedom Day Arrives Early
Experts Talk Stimulus, Reform in Recent Tax Policy Podcasts

Click here for a free subscription to Tax Watch.

Border Zone Cigarette Taxation: Arkansass Novel Solution to the Border Shopping Problem

Thu, 09 Apr 2009 00:00:00 EDT

Fiscal Fact No. 168

On February 12, the Arkansas General Assembly passed legislation to increase the state's excise rates on all tobacco products. As required by the bill, on March 1 the cigarette tax went from 59 cents to $1.15 per twenty-pack.¹ But the same tax rate will not be enforced statewide. In a novel provision, the legislation, Act 180 of 2009, included a lower, variable rate for certain towns and stores located near the Arkansas border.

A First in Cigarette Excise Taxation
The new law states that whenever there are two adjoining towns separated by the state line, the cigarette tax in the Arkansas town is required to be equal to the cigarette tax in the adjoining town outside of Arkansas plus 3 cents, as long as the resulting tax rate is not greater than Arkansas's standard tax rate. According to the law, both towns must have a population of 5,000 or more for the town on the Arkansas side to qualify for the reduced tax rate. Similarly, the law provides that the excise tax on cigarettes sold in Arkansas within 300 feet of the state line, regardless of the area's population, be taxed at the bordering state's rate plus 3 cents if the resulting rate is lower than Arkansas's standard rate.²

Arkansas legislators are shrewdly acknowledging that cross-border shopping for low-tax cigarettes is a major problem for tax enforcement. To retain tax revenue and stop tax evasion, Arkansas has established a low-tax zone on its own side of the border. If this policy is successful in Arkansas other state legislatures may follow suit. To understand the rationale for this policy, the first of its kind among states, it is necessary to understand the problems that sometimes accompany cigarette taxation.

Issues in Cigarette Excise Taxation
In addition to the federal excise tax rate of $1.01 per pack of twenty, every state levies its own cigarette tax. The rates vary widely, from $3.46 per pack in Rhode Island to $0.07 in South Carolina.³ In addition, states may permit localities to levy an additional excise tax. The combination of federal, state and local cigarette excise taxes can add up to a significant total tax rate. The average U.S. smoker is now paying about $1,000 a year in tobacco taxes; and in New York City where cigarette taxes add up to $5.26 per pack, an average smoker is paying tobacco taxes of about $2,000 per year. On top of excise taxes, tobacco companies are required by the 1998 tobacco Master Settlement Agreement to increase the wholesale price of their cigarettes, using the proceeds to make annual payments to reimburse state governments for the harm caused by cigarette smoking in the past. The price increases vary from state to state but average about $0.50 per pack nationwide.

It is well documented that various tax evasion techniques are often associated with high excise taxes on cigarettes.⁴ As cigarette taxes have increased around the country, smuggling cigarettes from low-tax to high-tax states has become an extremely profitable criminal activity. Internet sales are another source of excise tax evasion. When cigarettes are purchased tax-free on the internet the buyer is legally obligated to pay any applicable state and federal excise taxes, but in practice this can prove difficult to enforce, especially when the sellers are located overseas. Similarly, Native American Reservations are allowed to sell cigarettes to Native Americans without charging the state excise tax rate, but in practice the cheaper cigarettes are often sold to non-Native Americans. The same is true for military bases, where cigarettes are sold tax-free but often end up in the civilian market.⁵ All these illegal activities can be very difficult to prevent and consequently are a significant source of cigarette excise tax evasion. Economists recognize that this is one reason that actual revenues received from cigarette tax increases often fall short of projections.⁶

Another concern when states raise cigarette taxes is that high cigarette taxes tend to induce border shopping.⁷ Border shopping is another form of tax evasion and occurs when the residents of a state cross state lines to purchase cigarettes in a lower-tax state. Obviously the closer an individual lives to the border of a lower-tax jurisdiction the more economically feasible border shopping becomes. As when making online purchases, when the buyer crosses back into his or her own state there is a legal obligation to pay the higher excise tax in the home state. But again, this can be difficult and costly to enforce. While the buyer saves an amount per pack equal to the tax differential between the two jurisdictions, the home state misses out completely on any revenue it could have raised from the purchase.

Arkansas's new policy of reducing excise tax rates in border towns is probably designed to mitigate the revenue loss the state could experience from border shopping. Before the passage of Act 180 the state's rate was $0.59 per pack and it had three neighbors with lower rates: Louisiana ($0.36), Mississippi ($0.18) and Missouri ($0.17). With the increase to $1.15 Arkansas has surpassed Tennessee ($0.62) and Oklahoma ($1.03), leaving it with only one neighbor with a higher excise tax on cigarettes: Texas ($1.41). Five of the six neighboring states now have a lower cigarette tax, with Missouri's and Mississippi's taxes each being nearly a dollar less per pack than Arkansas's.

Lawmakers often ignore the realities of border shopping induced by high excise taxes, so it is significant that the Arkansas legislature is explicitly recognizing the problem of border shopping and is attempting to address it by eliminating the incentive to shop in these lower-tax states.

Effects of the New Policy
It is important to note that this policy effectively shrinks the "tax border" of Arkansas. While there is still a minimum rate differential of three cents between Arkansas and any low-tax neighbor, this amount is small enough to provide almost no incentive for Arkansas residents to buy in other states. A significant tax differential does still exist however. The differential is now between different jurisdictions within the borders of Arkansas rather than between Arkansas and other states. Consumers in a reduced-tax border zone will simply purchase within their home market. Consumers in an interior area subject to the standard tax rate, now $1.15, will have an incentive to shop in the border areas, an activity which is legal under the new border zone structure as long as the cigarettes are purchased for personal consumption. Either way, moving the tax differential within the state will eliminate most of the incentive for Arkansas residents to shop for cigarettes out-of-state since they can pay virtually the same price in-state.

This new tax structure will probably result in a net revenue gain for Arkansas. Instead of giving up all of the revenue that would normally be lost in border shopping, they are now giving up only the revenue represented by the tax differential.

Take for example, an Arkansas smoker living in a qualifying city that borders Louisiana. In the absence of the new border zone tax policy, the resident of Arkansas, which has a standard tax of $1.15 per pack, would have an incentive to travel to Louisiana, which has a tax of $0.36 per pack, to purchase cigarettes. In that case the revenue loss for the Arkansas government would be $1.15 since the purchase is made outside of its borders and it collects no tax on the purchase. However, under Arkansas's new policy there is little tax advantage in traveling to Louisiana to purchase cigarettes, all other things being held equal. In this case the buyer pays the reduced $0.39 excise tax (Louisiana's rate plus 3 cents) to Arkansas. Although Arkansas is not collecting the whole $1.15 required of normal cigarette purchases, it does collect significant revenue. Ideally the state would like to collect $1.15, but at that rate the buyer will border shop and the state will end up collecting nothing. To avoid this, the state sacrifices the 76-cent differential between its regular rate and the reduced border zone rate in order to make the sale in state, keeping its citizens legal and collecting some revenue.

In a sense border shopping will still occur, but to a large degree it will be contained within Arkansas since the tax differential is now contained within Arkansas. People who live close to qualifying reduced-tax jurisdictions within their state will now travel to those lower-tax areas to purchase cigarettes instead of traveling to a neighboring state. It is important to note that if other states were to adopt similar policies, the result would not be a net revenue increase in every case. The reduced tax in border zones could result in a net gain or a net loss, depending on the tax differential and the fraction of buyers that buy cigarettes out-of-state.

For example, a relatively low tax differential may not induce a large amount of border shopping, in which case reducing the tax would result in lower tax revenue per pack without much gain in the form of reduced border shopping. In such a case the state could see a net revenue loss from the policy. However, given that the tax differential between Arkansas and some of its neighbors approaches one dollar per pack, it seems likely that the result would be a net revenue increase. The revenue records over time will not yield a definitive conclusion, however, because this law takes effect at the same time as the state is nearly doubling its main tax rate.

Effects on Neighboring States
Since the reduced-tax zones will shift purchases from neighboring states back to Arkansas, the policy will serve to reduce neighboring states' revenues while it increases Arkansas's. It is unknown how neighboring states will react to Arkansas's policy change. The revenue loss might not be significant enough for them to take any action. In fact, it is difficult to imagine any policy that neighboring states could implement that would result in a large resurgence of border shopping. Any reduction in excise taxes would automatically be matched (plus 3 cents) in Arkansas's border jurisdictions. Moreover, adopting a similar border zone policy in response to Arkansas's policy would not induce Arkansas smokers to border shop since the tax rates in the two states are already so close to equal. If neighboring states wanted to recover the revenue loss that Arkansas shoppers had been providing, they might think to increase their statewide cigarette tax slightly, depending on the rates in other neighboring states.

Since the new border zone tax equalization policy is likely to be successful at reducing border shopping and boosting revenue in Arkansas, other states may start to enact similar policies. With state tax receipts suffering in the current economic climate, many states are looking for creative ways to raise revenue. Although Arkansas's border zone policy was enacted in conjunction with a tax increase, similar legislation could be enacted as a stand-alone revenue raiser by state legislatures reluctant to raise taxes in the current economic climate.

Potential Drawbacks
There could be some drawbacks to the border tax equalization policy. First, while the policy makes sense from a revenue-maximizing perspective, it is questionable whether it is fair to tax the same purchases differently based solely on where the purchases are made. For instance, one could raise the objection that if the purpose of the excise tax is to offset some externality from smoking, and assuming the rate is set at the optimal level to achieve this goal, then reducing the tax would be harmful to the smoker and others. That is, smoking near the border is no less damaging than smoking in the middle of the state, so why should Arkansas tax the two activities differently?

Another concern is that this policy effectively allows neighboring states to set Arkansas's excise tax rate in the border zones. If the neighbor raises its tax, the tax in Arkansas's border zones will increase, up to a maximum of Arkansas's regular rate. Likewise, if the neighbor decreases its tax the same will be true in Arkansas's border zones. The result is that Arkansas's border zone rate can be raised or lowered based on the actions of other states' legislatures and without any action from Arkansas's legislature, which may not be desirable for citizens or lawmakers in Arkansas.

There are also administrative challenges that will accompany this policy. First, Arkansas now has six cigarette excise tax rates to administer instead of just one. This added complexity makes administering and complying with the tax more burdensome for tax officials and retailers.

In addition, cigarette smuggling is still a concern. Cigarette smugglers make a profit by buying cigarettes in lower-tax jurisdictions, reselling them in higher-tax jurisdictions, and pocketing the difference. Ordinarily, one would expect that by raising the tax rate from $0.59 to $1.15, the second-highest rate in the region, Arkansas legislators would have made the state more appealing as a destination for smugglers. But the border zone policy might well counteract that effect and even reduce interstate smuggling.

At the same time, the new multi-zone rate structure will probably induce smuggling activity within the borders of Arkansas, an activity which is explicitly prohibited as part of the new border zone policy. While the new law allows residents of higher-tax jurisdictions to freely shop for personal consumption in lower-tax jurisdictions in state, wholesalers, retailers and individuals are prohibited from buying cigarettes in lower-tax jurisdictions and reselling them in higher-tax jurisdictions without paying the tax in the higher-tax jurisdiction.⁸ Though smuggling between the different tax jurisdictions within the state is illegal, it remains to be seen if it will become a significant problem in the same way that interstate smuggling has been in the past.

Other Similar Policies in Arkansas
Arkansas has actually implemented similar policies in the past with regard to other state taxes. For instance, Arkansas allows the citizens of certain cities or towns that are split by a state border to vote to replace their income tax with a 1% sales tax if the bordering state does not levy a state income tax.⁹ There is also a border equalization law for the state's motor fuels tax that keeps the tax rate in qualified border areas from being more than 1 cent greater than the neighboring jurisdiction.¹⁰ These policies, along with the new cigarette tax policy outlined above, are unique to Arkansas and represent an acknowledgement of the fact that tax competition and tax evasion are real and are significant concerns for lawmakers when they are creating tax policy.

Conclusion
Arkansas's border zone tax policy is a first in the world of cigarette excise taxation. This choice of policy is an acknowledgement of what many policy experts have been pointing out for a long time, that cigarette excise taxes are very susceptible to evasion through border shopping and other means, and that as tax differentials increase, these illegal activities become an increasing problem. Arkansas's policy may be successful enough that other states will consider similar policies in the future. While the policy will likely reduce border shopping and increase revenue to some degree, there are pros and cons that need to be weighed when states are considering whether to implement such a policy. The Arkansas experience will be instructive.

1. Arkansas State Legislature, Act 180, February 17, 2009. http://www.arkleg.state.ar.us/assembly/2009/R/Acts/Act180.pdf, accessed 4/02/2009.

2. Ibid.

3. "State Sales, Gasoline, Cigarette, and Alcohol Tax Rates by State, 2000-2009," Tax Foundation, January 28, 2009. http://taxfoundation.org/taxdata/show/245.html, accessed 4/02/2009.

4. Fleenor, Patrick. "Cigarette Taxes, Black Markets, and Crime: Lessons from New York's 50-Year Losing Battle," Cato Institute Policy Analysis, No. 468, February 6, 2003. http://www.cato.org/pubs/pas/pa468.pdf, accessed 4/02/2009.

