New Report from Citizens for Tax Justice

A new report from Citizens for Tax Justice examines hypothetical households that are representative of different income groups to determine how they would fare under the tax plans proposed by the presidential candidates The report calculates the income tax liability of each hypothetical household under the tax plans and explains how and why the plans would affect them differently.

We find that our hypothetical households in the low- and middle-income groups would receive a larger tax cut under Obama's plan than under McCain's plan. Our hypothetical households in the top one percent would have a tax increase that would be fairly small (as a percentage of their income) under Obama's tax plan, but they would receive breathtaking tax cuts exceeding $270,000 under McCain's plan.

While presidential candidate John McCain has promised to make permanent the Bush income tax cuts for all Americans, his opponent, Barack Obama, promises to make them permanent for almost all Americans. A new analysis from Citizens for Tax Justice shows that only a small percentage of the taxpayers in each state would lose a portion of the Bush income tax cuts if Obama's plan is enacted. For these very rich taxpayers, Obama would repeal most of the Bush income tax cuts before their expiration date at the end of 2010. For everyone else -- for 97.5 percent of taxpayers nationally -- all of these tax cuts would be made permanent.

Obama proposes to make all of the Bush income tax cuts permanent for married couples with adjusted gross income (AGI) below $250,000 and unmarried taxpayers with AGI below $200,000.

Nationally, we find that only 2.5 percent of taxpayers will fall above the $250,000/$200,000 AGI threshold in 2009. The state with the largest percentage of taxpayers above this threshold is Connecticut (5.1 percent) and the state with the lowest is West Virginia (1.0 percent).

"Senator Obama wants to extend the Bush income tax cuts for 97.5 percent of taxpayers, and then enact more tax cuts for middle-income families," said CTJ director Robert McIntyre. "Obama even wants to extend a portion of the Bush income tax cuts for that richest 2.5 percent of taxpayers. Senator McCain defines a 'painful tax increase' as any plan that does not continue Bush's policy of giving huge tax cuts to these very richest taxpayers and having future generations of average Americans pick up the tab."

When the Earned Income Tax Credit was expanded in the Tax Reform Act of 1986, President Reagan, who signed the bill into law, called the EITC "the best anti-poverty, the best pro-family, the best job-creation measure to come out of Congress."

The EITC provides a tax credit to very low-income working families. The credit can exceed federal income tax liability, meaning that some very low-income families actually receive a check from the IRS. Since pretty much all working people pay federal payroll taxes (and also some federal excise taxes like the gasoline tax) even if they don't owe income taxes, the EITC seemed like a justifiable break for struggling families.

Leaders of both parties agreed, as did President Reagan. That's as close to a consensus as anyone finds in Washington. It seemed this was one sort of tax cut that everyone supported.

Until now. Presidential candidate John McCain, who often claims to emulate Ronald Reagan, has lately argued that tax breaks exceeding income tax liability are "welfare," and has even suggested that they are socialism. While McCain's views are not entirely clear (since his own health care plan includes a refundable tax credit that would also benefit people without income tax liability) it's difficult to square his hostility towards Obama's proposed refundable tax credits with his tributes to the president who supported similar policies. As a short paper from CTJ explains, under McCain's new logic, even George W. Bush is a socialist.

Pinning down where Senator McCain stands on taxes has never been easy. He originally opposed the Bush tax cuts, saying. "I don't believe the wealthiest 10% of Americans should get 60% of the tax breaks. I think the lowest 10% should get the breaks."

A new report by Joel Slemrod of the University of Michigan and Andrew Johns of the IRS finds that more income is hidden from the IRS by higher-income people. The report uses data from the National Research Program (NRP) Individual Income Tax Reporting Compliance Study for the 2001 tax year. This is the same data that was used to produce the famous conclusion that the tax gap (the difference between taxes owed and taxes paid) for that year was $290 billion. The authors supplement this data with estimates of additional unreported income by the IRS.

They find that people whose real adjusted gross income (AGI) is between half a million and a million dollars fail to report 21 percent of their income on average. By contrast, those with real AGI between $40,000 and $50,000 fail to report just 7 percent of their income.

This is not surprising. Most of the income received by low- and middle-income people takes the form of wages, for which there is third party reporting. (Your employer reports how much you were paid to the IRS, which can easily verify that what you report is no different.) High-income people tend to have more income in the form of self-employment earnings, capital gains, rent income, partnership income or other types of income that are more difficult for the IRS to detect. The authors say this partially, but not entirely, explains why the rich misreport more. But given the abundance of tax shelters being peddled specifically to high-income taxpayers, we would be amazed if misreporting of income to the IRS was not more pronounced among the wealthy.

Last week, we informed you about a couple of surprising allies in Massachusetts and Oregon in the fight against regressive and irresponsible ballot proposals. Since then, more valuable support in favor of reasoned tax policy has come from another surprising source: key business groups in Massachusetts and Colorado.

Ballot Proposal to Repeal Massachusetts Income Tax

In Massachusetts, that support (in opposition to the proposed repeal of the state's income tax) comes in the form of a 26 page report prepared by the Global Insight consulting firm on behalf of the Associated Industries of Massachusetts, Greater Boston Chamber of Commerce, Massachusetts Business Roundtable, and the Massachusetts Taxpayers Foundation. Among the report's criticisms is that the measure would slash funds so drastically that low- and middle-income residents would be effectively deprived of access to higher education. The report also places emphasis on the inevitable decline in the state's infrastructure (a key component of doing business) that would accompany the repeal. An apt summary of the report, in the words of the Greater Boston Chamber of Commerce, is that repealing the income tax would "devastate the state's economy".

Ballot Proposal to Undo Part of the So-Called "Taxpayer Bill of Rights" in Colorado

Equally influential business groups in Colorado have expressed a similar desire for sound tax policy. In Colorado, the debate is over a proposal to alter the requirement under the "TABOR" amendment, passed a decade ago, that requires surplus revenues to be used for rebate checks sent to households. The proposal on the ballot this year would redirect the automatic TABOR refunds into a special fund for education, which would help free the state from the unrealistic restraints on revenue imposed by TABOR. Among the business groups in support of the measure are the Associated General Contractors, Boulder Chamber of Commerce, Colorado Hotel and Lodging Association, Colorado Retail Council, Colorado Springs Chamber of Commerce, Denver Hispanic Chamber of Commerce, and the Denver Metro Chamber of Commerce. In the words of the Colorado Springs Chamber of Commerce, "this proposal will help Colorado get out of the bottom in funding", and is simply "smart business".

The broad coalitions forming in each of these states vividly demonstrate the importance of the coming vote on these proposals. And at least in Massachusetts, a recent poll indicates that this broad-base of opposition appears to be producing results. But in Colorado, unfortunately, the numbers are looking much less favorable, although the vote is still too close to call.

Governor Jon Corzine recently revealed his economic stimulus plan, saying that the crisis on Wall Street will uniquely impact his state. "Economists predict New Jersey could lose tens of thousands of Wall Street jobs," he said, adding "our casino revenues are in decline, thousands of construction and manufacturing jobs have already been lost, auto and retail sales are down while inventories climb."

The Governor's proposal includes both short- and long-term strategies. The short term strategies include ensuring more seniors have access to property tax cuts, investing in public infrastructure, and expanding heating assistance.

The Governor's long-term strategies are more suspect. Among them is a proposal to change the state's formula for calculating business taxes to consider only sales made in the state (in other words, moving towards a single sales factor (SSF) approach). Unfortunately, the SSF is a huge revenue-loser in states that have already adopted it and results in a corporate tax structure that is less fair, as explained in ITEP's policy brief.

