Talking Taxes

Why Won't the Obama Administration Accept Taxing Employer-Paid Health Premiums?

2009-06-16T20:58:00.005-04:00

Barack Obama's fiscal policy platform as a presidential candidate was hardly a profile in courage, but he had his moments. This, however, was not one of them:

"For the first time in American history, [John McCain] wants to tax your health benefits. Apparently, Senator McCain doesn’t think it’s enough that your health premiums have doubled, he thinks you should have to pay taxes on them too. That’s a $3.6 trillion tax increase on middle class families. That will eventually leave tens of millions of you paying higher taxes. That’s his idea of change."

This was a fairly unprincipled thing to say, and begged the question: why shouldn't employer-paid health care be taxed? Obama never gave us an argument for this beyond the idea that it would be a "middle class" tax hike. In the end, you got the sense that he was saying this not because he believed it would be a bad idea to tax employer benefits, but because it was a good soundbite for him and allowed him to blur the distinction between the stereotypes of the tax-happy Dem and the tax-averse Republican.

One could hope that a year later, when the full extent of our fiscal crisis had become more apparent, the Obama administration would be able to quietly tiptoe away from this position. And Obama has indicated his openness to the idea of taxing employer paid health care like the income it is. But then along comes V-P Joe Biden on Meet the Press last Sunday:

MR. GREGORY: Will the president sign a bill that taxes healthcare benefits for employees?
VICE PRES. BIDEN: We made it clear we do not think that is the way to go. We think that is the wrong way to finance this legislation.
MR. GREGORY: So if the bill comes with that...
VICE PRES. BIDEN: But--no, no, no.
MR. GREGORY: ...the president wouldn't sign it?
VICE PRES. BIDEN: I didn't say that. I said when the bill is going to come, this is the most--this is going to be one of the most comprehensive changes in law since Medicare in the beginning. We'll have to see what the whole bill says. But we made it clear we do not believe you should be taxing, taxing the benefits that people receive through their employers now.

Once again, though, the question is: why take this position? Is there a principle behind it?
There's an easily-stated and compelling rationale for the opposite stance, treating employer-paid health care as taxable income: as Citizens for Tax Justice noted in a 1996 report, it's hard to see "why a person who pays cash for insurance should be taxed more heavily than another person who gets insurance as a fringe benefit (and accepts lower cash wages)."

Put more concretely, if worker A earns $50,000 a year and buys her own health insurance, while worker B gets $45,000 of salary and $5,000 of employer-paid health insurance, the two workers' incomes should be thought of as basically identical. But our tax system gives a preference to the worker who's accepted some of her income in the form of employer-provided health insurance.

The fact that Obama and Biden aren't making principled arguments the other way doesn't mean such arguments don't exist, of course. The best argument I've heard against undoing this tax preference has to do with the inequities between similarly situated workers that would result. Two workers for competing firms in the same industry can have very different health care premiums, depending entirely on how old and frail their co-workers are. The quality of care they personally receive can be identical-- they can even go to the same doctor--but one's employer-paid health premiums will be higher because his co-workers are more likely to be sick.

Under this scenario, taxing employer-provided health benefits could result in the same sort of tax inequity we see in the current system. To which the most obvious response is that these inequities would certainly be less widespread than the inequities of the current system. Add to this that taxing employer-paid health benefits would provide a clear incentive for employers to offer more competitively priced benefits and this argument (which, to be clear, Biden has not even made) becomes not at all compelling.

A variety of other arguments can be made that should give us pause before rushing into paring back the existing tax break: some have to do with equity, while others have to do with the potential administrative difficulty of valuing health benefits for tax purposes. Howard Gleckman summarizes some of these arguments here, in a thoughtful read.

But at the end of the day, the most compelling argument either way is an old and simple one borrowed from the 1986 Tax Reform Act: income is income. Whether it's capital gains or pensions or unemployment benefits, the presumption should be that all types of income are taxed in the same way. Failing to do so introduces economic distortions, encouraging employers to pay their workers in the form of more lightly-taxed forms of income. Those who benefit most from these distortions will yell loudest when they're taken away-- but that shouldn't blind us to the fact that it was wrong to enact them in the first place.