5. Wagner, Richard E. "State Excise Taxation: Horse-and-Buggy Taxes In an Electronic Age," Tax Foundation Background Paper, No. 48, May 2005. http://www.taxfoundation.org/files/72c2d12f36538b66b90f75f8f17052c7.pdf, accessed 4/02/2009.

6. Ibid.

7. Fleenor, Patrick. "How Excise Tax Differentials Affect Interstate Smuggling and Cross-Border Sales of Cigarettes in the United States," Tax Foundation Background Paper, No. 26, October 1998. http://www.taxfoundation.org/files/4cd5774343c1f82447a1381a01c62980.pdf, accessed 4/02/2009.

8. Arkansas State Legislature, Act 180, February 17, 2009. http://www.arkleg.state.ar.us/assembly/2009/R/Acts/Act180.pdf, accessed 4/02/2009.

9. Arkansas Code §26-52-601 through §26-52-607. http://www.arkleg.state.ar.us/SearchCenter/Pages/ArkansasCodeSearchResultPage.aspx, accessed 4/02/2009.

10. Arkansas Code §26-55-210. http://www.arkleg.state.ar.us/SearchCenter/Pages/ArkansasCodeSearchResultPage.aspx, accessed 4/02/2009.

How Do Americans Feel About Taxes Today? Tax Foundation's 2009 Survey of U.S. Attitudes on Taxes, Government Spending and Wealth Distribution

Wed, 08 Apr 2009 00:00:00 EDT

Special Report No. 166

Key Findings

A new 2009 poll of tax attitudes finds a majority of U.S. adults still believe that the federal income taxes they pay are "too high" (56 percent).
4 in every 5 adults say the federal tax code is complex (85 percent) and say that the tax system needs to be completely overhauled or needs major changes (82 percent).
The estate tax is seen as the most "unfair" federal tax, while the gas tax is seen as the most "unfair" state and local tax. Two-thirds (67 percent) favor a complete elimination of the federal estate tax.
While nearly one-third of all tax filers currently have no federal income tax liability after taking credits and deductions, two-thirds (66 percent) believe that everyone should be required to pay some minimum. Under half (44 percent) would be willing to give up some federal tax deductions in exchange for an across-the-board cut in federal income tax rates.
There is widespread opposition to taxes on food and drink deemed unhealthy, with over half (56 percent) opposing taxes on "junk food" in general. On the other hand, over half (53 percent) support government-run gambling operations such as lotteries and keno terminals.

Introduction

Despite the recent political and economic shakeups, the Tax Foundation's 2009 Survey of U.S. Attitudes on Taxes, Government Spending and Wealth Distribution shows that American opinions on tax issues have not changed markedly since 2007, the last time the survey was done. Issues of tax complexity, fairness and burdens continue to be important to the American people.

This report summarizes the findings of a survey done by Harris Interactive® on behalf of the Tax Foundation from February 18-27, 2009. The survey covers a nationwide cross-section of 2,002 adults aged 18 or older.

This year's survey includes three new questions on wealth redistribution, taxes on food and drink deemed unhealthy, and government-run gambling operations such as lotteries and Keno terminals. The survey also includes two new demographic categories, where the survey asks respondents to identify their party affiliation and their political philosophy.

All data from this and previous years' surveys are available for download free of charge at www.taxfoundation.org under "Public Opinion Surveys on Taxes."

From the House That Ruth Built to the House the IRS Built

Mon, 06 Apr 2009 00:00:00 EDT

New York City and New York Yankees Abuse PILOTs to Finance New Stadium

Fiscal Fact No. 167

Executive Summary
Baseball season is finally here, and thousands of baseball fans are heading to the ballpark to cheer on their teams and enjoy America's national pastime. One baseball club that is always discussed during this time of year (for better or for worse) is the New York Yankees. The Yankees are widely known for spending large sums of money to attract top baseball players. It was thus no surprise when it became known that the new Yankee Stadium would be expensive; priced at approximately $1.3 billion,[1] it will in fact be the most expensive stadium ever built. Tickets will also be pricey, with seats behind home plate selling for $2,500 per game.[2]

The stadium's construction costs have been publicly subsidized in the form of $942 million in tax-exempt bonds issued by New York City.[3] Seeking tax-free status for the bonds to ensure a lower interest rate, New York structured the deal to ensure it didn't run afoul of a federal tax code provision which requires that such bonds not be "private activity bonds." This serves as a huge benefit because the bonds are exempt from city, state, and federal taxes, and have an interest rate about 25 percent below that of taxable bonds.

There are two parts to this financing scheme which seem "foul." First, the new Yankee Stadium will be city-owned and thus exempt from property taxes. Meanwhile its primary tenant, the Yankees, will pay no rent. This clearly brings up the issue of whether such tax-exempt bonds should have been issued at all, and especially when the city is so far in the red.

Secondly, to pay off the bonds over time, New York City will receive payments theoretically equivalent to the property taxes that Yankee Stadium would otherwise pay. The city claims that these payments in lieu of taxes (PILOTs) equal taxes that would otherwise be owed. In reality, these payments are inflated by overvaluing the stadium property by three times that of comparable property. By inflating the payments in lieu of taxes, the City can say to taxpayers that the Yankees are paying a significant part of the stadium's cost, while telling the IRS that the City is paying for almost all of it.

While the IRS signed off on the deal, it has subsequently approved a regulation prohibiting such shell games in the future. The regulation applies only to bonds sold on or after October 24, 2008, leaving previously issued bonds for the Yankees project and even newly issued bonds to pay for cost overruns in the clear. (However, the project's alleged use of inflated assessments remains the subject of public debate and congressional hearings.) Going forward, local governments will still be able to use tax-free status for private projects, but only if public benefit is convincingly demonstrated by meeting a more rigorous standard.

Tax-Exempt Financing Is Extensively Used, Increasingly Abused
In order to completely understand how the City of New York and the Yankee organization have truly taken advantage of the tax code and taxpayers, it is essential to have a basic understanding of tax-exempt financing. Tax-exempt bonds are an important source of financing for state and local governments. Interest earned on bonds issued to support projects determined to benefit the public as a whole is exempt from federal income tax.[4] However, interest earned on bonds issued to fund projects partly or wholly benefiting only private parties (known as private activity bonds) are generally subject to federal income tax.[5]

A private activity bond will be taxed if it meets both the "private business use" test and a "private payment" test in the Internal Revenue Code.[6] The "private business use" test considers whether a private business uses more than 10 percent of the proceeds of an issue. Private business use generally arises when a private business has a legal right to use the bond-financed property. The "private payment" test considers the source of payment on the debt service in issue, taking into account whether the payments are directly or indirectly derived from property used by a private business. If 10 percent or more of the proceeds of the bond issuance are used for any private business use and if repayment is secured by private property or payments made on private property, the bonds cannot qualify for tax-free treatment.

Because Yankee Stadium and its associated projects are indisputably designed for private use by the Yankees organization, and because a private business will be paying rent for use of the bond financed property, they would ordinarily be classified as "private activity bonds" and not receive tax-free status under the Internal Revenue Code. However, due to the structure used to finance the stadium, such bonds were considered tax-exempt.

New York Relied on Tax-Exempt Financing to Sell the Stadium Project
In 2006, the City of New York and the New York Yankees' organization announced plans to build a new Yankee Stadium in the South Bronx. The financing of the stadium was meticulously structured in order to allow the Yankees to use tax-exempt bonds. The City agreed to own the land (thus exempting it from property taxes) and lease it to the New York City Industrial Development Agency (NYCIDA).[7] NYCIDA, a government entity with taxing and eminent domain power, would then lease both the land and the stadium to a special purpose entity created as an affiliate of the Yankees, which would, in turn, lease both to the baseball team. Rather than paying property taxes, the Yankees would make payments in lieu of taxes (PILOTs) to NYCIDA which would pay off the tax-exempt bonds. In addition, the initiative qualified for tax-exempt bond status since taxpayers, not the Yankees, would be paying for the project.

The cost savings provided by tax-exempt bond financing is immense. For the Yankees project, $942 million in tax-exempt bonds have been issued.[8] It is estimated that the tax-exempt status results in annual interest savings of approximately $7.7 million to $15.7 million for a period of thirty (30) years, totaling between $231 million and $471 million.[9] Without this generous subsidy, it is unlikely that such an expensive stadium could have been built.

It is, at the very least, debatable whether a new stadium for the Yankees benefits the public and serves a sufficiently broad public purpose to justify public subsidies. While financing with government bonds remains popular and attractive, studies have shown that publicly funded stadiums have no effect on the growth rate of real per capita income and may, in fact, reduce the level of real per capita income in cities that build them.[10] Congressman Dennis Kucinich, who chaired several congressional hearings held on publicly financed stadiums, warned, "Not only are other more important public safety projects ignored, such as repairing structurally deficient bridges and aging water distribution and treatment systems, but granting a federal tax exemption to bonds issued to build these stadiums means more and more expensive stadiums are being built than if there were no federal subsidy."[11] Kucinich also argues that the subsidy is a "transfer from the many to the wealthy."[12]

City officials, however, argue that the stadium will greatly benefit the community. Mayor Michael Bloomberg predicts that the stadium will "revitalize the South Bronx with thousands of jobs,"[13] including nearly 6,500 construction jobs and approximately 1,000 permanent jobs.[14] These projections have been criticized as overly optimistic.[15] With the projected ticket prices being out of reach for many people, some members of the community have likened the project to the creation of "a playground for Manhattanites." To assuage some of these concerns, the city has promised other development projects in the area, such as a new park, tennis courts, and other recreational facilities. However, these projects are far behind schedule and will probably not be ready until at least 2011.[16]

It is indisputable that the stadium and its associated projects are designed for private use by the Yankees' organization and that a private business will be paying rent for the use of the bond-financed property. Therefore, the issued bonds would ordinarily be classified as "private activity bonds" and be denied tax-free status under the Internal Revenue Code. However, the Yankees and the City of New York requested a Private Letter Ruling (PLR) from the IRS, seeking an exception to the private payments test.[17] They argued that because the rent payments are equivalent to generally applicable taxes, they are not private payments but rather payments in lieu of taxes and should qualify as a regulatory exception.

The city's claim that the Yankees' payments are akin to tax payments rather than debt service payments rests on the fact that the PILOTs are based on property tax assessments. A PILOT arguably satisfies the definition of "generally applicable tax" if the payment is not greater than the amount imposed for a tax of general application and the payment is designated for a public purpose.[18] For example, if $50 million was needed annually to pay off the bonds, but actual property taxes would amount to only $30 million, a PILOT that would qualify for tax-free status could not exceed $30 million.

The city was determined to ensure that the payments would cover all bond costs, and equally determined to receive tax-exempt status on the bonds. Consequently, it was important that the stadium property be assessed at a value greater than the bonds in order for the payments to equal the debt service and be at a value which would produce property taxes equal to or less than what the taxes on the actual property would have otherwise been. Three appraisals were conducted, each purportedly using comparable land and taking into account the size, location, and appreciation in value from the development.

Using Manhattan Land to Value a Bronx Stadium
The first land assessment was performed by the New York Department of Finance (DOF). The DOF chose eight parcels of land located in Manhattan as comparables for the assessment, rather than in the Bronx where the stadium was to be located. The Bronx is the poorest district in the country,[19] compared to Manhattan which has some of the highest real estate values in the world. The Manhattan-based appraisal was also calculated using 17 acres, compared to the 14.5 acres upon which the stadium is located. These two dubious assessment methods used by the DOF resulted in an inflated assessed value of $204 million.[20]

Two independent assessments provided significantly lower figures than the DOF appraisal.[21] One estimated the amount of money which would be required to replace park land lost by the stadium's construction. This appraisal evaluated comparable property in the Bronx and determined the land was worth $26.8 million. The third appraisal, performed by a private firm at the request of the New York City Industrial Development Agency (NYCIDA), assessed the land at $40 million. Not surprisingly, only the DOF appraisal for $204 million was submitted to the IRS.

In addition to the valuation of the land, DOF did an assessment of the stadium itself and, working with Goldman Sachs, valued the stadium at $1.025 billion.[22] The final dollar value of the assessment was $1.129 billion.[23] Typically, a project engineer will verify the assessment numbers in a certified cost schedule; however, no verification was provided in this case, which raised serious questions concerning a number of project costs which appeared to be overstated or counted twice.

Despite obvious concerns over these assessments, NYCIDA approved the issuance of $920 million in tax-exempt bonds and $25 million in taxable bonds, both to be repaid by the Yankees by PILOTs. City officials further contended that funding for the $800 million in construction would be fully provided by the Yankees.

The IRS Approved the Tax-Exempt Bonds But Has Moved to Tighten Standards
NYCIDA submitted only the DOF valuation when it presented its request for a PLR. These valuations indicated that the PILOTs would be sufficient to cover the debt service requirements of the bonds. City officials argued that the financing plan complied with IRS rules and that the Yankees did not receive special treatment beyond that which any other taxpayer would have received. In considering similar requests, the IRS does typically give great deference to state and local governments in determining if sufficient public benefits exist to justify tax-exempt financing for projects. In this case, the IRS deferred to the city's assertion that the PILOT payments and the property taxes were closely linked, and approved the stadium project bonds for tax-exempt financing. However, the IRS further stated in its private letter ruling that its opinion was strictly based on the figures provided by the NYCIDA, and any deviation from those facts and representations could cause the PLR to become inapplicable.[24]

The use of PILOTs approved by this private letter ruling issued by the IRS appears to be prohibited by two separate Treasury Department regulations. First, a PILOT should be treated as a special charge if it is "made in consideration for the use of property financed with tax-exempt bonds."[25] In the present case, the Yankees' PILOTs appear to be designed to be "made in consideration" for the construction and "use of property" (i.e. the stadium) "financed with tax-exempt bonds."

