"Americans for Prosperity", a national anti-tax organization, has been gathering signatures for an initiative petition that would, if passed, cut the state income tax by 50 percent and the state corporate tax by 15 percent. The group is aiming to put the measure before the people on the November 2008 ballot. This week former North Dakota Lt. Governor Lloyd Omdahl published an editorial criticizing the initiative. Mr. Omdahl noted that North Dakota is already a low-tax state, ranking 37^th nationally. More importantly he also pointed out that North Dakota has real education needs and cutting taxes certainly won't provide students with the resources they need to learn. Mr. Omdahl's editorial is commendable for pointing out so succinctly the folly of what he terms a meat axe approach to tax reform.

Late last month, New Hampshire adopted legislation that could serve as a model for other states seeking to modernize their corporate income taxes. As part of their biennial budget process, Granite State lawmakers approved a change in the way they decide which multi-state companies are subject to the state's business enterprise tax, moving from a standard based on "physical presence" to one based on "economic presence." This change may sound esoteric, but it's important because the "physical presence" standard leads to all sort of strange outcomes, including advantages for huge out-of-state corporations that do business with state residents over the locally owned businesses that operate entirely within the state.

Changing this standard (also known as "nexus") to one based on economic presence will help New Hampshire ensure that corporations that take advantage of the economic market the state fosters - its transportation infrastructure, judicial system, and educated workforce - will pay their fair share in taxes, even if they don't have offices or factories in the state. In fact, as we previously noted in our Talking Taxes blog, the US Supreme Court earlier this year declined to hear two cases - Lanco and MBNA - in which New Jersey and West Virginia had subjected companies to business taxes because they had substantial economic presence in the state. For more information on the "physical presence" standard and how it can harm state residents, see the ITEP paper on this topic.

Loopholes Turn Corporate Tax into Swiss Cheese

The U.S Treasury has been causing some business investors heartburn this week by suggesting that some cherished loopholes in the tax code could be closed and the resulting revenue used to lower the corporate tax rate. The argument was made in a report published by the Treasury and then discussed at a conference yesterday. Among the tax subsidies mentioned were the research credit, which Citizens for Tax Justice has criticized in the past, as well as several others that we noted last week in our "Hidden Entitlements in the Federal Tax Code" feature. The report finds that loopholes reduce the Federal corporate tax base by around 25 percent.

It's certainly true that there are plenty of business-oriented loopholes in the tax code that need to be closed. As the report points out, many of these are quite inefficient and result in business decisions based on tax reasons rather than cost-effectiveness.

But it's not at all clear that the revenue generated by closing loopholes should be used to lower the corporate tax rate. If federal revenue is not increased at some point, Congress may have to cut public services that Americans from all walks of life depend on. Further, if the corporate rate falls far below the top personal income tax rate, this may encourage wealthy people to use corporate entities to avoid the personal income tax.

International Tax Avoidance Also a Major Issue

But the report does not address another factor that is seriously eating away at corporate tax revenue: tax avoidance associated with multinational firms involving transfer pricing. Transfer pricing is basically the accounting that must take place when divisions of a corporation that are based in different countries "sell" and "buy" products or services to and from each other. In theory, if an American division of a company buys something from its division in another country, then that purchase can be deducted for American federal tax purposes. The foreign division has revenue and may have a profit, but in theory, the foreign government will tax that profit.

The problem is that a multinational corporation can exploit this system. For example, it may transfer its patents and trademarks to a division in a low-tax foreign country with little transparency (a tax haven) and then have that division "charge" the American division for the use of these "intangibles." The accounting can be done in such a way that the American division appears to have no profits after making these payments, and all the profits appear to go to the division in the tax haven.

A recent report from the Hamilton Project of the Brookings Institution explains the inefficiencies in this system and cites a study finding that a 35 percent reduction in corporate tax revenue results. The report argues that the United States and its major trading partners should switch to a system in which a company's total global expenses and profits are calculated and then tax is apportioned to the various countries where it does business based on sales in each country.