Georgia: Perdue Vetoes Capital Gains Tax Cut

2009-05-11T23:50:00.003-04:00

A big tax fairness gain in Georgia today: after thinking on it for a few weeks, Governor Sonny Perdue has decided to veto legislation that would have cut the state's income tax on capital gains. The proposed tax cut, which the legislature had approved at the same time as a bill ending state funding for a property tax credit for homeowners, would have done little or nothing for most middle- and low-income Georgians. Viewed in combination with the property tax legislation, moreover, the combined effect would have been a tax hike on middle-income folks and a tax cut at the top! ITEP's analysis has details.

Opponents of the capital gains cut argued that the cap gains cut was essentially being paid for by the repeal of the homeowner property tax credit. While this isn't technically true, it is essentially correct: the legislature made the politically-odd choice to repeal a popular homeowner tax break not because they wanted people throwing bricks thru their windows, but because they needed the money to balance the budget. And they needed more money because of their zeal for cutting cap gains taxes.

The "Think Progress" blog is already arguing that Perdue's decision constitutes a repudiation of supply-side policy. This is wishful thinking, or else just a rhetorical cheap shot. Perdue's veto message says pretty clearly (to my eyes) not that capital gains tax cuts don't work, but that they take more than one year to work:

Georgia is constitutionally required to maintain a balanced budget: for every dollar in decreased revenue, we must correspondingly cut expenditures. We cannot deficit spend as the federal government does, even if those deficits generate economic growth in the long term.

In other words, in a deficit environment, when the goal for the state has to be to make things balance in the current year, he's saying it's impossible to push a tax cut unless you can pay for it immediately. Cap gains tax cuts will still grow the economy, he's saying-- it's just that the growth will happen outside the single-year budgetary window. National anti-taxers don't need to get nervous-- Perdue is not rejecting supply-side principles. He's simply operating within a political framework that doesn't recognize that sometimes supply-side policies need a big canvas to work on in order to be effective. A reeaalllly big canvas.

Having said that, I'll take the outcome. The cap gains bill was a real threat to the income tax (and to the fairness of the tax system), and repealing the property tax break is hardly all bad. Of course, using the lost revenues to enact a new "circuit breaker" property tax break would be a great thing. But the important first step is to recognize that the existing property tax credit is a big, fat, untargeted, unaffordable thing, and the legislature has done that.

But it's not over-- the cap gains fight, after all, is NEVER really over. Secretary of State Karen Handel (who clearly has no interest at all in higher office) had this to say:

While I appreciate the Governor’s position that the tax cuts included in the bill would have made balancing our state budget even more difficult, I believe that the economic benefits to our state would have outweighed these concerns.
Now is the time for us to cut taxes in order to help grow jobs and ignite our economy.

Taken at face value, Handel is saying one of two things here: either (1) Perdue is wrong because the cap gains cuts actually would have grown revenue immediately, offsetting the revenue loss, or (2) silly budget deficit rules don't matter and we can ignore them. Neither position speak well for Handel's abilities to manage a budget if she ever decides she'd like to hold a higher office than she currently does

Another feather in the cap for the Georgia Budget and Policy Institute, which got editorial attenion statewide for its criticisms of the capital gains cut.

Illinois EITC Expansion: "Welfare?"

2009-04-30T08:50:00.002-04:00

The debate over how to resolve Illinois' looming budget deficit has, so far, been an unusually gratifying one. A brand-new governor with little political capital to spend has made a gutsy (and, in our view, basically correct) decision to push for an increase in the state's personal income tax, which is bar-none the least fair in the nation and among the very lowest as well.

There are, of course, things missing from the governor's plan. Eliminating income tax exemptions and sales tax exemptions would make the tax base more sustainable (and would reduce the pressure to increase tax rates). But in the short run Quinn's doing what is needed to make ends meet and has picked a quite fair way of doing it.

If there's one quite legitimate beef with the governor's plan as proposed, it's that there's not sufficient attention devoted to low-income tax relief. Which is why it's great to see the editorial board at the Springfield Journal-Register coming out in favor of an expansion of the state's Earned Income Tax Credit. The SJR's (correct) rationale:

This kind of credit is especially valuable to low-income working families in Illinois, where the poorest one-fifth of Illinois families spend an average of nearly 13 percent of their earnings in state and local taxes while the wealthiest 1 percent of Illinois households spend less than 6 percent of their incomes likewise.