Secondly, the PLR explained that these PILOTs are not rightly characterized as "payments for a special privilege granted or service rendered"[26] because they "do not create a new charge separate and apart from the system of real property taxes that are due for use of the stadium."[27] Thus, the defenders of the Yankees' PILOT are trying to analogize PILOTs to tax abatements. By this reasoning, it would be difficult to imagine any application for a PILOT being denied because PILOTs are typically derived from "the system of real property taxes"—they are, after all, payments in lieu of taxes. The IRS fell short in this PLR of correctly applying the PILOT rule and other Treasury Department regulations and failed to demonstrate that the IRS was obligated by the regulations to allow the use of the Yankees' PILOTs.

It comes as no surprise that after issuing the ruling, the IRS proposed and finalized a new regulation narrowing the use of PILOTs. The new regulation applies to bonds sold after October 24, 2008, and therefore does not apply to Yankee stadium since all the bonds for that project had been sold prior to this date.

There is no doubt that the Yankees hit a home run to win the tax-exempt game in the final inning. For others not so fortunate, the new regulation requires that an eligible PILOT must represent "a fixed percentage of, or reflect a fixed adjustment to, the amount of generally applicable taxes in each year, based on comparable current valuation assessments."[28] This eliminates the ability of state or local governments to set PILOTs at fixed annual amounts that do not fluctuate with changes in the generally applicable taxes on which the PILOT is based. The regulation also requires periodic recalculation of any PILOTs based on current assessed value and provides a standard to determine whether a PILOT payment is "commensurate" with generally applicable taxes, as such term is used in section 1.141-4(e)(5). Clarifying the "commensurate" standard provides more certainty to issuers with respect to the application of PILOTs.

Conclusion
It is doubtful the city would have foregone the property tax revenue to build a new baseball stadium given the current state of its budget, which is looking at an approximate $4 billion shortfall for FY 2009-2010. However, putting aside the turbulence of economic conditions and whether $2,500 seats are likely to be sold, it is still debatable whether a new Yankee Stadium built with tax funds could be a benefit for the public. But because of the way the project is being financed, it is difficult to know what the actual cost to the taxpayer is, let alone whether it is the best use of scarce taxpayer dollars.

Here, New York City has tapped into taxpayer funds by shifting the financing through different layers of local government while essentially claiming that the stadium will pay for itself.

If there are justifiable uses for PILOTs, the Yankee Stadium project does not appear to be one of them. When taxpayers elsewhere hear that any project is being funded by PILOTs, they should remember the cautionary tale of the Yankee PILOTs and insist on strict transparency and accountability so that their taxpayers do not end up subsidizing private uses with public funds.

Notes

[1] "New Yankee Stadium to Cost $1.3 billion," Forbes (Feb. 7, 2008).

[2] "Seats Behind Home-Plate at Yankee Stadium to Cost Between $500- $2500," ESPN.com (Mar. 21, 2008) (accessed on November 18, 2008) http://sports.espn.go.com/mlb/news/story?id=3305979.

[3] Mark Giannotto, "Yankee Stadium Bonds Request Defended as Good for the Bronx," The New York Sun (Jul. 3, 2008).

[4] See 26 U.S.C. § 103 (a). Gains realized from the sale of exempt bonds are taxed.

[5] See 26 U.S.C. § 103(b)(1); 26 U.S.C. § 141. Even private-activity bonds which qualify for exclusion from federal income tax are taxed under the Alternative Minimum Tax (AMT), which denies tax preferences to many high-income taxpayers. See 26 U.S.C. § 7(a)(5)(C).

[6] 26 U.S.C. § 141(a).

[7] The House That You Built: Hearing Before the NY State Comm. on Corp., Authorities, and Comm. (2008) (testimony of Assemblyman Richard L. Brodsky).

[8] Gary Thorne, "Tax-exempt Bonds Part of Baseball's Growth Plan," USA Today (Nov. 4, 2008).

[9] See supra note 7.

[10] Dennis Coates and Brad R. Humphreys, "The Growth Effects of Sport Franchises, Stadia, and Arenas," UMBC Dept. of Economics Working Paper #97-02 (Sep. 27, 1997).

[11] Gaming the Tax Code: Public Subsidies, Private Profits, and Big League Sports in New York: Oversight and Gov. Reform Comm., 110th Cong. (2008) (statements by Rep. Dennis J. Kucinich).

[12] Id.

[13] August 16, 2006, NYC Press Release.

[14] Id.

[15] See supra note 7.

[16] See Tom Ferrey, "South Bronx Neighborhood Taking Hit From New Stadium," ESPN.com (Sept. 19, 2008), http://sports.espn.go.com/mlb/news/story?id=3598021 (last visited on Nov. 18, 2008).

[17] See supra note 7.

[18] Treasury Reg. section 1.141-4(e)(5).

[19] See supra note 16.

[20] See supra note 7.

[21] Id.

[22] Id.

[23] Id.

[24] Id.

[25] Treas. Reg. § 1.141-4(e)(5).

[26] Treas. Reg. § 1.141-4(e)(3).

[27] See supra note 7.

[28] Treasury Reg § 1.141-4(e)(3).

The Effect of the Federal Cigarette Tax Increase on State Revenue

Wed, 01 Apr 2009 00:00:00 EDT

Fiscal Fact No. 166

Today the federal cigarette tax will rise from 39 cents to $1.01 per pack. The proceeds will help fund expansion of the federal State Children's Health Insurance program. This program provides federal matching funds to states to assist them in providing health insurance to families and children. The SCHIP program is targeted at families with modest incomes above Medicaid eligibility limits.

Of course what the federal government gives with one hand it takes with the other. A $6.3 billion increase in the federal cigarette excise will reduce the disposable incomes of residents in the states. Table 1 shows that this reduction ranges from $581 million in California to $10.8 million in the District of Columbia.

Table 1 Increased Federal Tobacco Excise Payments by State, Resulting from the 62-cent Federal Cigarette Tax Hike
Calendar Year 2010

Total	$ 6,340,750,000
Alabama	$ 109,978,857
Alaska	$ 15,600,214
Arizona	$ 134,852,031
Arkansas	$ 67,864,689
California	$ 581,127,778
Colorado	$ 104,058,146
Connecticut	$ 58,536,581
Delaware	$ 17,692,891
Florida	$ 379,981,723
Georgia	$ 201,691,767
Hawaii	$ 21,828,374
Idaho	$ 30,543,511
Illinois	$ 279,479,473
Indiana	$ 163,995,056
Iowa	$ 62,604,547
Kansas	$ 53,229,601
Kentucky	$ 128,026,882
Louisiana	$ 107,844,936
Maine	$ 28,467,786
Maryland	$ 104,345,971
Massachusetts	$ 116,613,891
Michigan	$ 231,677,653
Minnesota	$ 94,399,505
Mississippi	$ 76,066,634
Missouri	$ 154,309,350
Montana	$ 19,280,691
Nebraska	$ 37,285,410
Nevada	$ 63,143,599
New Hampshire	$ 28,470,956
New Jersey	$ 163,676,384
New Mexico	$ 42,409,119
New York	$ 395,510,605
North Carolina	$ 224,489,092
North Dakota	$ 13,404,840
Ohio	$ 281,256,032
Oklahoma	$ 98,940,497
Oregon	$ 67,665,226
Pennsylvania	$ 271,838,059
Rhode Island	$ 20,142,604
South Carolina	$ 103,204,568
South Dakota	$ 16,431,769
Tennessee	$ 160,546,327
Texas	$ 501,970,744
Utah	$ 32,463,700
Vermont	$ 11,923,948
Virginia	$ 155,510,031
Washington	$ 116,875,664
West Virginia	$ 49,692,858
Wisconsin	$ 117,357,576
Wyoming	$ 11,645,403
District of Columbia	$ 10,796,448

In addition to affecting residents' pocketbooks, a hike in the federal tax would also depress state and local government revenues. To varying degrees state and local governments rely on the sale of cigarettes for three sources of revenue.¹ The first is excise tax revenue, or product-specific taxes levied on cigarettes. Under current law, cigarette excise taxes range from 7 cents per pack in South Carolina to $2.75 in New York. States also receive revenue from the Master Settlement Agreement (MSA) they signed with the four major tobacco companies in 1998. The amount of money each state receives varies and is a function of the number of packs sold in the state each year. In addition, almost all states levy a general sales tax on cigarettes.

Congressional authorities estimate that the sale of tax-paid cigarettes will drop by about 10 percent—or 1.7 billion packs—in the aftermath of the federal tax hike. Table 2 shows that Tax Foundation analysts estimates that this will reduce state and local revenues by $2.3 billion in fiscal 2010, the first year the tax is fully in effect. The bulk of these losses will result from $1.6 billion in lost excise tax revenue. MSA payments are also expected to fall by $805.8 million. On the positive side of the ledger, because the federal tax will drive up the cost of cigarettes, sales tax receipts are expected to rise by $105.8 million.

Table 2 Revenue Lost by State and Local Governments, Resulting from 62-cent Federal Cigarette Tax Hike State Fiscal Year 2010 (July 1, 2009 - June 30, 2010) Dollar Amounts in Thousands
State	Taxed Sales (thousands of packs)	Total Revenue	Excise Revenue	MSA*	Sales Tax Revenue

Total	-1,655,638	-$ 2,296,311	-$ 1,596,304	-$ 805,789	$ 105,783
Alabama	-39,680	-$ 30,678	-$ 19,461	-$ 13,669	$ 2,452
Alaska	-2,250	-$ 7,638	-$ 6,034	-$ 1,605	$ 0
Arizona	-17,266	-$ 41,710	-$ 34,531	-$ 8,530	$ 1,351
Arkansas	-19,067	-$ 26,293	-$ 21,927	-$ 5,754	$ 1,387
California	-110,474	-$ 183,570	-$ 96,112	-$ 96,810	$ 9,353
Colorado	-23,309	-$ 28,664	-$ 19,580	-$ 9,879	$ 794
Connecticut	-13,400	-$ 36,808	-$ 26,799	-$ 11,186	$ 1,177
Delaware	-11,362	-$ 15,531	-$ 13,066	-$ 2,465	$ 0
Florida	-136,680	-$ 92,651	-$ 46,334	-$ 54,787	$ 8,470
Georgia	-66,117	-$ 42,400	-$ 24,463	-$ 21,634	$ 3,698
Hawaii	-3,654	-$ 10,592	-$ 7,856	-$ 2,986	$ 250
Idaho	-9,027	-$ 7,795	-$ 5,146	-$ 3,229	$ 580
Illinois	-50,890	-$ 90,731	-$ 66,547	-$ 28,636	$ 4,452
Indiana	-53,342	-$ 63,425	-$ 53,075	-$ 14,611	$ 4,260
Iowa	-16,366	-$ 25,700	-$ 22,258	-$ 4,661	$ 1,219
Kansas	-14,538	-$ 17,102	-$ 11,485	-$ 6,501	$ 884
Kentucky	-61,742	-$ 45,951	-$ 37,045	-$ 12,834	$ 3,928
Louisiana	-42,665	-$ 34,184	-$ 15,360	-$ 20,564	$ 1,739
Maine	-5,657	-$ 14,765	-$ 11,314	-$ 3,879	$ 428
Maryland	-20,713	-$ 53,885	-$ 41,427	-$ 14,058	$ 1,599
Massachusetts	-17,243	-$ 62,200	-$ 43,281	-$ 20,358	$ 1,439
Michigan	-43,066	-$ 107,270	-$ 86,132	-$ 24,897	$ 3,759
Minnesota	-23,072	-$ 48,813	-$ 34,447	-$ 16,336	$ 1,969
Mississippi	-29,628	-$ 20,732	-$ 5,333	-$ 17,518	$ 2,118
Missouri	-70,488	-$ 32,539	-$ 14,249	-$ 21,739	$ 3,449
Montana	-4,315	-$ 9,991	-$ 7,336	-$ 2,655	$ 0
Nebraska	-12,596	-$ 13,081	-$ 8,061	-$ 5,742	$ 722
Nevada	-16,912	-$ 17,526	-$ 13,529	-$ 5,212	$ 1,215
New Hampshire	-13,772	-$ 22,403	-$ 18,317	-$ 4,086	$ 0
New Jersey	-21,428	-$ 72,492	-$ 55,177	-$ 19,790	$ 2,475
New Mexico	-7,125	-$ 11,232	-$ 6,484	-$ 5,144	$ 395
New York	-34,763	-$ 163,418	-$ 108,729	-$ 57,189	$ 2,500
North Carolina	-80,618	-$ 43,998	-$ 28,216	-$ 19,274	$ 3,493
North Dakota	-5,490	-$ 5,922	-$ 2,416	-$ 3,780	$ 273
Ohio	-72,152	-$ 119,460	-$ 92,515	-$ 31,754	$ 4,808
Oklahoma	-32,865	-$ 42,076	-$ 33,851	-$ 8,225	$ 0
Oregon	-18,971	-$ 31,465	-$ 22,386	-$ 9,079	$ 0
Pennsylvania	-75,206	-$ 140,031	-$ 101,528	-$ 43,921	$ 5,418
Rhode Island	-3,495	-$ 11,851	-$ 8,597	-$ 3,638	$ 384
South Carolina	-48,964	-$ 12,660	-$ 3,428	-$ 11,944	$ 2,712
South Dakota	-3,969	-$ 8,005	-$ 6,073	-$ 2,120	$ 188
Tennessee	-47,788	-$ 42,706	-$ 29,631	-$ 16,561	$ 3,486
Texas	-97,905	-$ 182,283	-$ 138,046	-$ 51,856	$ 7,619
Utah	-8,914	-$ 9,681	-$ 6,195	-$ 3,935	$ 449
Vermont	-2,569	-$ 7,000	-$ 5,112	-$ 2,110	$ 221
Virginia	-64,835	-$ 40,369	-$ 26,837	-$ 16,812	$ 3,280
Washington	-16,340	-$ 43,643	-$ 33,088	-$ 12,148	$ 1,593
West Virginia	-23,637	-$ 20,478	-$ 13,000	-$ 8,898	$ 1,420
Wisconsin	-33,121	-$ 70,919	-$ 58,623	-$ 14,348	$ 2,052
Wyoming	-4,654	-$ 5,541	-$ 2,792	-$ 2,942	$ 193
District of Columbia	-1,539	-$ 6,450	-$ 3,077	-$ 3,503	$ 131
*Master Settlement Agreement signed in 1998 between the governments of 46 states and the four largest tobacco firms.

