The vast majority of the attention given to the Bush tax cuts has been focused on changes in top marginal rates, the treatment of capital gains income, and the estate tax.  But another, less visible component of those cuts has been gradually making itemized deductions more unfair and expensive over the last five years.  Since the vast majority of states offering itemized deductions base their rules on what is done at the federal level, this change has also resulted in state governments offering an ever-growing, regressive tax cut that they clearly cannot afford. 

In an attempt to encourage states to reverse the effects of this costly and inequitable development, the Institute on Taxation and Economic Policy (ITEP) this week released a new report, "Writing Off" Tax Giveaways, that examines five options for reforming state itemized deductions in order to reduce their cost and regressivity, with an eye toward helping states balance their budgets.

Thirty-one states and the District of Columbia currently allow itemized deductions.  The remaining states either lack an income tax entirely, or have simply chosen not to make itemized deductions a part of their income tax — as Rhode Island decided to do just this year.  In 2010, for the first time in two decades, twenty-six states plus DC will not limit these deductions for their wealthiest residents in any way, due to the federal government's repeal of the "Pease" phase-out (so named for its original Congressional sponsor).  This is an unfortunate development as itemized deductions, even with the Pease phase-out, were already most generous to the nation's wealthiest families.

"Writing Off" Tax Giveaways examines five specific reform options for each of the thirty-one states offering itemized deductions (state-specific results are available in the appendix of the report or in these convenient, state-specific fact sheets).

The most comprehensive option considered in the report is the complete repeal of itemized deductions, accompanied by a substantial increase in the standard deduction.  By pairing these two tax changes, only a very small minority of taxpayers in each state would face a tax increase under this option, while a much larger share would actually see their taxes reduced overall.  This option would raise substantial revenue with which to help states balance their budgets.

Another reform option examined by the report would place a cap on the total value of itemized deductions.  Vermont and New York already do this with some of their deductions, while Hawaii legislators attempted to enact a comprehensive cap earlier this year, only to be thwarted by Governor Linda Lingle's veto.  This proposal would increase taxes on only those few wealthy taxpayers currently claiming itemized deductions in excess of $40,000 per year (or $20,000 for single taxpayers).

Converting itemized deductions into a credit, as has been done in Wisconsin and Utah, is also analyzed by the report.  This option would reduce the "upside down" nature of itemized deductions by preventing wealthier taxpayers in states levying a graduated rate income tax from receiving more benefit per dollar of deduction than lower- and middle-income taxpayers.  Like outright repeal, this proposal would raise significant revenue, and would result in far more taxpayers seeing tax cuts than would see tax increases.

Finally, two options for phasing-out deductions for high-income earners are examined.  One option simply reinstates the federal Pease phase-out, while another analyzes the effects of a modified phase-out design.  These options would raise the least revenue of the five options examined, but should be most familiar to lawmakers because of their experience with the federal Pease provision.

Read the full report.

The vast majority of the attention given to the Bush tax cuts has been focused on changes in top marginal rates, the treatment of capital gains income, and the estate tax.  But another, less visible component of those cuts has been gradually making itemized deductions more unfair and expensive over the last five years.  Since the vast majority of states offering itemized deductions base their rules on what is done at the federal level, this change has also resulted in state governments offering an ever-growing, regressive tax cut that they clearly cannot afford. 

In an attempt to encourage states to reverse the effects of this costly and inequitable development, the Institute on Taxation and Economic Policy (ITEP) this week released a new report, "Writing Off" Tax Giveaways, that examines five options for reforming state itemized deductions in order to reduce their cost and regressivity, with an eye toward helping states balance their budgets.

Thirty-one states and the District of Columbia currently allow itemized deductions.  The remaining states either lack an income tax entirely, or have simply chosen not to make itemized deductions a part of their income tax — as Rhode Island decided to do just this year.  In 2010, for the first time in two decades, twenty-six states plus DC will not limit these deductions for their wealthiest residents in any way, due to the federal government's repeal of the "Pease" phase-out (so named for its original Congressional sponsor).  This is an unfortunate development as itemized deductions, even with the Pease phase-out, were already most generous to the nation's wealthiest families.

"Writing Off" Tax Giveaways examines five specific reform options for each of the thirty-one states offering itemized deductions (state-specific results are available in the appendix of the report or in these convenient, state-specific fact sheets).

The most comprehensive option considered in the report is the complete repeal of itemized deductions, accompanied by a substantial increase in the standard deduction.  By pairing these two tax changes, only a very small minority of taxpayers in each state would face a tax increase under this option, while a much larger share would actually see their taxes reduced overall.  This option would raise substantial revenue with which to help states balance their budgets.

