This week, the Institute on Taxation and Economic Policy (ITEP), in partnership with state groups in forty-one states, released the 3rd edition of “Who Pays? A Distributional Analysis of the Tax Systems in All 50 States.” The report found that, by an overwhelming margin, most states tax their middle- and low-income families far more heavily than the wealthy. The response has been overwhelming.
In Michigan, The Detroit Free Press hit the nail on the head: “There’s nothing even remotely fair about the state’s heaviest tax burden falling on its least wealthy earners. It’s also horrible public policy, given the hard hit that middle and lower incomes are taking in the state’s brutal economic shift. And it helps explain why the state is having trouble keeping up with funding needs for its most vital services. The study provides important context for the debate about how to fix Michigan’s finances and shows how far the state really has to go before any cries of ‘unfairness’ to wealthy earners can be taken seriously.”
In addition, the Governor’s office in Michigan responded by reiterating Gov. Granholm’s support for a graduated income tax. Currently, Michigan is among a minority of states levying a flat rate income tax.
Media in Virginia also explained the study’s importance. The Augusta Free Press noted: “If you believe the partisan rhetoric, it’s the wealthy who bear the tax burden, and who are deserving of tax breaks to get the economy moving. A new report by the Institute on Taxation and Economic Policy and the Virginia Organizing Project puts the rhetoric in a new light.”
In reference to Tennessee’s rank among the “Terrible Ten” most regressive state tax systems in the nation, The Commercial Appeal ran the headline: “A Terrible Decision.” The “terrible decision” to which the Appeal is referring is the choice by Tennessee policymakers to forgo enacting a broad-based income tax by instead “[paying] the state’s bills by imposing the country’s largest combination of state and local sales taxes and maintaining the sales tax on food.”
In Texas, The Dallas Morning News ran with the story as well, explaining that “Texas’ low-income residents bear heavier tax burdens than their counterparts in all but four other states.” The Morning News article goes on to explain the study’s finding that “the media and elected officials often refer to states such as Texas as “low-tax” states without considering who benefits the most within those states.” Quoting the ITEP study, the Morning News then points out that “No-income-tax states like Washington, Texas and Florida do, in fact, have average to low taxes overall. Can they also be considered low-tax states for poor families? Far from it.”
Talk of the study has quickly spread everywhere from Florida to Nevada, and from Maryland to Montana. Over the coming months, policymakers will need to keep the findings of Who Pays? in mind if they are to fill their states’ budget gaps with responsible and fair revenue solutions.
Recent News about California
A new report from Citizens for Tax Justice makes the case for a “performance review” system designed to evaluate the effectiveness of special tax breaks in achieving their stated goals. While CTJ's report primarily focuses on the importance of such a system at the federal level, most of its findings are equally applicable to the states.
The special breaks littered throughout state tax codes — or “tax expenditures,” as they are frequently called — are an enormous and often overlooked part of government’s operations. Although the primary purpose of a tax system is to raise the revenue needed to pay for public services, every state, as well as the federal government, also uses its tax system to accomplish a variety of other policy goals. Encouraging job creation, subsidizing private industry research, and promoting homeownership are just a few of the countless ends pursued via special subsidies contained in state tax codes. Rather than having anything to do with fair or efficient tax policy, these tax credits, exemptions, and other provisions are actually much more akin to government spending programs — hence the term, “tax expenditures.”
A performance review system takes the commonsense step of asking whether these provisions are doing what policymakers intended of them. Under such a system, tax credits designed to encourage research and experimentation, for example, would be regularly examined to determine the amount of new research undertaken as a result of the credits. Shockingly, the vast majority of states, and the federal government, do not currently attempt to answer fundamental questions of this sort with any type of rigorous evaluation.
Among CTJ’s findings are:
— “Procedural biases,” such as the omission of tax expenditures from the authorization and appropriations processes, allow tax expenditures to slip by with a fraction of the scrutiny given to direct spending programs. State legislative systems requiring supermajority consent to “raise taxes” (or eliminate tax expenditures) are particularly biased in this regard.
— “Political biases,” such as the erroneous belief that government can take a “hands off” approach, or reduce its overall size by offering special tax breaks, also contribute to the current lack of oversight.