Losses are expected to vary widely by state. California, Texas and New York are expected to each lose more than $150 million in revenue next fiscal year. Meanwhile, losses in Wyoming, North Dakota and the District of Columbia are expected to be less than $6.5 million.

Notes

1. This list is not exhaustive. A hike in the federal cigarette tax will also reduce state income, property and other tax receipts.

America Celebrates Tax Freedom Day

Tue, 31 Mar 2009 00:00:00 EDT

Special Report No. 165

Introduction

Tax Freedom Day® will arrive on April 13 this year, the 103rd day of 2009. That means Americans will work about three and a half months of the year, from January 1 to April 13, before they have earned enough money to pay this year's tax obligations at the federal, state and local levels. Tax Freedom Day falls a full two weeks earlier in 2009 than it did in 2007. In fact, not since 1967 has Tax Freedom Day come earlier than this year's April 13 date.

This shift has been driven by two factors: the recession has reduced tax collections even faster than it has reduced income; and the stimulus package, a.k.a. HR 1, the American Recovery and Reinvestment Act of 2009, includes large temporary tax cuts for 2009 and 2010. Nevertheless, in 2009, Americans will pay more in taxes than they will spend on food, clothing and housing combined.

While tax revenues are falling, government expenditures are expected to explode in 2009, also driven in significant part by HR 1. Tax Freedom Day, like almost all tax burden measures, ignores the current year's deficits. If the projected deficit for 2009 were counted as a tax, Tax Freedom Day would arrive on May 29 instead of April 13-the latest date ever for this deficit-inclusive measure.

Rhode Islands Business-Friendliness Ranking Would Improve Dramatically Under Governors Plan

Fri, 27 Mar 2009 00:00:00 EDT

Proposal to Phase Out Corporate Income Tax, Simplify Personal Income Tax Would Move Ocean State's Business Tax Climate from 46th to 16th in the Nation

Washington, DC, March 27, 2009 - According to new analysis, a tax proposal from Rhode Island Governor Donald Carcieri (R) would dramatically improve the ranking of the state's business tax climate. Had the proposal been in effect for 2009, Rhode Island would have moved from 46th to 16th in the nation when it comes to "business-friendliness."

Carcieri's plan would phase out the state's 9% corporate income tax over four years, making Rhode Island one of just four states without a major business tax. The plan would also simplify the individual income tax by cutting marginal rates, reducing the number of brackets and eliminating many deductions. The new top marginal rate would be 5.5%, down from 9.9%. Currently, the state offers an optional flat tax (at a 6.5% rate for 2009) and a reduced tax rate for capital gain income, both of which would be eliminated. The plan would also increase the estate tax exemption from $675,000 to $1,000,000. Additionally, the cigarette tax would be raised by $1 to $3.46 per pack, which would be, by a wide margin, the country's highest state cigarette tax.

"Rhode Island faces a tough tax situation because it has significantly lower per-capita income than its two neighbors, and therefore must impose higher taxes to raise revenues in line with its neighbors'," said Tax Foundation staff economist Josh Barro. "Unfortunately, those high tax rates add further incentive for wealthy people and businesses to leave Rhode Island for its lower-tax neighbors, or for other parts of the country."

Barro, author of the 2009 State Business Tax Climate Index, (a study that measures how well a state's tax system encourages investment by maintaining a broad tax base and low rates), analyzed the tax proposal's effects on Rhode Island's business tax climate ranking. Based on current law, the Ocean State ranks only 46th best out of 50 states. Neighboring Connecticut is 37th; Massachusetts, defying the "Taxachusetts" moniker, is second-best in New England at 32nd. With Carcieri's plan in effect, Rhode Island would have stood at 16th in the nation, 30 places higher than its actual performance. Instead of scoring 40th on the corporate income tax component of the Index, it would tie for first. The state would jump nine spots on the income tax portion (42nd to 33rd) and three on the property tax portion (43rd to 40th) because the Rhode Island corporate tax includes an assessment on corporate net worth. It would drop one position on the sales tax measure (30th to 31st).

"While small states can face competitive disadvantages with their larger neighbors (especially if those neighbors are wealthier), they also have an opportunity to specialize in attracting a certain kind of capital or business activity," Barro argues. "Now, Gov. Carcieri has identified an opportunity for Rhode Island to step out from its neighbors' shadows."

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

###

To schedule an interview, please contact Matt Moon, the Tax Foundation's Manager of Media Relations, at (202) 464-5102.

Proposed Tax on AIG Bonuses Raises Constitutional and Policy Concerns

Fri, 27 Mar 2009 00:00:00 EDT

90% Tax May Violate Bill of Attainder Clause and Sets Dangerous Precedent

Fiscal Fact No. 165

I. Introduction
On March 19, 2009, the U.S. House of Representatives voted 328 to 93 to pass H.R. 1586, which imposes a 90% income tax on bonuses earned by employees who work at a company that received an aggregate of $5 billion in federal TARP bailout funds, including specifically Fannie Mae and Freddie Mac.

The tax is in lieu of the regular income tax and alternative minimum tax, and applies either to any compensation not received as part of a regular wage or benefit, or to all income exceeding $250,000, whichever is lower. If enacted, the additional tax would be retroactive to January 1, 2009, but any employee who waives or returns the bonus before the end of 2009 would have the surtax waived.

The day after the House action, Sen. Judd Gregg (R-NH) did not use the word "unconstitutional" but derided the bill as a proposal "to use the taxing authority of the government in a manner that is arbitrary, punitive, and targeted on a single group of people who they have deemed as having acted improperly."[1] Two days later, while appearing on the news program 60 Minutes, President Barack Obama (D) also criticized the bill: "Well, I think that as a general proposition, you don't want to be passing laws that are just targeting a handful of individuals. You want to pass laws that have some broad applicability. And as a general proposition, I think you certainly don't want to use the tax code to punish people."[2]

Observers have noted that the bill is a direct result of bonuses awarded by bailout recipient American International Group (AIG), an insurance company now in something akin to bankruptcy trusteeship. Critics of the bill have raised policy concerns as well as suggestions that the bill may violate the constitutional prohibition on Bills of Attainder and other restrictions on legislation. Because the purpose of the legislation is to strip a specified group of people of their property, even though other nonpunitive options are available, and because the evidence suggests a punitive motive, the bill could be found unconstitutional as a bill of attainder.

II. That AIG Bonuses are the Target of the Tax is Common Knowledge
Media reports have labeled it the "AIG bonus tax," which is not surprising since the bill's introduction and passage occurred quickly after news broke that AIG had paid $165 million in bonuses (later revised upward to $218 million) to employees after the bailout. As Rep. Sheila Jackson-Lee (D-TX) summarized on the floor of the House of Representatives:

AIG has now received more than $180 billion in taxpayer money and is now nearly 80 percent owned by the government. As part of a restructuring plan announced by the Treasury Department earlier this month, AIG is set to receive an additional $30 billion in federal rescue aid.

The news that AIG paid $165 million in retention bonuses, including bonuses of at least $1 million each to 73 employees who worked in the financial products division that contributed to the company's troubles, has incited fervor among lawmakers and the public over the past week. Eleven of those top bonus recipients—including one who received $4.6 million—have since left AIG.[3]

Statements by supportive members of Congress during the one hour of floor debate indicate that the AIG bonuses were on their mind:

Rep. Carl Levin (D-MI) said, "The head of AIG has suggested their returning the bonuses. They should. And if they don't, we're taking action. We have the authority under the Tax Code not to punish but to protect the taxpayers of the United States of America."[4]
Rep. Gary Peters (R-MI) said, "I rise in support of H.R. 1586, legislation that I helped craft that will reclaim outrageous bonuses paid with our taxpayer dollars that were given out to AIG and other companies that received billions in TARP funds."[5]
Rep. Bob Etheridge (D-NC) said, "If AIG will not halt these bonuses, and if its employees will not voluntarily turn them down, then this bill will ensure that the money is returned to the taxpayers."[6]
Rep. Frank Kratovil (D-MD) said, "What I am interested in doing today is doing what we can do to recoup the taxpayer dollars that were used to pay AIG executives bonuses that not only did they not deserve but should be ashamed for having accepted. That is what this bill does."[7]
Rep. Lynn Woolsey (D-CA) said, "I urge my colleagues to support this legislation as a way not only to express our outrage, but also as our commitment to a new system of regulation and oversight."[8]
Rep. Dale Kildee (D-MI) quipped, "A bonus is supposed to be a reward for something good—for excellent performance, not for running your company into the ground and sending the economy into a tailspin. AIG's performance warrants a pink slip, not a paycheck."[9] Rep. Phil Hare (D-IL) added, "Clearly, the 'G' in AIG stands for greed."[10]
Rep. Sheila Jackson-Lee (D-TX) added, "I rise today with pitchfork in hand to take back from the executives at AIG, monies that rightfully belong to the taxpayers of this country."[11]

It would therefore be disingenuous to argue that reports of the AIG bonuses were anything less than the direct cause of the consideration of the tax legislation.

III. The AIG Tax Bill Has Been Criticized on Constitutional Grounds
Criticism of the bill on constitutional grounds has included reference to five separate sections of the U.S. Constitution. The Bill of Attainder Clause of Article I, Section 9 prohibits "[l]egislative acts...that apply to....easily ascertainable members of a group in a way as to inflict punishment on them without a judicial trial."[12] The Ex Post Facto Clause of Article I, Section 9 prohibits laws that "in effect impose[] a penalty or the deprivation of a right which, when done, was lawful."[13] The Contracts Clause of Article I, Section 10 bars states from passing any law "impairing the Obligation of Contracts." The Due Process Clause of the Fifth Amendment protects individuals from federal deprivation of "life, liberty, or property, without due process of law." The Takings Clause of the Fifth Amendment prohibits governments from taking private property except for public use and only with just compensation, and also encompasses equal protection claims against the federal government.

As the House considered the legislation, the eminent constitutional law scholar Laurence Tribe was asked to evaluate the constitutional claims. He easily disposed of the arguments relating to the Contracts Clause, which by its own terms applies only to state government actions, and the Takings Clause and Ex Post Facto Clause, where case law has not treated taxation as a taking or retroactive taxation as impermissible. Tribe also concluded that a claim under the Due Process Clause would be unlikely to prevail under prevailing judicial understanding of that clause. As for the Bill of Attainder Clause, Tribe also concluded that it would not bar the legislation, though with additional commentary.

Another renowned constitutional law scholar, Richard Epstein, penned an op-ed conducting a truncated but similar analysis, though suggesting that this would be more a result of a deferential court than constitutional command.[14]

IV. The AIG Tax Bill Could Be an Unconstitutional Bill of Attainder
The Bill of Attainder Clause exists "not as a narrow, technical prohibition, but rather as...a general safeguard against legislative exercise of the judicial function, or more simply—trial by legislature."[15] It serves as "a general safeguard against legislative exercise of the judicial function, or more simply-trial by legislature."[16] As Chief Justice Earl Warren once wrote for the U.S. Supreme Court, this is because "the legislative branch is not so well suited as politically independent judges and juries to the task of ruling on the blameworthiness of, and levying appropriate punishment upon, specific persons."[17] James Madison characterized bills of attainder as "contrary to the first principles of the social compact, and to every principle of sound legislation."[18]

One law review note that warned against a too expansive scope for the Bill of Attainder Clause nevertheless characterized a proper claim as one where the court must provide "protection of political minorities singled out for punishment by majoritarian legislatures."[19] Here, it is not disputed that a majoritarian legislature is singling out a very unpopular group for an action that the members of the group will find harmful.

