CTJ's Tax Justice Digest, July 20, 2007

New CTJ Fact Sheet Debunks Myths about the Private Equity Tax Loophole

As Warren Buffet recently stated, it's an outrage that Americans who are paid millions or even billions for their labor can be subject to lower federal tax rates than their middle-income receptionists. This is particularly true of private equity fund managers, the multi-millionaires who get a special tax break for the compensation they receive for managing people's money.

A receptionist, a firefighter or a police officer who is unmarried and earns $50,000 a year pays a federal income tax rate of 25 percent on a large share of her income. That's after she pays around 15 percent of all of her income in federal payroll taxes. But thanks to a loophole in the tax code, private equity fund managers pay only the 15 percent capital gains tax on what they call "carried interest," which is usually most of their compensation. This is despite the fact that the capital gains rate was enacted for those who invest and put at risk their own capital, not those who manage other people's money.

Congressman Sander Levin has introduced a bill (H.R. 2834) in the House of Representatives that would close this tax loophole. The private equity industry and its lobbyists have already started an aggressive campaign to confuse the public about this issue. Get the facts in CTJ's new fact sheet.

House Committee Votes to End Outsourcing of Tax Collection

The House Ways and Means Committee approved a bill (H.R. 3056) on Wednesday that would end the IRS's use of private debt collectors after its current contracts with collection agencies expire in March 2008. The IRS's private debt collection program pays contractors a commission of 21 to 24 cents for every dollar of tax debt that they recover, while it's estimated that IRS employees can do the job for about 3 cents for every dollar collected. The private contractors are paid on a commission unlike IRS employees, so there is a concern among many that they have an incentive to be overly aggressive and less respectful of taxpayers' privacy rights, a concern echoed by Nina Olson, the National Taxpayer Advocate.

Unfortunately, earlier efforts to kill the program in an appropriation bill failed on procedural grounds. Part of problem stems from a peculiar wrinkle in the pay-as-you-go (PAYGO) rules that were revived earlier this year by Congress. Ending the private debt collection program counts as a "cost" to the federal government under these rules, since the private agencies are expected to collect over a billion dollars over the next decade if the program is allowed to continue. As a result, the Ways and Means bill just approved includes over a billion dollars of revenue-raising provisions to offset the "cost." The biggest offset would collect $764 million over ten years by making it harder for people to get out of paying their federal taxes by renouncing their U.S. citizenship.

But it's absurd that killing the private debt collection program should have to be paid for. Cutting funds for traditional tax collection by the IRS is not counted as a "cost" under budget rules that Congress has to offset with revenue-raising provisions. And traditional tax collectors at the IRS bring in a whole lot more money than these private contractors ever will. The legislative recommendations made by the National Taxpayer Advocate in January start out by noting that on a budget of just over $10 billion the IRS manages to collect over two trillion dollars, a return-on-investment of about 210 to one.

In the Senate, a bill (S. 335) sponsored by Byron Dorgan (D-ND) would end the private debt collection program, but it's not clear when this bill will be considered.

State Tax Justice News

Florida Property Tax Proposal Comes Under Fire

Last month, Florida lawmakers passed a two-part property tax reform plan, including an immediate cut in local property taxes as well as a January 2008 referendum in which Florida voters will be asked to pass judgment on a new, optional homestead exemption that homeowners could choose in place of an existing cap on home value growth. In response to this legislation, Mayor Eric Hersh of the City of Weston filed suit last week challenging the constitutionality of the property tax legislation, calling it "misleading to the public" and "not in the best interest of all Floridians." Hersh contends that the recently implemented law ordering localities to roll back tax collection this year violates a constitutional amendment granting local government the authority to collect property taxes up to 10 mills.

He is also critical of the proposed amendment referendum, claiming it misinforms voters that all Florida homestead property owners would get a $50,000 exemption (those who choose to retain their Save Our Homes exemptions will not). He further argues that it should not even be on the special ballot in January 2008, but requires a general election vote in November. Hersh's criticism demonstrates the difficulty and foolhardiness of trying to legislate tax policy through the ballot box.

