A new working paper on tax reform options from Citizens for Tax Justice has a section describing a category of revenue-raising proposals that has not received much attention: ending tax shelters for investment income. As former Treasury Secretary Larry Summers noted in a recent op-ed: “What’s needed is an element that has largely been absent to date: [reducing] the numerous exclusions from the definition of adjusted gross income that enable the accumulation of great wealth with the payment of little or no taxes.”

The problem addressed by these proposals is partly related to the problem posed by the special, low rates that apply to capital gains and stock dividends. (Congress certainly needs to eliminate those special rates, so that investment income is taxed just like any other income.)

The breaks and loopholes criticized by Larry Summers and explained in CTJ’s new working paper allow wealthy individuals to delay or completely avoid paying taxes on their capital gains — at any rate. It does not matter what tax rate applies to capital gains so long as the wealthy can use these shelters to avoid paying any tax at all.

Path to Reform that Taxes All Income at the Same Rates

If these tax shelters are eliminated, that may make it easier for Congress to tackle the other problem with investment income — the special low rates that apply to investment income that takes the form of capital gains and stock dividends. Currently, the Joint Committee on Taxation (JCT), the official revenue estimator for Congress, assumes that people will respond to hikes in tax rates on capital gains by holding onto their assets or finding ways to avoid the tax, reducing the amount of revenue that can be raised from such a rate hike. (CTJ has explained why JCT’s assumptions are overblown in the appendix of our 2012 report on revenue-raising options.)

But if the various shelters that people use to avoid taxes on capital gains are closed off, JCT could logically assume that raising tax rates on capital gains will raise substantially more revenue.

Tax Capital Gains at Death

The tax shelter that is probably the largest, in terms of revenue, is the “stepped-up basis” for capital gains at death. Income that takes the form of capital gains on assets that are not sold during the owner’s lifetime escape taxation entirely. The heirs of the assets enjoy a “stepped-up basis” in the assets, meaning that any accrued gains at the time the decedent died are never taxed. (The estate tax once ensured that such gains would be subject to some taxation, but repeal of three-fourths of the estate tax has been made permanent in the fiscal cliff deal.)

The justification for the stepped-up basis seems to be the difficulty in ascertaining the basis (the purchase price, generally) of an asset that a taxpayer held for many years before leaving it to his or her heirs at death.

But this difficulty (which is decreasing rapidly because of digital records) does not justify the sweeping rule allowing stepped up basis for all assets left to heirs — even assets that have a clearly recorded value and assets that were only acquired right before death.

It is also not obvious that this difficultly with determining the basis is that different after the death of the owner of the asset. Consider an asset that was held for, say, 40 years and bequeathed at death and an asset that was held for 40 years and then sold to fund the taxpayer’s retirement. In the former situation, the gains that accrued over those 40 years are never taxed, but in the latter situation they are taxed. But any difficulties in determining basis would seem to be the same in these situations.

The proposal to tax capital gains at death, and the others described in the working paper, challenge some breaks that wealthy individuals and their accountants and lawyers are deeply attached to. But the vast majority of Americans whose income takes the form of wages are not able to use these maneuvers to delay or avoid taxes on their income. They would have trouble understanding why these tax shelters for the wealthy should be preserved while Congress considers dramatic cuts to public investments that support all Americans.

Comprehensive New 50-State Study Provides Detailed Profiles and Comparisons of Tax Systems and Distribution Including “Terrible Ten” Most Regressive States

State tax systems take a much larger share from middle- and low-income families than from wealthy families, according to the fourth edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States,” released today by the Institute on Taxation and Economic Policy (ITEP).  Combining all of the state and local income, property, sales and excise taxes state residents pay, the average overall effective tax rates by income group nationwide are 11.1 percent for the bottom 20 percent, 9.4 percent for the middle 20 percent and 5.6 percent for the top one percent. The report is online at www.whopays.org.

The ten states whose tax systems are tilted most heavily towards high earners (from most to least regressive) are Washington, Florida, South Dakota, Illinois, Texas, Tennessee, Arizona, Pennsylvania, Indiana, Alabama. In these states, middle-income families pay up to three times as high a share of their income as the wealthiest families; low-income families pay up to six times as much.

“We know that governors nationwide are promising to cut or eliminate taxes, but the question is who’s going to pay for it,” said Matthew Gardner, Executive Director of ITEP and an author of the study. “There’s a good chance it’s the so-called takers who spend so much on necessities that they pay an effective tax rate of 10 or more percent, due largely to sales and property taxes.  In too many states, these are the people being asked to make up the revenues lost to income tax cuts that overwhelmingly benefit the wealthiest taxpayers.” State consumption tax structures are particularly regressive, with an average 7 percent rate for the poor, a 4.6 percent rate for middle incomes and a 0.9 percent rate for the wealthiest taxpayers nationwide.

The income tax in particular is being targeted for elimination by self-described tax reformers across the country, and Who Pays? shows that of the ten most regressive states, four do not have any taxes on personal income, one state applies it only to interest and dividends and the other five have a personal income tax that is flat or virtually flat across all income groups.  “Cutting the income tax and relying on sales taxes to make up the lost revenues is the surest way to make an already upside down tax system even more so,” Gardner stated.

The data in Who Pays? also demonstrates that states commended as “low tax” are often high tax states for low- and middle- income families.  The ten states with the highest taxes on the poor are Arizona, Arkansas, Florida, Hawaii, Illinois, Indiana, Pennsylvania, Rhode Island, Texas, and Washington. Noted Gardner, “When you hear people brag about their low tax state, you have to ask them, low tax for who?"

The fourth edition of Who Pays? measures the state and local taxes paid by different income groups in 2013 (at 2010 income levels including the impact of tax changes enacted through January 2, 2013) as shares of income for every state and the District of Columbia.  The report is available online at www.whopays.org.