The Governor also proposes to "remove certain tax provisions that penalize New Jersey companies" including the "throw out rule." As another ITEP policy brief explains, many states have a "throwback rule" or, in the case of New Jersey, a "throw out rule" that prevents companies from shifting portions of their taxable income out of state. Every state that levies a corporate income tax must determine, for each corporation doing business within its borders, how much of the company's profit they can tax. Whether sales are in-state or out-of-state is one factor used to make this determination (and it's the only factor used in single sales factor states). In the absence of a throwback/throw out rule, some corporate sales fall between the cracks, and cannot be taxed by any state. (This can happen because, for example, a company stretches its operations so that its sales are recorded in a state that does not have a corporate tax or a state where it doesn't meet the requirements to be subject to the corporate tax).

This phenomenon is called "nowhere income." The "throwback/throw out" rule simply says that state of origin (the state that is the home of the company making those sales) can tax this income.

Mary Forsberg at New Jersey Policy Perspective wisely cautions policymakers to get the facts and not act hastily to adopt tax changes that could have long-lasting ramifications.

Why would the state even consider changes that would mainly help corporations avoid paying state taxes? It's true that New Jersey has more corporate CEOs, stockbrokers and hedge fund managers who are affected by the stock crash than most other states, but the state government seems to think this means all New Jersey residents belong to this wealthy elite. A surprising amount of attention has been given to how members of this elite are "feeling the pinch" as one recent article put it. A paper actually sent a reporter to Moorland Farms for the 88th annual Far Hills Race last Saturday to find wealthy attendees complaining that they have to cut back on dining at expensive restaurants and traveling over the holidays. Hopefully, tax policy changes will not be geared solely towards benefiting this group.

Ironically, in the Governor's address to a joint session of the Legislature he said, "It's our time to be courageous. Let's do what is right for the people and prosperity of New Jersey." Let's hope the Governor takes a step back and has the courage to do less for corporations and more for those hardest hit by his state's fiscal woes.

Last month we brought you word of a brewing controversy in New Hampshire. Retailers in the state were lobbying hard to delay a cigarette tax hike in hopes that more people would come to the state to purchase cigarettes proving that it wasn't necessary to raise the tax. Unfortunately for retailers, people in New Hampshire and surrounding states seem to have become aware that smoking is bad for their health. Cigarette tax revenues didn't hit the revenue target state officials identified and last week the state's cigarette tax rose by 25 cents to $1.33 a pack. But despite this increase in the tax, smokers who purchase cigarettes in New Hampshire will still pay a lower tax than smokers in neighboring states.

The financial collapse and the economic downturn of the past months begs the question of whether the economic policies of the Bush administration will be repudiated. Supply-side economics, the ideology that has driven the economic agenda of President Bush, has survived for years despite its complete failure in practice. For example, some anti-tax lawmakers and activists now claim that the answer to the economic crisis is... more tax cuts for investors. But now that we have seen two presidents over the last thirty years run up massive budget deficits through supply-side tax cuts that did not seem to make the economy any stronger, there is reason to think that politicians may finally start to see the failures of this ideology.

The Supply-Side Theory

This issue of the Tax Justice Digest explores supply-side economics, which is generally the idea that policies, particularly tax cuts for investment or for those who invest, can change incentives to invest in a way that will yield huge increases in economic growth. Most incredibly of all, this resulting economic growth is often argued to result in so much new tax revenue that the tax cut can be cost-free or can even lead to increased revenues. Keep in mind there is no actual evidence that tax cuts can pay for themselves or actually lead to increased revenues. The Treasury Department under President Bush issued a report finding that there was no evidence for this, and Bush's current budget director has also said that tax cuts do not pay for themselves or lead to increased revenue. And yet, President Bush and many of his allies (including, recently, John McCain) have stated numerous times that tax cuts cause increases in revenue.

The Laffer Curve

This idea of revenue increases resulting from tax cuts -- the crown jewel of the supply-side belief system -- could of course be true in some conceivable context. The concept is illustrated by the Laffer curve, named after its creator, which is basically a diagram showing that tax hikes will increase revenues only up to a point, after which tax hikes will actually lead to a decrease in revenue because incentives to work and invest are so severely damaged. If profits are already taxed at 95 percent, raising that rate might, in fact, lead to less revenue, as people realize there is little to be gained from investing or running a business and there are consequently less profits to be taxed. Lowering that rate could instead lead to more business activity, more business profits, and even more taxes paid on business profits. (Or at the very least, more business profits might be reported, leading to more taxes paid.)

But supply-siders often take this idea, which might apply in very few situations in real life, and apply it to the United States today.

While this is the most bizarre form that supply-side economics takes, even the ideology's more mainstream adherents seem to believe that tax cuts will lead to economic growth that is so great that higher budget deficits and starved public services should be considered nothing more than a minor side-effect.

Lawmakers and Media: The At-Risk Community

When a person brings up the idea that a tax cut might lead to increased revenues, serious economists laugh, but lawmakers and reporters often find themselves strangely mesmerized. An idea that justifies offering constituents both a tax cut and higher spending on services is like a narcotic for some lawmakers, impossible to resist even though its ill effects are obvious to all observers. Meanwhile, reporters who find economics to be outside of their area of expertise give uncritical and expansive coverage to an idea that almost no serious economist actually believes in.

How It Began

The supply-side movement began with, to put it mildly, a colorful cast of characters, as Jonathan Chait describes in his excellent book, The Big Con. One is George Gilder, whose book Wealth and Poverty, helped launch the movement. He is also known for such quotes as "There is no such thing as a reasonably intelligent feminist," and he is a strong proponent of ESP (extrasensory perception). Another is Jude Wanniski, who wrote another important book (The Way the World Works) and preached that high taxes led to all evils, including Hitler's decision to invade his neighbors. He later compared Slobedan Milosevic to Abraham Lincoln and insisted that Saddam Hussein never gassed his people.

Then, of course, there is Arthur Laffer, who met with Wanniski and Dick Cheney one day, drew his diagram on a cocktail napkin and convinced Cheney that tax cuts could result in increased revenues. The Laffer curve was born, and progressives have been trying to throw it back into the fires of Mordor ever since.

Rather than dwelling on these interesting characters, we have decided to provide the following information for those who would like to know what supply-side economics is about, how it has influenced policy-making and how we can respond to it.

Two New Reports Explore the Strange Allure of Supply-Side Economic Policies and the Overwhelming Evidence of Their Failure

Supply-Side Ideas Influence the Presidential Race

Isn't It Time to Reassess the Bush Tax Cuts for Investment Income?

Supply-Side Disasters in the Making at the State Level

Two recent reports help explain supply-side economics, its logical inconsistencies and its failures in practice. One is "Take a Walk on the Supply Side: Tax Cuts on Profits, Savings, and the Wealthy Fail to Spur Economic Growth" by Michael Ettlinger of the Center for American Progress and John Irons of the Economic Policy Institute. The report spends some time pointing out how supply-side economics is questionable even on a theoretical level. Do we really know that tax cuts always result in more work or more savings? What if you have a certain earnings goal or savings goal and you have to work or save less to reach that goal as the result of a tax cut? And how do we know more savings would mean more investment? Couldn't it lead to investment overseas, or maybe lower consumption which could in turn be harmful to the economy?

But things get even more interesting when Ettlinger and Irons look at the empirical evidence to compare economic performance after supply-side tax cuts during the Reagan and Bush II eras to economic performance after the deficit-reduction policies in the Clinton era. They look at the evidence in two ways: first, measuring economic indicators in a period immediately following the introduction of the new tax policy, and second, measuring economic indicators during the first economic expansion to take place after the introduction of the new tax policy. Investment is found to be stronger during the Clinton era than during the two supply-side eras. The same goes for GDP growth and several other indicators.