PA Budget Impasse Resolved but Long-Term Problems Remain

After a tumultuous legislative session, including a one-day government shutdown, Pennsylvania has a budget. Governor Ed Rendell, who had included an array of tax increases in his budget proposal, ultimately got none of them in the agreed-upon budget. Among the tax hikes left on the cutting-room floor were a 1 percent sales tax increase designed to pay for property tax cuts, a 10-cent cigarette tax hike earmarked for health care spending, an innovative proposal to impose a 3 percent payroll tax on companies that don't provide health care coverage for their employees, and an equally innovative plan to impose a new profits tax on oil companies that would have used combined reporting to curtail tax avoidance by Big Oil.

Rendell's only notable success on the tax front, in fact, was pushing through new tax breaks to encourage filmmakers to shoot in Pennsylvania, at a cost of up to $75 million a year, although the real winner here was actor-turned-lobbyist Paul Sorvino.

But the next six months are not likely to be any easier for the legislature (or for Rendell). Lawmakers have agreed to a September special session to discuss Rendell's energy-independence plans, and Pennsylvania's perpetual property tax problems haven't gone anywhere.

Some Maryland Lawmakers Hope to Address Deficit with Progressive Tax Reform

With a budget deficit of roughly $1.5 billion looming, the time has come for comprehensive reforms to Maryland's tax system. As the Maryland Budget and Tax Policy Institute explains, the alternative - trying to slash state spending by that amount - would be disastrous, "[impacting] in some negative way almost every family in Maryland."

Fortunately, it appears that policymakers in Maryland are now beginning to consider meaningful tax reforms, such as enacting combined reporting to combat corporate tax avoidance or expanding the state's personal income tax brackets and raising income tax rates for wealthier individuals and families. While these changes would generate much needed revenue and enable the state to continue to provide vital public services, they could also make Maryland's tax system much more equitable. As the Washington Post points out, Maryland's personal income tax brackets are among "the flattest in the nation", meaning that working-class families pay much the same rate as the ultra-rich. Other options for closing the budget gap, such as an increase in the sales tax, are available but as a recent op-ed in the Baltimore Sun notes, that approach would put a "disproportionate burden on the backs of those least able to pay."

Hidden Entitlements in the Federal Tax Code
CTJ's Multi-Part Focus on Welfare for the Rich and Middle-Class Courtesy of the Tax Code

This Week's Topic: Tax Subsidies for Business

A recent Wall Street Journal editorial regurgitates a Tax Foundation analysis noting that the US federal corporate income tax rate is one of the highest among developed countries, and argues that the federal government would collect more corporate tax revenue if the corporate rate was actually lowered. But the editorial largely misses the point that the statutory tax rate doesn't mean all that much by itself. What really matters is the effective tax rate — the tax paid as a share of overall corporate profits. The effective tax rate for most US corporations is considerably less than the statutory rate of 35 percent.

How can the effective tax rate on corporations be lower than the statutory rate? The answer is loopholes that allow big, profitable corporations to get by without paying the full corporate rate. To take an example from the Congressional Joint Committee on Taxation, America is giving out an estimated $309 billion from 2006 through 2010 for the various types of accelerated depreciation in the federal tax code. (Accelerated depreciation is the use of deductions for the decline in the value of assets, such as equipment and buildings used by business, that are allowed more quickly than is generally warranted by the actual wear and tear on these assets.) Another $180 billion will be handed out over five years through tax loopholes for insurance companies. About $34 billion over five years goes toward a deduction for manufacturing. Then there is $30 billion over five years for "deferral" of taxes on profits that American-owned corporations claim to earn offshore, which is really more like an exemption for income that is styled as "foreign." We could go on, but we won't.

The point is that closing the tax loopholes for businesses would save a lot of revenue that could pay for other things, including a lower corporate tax rate.

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