Lawmakers in North Carolina are looking seriously at repealing the state’s personal and corporate income taxes, and replacing them primarily with a larger sales tax.  As is often the case with plans to gut the income tax, the proposal is being sold as a way to “kick-start” the state’s economy.  In an attempt to bolster that argument, a conservative group in North Carolina called Civitas recently hired supply-side economist Arthur Laffer to write a report claiming that 378,000 new jobs and $25 billion in new income could be created through income tax repeal.  Our partner organization, the Institute on Taxation and Economic (ITEP) took a close look at the study and found that, as with Laffer’s previous work, the study is severely flawed to the point of making it entirely useless.  Among the study’s many flaws:

- Fails to control for a large range of important non-tax factors that affect state economic growth.
- Confuses cause and effect by assuming that recent declines in personal income were due to taxes rather than the Great Recession.
- Does not explain, or completely ignores, the economic impact of various tax changes it proposes to pay for income tax repeal.
- Cherry-picks blunt, aggregate economic measures in comparing state economies, and simply asserts that tax policy is the driving force behind these measures.
- Ignores the important role that public investments have to play in any successful state economy.

ITEP concludes that “In proposing a policy course that no state has ever taken—repealing the personal and corporate income taxes without a wealth of oil reserves to fall back on—ALME and the Civitas Institute have laid out an untested plan without any evidence that it will benefit the state’s economy.”

Read the full ITEP report

On Friday, the IRS held its EITC Awareness Day, working with local governments, non-profits and community groups to ensure that people potentially eligible for the Earned Income Tax Credit (EITC) file tax returns and claim it. The IRS says that one in five who are eligible for the EITC do not claim it.

The EITC, which is basically a tax credit equal to a certain percentage of earnings (up to a limit) to encourage work and reduce poverty, is widely misunderstood by many pundits and members of Congress. Like the Child Tax Credit, the EITC is a refundable tax credit, meaning it provides a benefit even when the credit is larger than the federal personal income tax that a taxpayer would otherwise owe. This can result in a negative income tax, meaning the IRS will send a check to the taxpayer.

These refundable credits are one reason why some Americans do not owe federal personal income taxes. (There are other reasons as well, like the fact that most of the Social Security benefits that retirees and people with disabilities receive are not subject to the income tax.)

Conservative Opposition to 2009 Expansions of EITC and Child Tax Credit

For the past couple years, conservative politicians and pundits have largely missed or ignored the fact that taxpayers with a negative income tax rate resulting from refundable credits do pay other types of taxes, which tend to be regressive. Federal payroll taxes, to take one example, are paid by everyone who works (and the EITC and the refundable part of the Child Tax Credit are only available to those with earnings). And all Americans pay state and local taxes, which are particularly regressive. The refundable credits in the federal personal income tax offsets some of the regressive impact of these other taxes.

Conservative politicians actually came out against expanding the EITC and the refundable part of the child tax credit in 2009, when President Obama proposed expanding the EITC for larger families and families headed by married couples and expanding the refundable part of the Child Tax Credit for very-low income working families. Those provisions were included in the economic recovery act enacted in 2009 and again in the deal the President made with Republicans at the end of 2010 to extend all the expiring tax cuts for another two years.

But each time Congressional Republicans introduced a proposal to extend tax cuts, it allowed these particular provisions to expire. CTJ’s figures showed what was at stake if these 2009 provisions expired. For example, CTJ’s state-by-state figures showed that in 2013, benefits for 13 million families with 26 million children would be lost if the provisions were not extended.

All Americans Pay Taxes

Conservative pundits claimed that these provisions led to nearly half of Americans not paying taxes. Paul Krugman at the New York Times, Ruth Marcus and Ezra Klein at the Washington Post and other observers have noted CTJ’s data showing that once you account for all of the different types of taxes, Americans in all income groups do, in fact, pay taxes and that our tax system overall is just barely progressive.

Mitt Romney and the 47 Percent

Perhaps the misinformation came to its spectacular climax when presidential candidate Mitt Romney was recorded making disparaging remarks about the 47 percent of Americans who, in his words, “believe that they are entitled to health care, to food, to housing, to you-name-it... These are people who pay no income tax.”

2009 Expansions of EITC and Child Tax Credit Extended for Only Five Years

One might think that the backlash produced by Romney’s comments, and his subsequent electoral loss, might have prompted conservatives to change their thinking. But they can only evolve so much, so fast. As an apparent concession to the right, the fiscal cliff deal approved by the House and Senate on New Year’s Day extended President Obama’s 2009 expansions of the EITC and Child Tax Credit for just five years — even though it made other tax cuts permanent.

Making permanent the EITC and Child Credit expansion would have cost in the neighborhood of $100 billion over a decade, and the five-year extension of these provisions cost around half that amount. This is real money, but insignificant compared to the $369 billion spent on making permanent estate tax cuts for millionaires or the $3.3 trillion spent on making permanent most of the income tax cuts first enacted under George W. Bush.

The EITC and the Child Tax Credit do a lot to offset the regressive impacts of the many types of taxes paid by low-income Americans. Congress should remember this and make the recent expansions of these refundable credits permanent.

A two-page report from Citizens for Tax Justice explains new evidence of offshore tax avoidance by corporations unearthed by the non-partisan Congress Research Service (CRS).

In a nutshell, CRS finds that U.S. corporations report a huge share of their profits as officially earned in small, low-tax countries where they have very little investment and workforce while reporting a much smaller percentage of their profits in larger, industrial countries where they actually have massive investments and workforces.

This essentially confirms that corporations are artificially inflating the share of their profits that they claim to earn tax havens where they don’t really do much real business. Remember that offshore tax avoidance by corporations often takes the form of convoluted transactions that allow U.S. corporations to claim that most of the profits from their business are earned in offshore subsidiaries in a tax haven like Bermuda, and that the offshore subsidiary my be nothing more than a post office box.