— A number of states have made strides in recent years to counteract these biases through performance reviews and other, similar means. Washington State’s efforts represent the most complete attempt at tax expenditure performance review yet to be undertaken in the United States. California, Delaware, Nevada, Oregon, and Rhode Island have also made attempts — with varying degrees of success — to enhance the level of scrutiny applied to their tax expenditures.
— The bleak state budgetary outlook makes the implementation of tax expenditure review all the more urgent. States, like the federal government, can no longer afford to deplete their resources with ill-advised and ineffective tax expenditures. By implementing a tax expenditure performance review system, states can pave the way for a reduction in tax expenditures by identifying those expenditures that are ineffective.
— A formal review system could also help to reconceptualize these provisions in the minds of policymakers, the media, and the public as spending-substitutes, rather than simply as tax cuts. This would further help reduce the rampant biases in favor of tax expenditure policy.
— The precise design of a tax expenditure review system is very important. States should be sure to include all taxes, and all tax expenditures within the scope of the review. Additionally, states should exercise care in selecting the criteria to be used in the reviews — Washington State’s criteria represent a good starting point from which to build. Other key design issues include choosing the appropriate body to conduct the reviews, timing the reviews to coincide with the budgeting process, allowing similar tax expenditures to be reviewed simultaneously, and attaching some type of “action-forcing” mechanism to the reviews so that policymakers must explicitly consider the reviews’ results.
— Tax expenditure reviews are necessary, though they may not be sufficient to correct for the biases in favor of tax expenditure policy. A tax expenditure performance review system can play a vital informational role either on its own, or alongside other, more aggressive tax expenditure control techniques such as sunset provisions or caps on tax expenditures’ total value.
Earlier this week, the Georgia Supreme Court ruled in favor of the City of Columbus and against hotels.com, an online travel company (“OTCs”) that charges customers one rate for booking a hotel room but pays local governments a lodging tax based on cheaper, wholesale room rates. The Court’s finding mirrors its decision in a case decided in June against Expedia.com. In both instances, the Court held that the tax for which the OTCs were liable should be based on the retail room rate paid by their customers.
OTCs contract with local hotels to provide rooms for a discounted or wholesale rate. When a customer books a room online, the OTC charges the customer a “marked-up” rate along with taxes and service fees. Under Georgia law, municipalities may impose hotel occupancy and excise taxes on the furnishing of any room, lodging, or accommodation. The Court noted that state law allows cities to impose a tax on the lodging charges actually collected.
The high court’s decisions are binding across Georgia, so the two Columbus cases could affect other suits filed by governments seeking to collect the proper amount of lodging taxes from OTCs. The cases have been remanded to the lower courts to determine how much money the online services owe in back taxes and penalties.
Importantly, numerous other cities – including Houston, San Antonio, and Miami have sued or initiated administrative proceedings against OTCs, asserting that they owe back taxes on their price mark-ups. While many cases have yet to be fully adjudicated, one other recent case yielded much the same verdict as Columbus’ suit against hotels.com. In February, multiple OTCs, including Orbitz and Travelocity, were ordered to pay the city of Anaheim, California, $21 million in back taxes, fees and penalties related to the payment of hotel occupancy taxes.
Rulings such as these have motivated OTCs to seek enactment of federal legislation that would ban state and local taxation of hotel room rentals when booked by such a company. However, as these rulings demonstrate, there is no justification for limiting the base for such a tax to the wholesale price of a hotel room, let alone eliminating taxation altogether. Hotel taxes are consumption taxes, which should be measured by the value of the consumption to the customer. Therefore, the tax should be imposed on the retail amount. For more on this subject and on the OTC’s push for federal legislation, see this helpful report from the Center on Budget and Policy Priorities.
After ten months of work, California’s “Commission on the 21st Century Economy” has finally released its recommendations for overhauling the California tax system. The Commission has proposed to eliminate the corporate income tax, eliminate the sales tax, sharply reduce the progressivity of the individual income tax, and enact a new “business net receipts tax” (BNRT) that would function in many respects as a new, less transparent sales tax. The income tax changes are especially appalling, as the Commission’s own presentation (see the last slide) concedes that taxpayers with incomes over $1 million would receive an average tax cut of over $109,000 per year, while those making under $50,000 would receive somewhere in the neighborhood of $3 annually from the plan.