Determining whether a law is a bill of attainder involves the application of a two-part test: (1) whether the legislature has acted with specificity, and (2) whether the legislature has imposed punishment.[20]

A. Specificity
While "bills [of attainder] are generally directed against individuals by name," they "may also be directed against a whole class."[21] The precise level of specificity at which point a class becomes unconstitutionally targeted is unsettled. In Nixon v. Adm'r of Gen. Servs., which involved a congressional attempt to seize audio tapes from the former President, the Supreme Court concluded that just because a class consists only of one does not necessarily make it too specific. "[A]ny individual or group that is made the subject of adverse legislation can complain that the lawmakers could and should have defined the relevant affected class at a greater level of specificity."[22] The attainder clause is not "a variant of the equal protection doctrine" nor does it "limit[] Congress to the choice of legislating for the universe...."[23] In Nixon, while the class contained only one former president, the Court noted that future presidents could be included, and that it "constituted a legitimate class of one."[24]

Here, Congress has defined the class subject to the tax as any employee working for a company that has received an aggregate of $5 billion in TARP funds (which includes others beyond AIG). This is the basis on which many scholars, Tribe included, have concluded that the law does not violate the constitutional prohibition against Bills of Attainder. It would be a mistake, however, to conclude that Nixon means that any punitive legislation affecting only a narrow class will necessarily survive a constitutional challenge. One court described the circumstances in Nixon as meeting the specificity test but failing the punishment test.[25]

Specificity is satisfied "if the statute singles out a person or class by name or applies to 'easily ascertainable members of a group.'"[26] In 2003, the D.C. Circuit of Appeals considered a bill of attainder challenge to a federal law that stripped parental visitation rights from fathers in specified situations. According the court, the "combination of factors is so exceedingly narrow and unlikely to coincide that the affected persons are indeed 'easily ascertainable.'"[27] "Despite a feeble attempt at generality, there is no doubt that Congress targeted Dr. Foretich for application of the Act's unique child custody standard."[28]

Thus, even where Congress applies a law to a broad group of people, if it is easily ascertainable that a particular person or class is the target of the legislation, it satisfies the specificity test. Here, as in Nixon, the class is defined but is likely to change over time with additions (from new companies receiving more than $5 billion in TARP funds). But the circumstances surrounding enactment, including the legislative statements referenced above, demonstrate that AIG bonuses were a specified target of the tax. Consequently, it could be concluded that Congress has acted with specificity.

B. Punishment
The punishment prong of the test is generally where bill of attainder claims founder. "In deciding whether a statute inflicts forbidden punishment, we have recognized three necessary inquiries: (1) whether the challenged statute falls within the historical meaning of legislative punishment; (2) whether the statute reasonably can be said to further nonpunitive legislative purposes; and (3) whether the legislative record evinces a [legislative] intent to punish."[29] A bill of attainder need not fit all three factors, but rather the three are together weighed in resolving the bill of attainder claim.[30]

"Unmistakable evidence of a punitive intent...is required before [a law] may be struck down on attainder grounds."[31] If "legislative history represents the considered [legislative] decision to further nonpunitive legislative goals,"[32] or "if [the] legislation has a legitimately nonpunitive function, purpose, and structure, it does not constitute punishment for the purposes of the Bill of Attainder Clause,"[33] the test is not met.

Here, the questions are whether singling out a group for a very high tax would constitute punishment under any of the three factors. For the first, it would be whether such a tax falls within the historical meaning on legislative punishment. For the second, it would be whether the tax's nonpunitive purposes outweigh the asserted punishment. For the third, it would be whether there is legislative record demonstrating punishment was a motivation behind the bill.

1. Historical Factor
Bills of attainder, while at first only encompassing legislative death sentences, have been expanded over the centuries to any legislative act that "'set[] a note of infamy' on persons to whom the statute applies."[34] Nixon outlined historically recognized bills of attainder of varying types, with the unifying principle being that they imposed "deprivations and disabilities so disproportionately severe and so inappropriate to nonpunitive ends that they unquestionably have been held to fall within the proscription of Art. I, Section 9."[35] One noted specifically is "the punitive confiscation of property by the sovereign."[36]

Our present federal income tax system has tax rates ranging from 10 percent to 35 percent. Imposing a new 90 percent rate is a big jump. Only once before in American history (1943-1963) has the federal income tax reached 90 percent, and then as part of a range of high rates on all taxpayers.[37] Unlike the AIG tax, there was no huge jump from the next lowest rate to the 90 percent rate. In this case, therefore, there is intent inherent in the structure of the tax bill to separate out the taxed class of bonus recipients for disproportionate treatment.

To the extent that Congress is generally using the tax system in this case to single out the bonus recipients for a disproportionate deprivation of their property, or to subject them to public infamy by legislative pronouncement, it would fall under the historical meaning of a bill of attainder, as outlined in the case law.

2. Functional Factor and Motivational Factor
If Congress can show with "sufficiently clear and convincing" evidence that a legitimate legislative purpose other than punishment was the purpose of the AIG bonus tax, it can survive the functional and motivational factor tests.[38] The floor statements cited above demonstrate a punitive motive.

In Nixon, for instance, the Supreme Court found that the objectives of the act were to preserve historical information, not to inflict punishment on President Nixon. In another case, where Congress limited federal financial aid to students who had registered for the draft, the Supreme Court found that the law was a rational means of furthering the selective service system.[39] In Consolidated Edison, the court there found that where "the legislature piled on a burden that was obviously disproportionate to the harm caused," it would be found punitive.[40] Another court characterized the standard as "where there exists a significant imbalance between the magnitude of the burden imposed and a purported nonpunitive purpose, the statute cannot reasonably be said to further nonpunitive purposes."[41]

Professor Tribe characterized the nonpunitive objective of the bill as "to ensure the appropriate use of government funds," as evidenced by application of the tax to companies that receive an aggregate of $5 billion in bailout funds, and not at least $5 billion.[42] This means that companies can reduce their federal funds outstanding to avoid employees' liability, although doing so would probably undermine the purpose of the bailout in the first place. Because of the statements expressing outrage at the use of bailout funds for AIG bonuses as opposed to other problematic uses, it is at least arguable that one challenging the AIG bill could show a punitive purpose.

If a less burdensome option was open to the legislature to achieve asserted nonpunitive objectives, that fact will weigh against Congress. "In determining whether a legislature sought to inflict punishment on an individual, it is often useful to inquire into the existence of less burdensome alternatives by which that legislature...could have achieved its legitimate nonpunitive objectives."[43]

Congress had nonpunitive options open to it, as described by Professor Candice Hoke.[44] In an article written for the Cleveland Plain-Dealer, Professor Hoke suggests that the bonus contracts could have been broken under existing law, and further notes that AIG executives have corporate duties and responsibilities to shareholders (in this case, the U.S. taxpayer).

If the real purpose of the AIG tax bill is to recoup wasted money from AIG, Congress could require AIG to repay the bailout funds used for the bonuses. By specifically extracting those funds from bonus recipients, Congress is using a method that is broader than necessary for any nonpunitive purpose.

In 2002, a federal appellate court struck down a law on bill of attainder grounds because it prohibited one energy company from recovering costs from ratepayers.[45] The action was a bill of attainder because "it defines past conduct as wrongdoing and then imposes punishment on that past conduct."[46] More to the point, the court there noted that a determination that "it would be unfair to force ratepayers to absorb the costs of Con Ed's error," had it been reached instead by a court, would have been doubtlessly "punishment."[47]

Here, Congress has decided that AIG bonus recipients should be stripped of their property due to their actions and the actions of their company. This judgment of their actions has occurred without benefit of trial by jury or presentation of witnesses or evidence. The Bill of Attainder Clause exists to prevent Congress from imposing punishments on groups based on past conduct because such a role is best served by judges and juries.

V. Commentators Have Raised Additional Policy Concerns with the AIG Tax Bill
Beyond constitutional arguments, several commentators have raised interesting policy concerns with the AIG tax bill.

As James Taranto pointed out in the Wall Street Journal, the total tax take could be a hefty one for some people, particularly those in New York City.[48] In addition to the 90% bonus tax, income subject to the tax earned in New York City would face a 1.45% Medicare tax, 6.85% state income tax, and 3.648% local income tax.

Commenter "D.F. Linton" on the Volokh Conspiracy blog muses whether a targeted 90% tax on other specified groups presumably for punitive reasons, such as gays or Republicans, would violate the bill of attainder clause if the AIG tax did not.[49]

Tax lawyer Jacoba Urist wrote about a perverse effect of applying the tax to married individuals filing separately at only $125,000:

Consider a typical professional New York couple: Tom, age 31, put himself through business school and currently works as a research associate, earning $250,000 a year-$100,000 in base salary with a $150,000 year-end bonus. If Tom were single, that would be the end of the story: no TARP penalty tax.

But Tom is married. His wife, Anne, a law firm associate, newly minted physician or McKinsey consultant (take your pick from the thousands of jobs that work here) also put herself through graduate school. She now earns an additional $140,000 for the family.

The outcome: Anne's income, added to Tom's, triggers the TARP bonus tax, even though she had absolutely nothing to do with AIG, Merrill Lynch or any of the companies that received government aid last fall. Anne's paycheck certainly doesn't "belong to the American Taxpayer." Surely Anne doesn't stand for "Arrogance, Incompetence, and Greed." Most disturbing, Anne and Tom are penalized for being married and for Anne's working outside of the home-the ultimate marriage penalty.

Unfortunately, Wall Street is still a boys club and this bill punishes a second household earner. Assuming even an extremely low estimate-let's say, only 60 percent of Wall Street executives are men-the law discriminates against married women in the paid workforce.[50]

Finally, and perhaps most generally, the Miami Herald eloquently stated on its editorial page why using the tax code for a purpose other than raising revenue is improper:

The national outrage over the scandalous bonuses paid to executives at AIG is fully justified, but the response in Congress doesn't make sense. Experience shows that legislation forged in haste amid the swirl of headlines and theatrical hearings tends to produce bad policy, and this case is no exception.

Using the tax code as a weapon to exact revenge on a select few, no matter how badly they've behaved, is a horrible idea. Slapping heavy taxes on the bonuses and on the company that issued them may satisfy enraged taxpayers who see incompetent executives being rewarded for failure, but it sets a bad precedent.[51]

VI. Conclusion
James Madison once wrote: "The sober people of America...have seen with regret and indignation that sudden changes and legislative interferences, in cases affecting personal rights, become jobs in the hands of enterprising and influential speculators, and snares to the more-industrious and less-informed part of the community."[52] The AIG tax bill upsets settled expectations and sets the precedent that our tax code can be used to inflict retroactive punishments on unpopular groups.

This has happened before. In 1969, after the revelation that 155 people with at least $200,000 in income had paid zero federal income tax, Congress reacted to the public outrage not by eliminating deductions that those high-income earners had taken advantage of, but instead by layering a second federal income tax system on top of the existing one.[53]

Consequently, it is not only poor tax policy but also constitutionally suspect. Congress and the American people have other avenues to express their outrage at AIG's use of bailout money in particular and the bailout policy in general. We should use the tax code only to raise revenue with the minimal distortions possible.

Joseph Henchman is Tax Counsel at the Tax Foundation. He supervises the Center for Legal Reform at the Tax Foundation, filing amicus curiae briefs and writing commentaries on federal and state constitutional law.

Notes

[1] Ken Strickland, Is That AIG Tax Constitutional?, (Mar. 20, 2009), http://firstread.msnbc.msn.com/archive/2009/03/20/1846610.aspx.

[2] CBS News, Obama On AIG Rage, Recession, Challenges, (Mar. 22, 2009), http://www.cbsnews.com/stories/2009/03/18/60minutes/main4873938.shtml.

[3] 155 Cong. Rec. H3,644 (2009) (statement of Rep. Jackson-Lee).

[4] 155 Cong. Rec. H3,657 (2009) (statement of Rep. Levin).

[5] 155 Cong. Rec. H3,657 (2009) (statement of Rep. Peters).

[6] 155 Cong. Rec. H3,659 (2009) (statement of Rep. Etheridge).

[7] 155 Cong. Rec. H3,662 (2009) (statement of Rep. Kratovil).

[8] 155 Cong. Rec. H3,663 (2009) (statement of Rep. Woolsey).

[9] 155 Cong. Rec. H3,663 (2009) (statement of Rep. Kildee).

[10] 155 Cong. Rec. H3,663 (2009) (statement of Rep. Hare).

[11] 155 Cong. Rec. H3,644 (2009) (statement of Rep. Jackson-Lee).

[12] Black's Law Dictionary, 6th Ed., citing United States v. Brown, 381 U.S. 437, 448-49 (1965).

[13] Id., citing Wilensky v. Fields, 267 So.2d 1, 5 (Fla. 1972).

[14] Richard A. Epstein, Is the Bonus Tax Unconstitutional?, Wall Street Journal (Mar. 26, 2009), http://online.wsj.com/article/SB123802257323941925.html.

[15] United States v. Brown, 381 U.S. 437, 442 (1965).

[16] Id.

[17] Id.

[18] The Federalist No. 44 (James Madison).

[19] Thomas H. Lee, Bill of Attainder: Fifth Circuit Holds that the Special Provisions of the Telecommunications Act of 1996 Are Not a Bill of Attainder, 112 Harv. L. Rev. 1385, 1390 (1998-99).