Another reform option examined by the report would place a cap on the total value of itemized deductions.  Vermont and New York already do this with some of their deductions, while Hawaii legislators attempted to enact a comprehensive cap earlier this year, only to be thwarted by Governor Linda Lingle's veto.  This proposal would increase taxes on only those few wealthy taxpayers currently claiming itemized deductions in excess of $40,000 per year (or $20,000 for single taxpayers).

Converting itemized deductions into a credit, as has been done in Wisconsin and Utah, is also analyzed by the report.  This option would reduce the "upside down" nature of itemized deductions by preventing wealthier taxpayers in states levying a graduated rate income tax from receiving more benefit per dollar of deduction than lower- and middle-income taxpayers.  Like outright repeal, this proposal would raise significant revenue, and would result in far more taxpayers seeing tax cuts than would see tax increases.

Finally, two options for phasing-out deductions for high-income earners are examined.  One option simply reinstates the federal Pease phase-out, while another analyzes the effects of a modified phase-out design.  These options would raise the least revenue of the five options examined, but should be most familiar to lawmakers because of their experience with the federal Pease provision.

Read the full report.

We’re in the heart of sales tax holiday season now.  Despite cooler heads prevailing in DC and Georgia, where sales tax holidays have been scrapped due to gloomy budget projections, Massachusetts and North Carolina have recently decided to move ahead with their holidays, and Illinois has decided to join the party for the first time.

By now, you may be familiar with all the reasons why sales tax holidays are a bad idea (read this ITEP policy brief if you’re not).  Aside from those groups with a vested interest in the holidays (e.g. retailers looking for free advertising, politicians looking to build their anti-tax credentials, and confused parents thinking these things actually save them money), just about everyone seems to agree that sales tax holidays are a worthless political gimmick.  Stateline pointed out last week that analysts as varied as those at Citizens for Tax Justice and the Tax Foundation have come to an agreement on this point.

But as long as sales tax holidays remain popular enough to remain impervious to most state budget crises, we might as well take a moment to marvel at some of their more glaring absurdities.  For example, this year, Massachusetts’ sales tax holiday will apply to alcohol.  College students in the state clearly have quite an effective lobbying presence in Boston.  Interestingly, neither tobacco nor meals will be included in the holiday.

In Illinois, which doesn’t have any experience with sales tax holidays, one columnist speculates that his wife isn’t alone in erroneously believing that the back-to-school holiday applies only to children’s clothes.  Indeed, adult clothes are included as well; as are aprons and athletic supporters.  Work gloves, however, will still be subject to tax.  You’d think that the Illinois Department of Revenue already has enough on its plate without having to worry about such minutia.

Finally, in South Carolina, it looks like the state’s Tax Realignment Commission is going to recommend quite a few changes to the state’s tax holidays.  For starters, the state’s bizarre post-Thanksgiving tax holiday on guns has to go, according to the Commission.  And changes could be in store for the August holiday as well.  The State reports that if the Commission gets its way, “this could be the last year to get your wedding gown, baby clothes, pocketbooks and adult diapers at a discount on back-to-school tax-free weekend.”  Interestingly, the South Carolina representative who first introduced the sales tax holiday idea actually agrees, claiming that he wanted only the holiday to apply to stereotypical “back to school” purchases – that is, things other than wedding gowns and adult diapers.

 

ITEP, CTJ, and dozens if not hundreds of other organizations have argued for years that a well-designed sales tax should apply to nearly all retail sales, including both goods and services. We have shifted over the years from an economy in which most people sell goods to an economy in which most people sell services. Taxing only the sale of goods is an antiquated and inadequate approach for any state or local government to take.

So why don't all states with sales taxes expand them to apply to services? The answer has nothing to do with what's good policy and has everything to do with politics. Pretty much every business that provides a service can conjure up some argument as to why this particular service is vital to the health and happiness of the state's residents, and from there will argue that a tax (no matter how minimal) will destroy their ability to provide this service.

The most recent example comes from Washington, DC. The DC yoga lobby flexed their political muscle yesterday, urging yoga consumers (apparently known as yogis) across the District of Columbia to oppose expanding the District’s sales tax base to include yoga services and gym memberships.  The “DC Yogis Against the Yoga Tax” — which appears to be a coalition of yoga studios, teachers, and consumers — argues in their boilerplate letter to the Council that “most yogis and gym members are middle income-ers who've simply made it a priority to invest in their health and well-being.  The DC Council should reward their behavior, and encourage more people to take responsibility similarly for their own well-being.” 

Their plea then subtly attempts to downplay the revenue that could be gained by a tax on yoga, implying that such a tax would encourage people to abandon yoga, and therefore result in losses in productivity, self-reliance, and basic human functioning — all of which would adversely impact DC’s coffers.