All true. The underlying point here, unstated by the SJR, is that the EITC is valuable because it's an income-tax based credit that is refundable, meaning it can be used not only to offset income taxes but to offset sales, excise and property taxes paid by low-income families as well. And the main reason why the poorest Illinoisans pay such a huge chunk of their incomes in tax is because of these non-income taxes.

So you've got to charitably assume that it's because the SJR editorial doesn't explain this point clearly that half a dozen commenters on the SJR editorial make the boneheaded assertion that the EITC constitutes "welfare" because folks who get it have "zero tax liability" and are therefore getting "free money." One commenter, who claims to work at the Illinois Department of Revenue, has this to say:

I work at Revenue. Under the current system, many people pay no tax and still get a refund of their EIC on their state return. This is a form of welfare. People are getting money from the state that is not theirs, and they did nothing to earn it.

This tells me only that it's possible to work for the Department of Revenue and understands precisely zero about how the EITC works. It's based on earned income. If you have a job and a salary, you get the EITC. The more you earn, the more you get. So to say that EITC recipients "did nothing to earn it" is quite possibly the single most breathtakingly wrong thing one could ever assert about it.

It's important for people to understand that refundable income tax credits play a critical role in helping to reduce the unfairness of state tax systems overall, and that they shouldn't be understood as applying only to income taxes. But it's equally important for people to get that the EITC is a work incentive, and that work incentives respond to... work. A generation of "welfare reformers" who've worked diligently to create work incentives for low-income poverty relief would put their heads in their hands and quietly weep (or pull their hair out in despair) at the notion that one can "do nothing to earn" the EITC.

And, I suppose, the fundamental underlying lesson of all this is that we should really just never even bother reading the 'comments' section of web-based newspapers articles.

Georgia Lawmakers Swap Income for Property Taxes

2009-04-07T18:13:00.002-04:00

Who knew Georgia lawmakers were such fans of the property tax? Only a year after giving serious consideration to a plan that would have repealed most local property taxes in the state, the state General Assembly has ratified, and sent to Governor Perdue, a budget plan that would provide a 50% exclusion for capital gains taxes that's estimated to cost north of $340 million a year, and pay for it by eliminating the state's $20,000 property tax homestead exemption (technically $8,000 of assessed value, but Georgia homes are valued at 40% of market value for tax purposes).

Paring back the property tax break, known as the Homeowner Tax Relief Grant or HTRG, isn't the dumbest idea you'll hear this week, but that's primarily because the capital gains plan takes that coveted spot.

A recent ITEP report gives the skinny on why state capital gains tax breaks are a misguided tax strategy in general, and the arguments presented therein all apply to Georgia. But there's an extra layer of absurdity to this strategy in the Peach State-- Georgia already allows a very generous capital gains break, and it's targeted to the group most lawmakers would say most need capital gains breaks: the elderly.

In 2008, a Georgia taxpayer aged 62 or older can deduct $35,000 of "retirement income" from her taxable income. This can include pension benefits, but can also include a full $35,000 of capital gains. This is on top of the regular exemptions and deductions available to all Georgians, mind you. And a married couple, both of whom are over 61, can deduct $70,000 of retirement income.

Bottom line is that it's fairly hard to be a senior in Georgia and pay any capital gains tax at all. So who benefits from the cap gains cut included in the budget? Very rich people. And not that many of them. A new ITEP analysis released today shows that 77 percent of the benefits from the capital gains proposal would go to the wealthiest 1 percent of families, and that the poorest 80 percent of the state's income distribution would collectively see less than 1 percent of the tax cuts.

The second-dumbest component of the Georgia plan is repealing the HTRG. Done correctly, this would be an OK move: smarter people than I have argued correctly that there are better approaches to targeted property tax relief than a state-funded homestead exemption, and that a targeted "circuit breaker" credit could provide more relief to fixed-income homeowners and renters at a lower cost than the HTRG.

But the legislature's action last week doesn't count as "done correctly." They've simply pulled the rug out from under local governments, forcing them all to choose either to continue to provide the homeowner exemption at their own expense or else increase property taxes on most Georgia homeowners.