[20] See generally SBC Communications, 154 F.3d 226, 233 (5th Cir. 1998) (summarizing Supreme Court rulings in bill of attainder cases), cert. denied, 525 U.S. 1113 (1999).

[21] Cummings v. Missouri, 71 U.S. (4 Wall.) 277, 323 (1856).

[22] Nixon v. Adm'r of Gen. Servs., 433 U.S. 425, 470 (1977).

[23] Id. at 471.

[24] Id. at 472.

[25] See Foretich v. United States, 351 F.3d 1198, 1217 (D.C. Cir. 2003).

[26] Id., citing United States v. Lovett, 328 U.S. 303 (1946).

[27] See Foretich, 351 F.3d at 1217.

[28] Id. at 1204.

[29] Selective Service System v. Minnesota Public Interest Research Group, 468 U.S. 841, 852, quoting Nixon, 433 U.S. at 473 (emphasis added).

[30] See Consol. Edison Co. v. Pataki, 292 F.3d 338, 350 (2d Cir. 2002), cert. denied, 537 U.S. 1045 (2002).

[31] Selective Service System, 468 U.S. at 856 n.15.

[32] Id. at 854. See also Nixon, 433 U.S. at 484 ("[W]e may look only to its [the challenged law's] terms, to the intent expressed by Members of Congress who voted its passage, and to the existence or nonexistence of legitimate explanations for its apparent effect.").

[33] SBC Communications, 154 F.3d at 241 (summarizing Nixon).

[34] Foretich, 351 F.3d at 1220, quoting 4 William Blackstone Commentaries 380.

[35] Nixon, 433 U.S. at 473-75.

[36] Id. at 473, citing In Re James' Claim, 1 U.S. (1 Dall.) 47 (1780), Respublica v. Gordon, 1 U.S. (1 Dall.) 233 (1788) (involving seizure of property of Tory sympathizers).

[37] See Tax Foundation, U.S. Federal Individual Income Tax Rates History, 1913-2009 (Jan. 2009), http://www.taxfoundation.org/taxdata/show/151.html.

[38] See Foretich, 351 F.3d at 1220-21, citing BellSouth Corp. v. FCC, 162 F.3d 678, 686 (D.C. 1998).

[39] See Selective Service System, 468 U.S. at 843. However, the Court recognized and permitted an effect on nonregistrants it described as "a strong tonic." Id. at 854.

[40] Consol. Edison. Co., 292 F.3d at 354.

[41] Foretich, 351 F.3d at 1221-22.

[42] See Greg Stohr, AIG Tax Measure Suits Likely to Come, Less Likely to Succeed, Bloomberg News (Mar. 21, 2009), http://www.bloomberg.com/apps/news?pid=20601087&sid=aSIkeD1UaJ2Q&refer=home.

[43] See Nixon, 433 U.S. at 482 ("In determining whether a legislature sought to inflict punishment on an individual, it is often useful to inquire into the existence of less burdensome alternatives by which that legislature...could have achieved its legitimate nonpunitive objectives.").

[44] See Candice Hoke, Recouping AIG Bonuses: Avenues for Proactive Public Protection, Cleveland Plain-Dealer (Mar. 22, 2009), http://www.cleveland.com/plaindealer/stories/index.ssf?/base/opinion/1237624592252470.xml&coll=2.

[45] See Consol. Edison, 292 F.3d at 338.

[46] Id. at 349, citing Nixon, 433 U.S. at 472-73 and Cummings, 71 U.S. (4 Wall.) at 325.

[47] Id. at 352.

[48] James Taranto, The 102% Tax, Wall Street Journal (Mar. 20, 2009), http://online.wsj.com/article/SB123757098072897381.html.

[49] Comment, Volokh Conspiracy (Mar. 22, 2009), http://volokh.com/posts/1237734930.shtml#551928.

[50] Jacoba Urist, The Working Women's Tax, Tax Prof Blog (Mar. 23, 2009), http://taxprof.typepad.com/taxprof_blog/2009/03/urist-the-aig-tax-is-sexist.html.

[51] Miami Herald, Tax Code Mustn't Be Used as Weapon, (Mar. 20, 2009), http://www.miamiherald.com/opinion/editorials/story/959108.html.

[52] The Federalist No. 44 (James Madison) (1788).

[53] Patrick Fleenor and Andrew Chamberlain, Backgrounder on the Alternative Minimum Tax, Tax Foundation Fiscal Fact No. 26 (May 2005), http://www.taxfoundation.org/publications/show/498.html.

States Use Gentle Hand in Taxing Timberland

Wed, 25 Mar 2009 00:00:00 EDT

Fiscal Fact No. 164

In the realm of real property taxation, the best-known tax is on residential property. Every U.S. homeowner knows that the local government will collect a small percentage of the property's fair market value each year, ranging from much less than one percent up to more than three percent.¹Local governments levy a similar, often higher tax on stores, factories, warehouses and other common types of commercial property.²State-level governments normally leave these types of real estate untaxed, focusing their property taxes mostly on cars and boats. As a result, local governments collect 95 percent of total property tax revenue.

However, there are exceptions to state governments' custom of leaving real estate taxation to local governments. Here we briefly survey the ways that state governments are taxing forest and timberland.

The Forgiving Nature of Current Use Value
In taxing timberland, states use a variety of assessment techniques limiting the ability of local governments to collect taxes on timberland: ad valorem or "current use" tax, flat property tax, yield tax and/or severance tax. In most cases, the systems favor maintaining current timberland.

All but five states use an ad valorem tax. This is the so-called current use tax, whereby the tax due depends on the value of the land as it's currently being used. This current use valuation is much lower than fair market value because many landowners do not put their land to its most profitable use. If owners of forested land had to pay a percentage of the land's fair market value, their payments would be much higher because potential buyers considering other uses for the land would drive up the fair market value. This fair market value system would increase pressure on land owners to make profitable use of their land or sell it to someone who would.

Another method for taxing the land is a flat tax. Unlike the ad valorem tax, this system does not consider the value of the land, but rather collects the same amount of money per acre on any acre of timberland. Currently, five states impose a flat rate, with rates ranging from $0.50 in North Dakota to $3.00 in Missouri. Similar to the ad valorem tax, these flat tax rates are much more favorable than the normal property tax rates.

In addition to the real property taxes, there are two methods states use for taxing the timber: the yield tax and the severance tax. The yield tax is a gross income tax, equal to some percentage of the stumpage value of the products cut; the tax is collected after the timber is harvested. Eight states have adopted the yield tax. Timber severance taxes are flat taxes on a specific unit of volume harvested (i.e., board feet, cubic feet, cords, tonnage etc.), and are levied at the time the timber is cut. The severance tax is currently used by ten states.

In addition to the forgiving nature of some of these timberland levies, some states have enacted special rates, or even total exclusions, to benefit timberland investment. For example, Oklahoma imposes a $0.75-to-$1 per acre tax on timberlands, while other crop lands are taxed at a rate two to three times higher. Thus, in areas that have a high concentration of timberlands (a.k.a. wastelands), property taxes are considerably lower than in other portions of the state. Four states exempt timberland from property tax entirely.

Due to these significant tax benefits, landowners have powerful incentives to have land classified as timberland. Paradoxically, after creating incentives for timberland, states have responded to the high demand for timberland classifications with burdensome administrative requirements to qualify for them. In Florida, it is up to the landowner to prove "agricultural use" based on several factors, and a taxpayer must renew his agricultural use classification annually. Georgia punishes the largest landowners by only permitting 2,000 acres to be classified as forest land, but it also makes life more difficult for the smallest landowners with a more rigorous test to prove agricultural use if the parcel is 10 acres or smaller.

The chart below provides a snapshot of the taxes imposed on timberland and forest areas in all 50 states. These provide only a rough guide, as timberland taxes are quite complex. Also, these are only the state tax laws. One must also look to local real property tax laws.

STATE	TAX ON TIMBERLAND*
Alabama	10% of current use value based on soil productivity; severance tax based on type of timber.
Alaska	Timber and land are exempt from general taxation.
Arizona	25% of full cash value or limited valuation; severance tax based on type of timber.
Arkansas	Current use value based on soil productivity (not to exceed 20% of current use); severance tax based on type of timber.
California	Valued at the present worth of the land (land must be worth more than $2.00/acre) and a 2.9% yield tax.
Colorado	The "actual value" of agricultural lands, exclusive of building improvements thereon, is determined by the earning or productive capacity of such lands during a reasonable period of time, capitalized at a rate of 13%; once the "actual value" is determined, the assessment rate of 29% is applied to arrive at the taxpayer's liability.
Connecticut	The rate of tax on forest land is limited to 10 mills (the local rate is applicable if lower). The rate is applied to the value of the land itself, excluding the value of the timber. Yield tax rate depends on number of years of timber growth on the land.
Delaware	Property tax is based on the value of land actively devoted to agricultural, horticultural or forest use and has been so devoted for at least the 2 successive years immediately preceding the tax year in issue (provides lower tax rates for qualifying land). In addition, any landowner who establishes a "commercial forest plantation" and meets other qualifications under Delaware law shall be entitled to a 30-year exemption from county property taxes on such plantation.
Florida	The current value of the land and its potential to produce income is calculated for the property based on the site's "productive value" (i.e., site index). Since the assessment is based on productivity and potential income, the higher the site index, the assessed value will also be higher.
Georgia	Tax rate is based on current use valuation. For ad valorem tax purposes, standing timber is taxed only once following its harvest or sale. Standing timber is taxed at 100% of its fair market value. It is subject to taxation even if the land underneath is exempt unless taxation has been prohibited by federal law or treaty.
Hawaii	Current use value based on agricultural production; varies by county. Agricultural land is taxed at a fixed amount per $1,000 assessed value.
Idaho	Bare Land and Yield- Current use and yield tax; approximately 1% of the bare land value of the property. State is divided into 4 districts and each district is rated good, fair or poor for growing trees. Yield tax is 3% of stumpage value determined by the State Tax Commission. Productivity Valuation- state is divided into 4 districts and each district is rated good, fair or poor for growing trees, and then taxed based on current use value (no yield tax imposed)
Illinois	Current use and yield tax; productivity index gives range of values for "other farmland" based on agriculture crops using soils; 4% yield tax.
Indiana	A flat $1.00 per acre (assessed value) on classified forest land.
Iowa	Agricultural real estate is valued at its current use with permanent forest or fruit tree reservations exempt; property assessed at its actual value by giving exclusive consideration to its productivity and net earning capacity determined on the basis of its use for agricultural purposes capitalized at a rate of 7% and applied uniformly among counties and classes of property.
Kansas	Valuations for each parcel of land devoted to "agricultural use" will be based on the agricultural income or productivity attributable to the land in its current usage (use value) under a degree of management reflecting median production levels.
Kentucky	Agricultural and horticultural land is assessed on the basis of the land's value for agricultural or horticultural uses; the use value of agricultural or horticultural land is based upon income producing capability and comparable sales of farmland purchased for farm purposes when the price is indicative of farm use value, excluding sales representing purchases for farm expansion, better accessibility, and other factors that inflate the purchase price beyond farm use value.
Louisiana	Assessed at 10% of current use value.
Maine	Forest land is eligible for current-use valuation in which the land is valued by reference to the market value of similar property rather than in comparison to land priced at a premium, for residential or commercial purposes. The 100% valuation per acre for each forest type for each area equals the value of the annual net wood production multiplied by a capitalization rate. The capitalization rate applied to the value of the annual net wood production is 8.5%.
Maryland	Land is assessed at $125 per acre (unless fair cash value is less than $100 per acre).
Massachusetts	5% of fair cash value (not less than $10) plus enrollment fee. 8% yield tax (assessed on cutting 2 years prior to classification).
Michigan	$1.00 per acre flat tax and 5% yield tax.
Minnesota	Net rate of 1% of the market value, however, there is a rebate for forest land; minimum rebate of $1.50 per acre for each acre enrolled in the sustainable forest incentive program.
Mississippi	Taxed at 15% of current use.
Missouri	$3.00 per acre flat tax (assessed value for 25 years) and $1.00 per acre if enrolled prior to 1974 and a 6% yield tax.
Montana	Calculated each year by dividing the total estimated tax due on forest lands by the total forest value of those lands. Severance tax is $0.15/MBF.
Nebraska	Assessed at 80% of current use value.
Nevada	35% of the current use value.
New Hampshire	Range in fixed assessment values by forest type, lower range of values with stewardship plan. An additional 20% reduction if recreation allowed. 10% yield tax.
New Jersey	Agricultural land is valued and assessed based on its current use, not the highest and best use; this value is adjusted for the productivity ratings of the soil. The higher the soil productivity rating the higher the value on a per acre basis.
New Mexico	Use of the land to produce forest products or in a manner that qualifies for compensation under a federal soil conservation program is considered an agricultural use that may entitle the land to be valued on the basis of its capacity to produce agricultural products. The production capacity of agricultural land shall be determined by the income method of valuation based on the income derived or capable of being derived from the use of the land for agricultural purposes.
New York	Bare land value with exemption of timber, 6% of timber stumpage value as determined by the assessor. Also has law permitting forest land to be taxed at 80% of FMV or $40 fixed value, whichever is the lesser.
North Carolina	Certain forestland and open-space land is designated as a special class of property under the authority of the North Carolina Constitution and, as such, is excluded from taxation or is otherwise specially treated. Severance tax depends on type of timber.
North Dakota	$.50 per acre flat tax.
Ohio	Current Agricultural Use Value- Based on soil productivity, generally assessed at $100/acre. Ohio Forest Tax Law- 50% of local tax rate on the FMV plus $50 application fee.
Oklahoma	For purposes of the assessment of Oklahoma real property tax, managed timberland used for the cultivation of timber should be classified at its fair cash value for that use.
Oregon	Forestland program- Property taxes under this program range from 40 cents per acre to $6.75 per acre, depending on location of the property and the ability of your property to grow timber. Small tract forestland option- A landowner pays an annual property tax on 20 percent of the forestland special assessment value. The STF Severance Tax is paid when the landowner harvests the timber from this property.
Pennsylvania	Current use value based on forest productivity; value based on FIA growth in 4 regions of the state - usually weighted within counties.
Rhode Island	The assessment rate, which is determined based on current use value, is set by the state Forestry Commission each year for all site classes and species. Property tax exemption for certain types of forestry.
South Carolina	For property tax purposes land used to grow timber is classified as "agricultural use land" and is taxed on the basis of its fair market value for agricultural purposes. Current assessment rate for agricultural use land (privately owned) is 4.0%.
South Dakota	Current use based on agricultural productivity. Forest land is not classified, though it can occupy a portion of agricultural land whether it is dry cropland, pasture, waste or non-productive.
Tennessee	Forest land is assessed at 25% of its current use value.
Texas	Landowners may apply for special appraisal based on their land's productivity value (which is lower than fair market value) rather than what the land would sell for on the open market (appraisal value may not exceed the market value of the land as determined by other appraisal methods).
Utah	Tax is based on current use value. Various components are considered in determining the use value of the land. Agricultural land is first grouped into land classifications, according to its capability to produce crops or forage. Productive values are established by the Utah State Tax Commission with assistance of a five member Farmland Assessment Advisory Committee and Utah State University. These factors are expressed in terms of value per acre for specific land classifications.
Vermont	Land will be valued based on its current use rather than highest and best use. Forest land is classified as either "productive forest land" or "non-productive forest land." Agricultural land is classified as either "agricultural land" or "non-productive agricultural land." Land values are reviewed annually by the "Current Use Advisory Board."
Virginia	A county, city or town may adopt an ordinance to provide for the use value assessment and taxation of property devoted to agricultural, horticultural, forest, or open-space use; a severance tax is also imposed with the rate depending on the type of wood.
Washington	Current use values on forest land are determined by the state Department of Revenue and vary depending on the productivity of the soil and other factors. Harvesting timber on either private or publicly owned land is subject to a 5% excise (yield) tax on the stumpage value of timber harvested for sale or for commercial or industrial use.
West Virginia	Productivity based on soil survey and a 3.22% yield tax.
Wisconsin	$0.83 per acre and a 10% yield tax.
Wyoming	The taxable value is based on a portion of the full value, the fractional amount is 9.5% for agricultural property.
* Every state has certain requirements which the timberland must meet in order to receive the valuation/exemption described. Please refer to specific state statutes to determine whether a particular parcel of timberland qualifies. In addition, much of this information was collected from timbertax.org; please refer to this website for more detailed information regarding timberland and property taxes.