Jean Ross with the California Budget Project (CBP) hit the nail on the head with her remark that the plan constitutes "a massive shift in ... financing public services from the wealthy and corporations to middle-income families [that] is nothing short of stunning." Ross is by no means the only person displeased with the Commission’s plan. Business groups, labor, and numerous tax experts have all already come out in opposition to major components of the report. One LA Times columnist reacted to the magnitude of the outcry by stating: “Sure, you can't please everyone. That's a given on anything controversial. But come on! Maybe at least a few people?” Fact is, there’s nothing here worth being pleased about.
Throughout the Commission’s deliberations, University of Connecticut law professor (and ITEP Board President) Richard Pomp has been a strong voice both for progressives and for anybody interested in good tax policy. In a 21-page criticism of the Commission’s work, released earlier this month, Pomp decried the plan’s regressive income tax cuts, its elimination of the corporate income tax, and its reliance on a new, untested, and unstudied business net receipts tax (BNRT). The purpose of the BNRT, notes Pomp, is to serve as a “non-transparent” consumption tax, meant to raise the revenue needed to finance the Commission’s income tax cuts, and allow the state to finally tax services while instead appearing to only tax California businesses.
Pomp has also written a statement on the Commission’s final package, which should be posted here at some point in the near future. To learn more, you can also listen to Jean Ross thoughts on the Commission's work.
California now has a budget for the fiscal year that started almost a month ago. But for advocates of sustainable tax and spending policy, the hard times are only beginning. As a new report from the California Budget Project explains, lawmakers faced with a $23 billion shortfall chose to rely on spending cuts to close two thirds of the gap. The list of cuts is grisly. Health, education, child services, support for the disabled, and just about every other category of state spending will be slashed significantly. The consequences for Californians are expected to be dire.
Astonishingly, the budget includes virtually no changes on the tax side of the ledger that can meaningfully be described as tax increases. While $3.5 billion of the current-year shortfall will be made up through tax changes, most of this revenue will be realized by accelerating collections rather than increasing the level of taxes. Specifically, $1.7 billion of the "new revenue" for fiscal year 2010 will be realized by accelerating personal income tax withholding so that more income tax will be withheld in the first half of the calendar year. This means, of course, that the legislature has just dug itself a $1.7 billion fiscal hole for the next fiscal year. Assembly Speaker Karen Bass, who's claiming that "in no way should this [budget] be misconstrued as kicking the can down the road,” must not have read this part of the budget agreement.
Bass -- and Governor Arnold Schwarzenegger, who boasted that the budget agreement "puts us on a path toward fiscal responsibility" -- must be equally unaware of a clever provision through which the state is closing $2 billion of the budget gap by forcing local governments to lend the state up to 8 percent of their property tax revenues in the upcoming fiscal year. The idea is that the state will pay back this loan, with interest, by the end of the 2013 fiscal year. In the short run, of course, this move will force local governments to make $2 billion worth of the hard decisions--cut spending or hike taxes and fees--that state lawmakers found themselves unable to deal with this year.
A broad base is an essential element of a good tax system. Fulfilling the principles of "horizontal equity," and "economic neutrality," both depend upon the use of a broad tax base. Unfortunately, the temptation to carve out special tax breaks for politically popular causes, or for powerful constituencies, if often irresistible to lawmakers.
But efforts are currently underway in Michigan to undo some of these special tax breaks, and a tax reform commission in California is at least pretending to consider a reform that would help pave the way for a careful reconsideration of many of that state's tax breaks. Furthermore, policymakers in North Carolina have expressed a strong desire to return to the task of base-broadening this fall, even as efforts to include base-broadening revenue-raisers in this year's budget agreement seem to have failed.
Earlier this month, Michigan Governor Jennifer Granholm stated her desire to eliminate between $500 million and $1 billion in special tax breaks as a way to reduce the state's looming deficit. While accomplishing such a feat will inevitably involve an uphill political battle, Michiganders should be grateful that the Michigan League for Human Services (MLHS) is closely following the action. MLHS Chairman Lynn Jondahl hit the nail on the head when he urged lawmakers to ask themselves, in reference to the state's film tax credit, "Would you be willing to appropriate $6 million to MGM, say, to make this film in Michigan? We're paying you to do something in lieu of filling pot holes or funding mental health treatment. Which do we value more?"