The second report is "Tax-Cut Snake Oil: Two Conservative Theories Contradict Each Other and the Facts," by Jeffrey Frankel at the Economic Policy Institute. Frankel adds to our understanding of the supply-side theory and the evidence that has discredited it after the tax cutting under Reagan and Bush II. He also adds a lot of interesting information about the key players involved. For example, he provides quotes from economists who worked for Reagan and George W. Bush saying that tax cuts cannot lead to increased revenues, as well as quotes of their bosses saying that they can.

But Frankel describes another development in the anti-tax movement that sits very strangely with supply-side economics: the "Starve the Beast" hypothesis put forward by many conservatives that cutting taxes will reduce revenues, run up deficits, and force politicians to shrink government. (This is put forward by those who believe shrinking the government would be inherently good.)

Frankel points out that it's not at all obvious why lawmakers would feel more constrained from spending under such a regime. Clearly, if constituents are told that increased spending might require tax increases now to pay for it, that might give some pause. But if taxpayers are told that increased spending will result in some future tax increase, that is surely less threatening to constituents and those who depend on their votes, and so there might be less pressure on lawmakers to limit spending. This is exactly what happens under the supply-side regime as deficits soar as a result of tax cuts. And of course, as Frankel points out, the Starve the Beast hypothesis should now be discredited by the explosive spending in the Reagan and Bush II eras.

Most amazing of all is that these two ideas -- cutting taxes is OK because it will lead to increased revenues, and, cutting taxes is good because it will lead to decreased revenues and thus smaller government -- somehow coexist within the same anti-tax movement.

Presidential candidate John McCain has made statements in the last year indicating that he believes tax cuts pay for themselves. Whether he actually believes this and how he came to this conclusion is all very murky. Senator McCain famously voted against the Bush tax cuts in 2001 and 2003 and has now reversed himself by favoring a permanent extension of all the Bush tax cuts even for the richest Americans, plus a lower rate for corporations and other cuts for business. When asked to explain his previous votes and his reversals, McCain has always given baffling and incoherent answers.

John McCain now says that he opposed the Bush tax cuts in 2001 and 2003 because he thought they needed to be accompanied by cuts in spending to keep the budget deficit under control. Actually, what he said in 2000 about then-Governor George W. Bush's tax plan was, "I don't think the governor's tax cut is too big-it's just misplaced. Sixty percent of the benefits from his tax cuts go to the wealthiest 10% of Americans-and that's not the kind of tax relief that Americans need."

But even if we take his word that he was concerned about the budget, wouldn't that only mean he would be even more opposed to the Bush tax cuts now that we have deficits instead of surpluses? He explained at a debate on September 5 that he voted against the 2001 and 2003 tax cuts because they did not include cuts in spending, which he thought were also necessary. But then he claims that "it's very clear that the increase in revenue we've experienced is directly related to the tax cuts that were enacted, and they need to be permanent."

McCain claims he went from worrying about how tax cuts might damage a budget in surplus to believing tax cuts will help a budget that is in deficit. His conversion may be inexplicable, but it's very real. His tax plan would extend the Bush tax cuts for the rich and slash taxes for corporations, which would benefit stock-holders. He would create an alternative "simplified" tax that would generally make the tax code more complicated. Since it would be voluntary, people would calculate their taxes under the regular system and under the alternative system to see which yields a lower tax. Our estimates show that it would cost in the neighborhood of $98 billion in 2012, half of which would go to the richest one percent.

During his 2000 presidential campaign, Senator McCain said, "There's one big difference between me and the others -- I won't take every last dime of the surplus and spend it on tax cuts that mostly benefit the wealthy. I'll use the bulk of the surplus to secure Social Security far into the future to keep our promise to the greatest generation."

So McCain once said he won't spend an entire budget surplus on tax cuts for the wealthy, but apparently he has no problem cutting taxes for the wealthy when the budget is in deficit. We would like to say this reversal is surprising but, sadly, we've seen it before.

What about McCain's opponent? One would hope that presidential candidate Barack Obama would represent a clean break with the supply-side thinking of the past, but the reality is slightly more complicated. During his speech at the Democratic convention in Denver, Senator Obama said, "Change means a tax code that doesn't reward the lobbyists who wrote it, but the American workers and small businesses who deserve it." Curiously then, Senator Obama proposes to keep in place a loophole for corporate dividends created in the Bush years. President Bush and his allies in Congress enacted a special loophole for dividends (a top rate of 15 percent) that will expire at the end of 2010 along with the rest of the Bush tax cuts if Congress simply does nothing. Instead of allowing the dividends loophole to completely expire, Senator Obama wants dividends to be taxed at a top rate of 20 percent for, roughly, the richest two and a half percent of Americans and a top rate of 15 percent for everyone else.

At the time the dividend tax cut was enacted in 2003, Michael Kinsley pointed out that "[u]nlike, say, interest on a savings account or money-market fund, which are taxed every year, corporate profits are allowed to compound tax-free until they are paid out as dividends or the stock is sold. A notorious quirk in the tax law wipes out a lifetime of taxes on stock that is passed on to your heirs. Dividends and capital gains are also exempt from the Social Security and Medicare taxes. One way or another, it is the rare dollar of corporate profits that bears a tax burden heavier than the burden on an employee's wages."

True, Senator Obama does want to allow tax rates on ordinary income to revert to the rates that existed under Clinton for the very richest Americans, and he will allow the tax subsidy for capital gains to shrink back to the level that existed under Clinton (a top rate of 20 percent instead 15). But apparently Obama agrees with President Bush that taxing dividends just like the income most people receive as wages would be either unfair, or damaging to the economy, or both.

Of course, Obama certainly has never claimed that tax cuts can pay for themselves. But the less insane aspects of the supply-side ideology have influenced some of what he has said about taxes. In particular, he seems to believe that not allowing most Americans to keep the taxes they received under Bush would be bad for the economy. He told the multitudes in Denver, "I will -- listen now -- I will cut taxes -- cut taxes -- for 95 percent of all working families, because, in an economy like this, the last thing we should do is raise taxes on the middle class." We could probably think of all sorts of things that would be the "last" thing we want to do in an economy like this (cutting back on education spending, allowing the health care system to plod along in its current inefficient manner) and that would be worse than having a higher tax bill.

So Obama is certainly not a supply-sider, but he's not exactly facing down the supply-siders either. Allowing everyone but the richest 2 and a half percent to keep the Bush tax cuts (and even extending some cuts for these very richest taxpayers) is not exactly a clean break with the failed supply-side policies of Bush. At the same time, his tax cuts would be aimed at the middle-class and would make the tax code more progressive overall, which would be an enormous improvement over the policies of the current president.

(See CTJ's recent report, "The Tax Proposals of Presidential Candidates John McCain and Barack Obama.")

It was bound to happen. In response to the crisis on Wall Street, some members of the Republican Study Committee in the House of Representatives proposed a familiar solution: tax cuts. In particular, they proposed a suspension of capital gains taxes for both individuals and corporations for two years, after which capital gains would be reduced from their current levels because "assets would be indexed permanently for any inflationary gains." The article from BNA that landed in our inboxes actually said that they proposed this measure "as a way to coax capital back into sluggish lending markets and offset the cost of a proposed government bailout of the U.S. financial system."

If suspending a tax altogether (that is, lowering its rate to zero) can increase revenue and offset the cost of anything, then supply-side economics may have risen above the laws of the known universe entirely into some new, unknown realm beyond our comprehension.

It would be comforting to believe that this thinking is confined to some small fringe group of lawmakers. Actually, the Republican presidential nominee is not far behind. John McCain recently proposed to temporarily slash the capital gains tax rate to a super-low 7.5 percent. (See CTJ's recent paper, "McCain's Proposal to Expand the Loophole for Capital Gains Would Be Unfair and Counterproductive.")

