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CTJ's Tax Justice Digest, August 17, 2007

Welcome to CTJ's Tax Justice Digest, our regular survey of new and interesting trends in state and federal tax policy. Click here tobrowse through archived editions of the Digest.

 

The Presidential Candidates on Taxes

Given that the 2008 presidential race started two years before the election, one can be forgiven for failing to keep up on all the candidates' views on tax fairness. We have already been subjected to a dozen debates, a bewildering number of candidates and a variety of tax proposals. If you have not attentively followed the race so far, don't worry, because we've done the work for you. Here is a quick review of the ideas the 2008 presidential candidates have put forward so far.

 

Bad Ideas

Make Permanent the Bush Tax Cuts

The tax cuts enacted under President Bush are scheduled to expire at the end of 2010.  The Republican candidates want to make them permanent, including John McCain, a candidate who actually voted against the biggest tax cut bills in 2001 and 2003.  It seems that all the Democrats would let at least some parts of the Bush tax cuts expire. New Mexico Governor Bill Richardson has made noises indicating that he doesn't want to be associated with opposition to any sort of tax breaks. Even he seems to have indicated (in a debate on June 28) that any tax cut for the richest two percent "has to go," but he would replace those with new tax cuts for the middle-class or for certain companies that train and pay workers above the prevailing wage. (You can see whether those candidates who were in Congress during the Bush years voted for or against the Bush tax cuts by looking up their records in CTJ's Congressional Tax Report Card.)

 

Repeal the Estate Tax

The estate tax is a federal tax placed on substantial inheritances, much of which consist of capital gains that were never taxed. The Republican candidates would repeal it while most of the Democrats probably would not. Those Democrats who were in Congress at the time, Joe Biden, Hillary Clinton, Christopher Dodd, Dennis Kucinich, and Barack Obama, all voted against the Republican proposal to slash the estate tax last year. John Edwards would make permanent the estate tax rules that apply this year, which exempt an estate worth $4 million for a married couple. A report from CTJ put out early this year shows that the estate tax affected only the largest 0.8 percent of the estates of those who died in 2005 (the most recent year for which data are available).

 

National Sales Tax

A proposal that anti-tax radicals call a "Fair Tax" is basically a national sales tax that replaces all other federal taxes. It's misleadingly described as a federal sales tax of 23 percent, and former Arkansas Governor Mike Huckabee claimed at a May 15 debate that the transition to this tax would be revenue-neutral. CTJ studied the idea of a national sales tax in 2004 and found that in order to maintain current revenue levels, this sales tax would have to be around 50 percent. It is also very regressive.  Low-income households would pay more for everything they buy, while the wealthy would hit the jackpot with tax-free capital gains, dividends and interest. We are fairly confident that this proposal will go nowhere when people realize that a house that costs, say, $200,000 would cost $300,000 under this plan.

Republican candidates Duncan Hunter, Tom Tancredo, Ron Paul, Mike Huckabee, and even John McCain have expressed support for the "Fair Tax" proposal.  Former Senator Mike Gravel seems to be the only Democratic candidate in favor of this notion, and has claimed that a national sales tax would even solve global warming.

 

Flat Tax

Some Republicans favor a flat federal income tax rate as opposed to progressive rates. The idea is to tax all income at the same rate and its proponents misleadingly argue that this will lead to simplification. (Of course, in reality it's the various deductions and credits and other factors in the tax code, not progressive rates, that makes taxes complicated.)  Mike Huckabee, Rudy Giuliani, and Sam Brownback are in favor of this plan, although Brownback has a plan to employ an optional flat tax system that will keep both progressive and flat tax rates available. Brownback's idea is perhaps the most bizarre because it's even more difficult to see how we could simplify anything by having two different tax systems.