In California, a tax reform commission that so far has shown interest mostly in cutting the progressive income tax is at least listening politely to a different idea. The so-called "blue proposal" currently before the commission, presented as a less regressive alternative to the much-ballyhooed flat-tax proposal supported by Governor Schwarzenegger, would require special tax breaks to be presented in the Governor's budget, saddled with a "sunset" provision, and evaluated based on their effectiveness in achieving their stated objectives. Of course, adopting this approach will amount to rearranging deck chairs on the Titanic if the commission acts on its apparent zeal for moving away from income taxes and towards regressive consumption taxes. And the "blue proposal" has its warts as well: provisions that would impose a spending cap and create a new "net receipts" tax in lieu of the current corporate income tax have progressives feeling, well, blue. But the tax-expenditure element of the "blue proposal" is a welcome dose of thoughtful policy at a time when California surely needs it.
Finally, in a recent development out of North Carolina, base-broadening appears to be off the agenda for the immediate future, though policymakers have expressed a strong interest in returning to the issue this fall. When they do return to the issue, they would be wise to review these recommendations, recently released from the North Carolina Budget and Tax Center, explaining how to broaden the state's tax base while simultaneously offsetting any potentially harmful effects on low- and moderate-income families.
Charged with finding a revenue neutral way to reduce the volatility of California's revenue stream, the "Commission on the 21st Century Economy" recently expanded the scope of its study, and announced its plans to seek an extension until the end of September. This extension (the second sought by the Commission) comes after a successful bid by Commissioner Fred Keeley to add a variety of more progressive options to the discussion. The options to be discussed include: retaining the state's progressive income tax, removing Prop 13 limitations on commercial property tax bills, expanding the sales tax to include services while lowering the sales tax rate, taxing carbon based fuels, and making more careful use of a rainy day fund, especially in regard to capital gains revenue. Keeley's goal is to offer solutions to the state's volatile budgetary situation that don't involve gutting the state's progressive income tax.
This delay of the Commission's recommendations means that California legislators will not be receiving any advice from the Commission during this legislative session. This is an unfortunate development, as the legislature is clearly in need of some guidance. California lawmakers recently unveiled a plan to balance the budget by gutting the state's education programs, while refusing to increase any taxes.
Of all Keeley's proposals, the removal of Prop 13 limitations on commercial property taxes has received particular attention as of late, including an LA Times column detailing some of its abuses as well as its high cost.
Corporate lobbyists in Sacramento could be dealt another blow soon. An effort is underway to repeal by ballot (in November 2010) the billions in corporate tax breaks passed by California legislators over the course of the past ten months.
Late last week, California Governor Arnold Schwarzenegger, in a meeting with the editorial board of the Sacramento Bee, floated the idea of adopting a flat tax with a rate of 15 percent as part of a major overhaul of the state's tax system. While it is unclear which taxes the Governor would replace with such a levy, what is clear is that "flat tax" proposals are a bad idea.
As CTJ Executive Director Bob McIntyre made plain in his testimony before the California Commission on the 21st Century Economy recently, a "flat tax" almost certainly means that poorer taxpayers would be asked to contribute more to government finances and that wealthier taxpayers would be required to put far less into state coffers than they do now.
For a more productive approach to reforming California's tax system (and addressing the state's fiscal woes), see this recent commentary by Jean Ross, head of the California Budget Project.
It's no secret that California's budget situation is dire. With that in mind, the decision by California policymakers to enact three corporate income tax cuts over the past 9 months, costing the state as much as $2.5 billion annually, is nothing short of appalling. A recent report from the California Budget Project (CBP) explains these cuts, detailing especially how their benefits will be skewed toward a few of the largest corporations in the state.
The largest of the three provisions examined by the CBP allows corporations to use a "single sales factor" to determine how their profits are apportioned among different states for corporate income tax purposes. You can read the ITEP Policy Brief on single sales factor here. The CBP notes that this provision alone would cause $1.5 billion to flow from already depleted state coffers into the hands of large corporations. At least 80% of the benefits would go to big business, defined generously here as corporations with gross receipts over $1 billion annually.