This seems like the ideal time to ask what exactly supply-side tax cuts for investment have accomplished. Bush expanded the tax subsidy for capital gains (lowering the special capital gains tax rate from 20 percent to 15 percent) and created a new one for dividends (which was taxed like any other income but is now taxed at a top rate of 15 percent). We do not know that the Bush tax cuts for investment actually contributed to the financial collapse. But the notion that they contributed to excessively risky investments and helped fuel the calamity is at least as reasonable as the notion that they helped grow the economy, considering our current economic situation.

There are several conceptual reasons why these tax subsidies for investment are simply not sensible policy. For one, it offends most people's idea of basic fairness that someone who earns $42,000 from work can be taxed at a higher rate than someone who receives the same amount of income by collecting dividend checks. Why someone like Paris Hilton, who probably lives off her wealth, should be taxed at a lower rate than someone who actually works has never been adequately explained by the proponents of these tax cuts.

But in addition to that, the subsidy leads to all sorts of shifty tax dodging behavior that makes the economy less efficient, since money is invested in certain activities or properties merely to get a tax break, rather than because it's the most efficient use of capital.

Supply-siders sometimes have their very best luck in convincing the naive to adopt their views when they're talking about the capital gains tax. Part of the reason for this is that capital gains tax revenues fluctuate wildly with economic cycles, rocketing upwards during the good times and crashing during recessions. The charts illustrating capital gains tax revenue have lines that look like rollercoasters, and supply-siders often confuse the unwary into believing that some cut in the capital gains tax rate caused one of the upswings.

For example, as a paper published earlier this year by CTJ explains, capital gains tax revenue crashed during the recession in 2001. This revenue of course climbed back up from that low point, as we would expect. But because this natural upswing coincided with Bush's cut in the capital gains rate from 20 percent to 15 percent, supply-siders (like the editorial board of the Wall Street Journal) argue that the Bush tax cut caused this revenue to increase. What they leave out of the story is the fact that capital gains tax revenue was higher at the end of the Clinton years, when the capital gains rate was higher.

The argument over revenues can seem like an arcane debate full of jargon and charts and tables, but the fairness problem posed by the loopholes for investment income is readily apparent. These loopholes direct a huge amount of money to the rich. Earlier this year, CTJ released a report finding that 70 percent of the benefits of the capital gains and dividends loopholes will go to the richest 1 percent of taxpayers in 2009. Of course recent events on Wall Street will lower the capital gains reported in 2009, but there is no particular reason why the distribution of the benefits from these loopholes would be any different. Unlike the supply-siders, we will resist the temptation to say that the coming change in capital gains tax revenue is a direct result of the Bush administration's policies. (Although the case could be made...)

One does not have to be elected to Congress or hired to anchor a national news show to become addicted to supply-side economics. State government and local media are equally at risk. This November, voters in several states will decide on ballot questions that are being promoted with supply-side justifications.

A proposal to be voted on in Oregon seeks to allow taxpayers to deduct (in full) their income tax payments to the federal government for state income tax purposes. Currently, only the first $5,600 one pays to the federal government is allowed to be deducted on Oregon state income tax forms. This arrangement already has regressive results, and by uncapping the deduction limit completely, those wealthy individuals who owe the most in federal income taxes will be allowed to slash their Oregon tax payments substantially.

Though the workings of the Oregon proposal may seem a bit confusing, its results most certainly are not. The vast majority (78 percent) of Oregonian families will get nothing, the wealthiest 1 percent will enjoy a nearly $16,000 annual tax cut, and the government of Oregon will have to make due with between $500 million and $1 billion less in revenues each year. (Six other states, Alabama, Iowa, Louisiana, Missouri, Montana, and North Dakota, currently allow for some deduction of federal income taxes, and they should all end this regressive practice.)

So how are backers of the Oregon proposal justifying this giveaway to the rich? You guessed it. One news account informs us that "[Russ] Walker, Oregon director of the national fiscal conservative group FreedomWorks [and co-sponsor of Measure 59], says the tax reduction would produce a supply-side result of economic expansion with more income and more tax revenue to offset the cut." The argument is that the tax cut will at least increase revenue enough to pay for itself -- the most extreme form of supply-side thinking.

North Dakota voters will also be taking a look at their income tax this fall. Backers of an income tax rate cut are enthusiastically pushing a plan that offers an average tax cut of just $83 to the bottom 60 percent of taxpayers statewide. What's the big deal? The wealthiest 1 percent of North Dakotans would save an average of over $11,000 per year. And those numbers don't even include the corporate income tax cuts, which are sure to also disproportionately benefit the wealthy. And to make matters worse, the proposal would cost the state over $200 million annually.

And how do backers of this measure justify giving away revenue to the rich? Well, if a tax cut simply pays for itself through supply-side magic, backers hope that the practical, common sense folk of North Dakota won't ask such uncomfortable questions. As one news account explains, "Measure 2 proposes to cut income taxes 50 percent and corporate taxes 15 percent, said Duane Sand of the group Americans for Prosperity [the measure's principal backer]. Sand said the state's tax policies have forced young and old to leave the state. The OMB estimates Measure 2 would cut state revenue about $415 million for the next biennium. That money would be replaced by higher tax collections from increased economic activity, Sand said."

A proposal on the ballot in Massachusetts provides perhaps the most obvious example of the recklessness so often involved in anti-tax ballot initiatives. Massachusetts voters will once again have to decide this November on a proposal to constitutionally end the income tax -- a move that would reduce government revenues by a whopping 40 percent, and would undoubtedly have dire consequences in the form of reduced government services. But while all Massachusetts residents would have to share in the pain of a 40 percent reduction in their government's budget, the wealthy would be the primary beneficiaries of the tax cut, since the income tax is the only major progressive tax levied by the state. Even more alarming is the fact that over 45 percent of Massachusetts voters supported a similar measure in 2002.

Now, even supply-siders would have trouble arguing that reducing a tax to zero can result in increased revenues. (Except that apparently the Republicans in the U.S. House of Representative do believe that about the capital gains tax, as we said in a previous article in this Digest).

But backers of the Massachusetts measure do argue, using supply-side logic, that less taxes will result in so much economic growth that no one will feel the loss of public services that would inevitably result.

Carla Howell, chairperson of the group backing the measure (and Libertarian candidate for governor in 2002) says that "In addition to giving each worker an annual average of $3,700, it will take $12.5 billion out of the hands of Beacon Hill politicians -- and put it back into the hands of the men and women who earned it. Every year. In productive, private hands this $12.5 billion a year will create hundreds of thousands of jobs in Massachusetts."

Actually, this proposal to slash state government revenue by 40 percent is so extreme that even business groups cite a report showing just how devastated infrastructure, education and other services would be if this proposal is approved.

So it seems that many states are on the verge of ruining themselves with the narcotic of supply-side tax economics. If these states fail to resist, then what? Rehabilitation is possible, but it's a long and hard road. Colorado is trying to break free of the mess it created a decade ago when taxes and revenues were strictly suppressed by the so-called "Taxpayer Bill of Rights" (TABOR) that was approved by voters. TABOR poses a serious problem given that the cost of government services sometimes increases at a rate greater than general inflation. Also, another amendment to the state's constitution requires regular increases in education spending. Reconciling these two competing demands proved impossible, and in 2005 Colorado voters temporarily suspended a significant portion of the TABOR requirement.