Getting to this point in the budget process took a lot of difficult and painful decisions-- which makes it all the more crazy that the HTRG got yanked to pay for something as frivolous as a capital gains tax cut.

The good news is that the budget is not yet law, because Governor Perdue hasn't signed it. And there's some indication that he's concerned about the fiscal implications of the cap gains cut. Here's hoping he throws some cold water on the legislature's drunken tax-cutting binge.

Why Does Blanche Lincoln Hate the Estate Tax So?

2009-04-03T18:44:00.008-04:00

The chart above probably answers the question asked by the title of this post. But we're getting ahead of ourselves.

If there was an "endangered species list" for tax policies, the federal estate tax would have been on it for the past fifteen years, starting when the anti-tax gang cleverly re-labelled it the "death tax." The gradual repeal legislation (which would be phased in between 2001 and 2010) passed at the behest of President Bush in 2001 didn't help matters, of course. But for those of us who think the estate tax plays a vital rule in preventing the concentration of economic (and, as important, political) power in the hands of a few elites, it was heartening to see the Congressional tax writing committees taken over by Democrats, and then to see the White House occupied by Barack Obama. The policy question, it seemed to most sensible folks, was how much (if any) of the Bush tax cuts that had already taken effect would be allowed to remain. The cuts that had not yet taken effect when Obama took office, of course, would never take place.

So how did we get here, with a Democratic Senate approving more estate tax cuts?

It was bad enough when Obama, even as a presidential candidate, signaled that he thought the best "reform" option for the estate tax was to make permanent most of the Bush administration's cuts in the estate tax rates. As a December 2008 Citizens for Tax Justice analysis of Obama's plan noted,

President-elect Barack Obama has proposed a change that would prevent the estate tax from disappearing in 2010, but which would also unnecessarily cut the estate tax below the level itwould reach in years after 2010 if Congress simply does nothing.

Put another way, Obama's first estate-tax-related act as President was not to reject the Bush administration's estate tax cuts, but to allow even more of them to take effect at the beginning of 2009. Even estate tax proponents whose reform ambitions were limited to "first, do no harm" were disappointed by this stance.

And now, at at time when the federal government faces deficits unrivalled since World War 2, Democratic Senator Blanche Lincoln is actively arguing that Obama's cuts aren't enough. The Lincoln proposal would drop the top estate tax rate to 35 percent and exempt the first $10 million of an estate's value from tax.

For Lincoln to view this as a priority, she has to somehow think that the 2009 rules Obama has allowed to take effect-- which exempt the first $7 million of a married couple's property from tax and then apply a rate structure with a top rate of 45 percent-- are just too onerous.

One has to ask the question: who are these guys with estates worth over $7 million that she's so worried about?

A look at the history of Arkansas estate tax collections (that's the chart at the beginning of this post, reprinted below) gives a hint. For much of the last 20 years, Arkansas estate tax collections have been pretty flat, hovering between $10 and $30 million a year. But in fiscal 1996, the state collected just under $120 million in estate taxes. While the state is (understandably) not telling what the source of the single-year bump was, it's generally understood to have been largely due to the death of Wal-Mart co-founder "Bud" Walton in 1995.

Given this history, and given the recent track record of the Walton family in pushing for estate tax repeal, Lincoln's opposition to the estate tax becomes more understandable-- but still remains profoundly disappointing.

Does Lincoln really have such a chronic case of "tin ear" that she's willing to make a high-profile stand for further estate tax cuts in the era of Madoff/AIG bonuses/etc? Apparently so.

Will Special Tax Breaks Be More Closely Scrutinized Under the Obama Administration?

2009-03-17T13:38:00.006-04:00

Buried in President Obama’s recently released budget blueprint were four little-noticed and perhaps unexciting sentences that could signal the coming of a major change in the way the executive branch thinks about, evaluates, and reports on tax expenditures:

The Administration will fundamentally reconfigure the Program Assessment Rating Tool. We will open up the insular performance measurement process to the public, the Congress and outside experts. The Administration will eliminate ideological performance goals and replace them with goals Americans care about and that are based on congressional intent and feedback from the people served by Government programs. Programs will not be measured in isolation, but assessed in the context of other programs that are serving the same population or meeting the same goals.