The second provision is an allowance for "net operating loss carrybacks". This new measure could reduce state revenues by up to a half billion dollars annually. California is now among a minority of states offering this type of tax break. For more on this topic, see this recent report from the Center on Budget and Policy Priorities detailing why states with NOL carrybacks should eliminate them.
The final provision examined by CBP allows tax credits earned by one corporation to be given to related corporations. This is eventually expected to result in losses of up to $400 billion for the state. A lucky 0.03% of California corporations will enjoy nearly 90% of the benefits.
It's hard to believe that California policymakers considered these items to be a priority despite their state's current budget nightmare. Repealing these breaks is the obvious next step in trying to restore fiscal sanity to the state -- though it will by no means end the state's problems. For a more comprehensive solution, Californians should look toward the elimination of the supermajority requirement for tax increases, and the elimination of Prop 13. These ideas seem to be gaining increasing attention, as exemplified in this recent LA Times Business column.
California's special election this week came with no surprises. Just as the pre-election polling had predicted, California voters roundly rejected most of the ideas sent to them by their representatives -- save the proposition limiting pay increases for elected officials. The most important consequence of the vote was the defeat of a cap on state spending, hastily placed on the ballot as a means of securing the Republican votes needed to pass a budget with two-thirds legislative support.
The rejection of this cap, however, brings with it the early expiration of a variety of recently enacted, but temporary tax increases. Instead of expiring in early to mid 2013, those increases will now cease to exist in early to mid 2011. This development does deal a sizeable blow to California's fiscal outlook, though even with the full tax increases an immense budget deficit would have remained.
Talk over the last few days has focused largely on themassive cuts that will be needed to bring the state's budget into balance. Additionally, the state would like to borrow to fill much of the gap. It hopes to have its loans guaranteed by the federal government in order to avoid the consequences associated with lost confidence in California's ability to pay back those loans.
Unfortunately, at least as of today, responsible, broad-based, progressive tax increases appear to be off the table. With California's budget in shambles for the foreseeable future, however, it's hard to think that the opportunity for meaningful, revenue-raising tax reform is completely out of the question. Such reform, of course, should start with the elimination of the two-thirds requirement for enacting tax increases and passing budgets.
California has an important special election coming up in just a few weeks. After a lengthy struggle over how to fill the state's immense budget gap, a compromise was reached when legislative leaders and the Governor agreed to place on the ballot a measure to cap state spending growth (using a formula based on inflation and population growth).
The most recent numbers suggest, however, that Californians aren't enamored with the idea, and for good reason.
As Jean Ross of the California Budget Project (CBP) put it, "Though touted as 'reform,' Proposition 1A does nothing to address the fact that the revenues raised by our state's tax system are insufficient to fund our current programs and services, much less the level that Californians want and expect... By adding more formulas on top of the state's already hamstrung budget, Proposition 1A will make it even more difficult to balance future budgets." Instead, as Ross points out, California's budget problems would be better addressed through a modernized tax system, and an elimination of the requirement that two-thirds of the legislature approve any tax increase -- an idea that has steadily been picking up some support.
It's hard to believe, but there may actually be a trend in state tax policy more prominent than increasing cigarette taxes. Business tax credits aimed at spurring economic development have been among the most popular ideas in statehouses scrambling for ways to reduce unemployment. Just last week, we described a plan in Minnesota to boost investment tax credits and a budget in California containing a few credits of its own. This week, proposals to do the same in Iowa, Kentucky, and Missouri are under discussion.
In Iowa, Republican lawmakers have suggested paying (via tax credit) half the salary of each new job created by private businesses. Oddly, because this payment would be administered through the tax code rather than as a direct grant, the debate has become confused to the extent that this policy has been labeled as a way to return to a "market-based, capitalistic system".
An excellent op-ed out of Kentucky helps clear things up a bit, noting that Gov. Beshear's proposed expansion of business tax incentives would be a costly, nontransparent, and likely ineffective way of encouraging job growth. The op-ed goes on to argue that a "broader" approach, including better targeted and more closely scrutinized spending programs, could do far more good than creating more tax credits.