This year, it appears many Coloradans have finally had enough with having to deal with inadequate government services under the unrealistic TABOR requirements. Voters will have the opportunity to decide on Amendment 59, which would end the automatic refunds to taxpayers used to suppress state revenues, in favor of diverting that money toward education. This effort gives hope to those who realize that public services like schools and roads are the building blocks of a state economy, and that to have these services we have to pay for them. It also should serve as a warning to people in other states where supply-siders are promising voters that they can have their cake and eat it too.

Citizens for Tax Justice has recently released several reports on the tax issues being debated during this presidential election season.

1. The Tax Proposals of Presidential Candidates John McCain and Barack Obama

Last week CTJ released this 15-page report on the tax plans offered by the two candidates. The report includes estimates of the distributional and fiscal effects of both candidates' plans in 2012, a year when almost all of the provisions of either plan would be in effect if enacted. These estimates include the effects of making the Bush tax cuts permanent (partially, in Obama's plan, and almost entirely, in McCain's plan) as well as their proposed changes to the AMT, corporate tax, and the other tax changes they propose.

The report finds that Obama's tax plan would give a larger tax cut, on average, to taxpayers in the bottom 60 percent of the income distribution than McCain's plan. Interestingly, while Obama's plan would give a small tax cut, on average, to the richest one percent, McCain's plan would give this group an average tax cut that is 43 times as large.

2. Obama and McCain Propose New Stimulus Plans, Including More Tax Breaks

In addition to the tax plans that both candidates have been promoting for months, McCain and Obama both have recently proposed new, temporary tax cuts as a way to stimulate the economy and help people avoid the consequences of the downturn in the market. As this report explains, neither of the candidates' tax cuts seem very promising when it comes to helping Americans who are genuinely struggling, but McCain's proposals are particularly alarming because their benefits would be heavily targeted to the rich. He proposes to slash the capital gains rate, which would further bias the tax code against work and in favor of people who live off their wealth, and we estimate that over three fourths of the benefits would go to the richest one percent.

McCain also proposes that withdrawals of up to $50,000 from 401(k)s and IRAs, which are currently taxed as ordinary income, be subject to a top income tax rate of 10 percent. This obviously does nothing for a senior whose income is too low to trigger income tax liability or whose taxable income does not exceed the 10 percent bracket. But it would be a real boon for a very rich senior who would otherwise pay income taxes at a rate of 35 percent on such a withdrawal.

3. McCain's Proposal to Increase the Tax Loophole for Capital Gains Would Be Unfair and Counterproductive

This report explains in more detail why lawmakers should not take up McCain's proposal to expand the existing loophole for capital gains, and why they should move in the opposite direction and start taxing investment income just like any other income. Anyone who thinks that doing away with the lower rates for capital gains and dividends is too radical an idea is reminded that Congress has done it before -- under the leadership of President Reagan.

4. Does Joe the Plumber Need a Tax Break?

No discussion about this presidential race would be complete without some mention of Joe the Plumber, the man who asked Obama about how he would be affected by Obama's tax plan if he became a small business owner. Obama responded that someone like Joe needs a tax cut now, when he's working his way up and saving money, rather than later on when he's joined the ranks of the very richest Americans. We also note the oddity of McCain professing to be worried about a tax code that punishes this man's hard work while proposing to expand the very loopholes that bias the tax code against work.

It's sometimes easy to forget that the Presidential race isn't the only battle over policy proposals going on right now. But Massachusetts and Oregon provide two examples of states where voters are about to make some very important decisions affecting the future of their tax systems.

There may be a silver-lining in the regressive and irresponsible nature of the proposals facing these two states. In both states, the anti-tax groups pushing these ridiculous proposals appear to have gone too far, causing groups traditionally supportive of tax cuts to fight these initiatives.

An Expensive and Unfair Tax Cut, Part 1: Massachusetts

The Massachusetts proposal is perhaps the worst tax-related question on any ballot in the nation. It would repeal the state's income tax. Aside from being the only major progressive tax levied by the state, the income tax is also a source of 40% of Massachusetts' revenue. The results of depriving the state of 40% of its funding are nearly unfathomable. So unfathomable, in fact, that the Massachusetts Taxpayers Foundation (MTF), a group that just last year opposed reforms to make Massachusetts' tax system more fair, recently released a report in opposition titled The Massive Consequences of Question 1.

The MTF report does not focus solely on the budgetary consequences of income tax repeal. Those consequences have already received tremendous publicity in recent months, especially given the state's already strained budgetary situation as documented in this brief from the Massachusetts Budget and Policy Center. Instead, what stands out about the MTF report is its examination of the distributional consequences of the tax cut. In contrast to the claims of those supporting the repeal, the vast majority of Massachusetts residents will not be receiving a $3,700 tax cut if the measure is approved. Instead, as the report indicates, that cut will be much smaller for those low-income residents most in need, and much, much larger for the most well-off taxpayers in the state.

An Expensive and Unfair Tax Cut, Part 2: Oregon

Oregon's proposal also seeks to reduce state revenues in a way that disproportionately benefits the wealthy, though on a much smaller scale than that proposed in Massachusetts. The proposal: allowing Oregonians to write off their federal income tax payments when determining their state income taxes. Since residents can already write off up to $5,600, this measure will only benefit the wealthiest 22% of households in the state who pay more than $5,600 in federal income taxes. As this report from the Oregon Center for Public Policy notes, 78% of Oregonians will see no benefit from this proposal. In fact, as another release explains, some 120,000 Oregonians -- most of them retirees -- would see their taxes rise if Measure 59 were made law, as the measure would prohibit Oregonians from deducting taxes paid on Social Security benefits or certain pensions, as they are allowed to do under current law.

Recent actions by a collection of Oregonian business groups demonstrate the degree of irresponsibility contained in the plan. The Associated Oregon Industries, Oregon Business Association, Oregon Business Council, and Portland Business Alliance recently came together to issue a joint statement against the proposal. These businesses worried the measure would "deeply hurt basic services, including those critical to our economy". And these groups are absolutely right: why throw money at those taxpayers already doing quite well, if it's going to result in a reduction in the education, healthcare, and safety protections that Oregon families and workers depend on?

Recently, the Tax Foundation released its annual ranking of state business tax climates. As always, there are more than a few good reasons to be skeptical of the results contained in the report. But aside from the traditional methodological criticisms of any ranking of this type, this year's report includes at least one assertion that should turn the head of even the most casual state tax policy observer.

Florida, a state with one of the most obviously unfair and criticized tax systems in the nation, ranks 5th in overall business tax climate. According to the authors of the report:

"[Florida is] one of just four states to rank in the top half on all five tax-specific indices. Even Florida's much-maligned property tax system ranks fairly well, scoring 19th out of 50 states. Of course, improvements can be made to any state's tax code... but Florida is in a better position than most states to be content with the tax code it has."

A property tax that ranks "fairly well"? Content with the tax code it has? These assertions should come as a great surprise to anyone familiar with Florida's tax system. As has been documented at length in previous Digest articles, Florida's tax system is both unfair and inadequate.

Multiple rounds of budget cuts have become the norm each year in the state. Oddities with the property tax system have forced neighbors with similar homes to pay vastly different amounts in property tax. And all the while, the rich have been let off the hook despite vast income inequality in Florida.

In large part as a direct result of some of the abovementioned flaws with its tax code, a number of problems are immediately visible in Florida's quality of life. According to the Florida Center for Fiscal and Economic Policy, Florida ranks:

• 50th in per capita funding for higher education


• 49th in all education funding per capita


• 41st in state health rankings


• 49th in percent covered by health insurance


• 46th in Medicaid spending per child


• 2nd highest in percentage of uninsured children


• 48th in progressiveness of major state & local taxes

It's hard to imagine unhealthy and poorly educated workers being good for the state's "business climate". A tax system that fails to adequately fund these services should not be ranked among the best in the nation for business. In reality, Florida has an even longer and tougher road to travel than most states before it should be "content with the tax code it has".