While the term “tax expenditure” isn’t explicitly included in this brief preview of things to come, a recently issued statement from Citizens for Tax Justice makes clear that meaningfully implementing the promises made above will have to involve shining a bright light on government programs hidden within the tax code.

For the uninitiated, the term “tax expenditure” essentially refers to tax laws that focus more on encouraging a specific activity or rewarding a particular group of people, rather than on trying to improve the efficiency, simplicity, or fairness of our tax system. Put another way, these provisions more closely resemble non-tax, spending-like programs than they do principled tax policy. Special tax breaks for capital gains income, research and development activities, mortgage interest payments, and retirement and health benefits all fit this billing. Altogether, there are more than 160 tax expenditures in our tax code (the precise number varies somewhat depending on the definition you use), and recent estimates peg their total size at upwards of $800 billion annually.

Even though most tax expenditures don’t constitute smart tax policy, it can at times be sensible to administer these programs as tax policies in order to piggyback on the IRS’ existing distribution structure. More often, however, these items are unwisely grafted to the tax code merely as a way to protect them from the annual scrutiny of the appropriations process, or to cash in on the widespread popularity of reducing taxes while simultaneously being able to re-direct government resources toward favored objectives.

Regardless of why these items ended up in the tax code, there’s a clear need to evaluate their effectiveness in achieving the goals for which they were enacted. Have the lower tax rates for capital gains and dividends income encouraged investment? Has the mortgage interest deduction resulted in a higher rate of home ownership? These kinds of questions deserve much more rigorous and visible consideration inside government than they have received in recent years.

Fortunately, if the President is sincere in his promise to assess programs “in the context of other programs that are serving the same population or meeting the same goals”, the OMB’s “Program Assessment Rating Tool” (PART) will have to be expanded and re-worked in a way that allows for the consideration of precisely these types of questions. How, for example, could one ever hope to evaluate any U.S. health care policy without considering it in the context of the $160 billion subsidy for health insurance given through the exclusion of employer provided health care? Likewise, what kind of housing policy analysis could ever ignore the $90 billion given to homeowners via the mortgage interest deduction? But as things stand today, this is exactly how the Program Assessment Rating Tool is used.

As the Citizens for Tax Justice statement pointed out, the push to include tax expenditures alongside other programs in the performance review process has received significant attention in the recent past. Unfortunately, however, up until this point its merits have not been enough to propel it past the political obstacles. In writing about the very specific language calling for tax expenditure performance reviews that was included in the Senate report accompanying the 1993 Government Performance and Results Act (GPRA), one observer pointed out:

Clinton’s Treasury Department, of which I was a part from 1998 to 2000, was unenthusiastic about performing these evaluations, reasoning that a comprehensive evaluation of tax expenditures would necessarily raise serious objections to measures enthusiastically advanced by the Administration … Although the menu of favorite tax expenditures changed when President Bush took office, the Office of Management and Budget has not published any new tax expenditure analyses

- Len Burman. “Is the Tax Expenditure Concept Still Relevant”. National Tax Journal. September 2003.

In order for real reform to occur, President Obama’s very visible push for greater government transparency will have to outweigh the coldly political calculations that have made for “politics as usual” up until this point.

Evaluating the National Retail Federation's "Tax Holiday" Idea

2008-12-24T12:32:00.002-05:00

Yesterday the National Retail Federation published an open letter to President-to-be Barack Obama urging that come January, Obama's stimulus package should including a national "sales tax holiday," three ten-day periods in 2009 during which states that normally collect sales taxes on retail purchases would stop collecting them.

A new Citizens for Tax Justice report takes the shine off this idea a bit, noting a few fairly important reasons why a tax holiday might be not the right answer for America at this time.

Among them:

As with state sales tax holidays, it's hard to know whether the benefits would go to consumers or retailers.
To the extent consumers would be better off, the savings would go to even the very best-off families. No effort could be made to target these savings to families hit hardest by the current downturn.
Even if Congress likes the idea, that's not enough to implement it. Every state with a sales tax would have to pass legislation to make this work. And then every retailer in these sales-tax states would have to train workers and program computers to stop collecting state sales tax (but keep collecting local sales tax) during the holidays.
Since the first proposed tax holiday would take place in March, the immediate effect of such a plan would be to... encourage people to spend less money right now, and wait until March. Which is an odd feature in a stimulus plan.