And Bermuda is a great example. CRS finds that the amount of profits that U.S. corporations report to earn in Bermuda is 1,000 percent of Bermuda’s GDP! That’s ten times Bermuda’s gross national product — ten times the tiny country’s actual economic output. This is obviously impossible and confirms that much of the profits that U.S. corporations claim are earned there represent no actual economic activity but rather represent profits shifted from the U.S. or from other countries to take advantage of that fact that Bermuda has no corporate income tax.

Sadly, most of the tax dodges practiced by U.S. corporations to shift their profits to tax havens are actually legal. CTJ’s report explains what type of tax reform is needed to address this.

Note to Readers: This is the second of a six part series on tax reform in the states.  Over the coming weeks, The Institute on Taxation and Economic Policy (ITEP) will highlight tax reform proposals and look at the policy trends  that are gaining momentum in states across the country. This post focuses on “tax swap” proposals.

The most extreme and potentially devastating tax reform proposals under consideration in a number of states are those that would reduce or eliminate one or more taxes and replace some or all of the lost revenue by expanding or increasing another tax.  We call such proposals “tax swaps.”  Lawmakers in Kansas, Louisiana, Nebraska and North Carolina have already put forth such proposals and it is likely that Arkansas, Missouri, Ohio and Virginia will join the list.

Most commonly, tax swaps shift a state’s reliance away from a progressive personal income tax to a regressive sales tax. The proposals in Kansas, Louisiana, Nebraska and North Carolina, for example, would entirely eliminate the personal and corporate income taxes and replace the lost revenue with a higher sales tax rate and an expanded sales tax base that would include services and other previously exempted items such as food.   

In the end, tax swap proposals hike taxes on the majority of taxpayers, especially low- and moderate-income families and give significant tax cuts to wealthy families and profitable corporations. For instance, according to an ITEP analysis of Louisiana Governor Bobby Jindal’s tax swap plan (eliminating the personal income tax and replacing the lost revenue through increased sales taxes) found that the bottom 80 percent of Louisianans would see their taxes increase. In fact, the poorest 20 percent of Louisianans, those with an average annual income of just $12,000, would see an average tax increase of $395, or 3.4 percent of their income. At the same time, the elimination of the income tax would mean a tax cut for Louisiana’s wealthiest, especially in the top 5 percent.  ITEP concluded that any low income tax credit designed to offset the hit Louisiana’s low income families would take would be so expensive that the whole plan could not come out “revenue neutral.” The income tax is that important a revenue source.

These proposals also threaten a state’s ability to provide essential services, now and over time. They start out with a goal of being revenue neutral, meaning that the state would raise close to the same amount under the new tax structure as it did from the old.  But, even if the intent is to make up lost revenue from cutting or eliminating one tax, these plans are at risk of losing substantial amounts of revenue due in large part to the political difficulty of raising any other taxes to pay for the cuts. Frankly, it’s taxpayers with the weakest voice in state capitals who end up shouldering the brunt of these tax hikes: low and middle income families.

Proponents of tax swap proposals claim that replacing income taxes with a broader and higher sales tax will make their state tax codes fairer, simpler and better positioned for economic growth, but the evidence is simply not on their side. ITEP has done a series of reports debunking these economic growth, supply-side myths. In fact, ITEP found (PDF) that residents of so-called “high tax” states are actually experiencing economic conditions as good and better than those living in states lacking a personal income tax. There is no reason for states to expect that reducing or repealing their income taxes will improve the performance of their economies; there is every reason to expect it will ultimately hobble consumer spending and economic activity.

Here’s a brief review of some of the tax swap proposals under consideration:

Last week Nebraska Governor Dave Heineman revealed two plans to eliminate or greatly reduce the state’s income taxes and replace the lost revenue by ending a wide variety of sales tax exemptions. ITEP will conduct a full analysis of both of his plans, though it’s likely that increasing dependence on regressive sales taxes while reducing or eliminating progressive income taxes will result in a tax structure that is more unfair overall.

If Kansas Governor Sam Brownback has his way he’ll pay for cutting personal income tax rates by eliminating the mortgage interest deduction and raising sales taxes. An ITEP analysis will be released soon showing the impact of these changes – made even more destructive because of the radical tax reductions Governor Brownback signed into law last year.

Details recently emerged about Louisiana Governor Bobby Jindal’s plan to eliminate nearly $3 billion in personal and corporate income taxes and replace the lost revenue with higher sales taxes. ITEP ran an analysis to determine just how that tax change would affect all Louisianans. ITEP found that the bottom 80 percent of Louisianans in the income distribution would see a tax increase. The middle 20 percent, those with an average income of $43,000, would see an average tax increase of $534, or 1.2 percent of their income. The largest beneficiaries of the tax proposal would be the top one percent, with an average income of well over $1 million, who'd see an average tax cut of $25,423. You can read the two-page analysis here.

North Carolina lawmakers are considering a proposal that would eliminate the state’s personal and corporate income taxes and replace the lost revenues with a broader and higher sales tax, a new business license fee, and a real estate transfer tax. The North Carolina Budget and Tax Center just released this report (using ITEP data) showing that the bottom 60 percent of taxpayers would experience a tax hike under the proposal. In fact, “[a] family earning $24,000 a year would see its taxes rise by $500, while one earning $1 million would get a $41,000 break.” The News and Observer gets it right when they opine that the “proposed changes in North Carolina and elsewhere are based in part on recommendations from the Laffer Center for Supply Side Economics.  Supply-side economics (or “voodoo economics,” as former President George H.W. Bush once called it) didn’t work for the United States…. We wonder why such misguided notions endure and fear where they might take North Carolina.”