Maryland is one of more than twenty states struggling with mid-year budget shortfalls as a result of a weak economy and the corresponding slump in tax collections. While this fact wasn't the original impetus for this November's ballot proposal to introduce 15,000 slot machines into the state, it has swayed some observers into supporting the measure, despite the fact that it would be years before the first slot machine lever is ever pulled.

As in Missouri, the backers of the proposal have tried to dress up slots in Maryland by linking the new revenue to education. But since no requirement exists that total education funding actually increase, there is no barrier to using revenues from the machines to simply replace revenue currently coming out of the general revenue fund. This hasn't deterred many supporters, though, as the increasingly dire situation of the Maryland budget has boosted the appeal of gaining additional government revenue (no matter how far off in the future) without raising taxes.

But taxes, particularly the income tax, have some notable advantages over gambling revenues as a means of paying for government. Though supporters of the measure have dismissed the idea of raising taxes during these tough economic times, they fail to acknowledge that gambling revenues are disproportionately collected from those less well-off individuals most harmed by the weak economy. Taxes also do not create the inevitable social ills that accompany gambling, which can end up draining a significant portion of the revenues expected from introducing slots.

Two other problems also plague the specific proposal facing Maryland. First, some question has been raised as to the accuracy of the revenue figures provided by Legislative Analysts in the state. Those estimates are unavoidably sensitive to economic conditions at the time of the introduction of slots, and to the gambling policies of other states.

Second, as Jeff Hooke of the Maryland Tax Education Foundation has pointed out, the proposal offers an unwarranted sweetheart deal to the horse raising industry, in the form of government subsidized winnings, or "purses". About $100 million of the government's portion of slot machine revenues will be dedicated to boosting racing purses. Hooke argues that this will do nothing to help Maryland's racing industry, and the majority of the money will go to out-of-state horse owners. Though this subsidy to racing purses has been reduced substantially from what was originally proposed, it is still an irresponsible use of slot machine revenues.

A report released earlier this month by the Oklahoma Policy Institute offers policymakers in the Sooner State several ideas for negotiating one of the fundamental tensions in state fiscal policy: the inclusion of groceries in a state's sales tax base. On the one hand, including groceries in the base is consistent with the notion that the base for any tax should be as broad as possible. Including groceries in the sales tax base also generates considerable revenue -- in Oklahoma, doing so yielded over $300 million in 2007. On the other hand, taxing groceries is highly regressive. The poorest twenty percent of Oklahomans paid two and a half times as much in grocery taxes, relative to their incomes, as middle income taxpayers in 2007.

Rather than removing groceries from the sales tax base altogether, OK Policy observes that policymakers could expand the state's existing "grocery tax credit," either by raising the value of the credit itself or extending it to additional taxpayers. Such a change would be in line with the recommendations of last year's Oklahoma Task Force on Hunger. To see more of the Oklahoma Policy Institute's work, visit www.okpolicy.org.

One of the most difficult tradeoffs policymakers have to make is in the level of taxes to collect vs. the level of services to provide. High taxes are generally politically unpopular, though if accompanied by a strong mix of valued government services, they are often considered to be worth the price. In contrast, a government that collects relatively little in taxes may be popular among its citizens come tax time, but the meager level of government services that comes with low taxes is rarely celebrated. Of course, since the federal government is free to run a deficit, sometimes this tradeoff can be delayed, as current spending can be paid for with higher taxes (or significantly reduced spending) at a much later date. Nonetheless, the tradeoff can never be avoided entirely. None of this is controversial.

Enter John McCain. According to Senator McCain,

"tax cuts, starting with Kennedy, as we all know, increase
revenues".

If true, the Senator from Arizona has found a way around one of the most dreaded problems facing our lawmakers. No longer must we weigh the pros and cons of higher taxes vs. better services. No, in McCain's world, lower taxes and better services are a natural pair. In fact, according to McCain, the tradeoff between taxes and services that policymakers have wrestled with for centuries is not only unnecessary, but also nonexistent:

"historically, when you raise people's taxes, guess what, revenue goes down". - Senator John McCain

Lower taxes aren't just the easy way to get more revenue - they're actually the only way!


The Laffer Hypothesis: Show Me The Money?

If only it were that easy. What McCain is referring to is the infamous "Laffer Curve", or "Laffer Hypothesis". Under this hypothesis, it is asserted that U.S. tax rates are so high that investment and overall economic activity has been greatly stifled. So stifled, in fact, that since individuals and businesses are paying so much of what they earn to the government, the incentives to take risks and work hard have been effectively removed from the economy - as a result, markedly less taxable economic activity is being than would otherwise be the case. With less taxable activity, there is less tax revenue. Under these extreme circumstances, lowering tax rates should actually boost economic activity to the degree that tax revenues will increase.

Unfortunately for McCain, the evidence against the Laffer Hypothesis is staggering, and few if any serious economists believe the hypothesis to be applicable to the U.S. tax code in its current state. The Department of the Treasury authoritatively showed this to be the case in this 2006 report. That report shows that in each of the four years following the 1981 and 2001 tax cuts, revenue markedly declined. In contrast, following the 1993 tax increases, revenue increased. Simple as that. It seems that the tradeoff does in fact exist: if you want more money to go to funding government services, you're going to have to pay more in taxes. This really shouldn't be all that surprising.


Not Just No Revenue ... No Growth, Either!

While the Treasury report just cited is more than enough to refute the Laffer Hypothesis on its own, there is also a wealth of literature examining the hypothesis' premises. Specifically, that literature looks at the merits of what is known as "supply-side economics", or the school of thought that cutting taxes for businesses and wealthy investors (the "suppliers", as opposed to the "consumers" in the economy) will markedly improve economic growth. In the American political landscape, this rationale for tax cuts has been equally if not more important than the issue of what will happen to government revenues.

Unfortunately, however, this rationale has been proven to have little if any merit. Ironically, not only have so-called "pro-growth" and "pro-investment" tax cuts been demonstrated to be incapable of raising revenues, they have also been shown (at least in their most recent manifestations) to be incapable of promoting growth or investment. The Center for American Progress (CAP) and the Economic Policy Institute (EPI) recently teamed up to add to the body of literature on this point with their report, "Take a Walk on the Supply Side: Tax Cuts on Profits, Savings, and the Wealthy Fail to Spur Economic Growth".

In their report, CAP and EPI find that investment growth, as well as overall economic growth, were much stronger in the years following the 1993 federal tax hike, than in the years following the 1981 and 2001 tax cuts. Numerous other indicators suggest a similar finding: median household income, wages, employment growth, and of course, the federal budget, were all in much better shape following the 1993 tax hike than during either of the periods that followed "pro-growth" tax cuts.

Of course, tax policy isn't the only determinant of economic performance. But if the supply-side argument has any merit, we shouldn't have seen the economy surge so dramatically following "anti-growth" tax hikes, and fizzle in an equally dramatic fashion in the wake of "pro-growth" tax cuts. At the very least, we would have expected these opposing sets of tax policies to have brought these three periods closer into line with each other. Simply put, when the supply-siders got their chance in 1981 and 2001, they failed to produce results, and dug the nation deep into debt.