Finally, as an expansion in economic development tax credits works its way through Missouri's legislature, the admission of at least one legislator that he is a "recovering tax credit addict" helped to shine some light on the unfortunate politics behind these types of tax credits. These programs can cost a state enormously, and are rarely defensible on principled tax policy grounds. Instead, they constitute a type of spending done through the tax code -- commonly referred to as "tax expenditures" -- which add complexity, shrink the tax base, require higher marginal rates, and offer little if anything in terms of making the system more responsive to individuals' and businesses' ability to pay.
As we mentioned last week, California enacted, as part of its budget compromise, a change in the rules determining what share of a corporation's income is taxable in the state. To be specific, California adopted an optional "single sales factor" apportionment formula, which multi-state corporations support -- because it will help them avoid taxes. Virginia appears to be following suit this week. Both of the state's legislative chambers have approved optional single sales factor apportionment, though only for manufacturers. The Governor has yet to sign the measure, and he has reportedly taken no position on the bill. You can read the ITEP Policy Brief explaining how single sales factor apportionment can reduce the fairness and adequacy of state corporate income taxes here.
Six Holdouts Realize State Budget Shortfall Could Not Be Fixed with Cuts Alone
The governor of California has finally signed a budget. After a prolonged struggle to convince a handful of anti-tax lawmakers that the state's problems were too large to be fixed without additional revenues, a package of spending cuts and tax increases was finally cobbled together. On the tax side, the most notable provisions include a temporary one percent sales tax increase, a temporary hike in state income tax rates, a temporary increase in the vehicle license fee, and a temporary cut in the dependent exemption credit. That's a lot of temporary help for a problem that's not likely to go away.
Negating some of the usefulness of these revenue gains are temporary tax credits for businesses, home buyers, and movie and TV production. Even worse, a permanent tax cut for multi-state corporations was enacted in the form of an optional single sales factor apportionment method. Nonetheless, securing a budget with any additional revenues at all was an important (and difficult) first step.
But the drama in California isn't over. One of the major compromises used to secure the supermajority needed to pass a budget was the inclusion of a provision placing a spending cap on the ballot for a May 19 special election. If voters reject the spending cap, the temporary tax increases will expire in early to mid 2011. If the spending cap is approved, however, the increases will be allowed to continue through early to mid 2013. Needless to say, you can expect plenty more coverage of the California saga as the story develops.
California legislators appear to finally be in the early stages of negotiations over a method to fix the current year's budget shortfall. As has been obvious to most observers for quite some time, California's budget gap is far too large to be fixed with spending cuts alone, and will require some kind of tax increase. Convincing California Republicans to recognize this fact was no easy task, and it now appears that the cost of securing their support could come in the form of a spending cap. Unfortunately, while a tax increase is absolutely necessary to solve California's short-term problems, allowing a spending cap to be slipped into the deal would be nothing short of devastating in the long-term.
The case against the spending cap was articulated brilliantly by Jean Ross of the California Budget Project in a recent op-ed published in the Los Angeles Times. Ross noted that "far from being a cure-all, a hard spending cap would place an arbitrary stranglehold on the state's ability to improve its schools, rebuild its infrastructure, care for its senior population and respond nimbly to future challenges. Disguised as a solution, this cap could quickly become one of California's most serious budgetary problems". She goes on to point out that her organization "found that if this cap had been enacted in 1995, using that year's budget as the base, it would have resulted in a 2008-09 budget $39.7 billion below what was enacted in September. While this would bring the budget into balance, it also would require spending cuts more than twice as large as those proposed by the governor."
Californians familiar with Colorado's TABOR debacle should be especially wary of what Ross points out next: "The hard spending cap also would be incompatible with Proposition 98, which guarantees a minimum level of state funding for K-12 education and community colleges. That guarantee would generally outpace increases allowed under the cap, which would result in education crowding out all other state spending". The parallels with the difficulties created by Colorado's Amendment 23 (which requires increases in K-12 spending of 1% plus inflation each year) couldn't be more obvious.
There isn't any question that California needs more revenue. Just look at the fact that California's bond rating was recently decreased by two grades, or that the state Controller had to start issuing IOU's instead of tax refunds today. But while securing more revenue should be a top priority this year, accepting a spending cap as part of the compromise would be an action that Californians would regret for years.