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.

Shoppers and state governments are both likely still recovering from "Black Friday" and especially "Cyber Monday," but for very different reasons. Consumers may be able to get great deals online, but state governments are losing necessary revenue. As the New York Times recently opined, "Online retailers who do not collect sales tax enjoy a significant and unfair advantage over rivals who must add the tax to their prices. They also cost the states billions of dollars a year in lost sales tax revenue -- money that cash-starved states cannot afford to forgo."

Wisconsin's Department of Revenue estimated that the state is losing $150 million a year on items sold online and this number is only likely to grow. Consumers are required to pay sales tax on items purchased online when they file their state income taxes. But in reality most consumers don't bother, and the U.S. Supreme Court has found that the constitution bars states from requiring most out-of-state catalog and online retailers from collecting sales taxes. But the court also said that Congress could step in to give states permission to do this, as explained in ITEP's Policy Brief on efforts to collect sales taxes on internet purchases.

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.

Last Tuesday, Wisconsin Representative Cory Mason unveiled the Wisconsin Jobs Initiative to take advantage of a federal program proposed by President Obama to invest in technical colleges. Rep. Mason's proposal would raise the income tax on millionaires by one percentage point and is expected to raise $145 million annually and secure another $135 million in federal matching grants if the President's initiative is enacted. Mason said, "I want Wisconsin to be first in line for those grants."

If the state is able to raise the funds necessary and received the grant, it's worth noting that Wisconsin millionaires who pay more in taxes would likely not pay the full $145 million. Instead they would benefit from their ability to write off their state income taxes on their federal tax forms. (Read ITEP's brief on the federal offset.) 

This proposal would make the state's income tax more progressive, but some state lawmakers want to move in the opposite direction. Rep. Peter Barca and other legislators are championing a proposal that would partially repeal the recent reduction of the state's capital gains exclusion from 60 to 30 percent by allowing a 60 percent capital gains exclusion for assets held longer than five years under the guise of encouraging "businesses to make long term investments in the state." For more on why capital gains tax breaks aren't helpful in terms of economic development, read ITEP's report on the issue.

Wisconsin is facing the largest budget shortfall in state history. This week, debate started in the General Assembly on ways to fill the expected $6.6 billion gap . Only $1.6 billion of the state's shortfall was predicted just last month, demonstrating how quickly the fiscal situation has deteriorated.

The budget proposal being debated uses a combination of spending cuts and tax increases to balance the books and is based on the plan passed by the Joint Finance Committee in late May. The Joint Finance Committee's budget bill included cigarette tax increases, reductions in the state's capital gains exclusion from 60 percent of net capital gains income to 40 percent, and a new top income bracket for "very high" income earners. For a complete summary of the Joint Finance Committee's proposals, see the helpful report from the Wisconsin Council on Children and Families.

Legislative leaders seem confident a budget will be passed before the start of the new fiscal year on July 1. The first hurdle is for Democrats who control the Assembly by a slim margin (52-46) to rally the 50 votes they need to pass their proposed budget.

But even if Wisconsin lawmakers resolve this shortfall, their fiscal challenges are not over. They learned Tuesday from the Legislative Fiscal Bureau that the state will likely face a $2.2 billion shortfall by the middle of 2013.

As state policymakers craft their budgets for the upcoming fiscal year, they must confront a pair of daunting challenges, one fiscal, the other economic. The budget outlook for the states is, at present, the most dire in several decades. In this context, then, states must find ways to generate additional revenue that create neither additional responsibilities for individuals and families struggling to make ends meet nor additional distortions in the economy as a whole.

For nine states -- Arkansas, Hawaii, Montana, New Mexico, North Dakota, Rhode Island, South Carolina, Vermont, and Wisconsin -- one straightforward approach would be to repeal the substantial tax breaks that they now provide for income from capital gains. In tax year 2008 alone, these nine states are expected to lose a total of $663 million due to such misguided policies, with individual losses ranging from $10 million to $285 million per state. A new ITEP report explains that repealing these tax preferences would help states reduce their large and growing budgetary gaps, enhance the equity of their current tax systems, and remove the economic inefficiencies arising from such favorable treatment.

This report explains what capital gains are, how they are treated for tax purposes, and who typically receives them. It also details the consequences of providing preferential tax treatment for capital gains income for states' budgets, taxpayers, and economies in nine key states. Lastly, it responds to claims about both the relationship between capital gains preferences and economic growth and the role capital gains taxation plays in state revenue volatility. (Appendices to the report provide detailed state-by-state estimates of the impact of repealing capital gains tax preferences.)

Read the report.

As we noted last week, up until now, New York has been the most encouraging example of a state considering a progressive approach to filling its budget gap. Now, with the unveiling of Wisconsin Gov. Jim Doyle's proposed budget, another state can be looked to by progressives as an example to be followed.