Backed by the Politicians, Refuted by the Experts

But aside from all the empirical evidence regarding the Laffer Hypothesis (the CAP/EPI report, as well as another EPI Report from Harvard Economist Jeffrey Frankel already cover that ground more than adequately), the other important point for today's debate is what to make of various politicians' inexplicable belief in this thoroughly disproved hypothesis. The allure of putting more money into the taxpayer's pocket (via tax cuts) while at the same time putting more money into the government's coffers (through increased economic activity and the associated higher tax revenues) is apparently irresistible, as evidenced by the following quotes taken from Frankel's paper:

"The increase in revenues should be financed not by new and higher taxes, but by lower tax rates that would produce more money for the government by stimulating higher earnings by corporations and workers"
- President Ronald Reagan


"Some in Washington say we had to choose between cutting taxes and cutting the deficit. That was a false choice. The economic growth fueled by tax relief has helped send our tax revenues soaring. That's what's happened"
- President George W. Bush


"The deficit would have been bigger without the [2001] tax relief package"
- President George W. Bush


"It's time for everyone to admit that sensible tax cuts increase economic growth, and add to the federal treasury"
- Vice President Cheney

More quotes of a similar vein can be found in Frankel's paper. Also contained in that piece are valuable quotes directly from each of these administrations' chairmen of the President's Council of Economic Advisers. The statements of these highly trained economists reflect a remarkably different opinion on the Laffer Hypothesis:

"The height of supply-side hyperbole was the 'Laffer curve' proposition that the tax cut would actually increase tax revenue because it would unleash an enormously depressed supply of effort . [this has been] proven to be wrong"
- Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan


"Although the economy grows in response to tax reductions, it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity"
- Glenn Hubbard, chairman of the Council of Economic Advisers under President George W. Bush


"Subsequent history failed to confirm Laffer's conjecture that lower tax rates would raise more tax revenue. When Reagan cut taxes after he was elected, the result was less tax revenue, not more"
- Greg Manikew, chairman of the Council of Economic Advisers under President George W. Bush

The conflict between these two sets of quotes reflects deep divisions between the politicians and the experts with which they surround themselves. John McCain fits this pattern perfectly. Since McCain is not President (at least not yet), he does not have his own Council of Economic Advisers to refute his wild claims regarding tax cuts. He does, however, have Douglas Holtz-Eakin as his Senior Policy Adviser. Holtz-Eakin is a Princeton-trained economist and former head of the Congressional Budget Office. He also is on record as explicitly rejecting the Laffer Hypothesis.

But McCain isn't taking Holtz-Eakin's word for it. Aside from the quotes from John McCain cited earlier, further deference to the Laffer Hypothesis from the McCain camp has been evidenced by the candidate's choice of Arthur Laffer, the chief proponent of the Laffer Hypothesis, as one of the campaign's special economic advisers.

This whole asinine situation brings to mind McCain's previous admission that "the issue of economics is something that I've never really understood as well as I should". Perhaps, given his inadequacies in the subject area, he would be better off deferring to those who do understand it. More "pro-growth" tax cuts targeted to the most fortunate members of society, like McCain's, are the exact opposite of what is needed.

On Friday, President Bush signed into law the financial rescue plan that had been approved by the House of Representatives just hours earlier. The House had rejected a similar financial rescue bill on Monday, but on Wednesday the Senate passed a version that was loaded with tax breaks in order to woo more votes in the House. The Senate bill combined the financial rescue plan with legislation to extend several temporary tax breaks (often called tax "extenders") as well as a measure to keep the Alternative Minimum Tax (AMT) from expanding to reach more taxpayers. The sweeteners added by the Senate were apparently enough to win over a majority of members in the House, who approved the bill on Friday and sent it on to the White House for Bush's signature.

The political dynamic was somewhat confusing throughout the debate over the bill. The financial rescue plan and the tax legislation were both bills that were opposed by the House, largely because of their costs. Counter-intuitively, the compromise was to pass both as one bill.

It almost sounded like a joke: What is bipartisanship? It's what happens when some lawmakers want new spending we cannot afford while other lawmakers want new tax cuts we cannot afford, and in the end Congress compromises by doing both and paying for none of it.

The Financial Rescue Plan

In all fairness, there are conservatives and progressives who supported and opposed the bailout legislation. Some argue that it is truly necessary to keep lines of credit open, and that its cost will be less than the widely-cited $700 billion figure. And there are surely some provisions among the tax cuts that we would all support. (One that comes to mind would make the child tax credit more accessible for low-income families.)

In theory, the government will eventually sell the assets it buys from financial institutions and recoup much of the costs (and it's possible, though unlikely, that the taxpayers could actually profit). And if the costs are not recouped after five years, the President is to propose legislation to Congress to recoup the money from the financial sector. (What shape this would take is unclear, but House Speaker Nancy Pelosi and others had earlier discussed a fee on financial institutions after the five-year period.) As discussed in last week's Digest article, Congressional leaders did win some concessions that improved the President's initial proposal. One involves limiting the deductibility of compensation to highly paid executives in the entities participating in the bailout. (However, some astute observers have pointed out that serious loopholes in that rule remain, including the fact that stock options are apparently not covered).

AMT Relief

The tax cut package has had a long and tortuous history. Generally speaking, the Democrats in the House have opposed passage of any type of tax cut legislation that will result in an increase in the budget deficit. This is entirely reasonable, especially given the massive deficits racked up throughout the Bush years, and in practice this means that any tax cuts must be accompanied by revenue-raising provisions or cuts in spending. In the Senate however, a minority of Republican Senators can block any legislation that has any sort of revenue-raising provision, and the result has been a long feud between the two chambers over whether to pay for AMT relief and other tax breaks.

The AMT is a backstop tax designed to ensure that well-off people pay some minimum tax no matter how proficient they are at finding loopholes to reduce or wipe out their tax liability. Tax liability is calculated under the regular rules and the AMT rules, and you only have to pay the AMT if your AMT liability exceeds your regular income tax liability.

For most middle-class taxpayers, this is usually not an issue. But the Bush administration chose to lower the regular income tax without making any permanent change to the AMT, so of course that means that more people are going have to pay the AMT. Another problem, albeit a less important one, is that inflation is eating away at the value of the exemptions that keep most of us from paying the AMT. The Clinton administration increased these exemptions, but no permanent increase in those exemptions has been made during the Bush years.

The adjustment in the AMT that was included in the bill will increase these exemptions so that most of us will continue to be unaffected by the AMT.

Earlier this year, the House approved AMT relief and the tax exenders, but included provisions in each that would offset the cost by closing tax loopholes. Republicans in the Senate objected to the offsets and vowed to block these bills.

More recently, the House actually relented somewhat and passed a bill that would provide AMT relief without paying for it, increasing the deficit by over $60 billion. Unfortunately, this was not enough for the Senate, which insisted on increasing the deficit even more by including the tax extenders without offsetting all of their costs.

Tax Extenders

The Senate had been insisting on the passage of a bill combining the AMT relief with the "tax extenders." The extenders include all sorts of handouts that either subsidize businesses that don't need subsidies (like the research credit), cut taxes in ways that are not particularly progressive (like the deduction for state sales taxes and the deduction for tuition which really only benefits fairly well-off families), or just offer very trivial benefits (like the provision allowing teachers to deduct $250 in classroom expenses, which yields a benefit of about $60 for teachers lucky enough to be in the 25 percent bracket).

The legislation includes one very wise provision to offset $25 billion of the cost by shutting down offshore tax schemes that help the already highly compensated avoid taxes on their deferred compensation. Generally, when a company pays into a deferred compensation plan for an employee, if that plan is "non-qualified" (meaning it exceeds certain limits that the super-compensated don't want to deal with) the company cannot take a tax deduction for the payment until it is actually received as income in later years by the employee. But some have figured out how to have their deferred compensation routed through an offshore entity in some tax haven so that there is no tax paid to the U.S. government or any other government, so not being able to deduct the payment is not an issue. This provision would make the deferred compensation in this situation immediately taxable to the individual, so that there would no longer be an incentive to use this scheme.

The passage of this reform is a positive development, but this still leaves a total $110 billion increase in the deficit as a result of the tax cuts.