The problems with the current system are evident. The New York Times recently reported on how drug companies are particularly likely to take advantage of transfer pricing. Eli Lilly, for example, only paid about 6 percent in U.S. federal taxes on its profits of around three and a half billion dollars last year.

The House Ways and Means Committee has pushed back its plans to hold a hearing on the tax loophole for private equity "carried interest" until September. The loophole allows private equity fund managers to pay only the 15 percent capital gains tax on carried interest, which is the majority of their compensation in many cases, even though they actually don't make capital investments. The result is that fund managers making millions, even over a billion dollars a year, pay a lower tax rate than middle-income people. A bill introduced by Sander Levin (D-MI) ( H.R. 2834) would close this loophole and tax carried interest as ordinary income. The industry has begun a fierce lobbying and PR campaign to defend this loophole, and CTJ has issued its own response to the deceptive claims being made.

The Senate Finance Committee is currently considering a more limited bill ( S. 1624) that would affect those private equity firms that are publicly traded partnerships, requiring them to pay corporate taxes like other publicly traded companies. Finance Chairman Max Baucus and ranking member Charles Grassley (R-IA) have indicated that they are interested in exploring the possibility of passing another bill in the future along the lines of the Levin bill. The committee held a hearing on the issue on July 11 and will hold another on July 31. Baucus expects to pass S. 1624 in the fall and consider a broader bill sometime after that.

Emotions were running high this week in Indiana during the state legislature's public property tax hearing. Hundreds of people showed up to protest in what some say is the beginning of a tax revolt. Protestors were angry over what they see as the unacceptable rise in property tax bills this year. Many speakers called the current property tax system "broken" and advocated drastic cutbacks in school spending, or even a complete repeal of the property tax system. Just this week, Governor Mitch Daniels ordered that property tax levies in four counties remain at their 2006 levels until reassessments are conducted and the list of counties where reassessments will be ordered is expected to grow. Governor Daniels has hinted at a calling a special session to deal primarily with property taxes. Expect this raging debate to continue.

Among those items pushed back to September is the Alternative Minimum Tax reform plan being developed by the House Ways and Means Committee. While no actual bill has been released, it is known that the House Democrats want to exclude families with incomes of up to $250,000 a year (or $125,000 for singles) from the AMT, reduce the AMT for those between $250,000 and $500,000, and pay for the reform with a surtax on those with incomes above $500,000. Anti-poverty advocates are excited that the plan would also include improvements in the child tax credit and Earned Income Tax Credit.

While there is some question of whether or not the President would sign such a bill, it's possible the White House would find it risky to veto a bill that saves millions of middle-income taxpayers from the AMT (which is scheduled to expand its reach from about 4 million to 23 million this year if Congress does not act) in order to protect the very wealthiest Americans, who have received most of the Bush tax cuts.

The Senate Finance Committee is said to be interested in simply passing a one-year or two-year "patch," or temporary extension of the exemption that keeps most people from paying the AMT. This would cost around $50 billion just for one year. Finance Chairman Max Baucus (D-MT) has implied that he might increase the federal budget deficit by this amount rather than find revenue to pay for it. The Finance Committee has not tried to introduce a bill before the August recess.

Among those items pushed back to September is the Alternative Minimum Tax reform plan being developed by the House Ways and Means Committee. While no actual bill has been released, it is known that the House Democrats want to exclude families with incomes of up to $250,000 a year (or $125,000 for singles) from the AMT, reduce the AMT for those between $250,000 and $500,000, and pay for the reform with a surtax on those with incomes above $500,000. Anti-poverty advocates are excited that the plan would also include improvements in the child tax credit and Earned Income Tax Credit.