If you live in the District of Columbia, we suggest that you write to your council member to tell them you support this tax proposal, which is essentially just an attempt to expand the base of the sales tax.

For more information, the DC Fair Budget coalition has additional details on the proposed sales tax base expansion, as well as on fiscal 2011 revenue options more broadly.  Also see the DC Fiscal Policy Institute’s take on sales tax base expansion, and on the recent outcry from the yoga community.

DC's yoga lobby is not unique. Maryland’s recent attempt to tax a handful of services met similar obstacles.  After proposing a list of perfectly sensible expansions of the sales tax base, industry lobbyists skillfully removed their clients from the list, one-by-one, until only the computer services industry remained (and of course, in time, the computer services industry was eventually able to avoid taxation as well). 

During all of this, the circling of the Annapolis capital building by lawn care trucks provided one of the most memorable and oft-cited examples of the influence that special-interests can have in a tax policy debate. 

For more on the importance of taxing services, be sure to read this recent op-ed by Sharon Parks of the Michigan League for Human Services.  In it she explains the history and merits of taxing services in Michigan, and advocates strongly for the proposal put forth by Michigan Governor Jennifer Granholm to expand the state’s sales tax base to include a host of new services, and to return some of the revenue gained to Michiganders via a 0.5 percentage point decrease in the sales tax rate.

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.

It's one thing for the federal government to allow a one-time amnesty for Americans who've hid their income from the IRS in offshore accounts. (See related story.) The "stick" is effective (prison) and the "carrot" is not overly generous (since these Americans will pay taxes, interest, and penalties).

But lately several states are providing their own tax amnesties that are very different and very misguided. According to a recent article in State Tax Notes (subscription required), the thirteen state tax amnesties already conducted or promised this year ties the 2002 record for most amnesties offered in one year.  Assuming that DC Mayor Adrian Fenty signs the budget (which contains a tax amnesty) that was recently passed by the DC Council, that record will be broken.  Pennsylvania and Michigan, however, still have a chance to avoid adding to the list of states enacting these short-sighted measures. Amnesties have been proposed within each state's legislature.

As we've argued before, allowing delinquent taxpayers to pay the taxes they owe with little or no penalty is unfair to those diligent taxpayers who paid their taxes on time.

This unfairness is compounded greatly if the interest owed on the late tax bill is reduced, or even waived entirely, as was done this year in Delaware.  Waiving the interest owed on late tax bills essentially means that delinquent taxpayers are granted an interest-free loan by the state, for no reason other than the fact that the state is now desperately in need of money. Had all taxpayers been aware of the possibility of this interest-free loan, the rate of noncompliance would undoubtedly have skyrocketed. 

Repeatedly offering amnesties, as is increasingly becoming the norm, harms the ability of states to enforce their tax laws.  With record numbers of tax amnesties having been offered in the last seven years, delinquent taxpayers can usually assume that they'll be offered an easy way out eventually -- if only they're patient enough.  As one revenue official from Kansas recently put it, "if you have amnesties too often, you're literally training taxpayers not to pay."

As in most places around the country, the District of Columbia recently concluded debates over how to close its budget deficit.

Council member Jim Graham proposed what was perhaps the best idea of the debates -- a modest income tax increase on incomes over a half million dollars.  As Ed Lazere, Executive Director of the DC Fiscal Policy Institute (DCFPI) recently stated, "If you are thinking about how to balance the budget while sparing the local economy, there is a pretty good consensus among economists that raising taxes among high-income folks is probably the best way to go, because it does not tend to affect their consumption."

Ultimately, however, Graham's proposal failed to gain support, and the city instead decided to increase sales, cigarette, and gas taxes, in addition to dramatically cutting spending.  While some kind of tax increase was undoubtedly necessary, the particular increases chosen by the council will disproportionately impact low-income families.  The same can be said of some of the city's spending cuts.  For example, Temporary Assistance for Needy Families (TANF) was modestly reduced under the new budget, though much larger proposed cuts in the program were avoided.  Education was hit especially hard -- to the tune of $30 million.

Fortunately, in addition to revenue raisers and spending cuts just described, the District also decided to require "combined reporting" of corporate income for tax purposes.  This measure should provide some additional revenue for the city, while also improving the fairness of the District's corporate income tax.

As the DCFPI points out, some of the cuts made by the council could have been mitigated if federal restrictions on the city's use of its rainy day fund were relaxed.  The DCFPI has a wealth of information on the DC budget debates on their website.

In recent months, New York has enacted -- and numerous other states, such as Connecticut, New Jersey, Minnesota, and Hawaii have debated -- an increase in the income taxes paid by wealthier residents as a means of responding to the current fiscal crisis. Recognizing a good idea when he sees it, DC Councilman Jim Graham has put forward a plan to raise the top tax rate in the District to 8.9 percent, but only for those taxpayers with incomes above $500,000.