Gov. Doyle's budget includes two main progressive reforms. First, the income tax rate on income over $300,000 per year would be raised by one percentage point. Second, the state's unusual exemption of 60% of capital gains income would be lowered to 40%. While a 40% exemption is still unnecessary and regressive, this change would be a major first step toward taxing those who live off their wealth at a rate more similar to those who work for a living. Both of these changes would primarily affect the upper-income individuals most capable of making it through this economic storm.

More good news for tax fairness advocates comes from a recent poll of New York State voters conducted by Quinnipiac University. As the poll shows, it turns out that progressive solutions make sense not just on policy grounds, but on political grounds as well. The poll found that nearly 80% of New York voters support raising the income tax on income over one million dollars. That number falls only slightly when New Yorkers are asked if they support raising income taxes on income over $500,000. Additionally, proposals to raise tax rates on income over $250,000 enjoy well over 50% support in New York. Click here for the complete poll results.

Finally, in addition to the progressive reforms described above, the Wisconsin governor is also pushing a proposal to institute combined reporting of corporate income. Enacting such a proposal is an absolutely vital part of maintaining the viability of any state's corporate income tax.

At the state level, the usual response to recommendations that taxes be increased to preserve vital state services has generally been: "Now is not the time". The most notable exception to this trend so far has been with the cigarette tax, as we've explained before. Increasingly, however, policymakers appear to be coming around to the idea of boosting gas tax rates in order to raise the revenue needed to maintain our nation's infrastructure. Given that most state gas taxes haven't been increased for quite a few years, and that during that time inflation has significantly eroded the value of most gas tax rates, our only response can be, "It's about time."

In Maryland, for example, the Senate President recently expressed an interest in raising the gas tax, urging that "there's got to be an increase in the transportation trust fund somewhere, and there's got to be a way we can find people with the political will to make it happen". Numerous governors have echoed this call as of late, most recently in Massachusetts, and Idaho.

In Idaho, especially, the Governor was able to hit the nail on the head with his observation that, "[we last raised] the fuel tax... 13 years ago. And now here we are trying to accomplish 2009 goals with 1996 dollars. Everyone in this room or listening to me throughout Idaho today -- everyone who has a household budget or runs a business -- knows that just doesn't work".

In response to this problem, Idaho Governor "Butch" Otter has recommended bumping the gas tax upward by 2 cents in each of the next 5 years. Addressing the root of the problem even more directly, Wisconsin Governor Jim Doyle has proposed indexing the gas tax rate to inflation -- a practice that had existed in Wisconsin up until 2006. Maine and Florida continue to index their gas tax rates today, with very favorable results in terms of providing each state with a somewhat more adequate and sustainable source of transportation revenue.

Importantly, the federal gas tax is not indexed to inflation, meaning that the Federal Highway Trust Fund is suffering from many of the same problems we see plaguing the states mentioned above. The federal gas tax has not been increased in over 15 years. President Obama's new Energy Secretary, Steven Chu, has previously gone on the record as supporting raising the gasoline tax. The views of Transportation Secretary Ray LaHood are not yet clear. What is clear, however, is that something will have to be done at the federal, as well as the state level, if gas tax revenues are to be restored to their previous purchasing power.

Of course, the gas tax is not perfect. Aside from the long-term issues arising out of improved fuel efficiency (which we need to begin planning for now), the regressivity of the tax is very worrisome, especially in these difficult times. Fortunately, low-income gas tax credits, as we've advocated on multiple occasions, are very capable of remedying this shortcoming.

This week the Wisconsin Way coalition released a report called Blueprint for Change which outlines recommendations for change in three areas: economic development, tax reform, and government spending/management. Members of the coalition are quite diverse and include the Wisconsin Education Association Council, the Realtors Association, and the Wisconsin Counties Association. The group has been working for over a year, holding forums across the state and engaging folks in a "public conversation about modernizing and refining taxes and government." Wisconsin is one of many states facing a budget shortfall so efforts to engage the public on important fiscal issues are certainly laudable, but many of the specific proposals discussed in the report make us question whether or not the coalition and members of the public understand basic tax principles.

For example, one of the strategic initiatives on tax reform is to "enhance fairness and progressivity in the levying and collection of taxes," but later in the report "increasing reliance on income sensitive revenue sources like sales and consumption taxes" is suggested. Ironically, it is exactly because sales taxes aren't income sensitive that they are such a regressive funding option. Increasing the state's reliance on sales tax is no way to increase the fairness and progressivity of Wisconsin's tax structure.