While there is some question of whether or not the President would sign such a bill, it's possible the White House would find it risky to veto a bill that saves millions of middle-income taxpayers from the AMT (which is scheduled to expand its reach from about 4 million to 23 million this year if Congress does not act) in order to protect the very wealthiest Americans, who have received most of the Bush tax cuts.

Lawmakers in Springfield are setting records that they certainly can't be proud of. The Chicago Tribune reports that Wednesday marked the 55th day the state has gone without a budget ("a modern day record"). The government is operating under a temporary one-month budget for July, but a long-term budget is fiscally and politically necessary. There was great hope at the beginning of the 2007 legislative session that this would be the year the state's school funding problems were solved, but now there's little hope that more than a business-as-usual budget will be eventually agreed to.

Senate Democrats are promoting a 75 cent cigarette tax hike. Illinoisans are interested in a fully funded pension system, health care reform, and fixing the state's school funding situation, but a cigarette tax hike would hand the bill to those least able to pay. Apparently, powerful Senate President Emil Jones has again come out in favor of an income tax increase for school funding, but according to this article the legislature may continue to put off this progressive solution.

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."

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.

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.

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.

New CTJ Fact Sheet

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.

This week the Ballot Initiative Strategy Center (BISC) released its comprehensive list of state ballot initiatives that are either qualified or circulating for this fall's election season. Folks interested in tax fairness may be concerned to learn that Tim Eyman is up to no good in Washington; he's heading up an initiative that would hamstring fiscal policymaking by imposing excessive barriers to any tax increase, no matter how necessary. A proposal to amend the state's constitution to increase cigarette taxes to raise money for kids' health care will be on the ballot in Oregon this November. For a complete list of states and their potential initiatives check out this list from BISC.

Anyone compiling a list of similarities between Hawai'i and the Cayman islands can now add "aspiring tax haven" to "sparkling beaches" and "mild climate." Late last month, Hawai'i Governor Linda Lingle signed into law a measure that will cap the premiums tax paid by so-called captive insurance companies in the hope of luring more of those companies to the Aloha State. (A captive insurance company is a subsidiary of a larger company that insures that larger company's property or employee benefits.)

Using tax policy to try to influence business location decisions is questionable enough on its own, but it's especially troubling in this case, since captive insurers can enable major corporations to avoid millions of dollars in federal taxes annually.

As reported earlier this year, Wells Fargo, by establishing a captive insurer in Vermont, will receive "tax breaks totaling at least hundreds of millions of dollars over the next 30 to 40 years"; ADM, Heinz, Alcoa, and Sun Microsystems may already be following suit. So, policymakers in Hawai'i may think that they're bringing more jobs to their shores, but what they're really doing is using scarce tax dollars to make federal taxes scarcer still.

Arizona Governor Janet Napolitano last week affixed her signature to HB 2515, an innovative piece of legislation aimed at curbing self-destructive tax incentive competition among municipalities in the Phoenix metropolitan area. The new law will reduce state-shared revenue to any city or town entirely in Maricopa or Pinal Counties that provides tax giveaways for retail development. While the new law won't undo such abuses as the $100 million tax break previously granted for Phoenix's CityNorth development, it could serve as a model for other states seeking to put an end to this inefficient and unsound approach to economic development.

Louisiana's 8-week legislative session came to a close late last month and Governor Kathleen Blanco has signed a variety of bills into law. HB 365 allows state income tax filers to claim the same itemized deductions they claim on their federal returns. The problem is, only the wealthiest 20 percent of Louisianans itemize. The estimated $157 million the provision will cost could be put to better use. SB 3 provides a "sales tax holiday" on the first Friday and Saturday in August and applies to the first $2,500 spent by consumers.The bill makes the holiday permanent and was introduced as a "back-to-school" benefit.The only improvement in tax fairness is SB 341, a progressive bill that provides for a refundable state Earned Income Tax Credit (EITC), equal to 3.5 percent of the federal EITC.This will distribute $40 million in refunds to low-income Louisianans (about 29 percent of all filers) on Tax Day.