The CTJ report is here.

Why Virginia Won't Hike Its CIg Tax

2008-12-20T09:35:00.004-05:00

Earlier this week, Virginia Governor Tim Kaine proposed doubling the state's cigarette tax from 30 to 60 cents per pack. Once upon a time, this would have been a pretty substantial hike. But with the wave of cigarette tax hikes nationwide over the past decade, this proposal would best be described as bringing Virginia's tax more in line with what the rest of the states currently do. As the Campaign for Tobacco-Free Kids reports, the nationwide average cig tax is now $1.19 per pack.

The Republican-led House quickly announced that it was having none of this. Their reason? Economic development:

[Virginia House Speaker William] Howell and [U.S. House member Eric] Cantor argued that a cigarette tax hike would send the wrong signal to other states, which might be more inclined to raise their cigarette taxes. That could lead to job losses in the tobacco industry, especially in Virginia.

The most obvious response to this rationale is that they're trying to close the barn door after the horses have gotten out. State lawmakers have looked--and continue to look, right now-- to cigarette taxes as their favorite source of new tax revenue for years now. The idea that other states are waiting for the official sanction of tobacco-producing states before further jacking up their cig taxes is pretty far-fetched.

But the more interesting question is why Howell views the tobacco industry as the most vital component of Virginia's economic development strategy going forward. (To say nothing of why Cantor, who after all is a member of the US Congress, not Virginia's legislature, is weighing in on this point.) Tobacco consumption has been falling for decades nationwide. Not just on a per capita basis either-- we're just collectively purchasing fewer and fewer smokes every year, as public knowledge of the immense healthcare costs associated with smoking increases.

It's a dying industry, a relic of the past. So why should Virginia, a state that has enjoyed a real technology boom over the past decade, want to reinforce the role of this industry in its economy? The Washington Post's Pete Earley has a disheartening, but probably apt, answer: because Virginia lawmakers got paid to think this way. As Earley notes, virtually every member of Virginia's tax writing committees in the House and Senate regularly take campaign contributions from the tobacco industry. You don't have to be a Rod Blagojevich for these contributions to have a subtle influence on how you think and vote on economic policy issues.

At a time when we're contemplating spending billions of dollars to prop up the US auto industry, it's hard to get too sniffy about efforts to keep the Virginia tobacco industry going. But as Virginia confronts a major budget deficit, every dollar of tax revenue not collected from the tobacco industry is coming from somewhere else. And by refusing to consider hiking the cigarette tax on economic development grounds, Virginia lawmakers are basically asserting that any other interest that could be taxed-- whether it's manufacturers, small retail businesses, or individual wage-earners and consumers-- are less vital to Virginia's long-term economic growth than are tobacco farmers. And it's hard to see any other explanation for this backwards approach to economic development than campaign contributions. As the late, great Mark Felt apparently never really said, "follow the money."

New York's "Soda Pop" Tax Proposal

2008-12-19T11:15:00.002-05:00

New York Governor David Paterson unveiled his budget proposal this week, and one proposed tax hike is drawing a lot of attention: a plan to introduce a new tax on sales of soda pop. The 18 percent tax-- which would be on top of the existing state/local sales tax, generally about 8 percent-- would also apply to sugary juice drinks.

Paterson clearly thinks this is a good idea because it's supposed to raise half a billion dollars a year. Nicholas Kristof thinks it's a fantastic idea, but for an entirely different reason: he thinks it will get people to stop drinking so much soda. Kristof goes so far as to call it "a landmark effort that, if other states follow, could help make us healthier."

With no apparent irony, the New York Times reports that

State officials projected that the tax would raise $404 million in the fiscal year that starts in April, and $539 million in the following fiscal year, but said the proposal was primarily a public health measure.

Of course, if the yield of the tax goes up, that means that people are drinking more sugary sodas, not less. So this thing is either going to be a budgetary savior for the state, or it's going to make people healthier by encouraging them to spend less on soda pop. You can't have it both ways.