Another contradiction in the report appears in the discussion about business development and job growth. The group purports to want to "enhance the ability of Wisconsin's tax structure to stimulate business development and expansion and job growth," but one of the action options they propose is to eliminate the state's corporate income tax. But there is solid evidence that state corporate taxes often aren't that important when companies are making decisions about where to locate.

We're puzzled by the Wisconsin Way report and wonder if a basic review of tax policy principles might be helpful for coalition members, who are welcome to look at a helpful ITEP policy brief on the issue. Despite the alleged input from 6,000 Wisconsinites, the Wisconsin Way so far seems to be exactly what Senate Majority Leader Russ Decker calls a "recipe for disaster for Wisconsin taxpayers."

Anybody following state politics recently knows that budget shortfalls are among the first issues that will have to be addressed when most state legislative sessions begin this January. In many cases, state policymakers have appeared heavily biased in favor of slashing services to remedy these gaps, usually based on the absurd assumption that raising taxes would somehow be more painful than stripping needed services from the nation's most vulnerable lower- and middle-income families. But Governor Jim Doyle of Wisconsin has recently set an intriguing example for other struggling states to follow by agreeing to consider an early revival of the state's temporarily suspended estate tax.

The estate tax is an incredibly progressive tax that only affects a few very wealthy families -- hardly the folks struggling most in our current economic crisis. As a recent CTJ report showed, less than 300 families paid any federal estate tax whatsoever in Wisconsin in 2007. This amounted to only 0.6% of Wisconsin estates. Nonetheless, even this relatively minor tax could result in enormous gains if the money is put back into the state's economy, such as by filling some of the 3,500 state jobs the governor has ordered be left vacant.

Last year around this same time we brought you word about the groundbreaking study from the Institute for Wisconsin's Future which found that two-thirds of companies filing 2003 Wisconsin income tax returns owed nothing in state taxes. This month the Institute issued another report that "highlights a $643 million shortfall in corporate income tax receipts in 2006 due to the use of tax loopholes."

The new report once again brings to light the number of Wisconsin companies that simply aren't paying any tax." Almost fifty thousand corporations filed tax returns with the Wisconsin Department of Revenue in 2005. Two out of three returns showed a bottom-line tax of zero dollars."

The study's shocking findings won't be allowed to collect bookshelf dust. Instead, the results have prompted a legislative response. On Wednesday Senator Hansen unveiled a creative corporate tax disclosure proposal that would, "require the large public corporations doing business in Wisconsin to submit publicly accessible annual disclosures of their income and all items that can be used to reduce their Wisconsin tax liability." Stay tuned into the new year for more developments on this important disclosure legislation.

At long last, the Wisconsin legislature approved a two-year $57.2 billion budget. The agreement comes 4 months after the budget deadline and is expected to be signed by the Governor Friday. A hospital tax and taxes on oil companies didn't make it into the final bill. But the bill did include a cigarette tax increase that will raise the tax on a pack of cigarettes from 77-cents to $1.77. The bill also includes additional school aid for low-income districts and children's health insurance expansion and eliminates the tax on Social Security benefits.

Wisconsinites may be relieved that the budget impasse is over. Advocates for tax fairness will find the budget compromise lacking. However, advocates seem pleased with the overall spending priorities set forth in the new budget. For more read this statement from the Wisconsin Council on Children and Families.

The budget clock is also ticking in Wisconsin as the Governor and the University of Wisconsin chancellors have both denounced the budget approved by the Assembly, saying that the budget cuts included would increase class sizes in universities and decrease class offerings. A conference committee is currently meeting to reconcile the Assembly budget with the Senate's which included tax increases and a health care plan. Senator Neal Kedzie says the state "could be in for a very long and bumpy ride."

The governors of both Pennsylvania and Wisconsin have proposed new taxes for oil companies. Governor Rendell would subject oil companies' gross profits in his state to a 6.17 percent tax in lieu of the state's corporate income tax. Governor Doyle would tax oil companies' gross receipts at 2.5 percent. It remains to be seen whether state governments can really ensure that the tax will be paid by the oil company shareholders, as both governors claim, rather than being passed onto consumers.

Probably the most important step a state can take to ensure that oil companies (and other businesses) are paying their fair share is to adopt combined reporting of corporate income for tax purposes. This prevents companies from shifting costs and profits (on paper) between subsidiaries in different states to get the lowest tax bill possible. Fortunately for Pennsylvania, Governor Rendell's tax on oil companies would be calculated using combined reporting. Experts like University of Wisconsin-Madison economist Andrew Reschovsky have suggested that Wisconsin needs to move in this direction as well. Reschovsky told the Milwaukee Journal Sentinel, "In my view, if the governor wants to raise more money from oil companies, and other multinational companies, the most effective thing he could do would be to urge the Legislature to adopt combined reporting."