In reference to Indiana Governor Mike Pence’s proposed tax plan, The South Bend Tribune urges lawmakers to “pass on this tax cut” and cites data (PDF) from our partner organization, the Institute on Taxation and Economic Policy (ITEP), to makes its case.  As the Tribune explains, “Needs of poor children, the elderly and mentally ill aren't being met … now is not the time to further stem income tax revenue. Gasoline tax revenue is down. Corporate taxes have been trimmed. The inheritance tax is being phased out. And then there's the Institute on Taxation and Economic Policy's analysis of Pence's across-the-board tax cut plan which concluded it would mostly benefit the wealthiest taxpayers. The poorest Hoosiers, who devote more of their household budgets to state and local taxes than any other income group, would be helped little, if at all.”

New Jersey’s expiring film tax credit is still paying out big bucks for TV shows and movies filmed years ago – even though these credits are billed as incentives. The state Economic Development Authority just handed the makers of Law & Order SVU $10.2 million of New Jersey taxpayers’ dollars for work done on the 2009-10 season of the show.  Hopefully New Jersey’s credit won’t be resurrected after 2015, given that studies have repeatedly shown them to be a poor use of taxpayer dollars.

Kudos to Wisconsin’s Transportation Finance and Policy Commission which will recommend to the legislature that the state increases its gas tax by five cents. This would be the first increase in the state’s gas tax since 2006. In more gas tax news, Washington State Senate Majority Leader Rodney Tom recently said that he would support an increase in the state’s gas tax. For more on the vital role that state gas taxes play in funding transportation needs across the state (and why states should raise theirs) read ITEP’s  Building a Better Gas Tax Report.

And in housekeeping news… We’ve done lots of behinds the scenes work to improve your experience when visiting the Institute on Taxation and Economic Policy (www.itep.org) and Citizens for Tax Justice’s (www.ctj.org) websites. Please take a minute and check out our slightly reorganized (and improved) site!

This weekend, Professional Golf Hall of Fame member Phil Mickelson hinted that he might move from California, and even expatriate to Canada, because of recent tax increases on the wealthy in his home state.  Aside from the fact that he would face higher taxes in Canada, if his tax rate is such a concern, Mickelson might consider Myanmar or Chad whose citizens enjoy some of the lowest tax rates in the world.

Many have been critical of Mr. Mickelson’s comments, since he is the 7^th wealthiest athlete in the world, and yesterday he walked them back. “Finances & taxes are a personal matter and I should not have made my opinions on them public. I apologize to those I have upset.” 

We tried to guess which of his corporate sponsors was most upset by the remarks and persuaded their 50-million dollar man to quit talking about taxes and issue the apology.  The pharmaceutical giant, Amgen, perhaps, which is uniquely skilled at dodging taxes by parking its profits in tax havens?  Or maybe it was Exxon Mobil, which has found ways to pay less than half the U.S. corporate tax rate in recent years.  Most ironic would be accounting behemoth KPMG, whose job is to help multinationals and high wealth individuals reduce their tax bills year after year.  Mickelson’s message that there are some tax increases you just can’t avoid can’t be good for business.

During his walk-back, Mickelson also said he was still learning about the new tax laws.  He might also want to brush up on his math, too, because he said his combined state and federal tax rate is 62 or 63 percent.  But with the highest average combined tax rate on the very wealthiest Americans hovering around 30 percent, that’s not likely.  Maybe that’s why it’s so very rare that Americans move to lower to their tax rates, once they understand how they work.

While the fiscal cliff debate may have seemed abstract and technical to many Americans, the results of the tax deal has become much more tangible to 77.5% of Americans who are seeing their take-home pay decrease in their first paychecks of the year, due to the expiration of the payroll tax holiday.

Anti-tax, anti-government types in the media and politics have taken advantage of the confusion over the fiscal cliff deal to make it seem like it was one big tax hike. One even argued that President Obama tricked the American public when he said he would only increase taxes on the wealthiest Americans. This is utter nonsense because what the deal really did was simply let a slew of temporary tax cuts expire. 

As to the payroll tax holiday, President Obama actually supported another one year extension, but was forced to abandon it by House Republicans who largely opposed extending the holiday as part of the fiscal cliff deal. Going back even further, the temporary payroll tax holiday was only even put into effect in 2010 because President Obama demanded it, (albeit as a second choice to the much more effective Making Work Pay Credit which Republicans opposed), as part of his economic stimulus package.

Moreover, while many Americans may feel the pain from lower take-home pay this year compared to last, the reality is that the fiscal cliff deal made 85 percent of the Bush income tax cuts permanent. These rate reductions and other provisions were all written to be temporary and expire in 2010, but now they are permanent parts of the tax code and amount to $3.9 trillion in tax cuts over the next 10 years. In other words, rather than shifting America back to the Clinton-era tax rates, President Obama instead opted to make permanent the historically low Bush-era tax rates for 99.1 percent of Americans.

Finally, it’s worth remembering why we pay the payroll tax to begin with. It is the funding source for Social Security, one of the most successful government programs in US history. Although paying lower payroll taxes was nice for a couple years, the reality is that the holiday could not have been extended forever without endangering the long-term viability of Social Security’s funding.

The expiration of parts of the Bush-era income tax cuts under the fiscal cliff deal affects just under one percent of taxpayers this year, while the expiration of the payroll tax cut affects over three-fourths of taxpayers this year, according to a new CTJ report that includes state-by-state figures.

The fiscal cliff deal (the American Taxpayer Relief Act of 2012), which was approved by the House and Senate on New Year’s Day and signed into law by President Obama, extended most of the Bush-era income tax cuts but allowed all of the payroll tax cut in effect over the previous two years to expire.

The figures in the report show the percentage of taxpayers in each income group nationally and in each state who will pay higher income taxes or payroll taxes as a result in 2013.

Read the report

Note to Readers: This is the first of a six part series on tax reform in the states.  Over the coming weeks, CTJ’s partner organization, The Institute on Taxation and Economic Policy (ITEP) will highlight tax reform proposals and look at the policy trends that are gaining momentum in states across the country.

Following an election that left half the states with veto-proof legislative majorities, 37 states with one-party rule and more than a dozen with governors who put tax reform high on their agendas, 2013 promises to be a big year for changes to state tax laws.