But of course the bigger problem with the flat tax is that it's just blatantly, unapologetically, regressive. Currently the wealthy pay income taxes at higher rates than middle-income and low-income families. (This helps balance out the regressivity of other taxes, like federal payroll taxes and state sales taxes.) A flat tax has just one income tax rate, which will be lower than the rates paid now by the wealthy and probably higher than the rates paid now by the middle-class. If the switch to a flat income tax is revenue-neutral, that means poor people will pay more in income taxes and rich people will pay less. If everyone can pay less, well, then it can't be revenue-neutral and must involve massive cuts in government spending. We'll take a wild guess that any such spending cuts won't be at the expense of the wealthy.

 

Increase Revenue by Cutting Taxes

Giuliani has said that new revenue can be generated by cutting taxes, which will cause the economy to grow so much that tax revenues paid to the federal government will actually increase. Giuliani, remarkably, told an audience on August 5 that we can raise revenue to fix collapsing bridges not by increasing the federal gas tax but by lowering taxes. And Giuliani is not alone among Republicans who believe this fantasy. In the May 15th Republican debate John McCain also claimed that the Bush tax cuts resulted in "dramatically increased revenues." 

What's remarkable is that McCain explains his votes against the Bush tax cuts in 2001 and 2003 by saying that needed spending reductions were not being made at the time taxes were lowered. But if tax cuts raise revenues, why should anyone care whether or not spending is reduced? Why not just keep cutting taxes until the revenues grow enough to pay for whatever spending we want? It's hard to believe that McCain doesn't see how absurd this theory is. One could be forgiven for thinking that he is contorting his positions in order to win over the conservative voters in the Republican primaries.

There's wisdom in the saying, "If it sounds too good to be true, it probably is." This saying applies to the theory that tax cuts raise revenues. President Bush's own Treasury Department issued a report last year that refuted the claim that tax breaks spark so much economic growth that they pay for themselves.

 

Tax Breaks for Healthcare

Rudy Giuliani's healthcare plan consists of a tax deduction of up to $7,500 for individuals and $15,000 for families who purchase health insurance.  But a tax deduction is worth the amount of the deduction times the top tax rate a family is subject to, so this offers more for the rich families in higher income brackets than middle-income or low-income families who actually need help obtaining health insurance.  And low-income people who pay payroll taxes, but not federal income taxes, get no benefit, even though they're the group most likely to be without healthcare. John McCain has proposed a $3,000 credit for healthcare. A credit is more progressive than a deduction since its value doesn't depend on the income tax bracket a family is in, but if it's not refundable it still won't help those who pay federal payroll taxes but not federal income taxes.

But the more important problem is that we should not use the tax code to push families towards the individual health insurance market (the market for coverage that is not employer-based). Individual health coverage is usually much more expensive, has less generous benefits, and may be more likely to involve high deductibles that discourage people from getting care they actually need.  

 

Eliminate the IRS

Mike Huckabee and Ron Paul, two Republican candidates, are both in favor of abolishing the Internal Revenue Service. It's not entirely clear who would administer the national sales tax these candidates support if there was no IRS.

 

Better Ideas

Repeal Bush Tax Cuts to Fund Other Priorities

While probably all the Democratic candidates would let at least some parts of the Bush tax cuts expire at the end of 2010, some have expressed interest in repealing certain parts of them before that time and using the revenue for other priorities like health care. Barack Obama and John Edwards both favor some version of this maneuver to fund their healthcare plans, with Obama repealing some tax breaks for families with incomes of $250,000 or more, and Edwards doing the same for families at $200,000 or more.

No reasonable person could disagree in principle with the idea of rolling back some of the tax cuts. By substantially cutting taxes, mostly for the rich, President Bush has managed to add $2.4 trillion to the national debt already, despite facing a small surplus when he came to office. By 2010, most of the benefits of those tax breaks will go to the richest 1 percent under the administration's budget plans.

However, repealing the Bush tax cuts does not create much new revenue compared to the budget baseline that Congress already uses, which assumes the Bush tax cuts will be allowed to expire at the end of 2010.