So what's the real answer? The Times' Clyde Haberman has a clear-eyed view:

Make no mistake, the last thing that government wants is for everyone, right this minute, to stop smoking, boozing, gambling and downing those nutritionally empty supersweet sodas. Too much money is at stake. By absolutely no coincidence, the New Yorkers who pay these particular taxes tend to be those who can afford them the least. Poor people spend disproportionately on smokes, booze and unhealthy soft drinks, not to mention on the prayer that God will drop everything else and shower lottery millions on them.
These are “habits that are more common among those who have the least amount of political power,” said Andrea Batista Schlesinger, executive director of the Drum Major Institute for Public Policy, a liberal but nonpartisan research center in New York. “To do something in the most politically efficient way is to tax or hike the fees of those who have the least power,” she said.

Folks like Kristof aren't wrong to want to discourage people from doing self-destructive things. But they're absolutely wrong to think that lawmakers' motive in proposing things like the soft drink tax is to improve public health. They're doing it because it's politically easier than the true tax reforms that could help keep New York's budget balanced years down the road.

PNC Bank: Next in Line at the Bailout Trough

2008-11-18T21:54:00.003-05:00

In the wake of revelations that Wells Fargo Bank stands to reap $20 billion in federal tax cuts from a probably-illegal tax giveaway imposed on us by departing leaders in the Bush Treasury Department, the most obvious question was which other large corporation would be next in line to cash in on this particular tax break. The answer: PNC, which just bought Ohio-based National City Bank.

As with the Wells Fargo case, the generosity of the tax break leaves one dumbfounded. As the Cleveland Plain Dealer asks:

How can PNC pay $5.6 billion for National City and get back more than $5 billion in tax breaks?

It's a rhetorical question, of course: the Plain-D guys know that this tax break exists because of clever back-room maneuvering by Bush Administration Treasury officials. The short explanation: 20 years ago, Congress passed a law (as part of the justly-celebrated Tax Reform Act of 1986) that prohibited banks from buying loss-ridden banks as a tax dodge. While lobbyists pushed hard for Congress to undo this change for, well, the next 20 years, they were unsuccessful-- until the Treasury Department decided to change the law themselves by issuing a notice saying that they've changed their interpretation of the law. Oversimplying a bit, Treasury officials have taken a law that says "this tax scam is not allowed" and basically crossed out the "not".

Plenty of people are now paying attention to this anti-democratic outrage, not least among which are the members of Congress who view the creation of absurd tax breaks as their domain alone. (They're right, for better or for worse.) But the real question remains: what can be done about this?

An incoming Obama Administration can (and should, if all else fails) simply rewrite the administrative regulations. Again resorting to a gross oversimplification, this means un-crossing-out the "not" mentioned above.

Alternatively, tax writers in Congress (who are peeved that Treasury usurped their authority on this one) could pass a law preventing banks from using this made-up loophole going forward.
A stickier issue is whether anything can be done to take away the tax breaks already claimed by Wells Fargo and PNC. If their purchases of unprofitable banks were driven by the tax break, it may seem unfair to take the tax breaks away retrospectively, but there's enough unfairness to go around: Wells Fargo got a tax break that Citigroup didn't, entirely because Wells Fargo tried to buy Wachovia right after Treasury's announcement-- and Citigroup had the bad luck to make its acquisition bid right BEFORE Treasury's announcement. Ain't nothing fair about that.

It would probably be best for Congress to tackle this one head on, even as it deals with allegations that the direct bailout costs (the much-ballyhooed $700 billion) are being doled out indiscriminately. Let's hope they do!

Wells Fargo Tax Giveaway (Finally) Attracting Some Notice

2008-11-11T11:35:00.003-05:00

Better late than never?
The truth of this saying may be tested in coming weeks, as lawmakers and regulators grapple with the question of how to fix an under-the-radar corporate tax break for a few large banks (the federal tax cut for Wells Fargo alone has been estimated at over $20 billion, and the new tax break overall could cost US taxpayers $140 billion) that seems to have been approved without Congress agreeing to it.

A Citizens for Tax Justice report from last week outlines the story:

When one company buys another company that has tax losses, the law prevents the acquiring company from using the purchased company’s tax losses. There’s a very sensible reason for this rule: to ensure that companies don’t purchase other companies simply as a tax dodge.
But a little-noticed September IRS administrative ruling creates a specific, temporary exemption from this rule for banks acquiring other banks whose tax losses are attributable to bad loans.