1. See "Property Tax on Owner-Occupied Housing, by County, Ranked by Property Taxes as a Percentage of Home Value, 2005-2007 Average," Tax Foundation Tax Data (Dec. 12, 2008), at http://www.taxfoundation.org/taxdata/show/24051.html.

2. Real property refers to real estate. Some state governments also tax property, but usually that is limited to personal property, mostly cars and boats.

Illinoiss Business-Friendliness Ranking Would Decline Sharply Under Governors Plan

Wed, 18 Mar 2009 00:00:00 EDT

News Release

According to new analysis, a tax proposal from Illinois Governor Pat Quinn (D) would sharply reduce the ranking of the state's business tax climate, moving it from the top half to the bottom half in the nation when it comes to "business-friendliness."

Quinn's plan would raise the personal income tax rate from 3 percent to 4.5 percent and the corporate income tax rate from 7.3 percent to 9.7 percent. The plan would also increase the personal exemption on the individual income tax from $2,000 to $6,000. A single person with income over $14,000 would face a tax increase under the plan; a married couple with two dependent children would face a tax increase if family income exceeds $56,000.

"Illinois has high property taxes and high sales taxes," said Tax Foundation staff economist Josh Barro. "Currently, those taxes are partly offset by a low personal income tax. With a 50% increase in the income tax rate, Illinois legislators would give up the state's one tax climate advantage."

Barro, author of the 2009 State Business Tax Climate Index (a study that measures how well a state's tax system encourages investment by maintaining a broad tax base and low rates), analyzed the tax proposal's effects on Illinois' business tax climate ranking. Based on current tax law, Illinois ranked 23rd out of 50 states for business-friendliness of its tax code. With Quinn's plan in effect, Illinois' ranking would have sunk to 31st.

The Index ranks states based on the taxes that matter most to businesses and business investment: corporate tax, individual income tax, sales tax, unemployment insurance tax and property tax. On the sales, unemployment insurance and property taxes, Illinois currently ranks 39th, 43rd and 41st in the nation, respectively. Under Quinn's proposal, the state would move from 10th to 13th on the personal income tax index, and from 28th to 40th on the corporate income tax index.

Barro also highlighted the effects of a sharp increase in the corporate income tax rate. Currently, Illinois imposes a 4.8% corporate income tax, plus a 2.5% "replacement tax" also levied on corporate income. Quinn's plan would raise the 4.8% rate to 7.2%, while retaining the replacement tax, for a total rate of 9.7%.

"Illinois would have the fourth highest state corporate income tax rate in the nation under Gov. Quinn's plan," says Barro. "Corporate tax burdens are ultimately borne by individuals, as businesses pass these costs onto their employees, customers and shareholders. This plan would raise the cost of doing business and creating jobs in Illinois."

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

###

To schedule an interview, please contact Matt Moon, the Tax Foundation's Manager of Media Relations, at (202) 464-5102.

Who Pays for Climate Policy? New Estimates of the Household Burden and Economic Impact of a U.S. Cap-and-Trade System

Mon, 16 Mar 2009 00:00:00 EDT

Working Paper No. 6

Abstract
Many U.S. lawmakers view cap and trade as a politically superior non-tax approach to climate policy. However, cap and trade imposes identical economic burdens on households to a similarly designed carbon tax. Using the newly-released 2002 input-output accounts we present new estimates of the distributional impact of a typical cap-and-trade system by income, age, U.S. region and family type. In total, households would face an annual burden of roughly $144.8 billion per year with costs disproportionately borne by low-income households, those under age 25 and over 75 years, those in Southern states, and single parents with dependent children. Using RIMS II multipliers we estimate the broader economic impact of cap and trade. Depending on how the system is structured, cap and trade could reduce U.S. employment by 965,000 jobs, household earnings by $37.8 billion, and economic output by $136 billion per year or roughly $1,145 per household. Lawmakers weighing the costs and benefits of climate policy should be aware that cap and trade would impose a significant and regressive annual burden on U.S. households, and would not represent a "tax free" way to reduce greenhouse gas emissions.

Testimony before Maryland Legislature on Tax Increase Supermajority Requirements

Thu, 05 Mar 2009 00:00:00 EST

Testimony of Joseph Henchman

Tax Counsel and Director of State Projects, Tax Foundation

Committee on Ways and Means

March 5, 2009

Regarding H.B. 684

My name is Joseph Henchman, and I am currently Tax Counsel and Director of State Projects at the Tax Foundation. We are a non-partisan, non-profit research institution founded in 1937 to analyze tax issues and raise economic awareness among taxpayers, lawmakers, and the media. We track tax-related issues at all levels of government, and follow tax policy and tax legal issues at the federal and state levels closely.

I appreciate the invitation to submit this testimony regarding H.B. 684 to the Ways and Means Committee. The Tax Foundation takes no position on the bill, but is eager to provide information about the subject matter. In my remarks, I will try to do three things. First, I hope to provide a comparative picture of tax increase supermajority requirements in other states. Second, I want to evaluate arguments made against tax increase supermajority requirements as best I can. Third, I will review how a tax increase supermajority requirement comports with principles of sound tax policy.

State legislation is often described as an expression of majority rule. However, the legislative process contains steps that seem designed to hinder spontaneous expressions of majority sentiment. The members of the committee need no reminder that to even come up for a vote, a bill needs to demonstrate a likelihood of success and some measure of approval from legislative leaders. Passage must be agreed to by two separate popularly elected houses. The Governor, himself popularly elected, must sign the bill. Simply put, the normal legislative process has an implicit goal of ensuring final products are subjected to extensive consideration over a period of time by several actors, and has incorporated elements that further that goal.

In many states, to become law, tax increases must constitutionally survive one additional hurdle beyond the hurdles other legislation must survive. These hurdles can include voter approval, multiple readings, and committee origin requirements (as in the federal government). In sixteen states, the hurdle rises to a higher threshold of legislative approval.

Requiring a higher threshold for taxes has historically been justified on similar grounds as for other subject matters subject to supermajority requirements. Impeachments and removals from office, constitutional amendments, and ending filibusters are all common examples of matters considered so important that a simple majority vote would not deliver the sought-after public consensus and thorough consideration.

The sixteen states that have such a rule for tax increases are as follows:

tate	Year of Adoption	Required Vote	Notes
Arizona	1992	66.6%
Arkansas	1934	75.0%	Only applicable to taxes existing in 1934
California	1979	66.6%
Colorado	1992	66.6%	Also subject to voter approval
Delaware	1980	60.0%
Florida	1971	60.0%	Corporate income tax only, if increase exceeds 5% limit
Kentucky	2000	60.0%	Taxes and fees, in odd-numbered years only
Louisiana	1966	66.6%
Michigan	1994	75.0%
Mississippi	1970	60.0%
Missouri	1996	66.6%	Only if Governor declares emergency; otherwise requires voter approval
Nevada	1996	66.6%
Oklahoma	1992	75.0%
Oregon	1996	60.0%
South Dakota	1996	66.6%
Washington	1993	66.6%	Tax increases over spending limit also require voter approval

Supermajority requirements for tax increases are common and long-standing in the states. It would be silly to say that these requirements are unusual or have destroyed the states where they exist. It is true that they diffuse the will of a bare majority, but so do many other steps in the lawmaking process.

Opponents of tax increase supermajority requirements make three basic arguments. First, they say that such requirements are unnecessary given Americans' aversion to taxes. Because of this aversion, they say, tax increases are already scrutinized and rare. But as Marylanders know, tax increases are not so scrutinized and rare as this argument suggests. Once they have momentum toward passage, tax bills often become a magnet for any number of special interest provisions that increase the complexity and reduce the neutrality of the tax code. Increasingly states are shifting tax burdens to unpopular political minorities, as Maryland did in 2008 with smokers and high-income earners. With only a simple majority needed, there is little need to slow down and consider concerns shared by, or imposed on, a minority.

Second, opponents say that supermajority requirements empower a minority, which in turn can become obstructionist and demand unrelated favors in return for votes. I will concede that a supermajority requirement empowers a minority; indeed, that is its purpose. This in of itself is not a bad thing; much of our constitutional structure and the rules of parliamentary procedure are designed to protect the rights of a minority against an otherwise steamroller majority. Logrolling, of course, can present a problem for legislatures no matter the vote threshold. In California, recently, legislators had to concede the creation of a harmful special interest tax provision and schedule an unpopular initiative for the ballot in return for the final two votes it needed to pass the budget. However, prior to those final deals, the budget bill was greatly improved because of the need to reach a two-thirds threshold. One side wanted tax increases and the other side wanted spending cuts, and the final result was a compromise of the two, as intended. For a state like California, it must be said, there is a real danger that without the two-thirds rule, California would essentially be a one-party state in the Legislature, greatly curtailing the thoughtful consideration of legislation. The supermajority requirement helps that survive.

Third, opponents say that many supermajority requirements have led to legal uncertainty, primarily because many cover taxes but not fees. A legal scholarship must then be developed, distinguishing taxes from fees, and this is not always easy. I have two responses. First, some states cover both taxes and fees, which eliminates this uncertainty. Second, such a legal scholarship exists and has come to a remarkable consensus. The Tax Foundation tracks dozens of cases and laws in dozens of states, many of which have developed cogent definitions of what taxes are and when they differ from fees. Maryland, if it adopted this bill, could rely on these precedents quite easily.

Finally, I would urge that the members and other legislators consider the principles of sound tax policy when evaluating tax legislation. Originally developed by Adam Smith, these principles guide Tax Foundation analysis and are the subject of surprising consensus between left and right. The key principles are four. First, is simplicity-is the tax code easy to understand for those who must comply with it? Second, is transparency-is the method of changing the tax code visible and open? Third, is stability-are taxpayer obligations and state revenues unlikely to change dramatically from year to year? Fourth, is neutrality-does the tax code focus on raising revenue for the programs society wants to fund, without picking winners or losers or trying to influence behavior one way or the other?

The bill under consideration impacts at least two of these principles: transparency and stability. Requiring additional consideration and empowering a minority when considering tax issues means a greater likelihood that the resulting bill will be the product of consensus and thoughtful consideration. The additional consideration also sends the signal that tax increases will not happen suddenly, and the additional legislative give-and-take reduces the chance that a minority will alone bear the burden of higher taxes. This increased stability in turn furthers the certainty required for investment, capital formation, and job creation.