Obama has not specified how his healthcare program will be funded past the first year.  Edwards, on the other hand, claims that his healthcare plan with be funded permanently through the repeal of the 2001 tax cuts for those with income over $200,000. The cost of extending the tax cuts for those with incomes below $200,000 would reduce revenues, a cost that he has not yet accounted for. Although his heart is in the right place when it comes to healthcare, his plan could be improved with additional provisions to raise needed revenue.

But at least these candidates are facing the fact that taxes must be raised. Clinton is still "wrestling" with whether or not to increase taxes and she and Richardson (and to an extent, Obama) both seem to think that they can pay for their plans partly by eliminating inefficiencies in the healthcare system.

 

Stop Taxing Work More than Wealth

One extremely good idea proposed by John Edwards is to end the tax subsidy for people who have capital gains. One signature tax cut enacted by President Bush reduced the tax rate on capital gains from 20 percent to 15 percent and made dividends, which had been taxed as ordinary income, also taxed at 15 percent. At the end of 2010, that break will expire if Congress doesn't extend it and dividends will be taxed as ordinary income and capital gains will be taxed at 20 percent again.

But even the 20 percent tax rate is a break for the wealthy investors whose other income is mostly taxed at the highest ordinary income rate (currently 35 percent). CTJ recently found that the cost of the current tax treatment of capital gains and dividends was about $92 billion in 2005 alone and three fourths of that went to the richest 0.6 percent. Edwards has proposed taxing capital gains at 28 percent, which is certainly a huge step in the right direction.

Unfortunately, the Republican candidates would like to make permanent the tax breaks for capital gains and dividends and those who support a flat tax or national sales tax generally assume capital gains and dividends won't be taxed at all. Mitt Romney has the strange idea of making interest, capital gains and dividends tax-free for "middle-income" people. It's unclear how he defines middle-income given the CTJ data showing that capital gains and dividends mostly benefit the wealthy.

 

Close the Loophole for Carried Interest

The only thing more senseless than a huge capital gains tax break is allowing it for income that isn't a capital gain. Private equity fund managers, who can earn hundreds of millions of dollars, use a tax loophole to have part of their compensation that they call "carried interest" taxed as capital gains, and thus at the 15 percent rate instead of the 35 percent rate that applies to their ordinary income. Various arguments are being put forth by the industry to support this tax break, most of which are easily refuted. The bottom line is that they are getting paid for the work they do, just like the rest of us, and yet they pay a lower tax rate on the hundreds of millions they earn.

Hillary Clinton, Barack Obama, and John Edwards have all come out in favor of legislation proposed by Congressman Sander Levin (D-MI) to close this loophole. Chris Dodd has expressed some misgivings about the legislation but has not taken a position yet.

 

Taxing Carbon Emissions

Democratic candidate Chris Dodd has come out for a corporate carbon tax as a way to reduce energy consumption and reduce emissions of carbon dioxide into the atmosphere. Clinton, Edwards and Obama are for a cap and trade program, which could have the same effect. A cap and trade program would involve a cap on the total amount of carbon that can be emitted and would allow companies to buy and sell the rights to emit carbon. 

The only fear among some progressives is that under either a carbon tax or a cap and trade program, the added cost would likely be passed on to consumers in the form of higher prices that disproportionately burden low-income families. An increase in the cost of gasoline, for example, might have only a minuscule effect on the total budget of wealthy family, who would anyway be more able to rearrange their life to reduce driving. Eventually our concerns about the environment may have to be balanced against our concerns about the incidence of the cost of such policy changes. The outcome of that debate will hinge on what can be done to lower the costs for those who can least afford to pay them.

It should be noted that several candidates have expressed interest in ending tax subsidies for oil companies. During the debates, Biden, Edwards, and Clinton all expressed interest in taking this step in some form or another. These tax subsidies are described in CTJ's paper calling for their repeal and they make little sense at a time when oil companies are making record profits while the public wants to reduce and reverse global warming. 

 

 


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