As Isaiah Poole at the Campaign for America's Future observed this week,

"Whatever the merits of these tax measures -- and you can be sure that the merits of many of these provisions are highly questionable and exist only at the behest of lobbyists or lawmakers pandering for votes -- they certainly make a mockery of all the protestations of not turning the economic rescue effort into a "Christmas tree" of special-interest provisions. As it turns out, the "Christmas tree" concern only applies to provisions that would, for example, fund community organizations that have a track record of helping homeowners avoid foreclosure. You know, things that would help ordinary people directly affected by the financial crisis."

Just like individuals, entities that have any sort of income are required to pay taxes on that income. This is how we pay for roads, schools, tanks and many other things. But because life is complicated, we have made exceptions for some entities, allowing them to claim tax-exempt status. One would think that the taxpayers, acting through their elected officials, should be able to decide what the conditions are for enjoying such tax-exempt status. For example, there seems to be no reason to grant a tax subsidy to an organization that endorses a political candidate. Most people would agree that we should not grant a tax subsidy for activities geared towards winning political power for an individual or party.

But there is at least one organization that disagrees. The conservative Alliance Defense Fund seems to believe that Congress has no right to set such conditions on an entity enjoying tax-exempt status. The ADF sponsored what it called "Pulpit Freedom Sunday" a week ago, which consisted of 33 conservative pastors endorsing presidential candidate John McCain during church services. If any church loses its tax-exempt status, the ADF wants to challenge this action by the IRS on the grounds that the right to free speech under the First Amendment is being violated.

As one preacher in Minnesota recently put it, "The scripture is very clear about our need to obey all laws," he said. "I want people to realize that there are two laws here that compete with each other. The IRS says that I cannot talk about politics. The Constitution says I can. Unless there's a court battle, we don't know which law to obey."

Actually, there is no conflict, and such a challenge will not stand up in court. Every organization is free to endorse whomever it wants for any political race. The law simply says the government will not grant any organization doing so an exemption from taxes.

Some of the pastors involved actually seemed quite aware of this. The same Minnesota pastor said he was aware that his church could lose its tax-exempt status "but it's not that big a deal... The church will go on." That's actually a rather startling admission. If the churches don't actually need a tax exemption, then there really is no conflict here after all.

CTJ Report Calls on Congress to Close the Tax Loopholes for Capital Gains and Dividends

A new report from Citizens for Tax Justice argues that since Wall Street needed a government bailout that taxpayers have no interest in paying for, this seems like a good time to close the biggest subsidy currently enjoyed by Wall Street: The tax loopholes for capital gains and dividends. These loopholes subsidize people whose income results from investments rather than wages, as well as the Wall Street brokers who rely on their business.

President Bush and his allies in Congress significantly expanded a loophole for capital gains (which was previously taxed at a top rate of 20 percent and is now taxed at only 15 percent) and created a new one for corporate stock dividends (which used to be taxed just like any other income but are now also subject to a top rate of 15 percent). As the report explains, the result is that someone living off their wealth can pay taxes at a lower rate than someone who works for wages and has a lower income.

The report also refutes some misconceptions about these tax subsidies, including the "supply-side" idea that they somehow pay for themselves.

Closing these loopholes is not a particularly radical idea. President Reagan signed a tax reform law in 1986 that applied the same tax rates to all income, regardless of whether it took the form of wages or investment income.

Many economists believe that tax cuts are not as effective as certain types of public spending in stimulating the economy, and we share that view. One thing that is even less effective as economic stimulus is tax cuts that are not received by the low-income people who are most likely to pump the money back into the economy by spending it immediately.

Unfortunately, it appears that millions of taxpayers who could most benefit from the stimulus have actually not received their checks. The deadline, October 15, is fast approaching for individuals to file their taxes so that they can receive their tax rebate checks. Here's a quick reminder of what's at stake: Taxpayers who filed their 2007 federal income taxes and had incomes of less than $75,000 ($150,000 for married couples) probably already received a rebate equal to income tax liability up to a maximum of $600 ($1,200 for married couples) or a minimum rebate of $300 ($600 for married couples). But those who did not file income taxes for 2007 are at risk of missing out if they still have not filed.

Last week the Center on Budget and Policy Priorities issued state fact sheets describing the number of rebates by city and county that are currently left unclaimed. Many of those folks who haven't claimed their rebate are those who could most utilize the checks -- low-income seniors and disabled veterans. Over 100,000 people in Michigan have yet to file and receive their checks. While there is some debate about whether or not the rebate checks have stimulated the economy, it's clear that no one benefits if the rebates go unclaimed by those who need them the most

From coast to coast, state and local governments are coming face-to-face with the consequences of turmoil in the nation's housing and financial markets, as tax collections are falling well short of expectations and are opening up substantial budget gaps. The country's two Washingtons -- the city of Washington, DC and the state of Washington -- provide two troubling examples. Last month, Washington State's Economic and Revenue Forecast Council announced that it was reducing its revenue projections by $530 million, bringing the anticipated 2009-2011 budget deficit to $3.2 billion. Similarly, Washington, DC's Chief Financial Officer, Natwar Gandhi, revealed at the end of September that the District would likely face a deficit of roughly $131 million in fiscal 2009. Fortunately, sensible solutions to these problems are available. Both the Washington Budget & Policy Center and the DC Fiscal Policy Institute have offered outlines for addressing the respective shortfalls, including using a portion of existing reserve funds, reconsidering ineffective tax exemptions or incentives, and at least temporarily raising taxes. You can read their recommendations here and here.

Late last month, Rep. Dennis Kucinich (D-OH) held a hearing on Capitol Hill to investigate the nearly $950 million in tax exempt bonds approved to build the new Yankee Stadium. One of the most egregious discrepancies so far is that the appraiser hired by the city estimated the value of the land for the new stadium at about $40 million. The figure used in documents city officials turned in to the IRS to qualify for tax-exempt bonds was $204 million. Even a columnist for ESPN cited New York Assemblyman Richard Brodsky's report which said that taxpayers will be charged between $550 and $850 million for the new stadium. To add to taxpayer outrage, the Yankees have even raised their ticket prices significantly for next year, even though the Yankees didn't make it to the playoffs. Assemblyman Brodsky put it best when he said, "We do things for professional sports we wouldn't do for any other business. When it comes to professional sports, we become socialists; for everyone else, we're capitalists." Good Jobs First New York has followed the development of the new stadium for some time. To read more about how New Yorkers won't benefit from the stadium deal, check out Good Jobs First New York.

As was discussed in the Digest last week, despite (or perhaps because of) all the recent changes that have been made to the Michigan Business Tax (MBT), many businesses in the state are still unhappy with their tax bills. That frustration most recently materialized in the state senate in the form of two bills: one seeking to reduce, and one seeking to eliminate entirely, the annual surcharge imposed on the MBT. Both bills passed last Thursday. The surcharge was originally enacted to help fill the gap created by the repeal of the services tax.

Because of the fervor with which Michigan businesses have been voicing their displeasure with the surcharge, policymakers are now clamoring to appease them. But given the importance of government services to Michiganders, especially during these difficult economic times, it seems indisputable that the state should not begin cutting business taxes until other revenue streams are secured. Fortunately, Governor Granholm has said that she would only support reducing the surcharge on the condition that the lost revenues are offset with higher revenues from elsewhere.

Of course, a variety of good options exist for raising additional revenues in Michigan. At the top of that list should be an enhancement of the progressivity of the state's income tax, so that the rest of the state can begin to share in the enormous gains wealthy Michiganders have enjoyed in recent decades. Aside from that, a good starting point for policymakers would be a careful examination of this list, put together by the Michigan League for Human Services, of questionable tax exemptions, deductions, and credits.