The scrutiny lawmakers will be giving to their state and local tax systems presents an extraordinary opportunity to assess and address structural flaws and ensure that states have the necessary revenue to provide vital public services now and in the future. Yet, it is already clear that “tax reform” for some state lawmakers may be little more than a vehicle for ideological goals like shrinking government spending or cutting taxes for profitable corporations and the wealthy.

Lawmakers in more than 30 states will take on taxes in some shape or form this year – at least 15 states are expected to consider a major tax overhaul (CA, IA, KS, KY, LA, MN, MO, NC, NE, NY, OH, OK, OR, VA, WI) and the list seems to grow by the week.

In the past week, Governors’ proposals in Louisiana, Kansas, Nebraska, Ohio and Wisconsin have been taking shape and what we are seeing is not pretty. Tax cutting and wholesale elimination of the progressive personal income tax is high on these governors’ agendas, and North Carolina is likely to be the next state to join this list.

As a historic number of states gear up for major tax changes, we know that Grover Norquist, Arthur Laffer, and other anti-tax advocates will be making their case for less taxes, smaller government and a higher reliance on the sales tax.  There needs to be a real policy discussion in the states that helps people understand there’s a smart way to do tax reform, that it can’t just mean cuts or eliminating revenue sources, and that reform has wide ranging, long term consequences.

Enter the Institute on Taxation and Economic Policy (ITEP), CTJ's partner organization. ITEP is closely monitoring tax reform proposals as they develop and will run them through the microsimulation model to see how proposed changes get distributed across different groups of taxpayers – who benefits and who doesn’t and by how much.

ITEP has identified several emerging trends and this series will examine and explain these five major kinds of proposals anticipated this year:

1) Proposals that would sharply reduce or eliminate one or more taxes and replace some or all of the lost revenue by expanding or increasing another tax (“Tax Swaps”)

2) Proposals that would significantly reduce the personal income tax paid by individuals or businesses

3) Proposals to revamp gas taxes

4) Real tax reform- proposals that fix tax codes’ structural flaws rather than dismantling or eliminating taxes

5) Other tax reform ideas including reducing or eliminating property taxes and cutting business taxes

Not only does Hawaii have the highest cost of living in the country, it also has some of the highest overall taxes on the poor. A new report from the Hawaii Appleseed Center, however, explains how to change the tax code to take some pressure off the state’s low-income families. Using data from CTJ’s partner organization, the Institute on Taxation and Economic Policy (ITEP), the report proposes a new poverty tax credit that would eliminate state income taxes for any Hawaii family below the poverty line.  This change would end the state’s embarrassing distinction as one of just 15 states that actually taxes its poor deeper into poverty through the state income tax.

Rather than simply enacting the poverty credit in isolation, the report also recommends pairing it with a refundable Earned Income Tax Credit (EITC) equal to 20 percent of the federal EITC.  Together, these two reforms would both incentivize work and chip away at the regressivity of a state tax system that requires its poorest residents to pay more of their household budgets in taxes than any other group (PDF).  As the Appleseed report shows, these two credits would boost the after-tax income of Hawaii’s poorest families by 1.4 percent, while costing the state $47 million in foregone revenue.

Like many states, Hawaii has more than a few tax breaks on the books that are expensive and unjustified, and the Appleseed experts offer up five of them as suggestions for how the state could replace that foregone revenue (and then some) without compromising vital state services:

1- Repeal the state’s sharply regressive tax break (PDF) for capital gains income.

2- Phase-out the benefits of lower tax brackets for high-income taxpayers.

3- Pare back the state’s enormous tax breaks for wealthy retirees (PDF).

4- Eliminate the state’s nonsensical deduction for state income taxes paid.

5- Enact an “Amazon law” to require more online retailers to collect and remit the sales taxes currently due (PDF) on purchases made by Hawaii residents.

Taken together, the reforms in the Appleseed report could greatly reduce the unfairness built in to Hawaii’s tax code, and put it on a more sustainable footing for generating sufficient revenues in the years ahead.

Late last week details emerged of Louisiana Governor Bobby Jindal’s plan to eliminate nearly $3 billion in personal and corporate income taxes and replace the lost revenue with higher sales taxes. Knowing that sales taxes take the biggest bite out of low-income family budgets, the Institute on Taxation and Economic Policy (ITEP) decided to issue an analysis to determine just how that tax change would affect all Louisianans. 

Though the governor indicated interest in some unspecified mechanism to mitigate the impact for the state’s poorest residents, he didn’t provide any details so ITEP couldn’t analyze it. But in any case, ITEP concluded that the “overall shift in tax liability is so dramatic that the plan is virtually guaranteed to have a regressive impact regardless of whether or not a low-income relief program is added to the package.”

In particular, ITEP found that the bottom 80 percent of Louisianans in the income distribution would see a tax increase. Specifically, the poorest 20 percent of taxpayers, those with an average income of $12,000, would see an average tax increase of $395, or 3.4 percent of their income. The middle 20 percent, those with an average income of $43,000, would see an average tax increase of $534, or 1.2 percent of their income. The largest beneficiaries of the tax proposal would be the top one percent, with an average income of well over $1 million, who'd see an average tax cut of $25,423.

You can read the 2-page analysis here.

The Governor said, “[e]liminating personal income taxes will put more money back into the pockets of Louisiana families and will change a complex tax code into a more simple system that will make Louisiana more attractive to companies who want to invest here and create jobs.” But this is doubly not the case. Far from putting more money back into the pockets of Louisiana families, his proposal would raise taxes on the poor and middle class. It would also threaten Louisiana’s ability to provide critical services (from schools to roads to a public health) in the future that are essential to the health of the state’s economy.

Fortunately, ITEP’s report is already helping inform the debate. Jindal tax reform proposal equates to increase for bottom 80%, Jindal tax plan draws mixed reviews and Cutting income tax is the easy part; filling the gap is trickier are a few of the news stories the report has generated.  If Governor Jindal offers more specifics or modifications, you will find updated analyses here and at www.ITEP.org.