The Administration has reduced its economic growth projections but is still arguing that its tax policy is stimulating the economy. President Bush is now touting projections that the federal budget deficit for fiscal year 2007 will be only $205 billion as proof. The projections came Wednesday in the Mid-Session Review from the Office of Management and Budget. The Center on Budget and Policy Priorities rightly points out that revenues have increased, reducing the deficit from its high of $413 billion in 2004, but that always happens in an economic recovery, and usually revenues increase by more (by around 12 percent, as opposed to the 3 percent increase that we've seen since the beginning of this economic cycle in 2001). What's more, revenue increased by 16 percent in a similar period in the economic cycle during the 1990s after taxes were increased. Finally, the Administration actually reduced its growth forecast for this year from what it projected back in February.

The only thing we would add is that the real deficit is bigger than $205 billion. The Mid-Session Review clearly indicates (on page 32) that the Administration will borrow $180 billion from the Social Security Trust Fund this year to keep the total deficit as low as $205. Social Security is projected to collect $180 billion more in payroll taxes than it will pay out in benefits this year. Social Security was changed back in the 1980s to collect a surplus that would make it easier to pay benefits later on, when the baby boomers retire in large numbers and more Social Security benefits must be paid out. The Social Security Trust Fund is essentially the accounting mechanism that keeps track of this, and it was never intended to be used to make budget deficits appear smaller than they really are. Not counting the Social Security surplus, this year's budget deficit is really $385 billion.

It seems that every time the waves splash against Georgia's shores another Georgia policymaker is singing the praises of eliminating one tax or another. This time Georgia House Speaker Glenn Richardson says that eliminating property taxes will be his main legislative priority for the 2008 session. He would replace the lost revenue by broadening the sales tax base to include groceries and services. He'd also implement a rebate for taxpayers with incomes less than $40,000. Georgia's tax structure is regressive and taxes some families living in poverty. Speaker Richardson's proposal will likely do nothing to improve those basic facts. Let's hope before the legislative session begins he changes his tune.

People who follow tax issues know that cigarette taxes are regressive, meaning they take a larger percentage of a poor person's income than a wealthy person's income. This is generally true of other consumption taxes such as sales taxes and gasoline taxes because poor people consume a larger percentage of their income than wealthy people, who have the luxury of saving and investing a large percentage of their income.

So cigarette taxes are not the best way to raise revenues from a fairness perspective. But there seem to be situations in which the only tax increases politicians will tolerate are the unfair ones. The state legislature in Delaware wanted revenue to address health and school construction, and just raised $48 million by increasing cigarette taxes from 55 cents to $1.15 a pack. Raising progressive taxes (for example, state income taxes) would be a fairer alternative, but tobacco taxes may be a second-best option when lawmakers refuse to increase other taxes.

New Hampshire just enacted a budget that includes a cigarette tax increase of 28 cents to $1.08 a pack as well as several other regressive fee hikes. While this is unfortunate, the budget also expands children's health insurance by as many as 10,000 kids, which might be hard to do in tax phobic New Hampshire. In Connecticut, the legislature recently approved a budget that raises the cigarette tax 49 cents to $2 per pack in a compromise between Republican Governor Jodi Rell and the Democratic-controlled Assembly. (Rell had earlier suggested increasing income taxes but quickly changed her mind about that.)

Now members of Congress are eyeing an increase in the federal tobacco tax from 39 cents to $1 a pack to fund an expansion of the State Children's Health Insurance Program (SCHIP). Some members of both parties on the Senate Finance Committee have come to a tentative agreement to raise $35 billion over 5 years (less than the $50 billion envisioned in the Senate budget passed several months ago). One can imagine many more progressive ways of raising federal revenues. But if the Senate lacks the leadership and courage to fight for more progressive funding sources, this may be the best chance to expand children's health care this year.