Once again, I would like to express my appreciation for being invited to submit this testimony today. My contact information is included with my written testimony if any member would like to contact me on this or any other issue. I would also be happy to take any questions you may have at this time.

Yours Very Truly,

Joseph D. Henchman
Tax Counsel & Director of State Projects
Tax Foundation

Facts & Figures Handbook: How Does Your State Compare?

Tue, 24 Feb 2009 00:00:00 EST

How do taxes in your state compare nationally? This convenient pocket-size booklet compares the 50 states on 38 different measures of taxing and spending, including individual and corporate income tax rates, business tax climates, excise taxes, tax burdens and state spending.

For a free copy of Facts & Figures: How Does Your State Compare?, please send an e-mail to publications@taxfoundation.org and include your name and mailing address (street address or PO box). Please allow two weeks for delivery. A PDF of the booklet can be downloaded at the bottom of this page.

Facts & Figures Handbook: How Does Your State Compare?

Tue, 24 Feb 2009 00:00:00 EST

Update: The Tax Savings from Final Fiscal Stimulus

Mon, 23 Feb 2009 00:00:00 EST

Fiscal Fact No. 163

On Tuesday, February 17, President Obama signed the American Recovery and Reinvestment Act of 2009 (ARRA 2009), also know as the stimulus bill. It includes several provisions that change the individual income tax. Tables 1, 2 and 3 below show the tax savings for typical American families with various income levels and in different stages of life. Table 4 provides a brief description of the tax provisions included in the stimulus bill.

Table 1 shows the tax savings for a family with two children, one in college and one under age 17. Savings are shown for both a married couple and a single parent. At most income levels, the savings are largely due to the refundable Making Work Pay credit ($400 for a single filer, $800 for a couple) and the increased and now partially refundable education credit (now called the American Opportunity credit). The so-called AMT patch also makes up a substantial portion of the savings for the married couple at most incomes shown and for the single parent at higher incomes.

Oddly, the calculation of a person's AMT liability is so confusingly interwoven with the calculation of regular tax liability that the so-called AMT patch can actually provide tax relief to people who would not have had to pay the AMT even without the patch. In permanent law, the AMT prohibits the full use of certain tax credits, but with the one-year patch, the full value of those credits can be taken, and so even taxpayers with modest incomes often see significant savings from the AMT patch.

Table 1: Tax Savings in 2009 under ARRA 2009 for a Typical Family of Four with College Expenses (a)

Couple with Two Children Earning: (a)	Tax with No Stimulus Bill	Tax under the Stimulus Bill	Savings
$40,000	($1,721)	($3,915)	$2,194

$60,000	$2,900	($33)	$2,933

$80,000	$5,604	$2,518	$3,086

$100,000	$10,180*	$4,978	$5,202

$200,000	$35,750*	$30,191	$5,559

Single Parent with Two Children Earning: (a)
$20,000	($5,274)	($6,674)	$1,400

$40,000	$0	($1,100)	$1,100

$60,000	$4,753	$1,853	$2,900

$80,000	$9,103	$6,303	$2,800

$100,000	$14,105*	$13,953	$152

$200,000	$41,113*	$37,746*	$3,367
(a) The couple is assumed to be a two-earner couple with equal earnings and income from no other source. One child is assumed to be under age 17 and the other child of college age with college expense of $4,000. Itemized deductions are assumed to be 18 percent of earnings. It is assumed that the taxpayer does not purchase a first home in 2009. The same assumptions apply for the single parent.
*Indicates taxpayer is required to pay the Alternative Minimum Tax.

Table 2 below shows the tax savings for a couple who have three young children and have purchased their first home in 2009. Again, much of the savings comes from the Making Work Pay credit and the AMT patch. Additionally, the couple making $40,000 sees significantly increased savings due to the expansion of the earned income credit (EIC).

In this example, the taxpayer benefits from a once-in-a-lifetime tax benefit: a credit for purchasing one's first home. The stimulus bill added $500 to the First-time Homebuyer credit, raising it from $7,500 to $8,000, but that was not the most important change. As originally enacted last summer as part of the Housing and Economic Recovery Act, the homebuyer credit had to be repaid over a 15-year period. That made it more like an interest-free loan than a true tax credit. The stimulus bill eliminates that repayment requirement for homes purchased in 2009, turning it into a regular refundable credit. Our single-year snapshot examples don't change as a result, but this change does make the credit much more valuable to many low- and middle-income buyers of a first home. Upper-income buyers of a first home do not benefit because the credit begins to phase out when income surpasses $150,000 ($75,000 for a single taxpayer).

Table 2: Tax Savings in 2009 under ARRA 2009 for a Typical Family of Five Who Purchase Their First Home (a)
Earnings:	Tax with No Stimulus Bill	Tax under the Stimulus Bill	Savings
Earnings:	Tax with No Stimulus Bill	Tax under the Stimulus Bill	Savings
$40,000	($10,186)	($12,509)	$2,322

$60,000	($6,600)*	($8,080)	$1,480

$80,000	($3,896)*	($5,530)	$1,634

$100,000	$680*	($3,070)	$3,750

$120,000	$5,756*	$1,115	$4,641

$140,000	$11,332*	$6,215	$5,117

$160,000	$20,658*	$15,515	$5,143

$180,000	$30,030*	$24,548	$5,482

$200,000	$35,750*	$29,169	$6,581
(a) The family consists of a married couple with 3 children under age 17. The couple is assumed to be a two-earner couple with equal earnings and income from no other source. It is assumed that the first home is purchased for $150,000. Itemized deductions are assumed to be 18 percent of earnings.
* Indicates taxpayer is required to pay the Alternative Minimum Tax.

Table 3 shows the tax savings for a retired couple with $12,000 of Social Security income and various amounts of pension and investment income. Because they have no earned income (like salaries or wages) the retired couple is not eligible for the Making Work Pay credit or the earned income credit. In this case the only benefit the elderly couple receives from the stimulus is from the AMT patch at upper incomes.

Table 3: Tax Savings in 2009 under ARRA 2009 for a Typical Retired Couple (a)
Other Income:	Tax with No Stimulus Bill	Tax under the Stimulus Bill	Savings
Taxable Pension:$0 Ordinary Dividends: $0	$0	$0	$0

Taxable Pension: $20,000 Ordinary Dividends: $5,000	$410	$410	$0

Taxable Pension: $40,000 Ordinary Dividends: $10,000	$5,060	$5,060	$0

Taxable Pension: $60,000 Ordinary Dividends: $15,000	$10,452*	$8,810	$1,642
(a) It is assumed that the retired couple has $12,000 in Social Security Income. Itemized deductions are assumed to be 18 percent of earnings.
* Indicates taxpayer is required to pay the Alternative Minimum Tax.

In summary, some taxpayers are set to receive a considerable tax cut from the stimulus bill because it includes an AMT patch, a new Making Work Pay credit, and the increased American Opportunity and First-time Homebuyer credits. In addition to these major changes, there are other tax changes in the stimulus which are not included in the examples we have looked at here. These include an above-the-line deduction for sales taxes paid on the purchase of a new car and the exclusion of up to $2,400 of unemployment benefits from gross income. See Table 4 for a glossary of the stimulus bill's tax provisions.

Table 4: Description of Tax Provisions Included in the American Recovery and Reinvestment Act of 2009
Provision	Stimulus Bill (a)
Making Work Pay credit: New credit; 6.2% of earned income, up to a maximum credit of $400 per earner ($800 for a couple who both have earned income over $6,450).	Credit phases out at rate of 2% of income over $75,000 ($150,000 for joint filers). Therefore individuals with income over $95,000 and couples with income over $190,000 would not receive any portion of the credit.
Earned income tax credit: Current credit equals a fixed percentage of income until the maximum credit is reached. Credit begins to phase out when income is greater than the phase-out threshold (credit rate, thresholds, and phase-out rate are based on the number of children in the family).	Increase credit rate from 40% to 45% for filers with 3 or more children. Income level at which credit begins to phase out for joint filers is increased to $5,000 above the threshold for singles.
Additional child tax credit (ACTC): This is the refundable portion of the child tax credit (CTC), and is allowed for certain taxpayers who cannot claim the full CTC because their tax liability is not high enough.	Reduces the income level at which a taxpayer can begin claiming the ACTC from $12,550 in 2009 to $3,000 in 2009 and 2010.
American Opportunity credit: New credit; replaces the current Hope credit. A credit for higher education expenses. 100% of first $2,000 of qualified expenses and 25% of next $2,000.	The income threshold at which the credit begins to phase out is increased from $50,000 to $80,000 ($100,000 to $160,000 for couples). 40% of the credit would be refundable and therefore available to taxpayers with little or no income tax liability.
First-time Homebuyer credit: Credit is lesser of $7,500 or 10% of purchase price. Available to first-time homebuyers who purchased a home between April 9, 2008, and June 30, 2009. Currently, the credit is refundable but must be paid back over a 15 year period. The credit phases out between AGI of $75,000 and $95,000 ($150,000 and $170,000 for joint filers).	Extends the eligible period to Dec. 1 2009 and increases the maximum credit to $8,000 for homes purchased between Jan. 1, 2009 and Dec. 1, 2009. Waives the repayment requirement for homes purchased in 2009 (must hold home at least for 3 years)
Unemployment compensation: Currently unemployment compensation is included in gross income.	Allows taxpayers to exclude up to $2,400 in unemployment compensation from gross income for 2009.
Sales tax deduction for certain car purchases: Currently there is no special deduction for non-itemizers who purchase a car.	Provides a permanent "above-the-line" deduction for state and local sales or excise taxes imposed on the purchase of a new vehicle which meets Clean Air Act standards. The deduction applies to the amount of tax that is attributable to the vehicle price up to $49,500. The deduction phases out for taxpayers with income between $125,000 and $135,000 ($250,000 and $260,000 for couples). The deduction is allowed for taxpayers who do not itemize (i.e. it is an "above-the-line deduction) and is also allowed against the Alternative Minimum Tax.
Alternative minimum tax relief: The AMT exemption amounts are not indexed for inflation. In order to keep millions of taxpayers from having to pay AMT, Congress has routinely passed short-term patches for the past several years. Currently there is no AMT patch for 2009.	Includes an AMT patch for 2009. The patch increases the exemption amounts to $46,700 for individuals and to $70,950 for joint filers. Also, AMT liability can be reduced by the nonrefundable personal credits.
(a) Unless otherwise noted, all provisions are for taxable years beginning in 2009 and 2010 only

Tax Foundation - Publications > Overview

How Much Does President Obamas Budget Redistribute Income?

Tax Watch, Summer 2009

Illinois Tax Plan Would Sacrifice Its Only Tax Advantage Over Other States

The Pine Tree State Chops Down Income Tax: Maine Enacts Major Tax Reform

Justice Souters Tax Opinions Show Steady Erosion of Respect for Commerce Clause

New Jerseys Gubernatorial Race, Part II: Governor Corzines Challengers Call for Lowering Tax Burdens

New Jerseys Gubernatorial Race, Part I: Governor Corzine Proposes 10.75% Income Tax Rate

A Golden Opportunity: Californias Budget Crisis Offers a Chance to Fix a Broken Tax System

Bank Secrecy, Tax Havens and International Tax Competition

The Price of Paradise: Hawaii Becomes Fifth State to Adopt New Income Tax Brackets on High-Earners

Tax Watch, Spring 2009

Border Zone Cigarette Taxation: Arkansass Novel Solution to the Border Shopping Problem

How Do Americans Feel About Taxes Today? Tax Foundation's 2009 Survey of U.S. Attitudes on Taxes, Government Spending and Wealth Distribution

From the House That Ruth Built to the House the IRS Built

The Effect of the Federal Cigarette Tax Increase on State Revenue

America Celebrates Tax Freedom Day

Rhode Islands Business-Friendliness Ranking Would Improve Dramatically Under Governors Plan

Proposed Tax on AIG Bonuses Raises Constitutional and Policy Concerns

States Use Gentle Hand in Taxing Timberland

Illinoiss Business-Friendliness Ranking Would Decline Sharply Under Governors Plan

Who Pays for Climate Policy? New Estimates of the Household Burden and Economic Impact of a U.S. Cap-and-Trade System

Testimony before Maryland Legislature on Tax Increase Supermajority Requirements

Facts & Figures Handbook: How Does Your State Compare?

Facts & Figures Handbook: How Does Your State Compare?

Update: The Tax Savings from Final Fiscal Stimulus

How Much Does President Obamas Budget Redistribute Income?

Justice Souters Tax Opinions Show Steady Erosion of Respect for Commerce Clause

New Jerseys Gubernatorial Race, Part II: Governor Corzines Challengers Call for Lowering Tax Burdens

New Jerseys Gubernatorial Race, Part I: Governor Corzine Proposes 10.75% Income Tax Rate

A Golden Opportunity: Californias Budget Crisis Offers a Chance to Fix a Broken Tax System

Border Zone Cigarette Taxation: Arkansass Novel Solution to the Border Shopping Problem

Rhode Islands Business-Friendliness Ranking Would Improve Dramatically Under Governors Plan

Illinoiss Business-Friendliness Ranking Would Decline Sharply Under Governors Plan