An informative new report from the DC Fiscal Policy Institute (DCFPI) details the merits of the plan and concludes that, "[b]ecause it would raise revenues progressively, without adversely affecting low-income residents, the Equitable Income Tax Act is a reasonable approach to boosting revenue in this challenging budget year." DCFPI offers numerous other resources for those interested in following local tax and budget debates, in particular its FY10 Budget Toolkit.

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.

Earlier this week, the Institute on Taxation and Economic Policy (ITEP) released a brief report using IRS data and revealing that the most unequal states in the country also happen to be states that lack the type of progressive tax provisions that could reduce this inequality and raise badly needed revenue. The most unequal states either don't have a personal income tax or have one in need of improvement. Consequently, these states are left with tax systems that, on the whole, are unsustainable, inadequate, and unfair over the long-run.

The IRS data show that, in 2006, ten states -- Wyoming, New York, Nevada, Connecticut, Florida, the District of Columbia, California, Massachusetts, Texas, and Illinois -- have greater concentrations of reported income among their very wealthiest residents than the country as a whole. Yet, the tax systems in these states generally ignore that very important reality. Of those ten states, four lack a broad-based personal income tax and three either impose a single, flat rate personal income tax or have a rate structure that all but functions in that manner. Three do use a graduated rate structure, but of these, two have cut income taxes for their most affluent residents substantially over the past two decades.

Given this mismatch, it should not be too surprising that over half of these states face severe or chronic budget shortfalls. After all, the lack of an income tax, the lack of a graduated rate structure, or moves to make the income tax less progressive all mean that a state's revenue system will not completely reflect the concentration of income among the very wealthy and therefore will not yield as much revenue.

Case in point: New York. As the Fiscal Policy Institute observes, over the last 30 years, the state has reduced its top income tax rate by more than 50 percent. Most recently, in 2005, it allowed to lapse a temporary top rate of 7 percent on taxpayers with incomes above $500,000 per year. Today, the state must confront a budget deficit of more than $6 billion for the coming year and more than $20 billion over the next three. New York residents seem to understand the disconnect between the enormous disparities of wealth in their state -- where the richest 1 percent of taxpayers account for 28.7 percent of reported income -- and the state's fiscal woes. A poll released this week shows that nearly 4 out of 5 people surveyed support increasing the state's income tax for millionaires. Hopefully, Governor David Paterson is listening. As it stands, he'd rather cap property taxes than ensure that millionaires pay taxes in accordance with their inordinate share of New York's economic resources.

The District of Columbia this week increased its already highest in the nation Earned Income Tax Credit (EITC) from 35% to 40% of the federal EITC. This change will provide much needed relief to low-income families in the District who are feeling the pinch of rising prices during the current economic slowdown. It also sends a message to policymakers everywhere about the effectiveness of the EITC as a method for offsetting regressive sales and property taxes for those with the most need. Twenty-three states and the District of Columbia currently have an EITC. Nine of those states, however, have EITCs of less than ten percent of the federal. In addition, three states fail to make their credits refundable -- meaning those lowest-income families with little income tax liability are unable to see any benefit. While all these states should be praised for at least having an EITC, this recent change to the EITC in D.C. provides a great example towards which these states with less generous credits should strive.

The fiscal storm clouds are already gathering for newly-elected District of Columbia Mayor Adrian Fenty. A Washington Post article reports that the city faces an unanticipated revenue shortfall of $300 million over the next two years. No big deal ... except that as a candidate seeking to distinguish himself from a crowded Democratic primary field this past spring, Fenty took a "no new taxes" pledge, arguing that that the books could be balanced with that old favorite, eliminating "waste, fraud and abuse." The new projected shortfalls are, of course, only projections ... but they serve as a dramatic reminder of the dangers of not leaving all fiscal policy options on the table.

Sales tax holidays are growing in popularity this year with four more states, Alabama, Maryland, Tennessee and Virginia, joining nine others and the District of Columbia in waiving sales and use taxes for a limited time during July and August. To see a list of participating states and tax holiday dates, click here.

As ITEP staff told USA Today earlier this week, "This tax break makes sense for lawmakers because it's cheap and avoids real reform." State legislatures claim that tax holidays alleviate the tax burden on working families and jump-start local retail businesses. In reality, however, sales tax holidays are a political gimmick that probably helps consumers less than proponents claim.

ITEP Testimony on D.C. Tax Reform Legislation

ITEP's analysis of Bill 16-35 shows that it would impact the District's tax system in two important ways. First, the bill would make the District's tax system less unfair by reducing the income tax on low- and middle-income D.C. residents. Second, it would reduce the revenues available to fund public services by about $86 million if implemented in 2004...