To see ITEP’s recent preview of state tax reform prospects nationwide, click here.

There’s no doubt the fiscal cliff compromise reached on New Year’s Day will impact state budgets in complex ways, as CTJ’s partner organization, the Institute on Taxation and Economic Policy (ITEP) will be explaining in the coming weeks.  In the meantime here’s an important blog post from the Wisconsin Budget Project on why extending the federal estate tax cut will actually reduce Wisconsin state tax revenues.

The Roanoke Times is wrong to call Virginia Governor Bob McDonnell’s plan to eliminate the gas tax “worth debate” (we explain why here), but the editors hit the nail on the head with this: “The component of McDonnell's plan that does not merit consideration is his reliance on money plundered from education, health care, public safety and other programs to backfill transportation. The highway program is starved for money because the gas tax rate has not changed since 1987. Are teachers and their students to blame? No, they are not. Did doctors and mental health workers cause the problem? Absolutely not. Did sheriff's deputies and police officers? No. Legislators themselves are at fault, and it is shoddy business for them to strangle other services rather than accept responsibility.”

Focus on State of the State: In his combined inaugural and state-of-the-state address last week, Vermont Governor Peter Shumlin proposed cutting his state’s refundable Earned Income Tax Credit (PDF) by more than half to pay for an expanded low-income child care subsidy.  The Public Assets Institute called the governor out, observing that his proposal “would take from the poor to give to the poor.”  Rather than supporting broad-based tax increases to boost available revenue to pay for state priorities such as affordable child care, Governor Shumlin’s plan will substantially raise taxes on the very families he purports to help. From the Public Assets Institute: “...if the governor is going to insist on a zero-sum game and take from one group of Vermonters in order to “invest” in another, he should look elsewhere for the child care money. Vermont’s business tax credits would be a good place to start. The EITC was created to reduce poverty, and it’s been a great success. The same can’t be said about business tax credits and jobs.”

Focus on State of the State: During his 2013 State of the State speech, Idaho Governor Butch Otter officially outlined his intention to eliminate the state’s personal property tax. The state policy team at ITEP recently previewed this proposal (among others), saying that Idaho’s “personal property tax raises 11 percent of property tax revenue statewide, and in some counties it raises more than 25 percent. Some legislative leaders in the Senate have expressed doubts about the affordability of repeal, especially on the heels of last year’s $35 million income tax cut for wealthy Idahoans—a change that put more than $2,600 in the pocket of each member of Idaho’s top one percent (PDF), while failing to cut taxes at all for four out of every five Idaho families.”

Senator Minority Leader Mitch McConnell argued on Sunday that, with the passage of the fiscal cliff deal, the “tax issue is finished” and that instead of raising more revenue we need to confront our “spending addiction” in order to reduce the deficit. What McConnell failed to mention was that lawmakers in Washington have already passed trillions of dollars in deficit-reducing spending cuts, while at the same time enacting trillions of dollars in deficit-increasing tax cuts.

Perhaps the biggest flaw in McConnell’s logic is the idea that lawmakers have already raised a substantial amount of revenue. According to the Joint Committee on Taxation (JCT), the official revenue estimators for Congress, the fiscal cliff deal will actually reduce revenue by $3.9 trillion over the next decade. The deal raises revenue only if compared to what would happen if Congress had extended all the tax cuts (which were set to expire by law at the end of 2012).

If you accept this baseline as touted by the President and others who supported the deal, the fiscal cliff resolution can be said to be a $620 billion tax “increase” on the rich. But even if you accept that logic, it is nonetheless true that the substantial spending cuts already enacted in order to reduce the deficit justify raising a lot more revenue.

According to the Center for American Progress, since fiscal 2011 nearly $3 in spending cuts were enacted for every $1 in revenue raised. In other words, even under the artificial baseline that allows us to pretend Congress just raised revenue, we would need to raise roughly $1.2 trillion in additional revenue before even reaching parity with the level of spending cuts already implemented.

Anti-tax lawmakers like Senator McConnell claim that spending is so out of control that we can’t possibly raise enough revenue from taxes to reverse the growth of the debt. But, according to the non-partisan Congressional Budget Office (CBO), the long-term debt crisis is largely driven by the persistence of the Bush tax cuts, rather than spending. In fact, the CBO’s long term budget outlook found that had Congress done nothing and simply allowed all the Bush era tax cuts to expire, the debt would have been on track to begin dropping substantially starting in 2015 and over the coming decades.

There is also the related matter of fairness in our tax code. The reality is that the fiscal cliff deal did very little to change the tax rate paid by wealthy investors like Warren Buffett or Mitt Romney and actually included an extension of many of the corporate tax breaks that allow companies like General Electric to avoid taxes altogether. As we’ve explained, these corporate tax breaks are likely to be extended again and again and end up costing more than was saved by ending some of the tax cuts for the rich.

Considering it’s centrality to fixing the debt and improving fairness, the “tax issue” is certainly not finished. It’s really just getting started.

In the first two days of the new Congress, 21 bills to amend the tax code were introduced in the House of Representatives. The 113th Congress officially convened at noon on January 3rd and by the end of the business day on January 4th, House members had introduced 218 bills and over 40 resolutions. (By way of comparison, the 112th Congress passed only 219 bills during its entire two-year session, making it the least productive Congress on record!)

Bills to reduce taxes and revenues outnumber other kinds of tax proposals. For example, there are two designed to abolish the estate tax forever. There are proposals to repeal the 16th amendment, (that allows Congress to collect taxes in the first place), and to eliminate the Internal Revenue Service. Subtler proposals are special interest giveaways.  For example, there’s one that would extend tax-free health savings accounts to church-based health insurance co-ops, another that would roll back transfer taxes on farmland and a couple designed to expand or entrench the obscenely expensive (PDF) research tax credit for business. And one more asks Congress to commit to protecting the tax break that experts across the ideological spectrum would like to see end: the mortgage interest deduction on second homes.

It’s worth mentioning that the anti-tax beast is not just a Beltway menace; similarly radical ideas are on the agenda in the states, too. As recently as November 2012, voters in 11 states faced 17 tax-related ballot initiatives, and most of them would have exacerbated income inequality and drained revenues.  (Some prevailed, some did not.) Looking ahead, some 30 states are looking at tax changes of some kind this year and 15 are likely to undertake a substantial overhaul of their tax codes. Only a few, however, will be doing it in a way that makes their tax systems more fair and sustainable, and too many proposals mimic the disastrous laws already passed in states like Kansas and Michigan.

The federal fiscal cliff deal that left 85 percent of the Bush era tax cuts in place indefinitely was a bad deal for most Americans; it raises too little revenue and leaves all of the same breaks and loopholes available to the very rich and the large corporations.  The lobbyists who brought you that stinker were back at work on January 2^nd pushing for more, and their friends in the 113^th Congress seem all too happy to help.  

Perhaps the most striking thing about tax policy in 2012 is that it featured a presidential campaign focused on taxes and then ended with major legislation that resolved none of the issues raised in that campaign.

Even after the fiscal cliff deal (the American Taxpayer Relief Act of 2012) takes effect, Warren Buffett and Mitt Romney will still pay a lower effective federal tax rate than many relatively middle-income working people. Their effective tax rate may be five percentage points higher (since the capital gains and stock dividends that wealthy investors live on will be taxed at a top rate of 20 percent rather than 15 percent) but this does not eliminate the unfairness that Warren Buffett highlighted.

Meanwhile, the tax loopholes that allow profitable corporations like General Electric (GE) to avoid taxes were actually extended as part of the fiscal cliff deal. The law includes a package of provisions often called the “extenders” because they extend several special interest breaks for one or two years each. The extenders officially only add $76 billion to the costs of the law, but a recent CTJ report explains how their cost is likely to be far greater because Congress has shown a desire to extend these provisions again each time they expire.

One of the “extenders” is the one-year extension of “bonus depreciation,” which allows companies to write off the costs of equipment purchases far more quickly than those assets actually wear out. When these purchases are debt-financed, the result is that these investments have a negative effective tax rate, meaning the investments are actually more profitable after-tax than before tax. While corporations don’t usually reveal exactly which loopholes facilitate their tax avoidance, this one is certainly among those used effectively by GE and the other corporate tax dodgers identified in CTJ’s reports.

However, another tax break extended in the fiscal cliff deal actually has been identified by GE, in its public filings with the SEC, as having a significant effect in lowering its effective tax rate. This is the so-called “active financing exception,” which was extended through 2013 (and retroactively to 2012, since it had expired at the end of 2011). A CTJ report from 2012 explains that this break essentially makes it easier for U.S. corporations with income from financial activities to shift their profits to offshore tax havens.

The New York Times article from March 2011 that famously exposed GE’s tax avoidance explained that the head of GE’s 1,000-person tax department literally “dropped to his knees” in the House Ways and Means office as he begged for — and won — an extension of the active financing exception.

One thing is clear: Despite what Senator McConnell says, the tax debate is not over. There is a need for real tax reform, which means eliminating loopholes and ending the practice of extending “temporary” loopholes every couple years.  

The recently approved fiscal cliff deal (the American Taxpayer Relief Act of 2012) includes a package of provisions often called the “extenders” because they extend several special interest tax breaks for one or two years each. CTJ’s recent report on the revenue impacts of the fiscal cliff deal highlights a strange thing about the revenue “score” of these provisions from the Joint Committee on Taxation (JCT), the official revenue estimators for Congress.

JCT’s figures show that while the ten-year cost of the extenders is $76 billion, the cost in the first two years would actually be over $100 billion — which is greater than the revenue “saved” in the first two years of the decade by allowing the high-income Bush tax cuts to expire.

This is largely explained by one of the most significant of the extenders: the provision extending “bonus depreciation,” which allows companies buying equipment to take depreciation deductions more quickly than the equipment actually wears out.

The provision will allow companies to take depreciation deductions much earlier than they otherwise would, which will cost the Treasury more than $50 billion over the first two years of the decade, according to JCT. But because those deductions will then be unavailable in later years when they would have otherwise have been claimed, the Treasury will actually collect more revenue during the rest of the decade, so that, according to JCT, the extension of bonus depreciation will have a net cost of just $4.7 billion by the end of the decade.

Of course, in the event that Congress perpetually extends this provision, it will continue to have a large cost each year — and the legislative history makes this result seem likely. Bonus depreciation was enacted in 2002 and has only been allowed to expire for two years (2006 and 2007) since then. In every other year since 2002, Congress made this “temporary” break available. This legislative history is explained in a report from the Congressional Research Service which reviews efforts to quantify the impact of the provision and explains that “the studies concluded that accelerated depreciation in general is a relatively ineffective tool for stimulating the economy.”

Other breaks extended as part of the “extenders” package, like the research credit and the so-called “active financing exception” are officially “temporary” measures but have been extended over and over again for the last several years. Clearly, Congress’s practice of extending these breaks every couple years must end.

Perhaps he was just floating a trial balloon when Governor Bob McDonnell said he was open to increasing Virginia’s gas tax in some way.  If so, it seems to have been a lead balloon because this week he announced his intention to eliminate the gas tax altogether.

But, experts at the Institute on Taxation and Economic Policy have concluded that the Commonwealth’s gas tax actually needs to be raised by 14.5 cents per gallon, right now, just to make up the revenue ground it’s lost having been stagnant for a quarter century.

Calling the gas tax an unviable revenue source (which is true only when lawmakers like McDonnell fail to modernize it!), the Governor proposed replacing it by raising the sales tax (from 5 percent to 5.8 percent) and increasing vehicle registration fees by $15 for most vehicles and $100 for alternative fuel vehicles.

McDonnells’ plan is riddled with flaws. For starters, this “tax swap” shifts the responsibility for paying for roads away from frequent and long-distance drivers (and the owners of heavier passenger vehicles), onto everybody else.  He very literally gives drivers a “free ride” by eliminating the gas tax, likely leading to more congestion, more wear-and-tear on roads, more air pollution and probably even excessive sprawl in the long run.

Oddly, by repealing only the gasoline tax and leaving the diesel tax untouched, his plan also discriminates sharply between motorists depending on the type of fuel they use to fill up.  The aim here is clearly to continue requiring the trucking industry to pay for their use of the roads (since heavy, diesel-powered trucks produce a disproportionate amount of wear-and-tear, as the Governor understands).  But many light trucks, vans and even some passenger vehicles run on diesel as well, and owners of these vehicles will see their sales taxes rise but won’t see any benefit from the gas tax cut.

McDonnell’s plan also does nothing to improve the fairness of Virginia’s taxes from a progressivity perspective, since both gas and sales taxes are regressive.  If the Governor were instead using a progressive income tax increase to fund transportation, at least he could argue that his plan improves Virginia taxes from an ability-to-pay perspective, even if it makes tax fairness much worse from a “benefits principle” (PDF) perspective—that is, a taxing in accordance with the benefits a given taxpayer receives.

Aside from the changes in tax policy, the Governor’s plan includes an expensive bailout of the transportation fund, when that fund could easily be fixed through gas tax reform.  The legislature has rejected such bailouts in the past for the very good reason that the state can’t afford to spend less on education and the other services which will necessarily have to be cut to fund McDonnells’ bailout.

The legislation signed into law by President Obama on Wednesday makes permanent 85 percent of the Bush-era income tax cuts and 95 percent of the Bush-era estate tax cut still in effect in 2012. It also directs 18 percent of its income and estate tax cuts to the richest one percent of Americans — and directs an identical 18 percent of the tax cuts to the poorest 60 percent of Americans.

These are some of the findings of two reports from Citizens for Tax Justice. One examines the revenue impacts of the fiscal cliff deal and explains why the White House claims the bill saves $620 billion over ten years even while it is official estimated to reduce revenue by $3.9 trillion over ten years. The report also explains that the law includes a package of provisions known as the “extenders” because they extend several special-interest tax breaks for two years, and that these provisions are likely to be extended again in the future and eventually offset the revenue saved from allowing high-income tax cuts to expire.

The second CTJ report examines the distributional effects of the law. It finds that while the law will give the middle fifth of Americans an average tax cut of $880 this year, which is equal to 2.0 percent of their income. At the same time, the law will give the richest one percent of Americans an average tax cut of $34,190, equal to 2.3 percent of their income.

Read the two reports:

Revenue Impacts of the Fiscal Cliff Deal

Poorest Three-Fifths of Americans Get Just 18% of the Tax Cuts in the Fiscal Cliff Deal

Also see CTJ’s New Year’s Day report:

The Biden-McConnell Tax Deal Would Save Less than Half as Much Revenue as President Obama's Original Tax Proposal

Former President George W. Bush mused recently that if the tax cuts he signed in 2001 and 2003 weren’t named after him, maybe more people would like them. But what’s to like about a package of tax policies that contributed trillions to our national debt and to the consolidation of wealth among an unsustainably small minority of American families?

Well, there’s not much more to like about the eleventh hour legislation just passed by Congress that enshrines the vast majority of those policies permanently in the federal tax code.

The American Taxpayer Relief Act, passed by the U.S. Senate and then the House hours before we all went back to business on January 2, 2013, has generated thousands of contradictory headlines. It’s a tax hike on the rich! A tax hike on the poor! The middle class is saved! The middle class is screwed!

One thing is sure: the U.S. Treasury is screwed. Had these 2001 and 2003 tax cuts – scheduled to expire after ten years because of their onerous cost, but extended for another two in 2010 – actually been wiped from the books, we would have been on the fast track to deficit reduction even without any spending cuts. But having preserved the vast majority of those low rates and loopholes, we’ll be hemorrhaging almost four trillion dollars over the next ten years.

When we first learned of the Senate deal taking shape on New Year’s Eve, we wrote:  

Today, several news reports indicate that the deal taking shape in Washington would raise less revenue than the President's December 17 proposal. There are reports that the threshold for higher income tax rates would be $400,000 for singles and $450,000 for married couples, and that this $450,000/$400,000 threshold would also apply to higher income tax rates on capital gains and dividends…. Congress should reject any deal that extends more of the Bush income tax cuts or Bush estate tax cuts than President Obama originally proposed to extend. America would be better off if Congress simply does nothing and allows the Bush income and estate tax cuts to expire completely.

When the Senate passed legislation based on that deal, we ran the numbers and published our results on New Year’s Day, 2013, we concluded:

The tax deal negotiated between Vice President Joe Biden and Senate Minority Leader Mitch McConnell and approved by the Senate early on January 1 would save less than half as much revenue as President’s Obama’s original proposal…. The Biden-McConnell deal includes estate tax provisions that are much closer to the even more generous rules of 2011 and 2012 than the 2009 rules.

After a false start and dramatic reconvening, the U.S. House passed that Senate-approved legislation moments before midnight on New Year’s Day, and the President signed it on January 3^rd.

Our full analysis of the legislation is contained in two new reports:

Poorest Three-Fifths of Americans Get Just 18% of the Tax Cuts in the Fiscal Cliff Deal

Revenue Impacts of the Fiscal Cliff Deal

The so-called Bush tax cuts that dominated fiscal debates for far too long are now history, and we may never speak of them again. But their legacy endures in our crippling deficit, and our growing economic inequality. And now, thanks to President Obama and the 112^th Congress, they will continue to distort our tax system into the foreseeable future.