It's not that often that a new tax cut gets implemented without Congress ever lifting a finger, but that's what happened when the Bush Administration's Treasury officials decided to reinterpret an existing law in a way that would cut taxes dramatically for a few well-off banks. Senator Charles Grassley, who's accustomed to being at the steering wheel (or at least in the car!) when the tax policy express hits the road, is very angry about it, although he's stopped short of saying that the Administration's move is illegal.

Yesterday's Washington Post has a detailed story discussing how this came about, and today's Los Angeles Times has this story noting that the state if California stands to lose a couple of billion dollars of its own corporate income tax revenue to boot.

This is obviously an important issue for Congress-- the bailout was unpopular enough before it became widely known that it was being hijacked to benefit a few big corporations, so Congressional tax writers have a real incentive to clean this mess up in a way that makes it clear the bailout ultimately benefits America's economy, not a few fat cats.

But, as Citizens for Tax Justice notes in its analysis of the problem, this is also something state lawmakers need to worry about:

Because states with corporate income taxes almost universally base their corporate taxes on federal rules, federal tax cuts for corporations generally result in state tax cuts as well. When affected states have rules making it difficult to enact tax increases (as istrue of California, whose budget deficit is already in the billions of dollars), state governments find themselves practically unable to avoid costly corporate tax cuts they never wanted... At least eighteen states that tax corporate profits will likely take a hitfrom the new IRS ruling—and any state that taxes the profits of financial companies is at riskof helping to fund the next bank that chooses to purchase another financial company.

With state budgets already going up in flames, this is a problem state lawmakers don't need. Stay tuned...

Tax Cuts, As We All Know, Increase Revenues??

2008-10-10T15:12:00.010-04:00

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

Enter John McCain. According to Senator McCain,

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

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

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

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

The Laffer Hypothesis: Show Me The Money?

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

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

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

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

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

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

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

Backed by the Politicians, Refuted by the Experts

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

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

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

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

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

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

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

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

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

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

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

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

Florida: The Case of the Missing Tax Break

2008-08-19T16:08:00.002-04:00

In the past year, Florida lawmakers (and voters) have ratified a couple of measures designed to reduce property taxes, by forcing local government tax rates downward and expanding homestead exemptions. So one would expect homeowner taxes to "drop like a rock" (to steal a phrase from Governor Charlie Crist) in the wake of these changes, right?

Well, no. As the Pensacola News-Journal's Michael Stewart points out, for many homeowners part of the tax savings from the previously enacted tax cuts is getting eaten up by an arcane "recapture rule." In a nutshell, the recapture rule says that if a home's market value falls, its assessed value will still rise by up to 3 percent.

If this rule sounds screwy, it's not-- or, at least no screwier than the "Save our Homes" tax break that is entirely responsible for it.

Here's the problem: since 1995, Florida has had in place a cap on the amount by which a home's assessed value can grow each year. It's 3% or inflation, whichever is less. This cap is known popularly (and with a touch of drama) as "Save Our Homes."

Of course, when market values are growing and the assessed value is not allowed to grow along with it, the result is a gap between what a home is really worth and what the tax system says it's worth. This gap is an inequity-- it takes the tax system further away from being fair and measuring things properly. The recapture rule is designed to undo this inequity. Simple as that.

An example: suppose you bought your house in 1995 for $100,000. Between 1995 and 2006, your home value doubles to $200,000. A properly functioning tax system would take account of the fact that your home is worth a lot more. But Florida's tax system only allows your home's value to grow at 3 percent a year. At this rate, the assessed value of your home in 2006 would only have risen to $138,000.

So in this example, your home is worth $200,000 and the tax system is treating it as if it were worth $138,000-- the tax system is basically pretending one-third of the value of your home doesn't exist. And all you've done to "deserve" this tax break is to not sell your house. Doesn't matter if you're rich or poor. Doesn't matter who you are, just that you didn't sell your house.

If you treat this $62,000 as basically an unearned, incorrect tax giveaway, then a mechanism that reduces the size of that giveaway seems like a good idea.

And that's what the recapture does.

Palm Beach County Appraiser Gary Nikolits knows this perfectly well, which is why it's a laughably political move when he writes a letter to the governor expressing shock that this sort of thing could happen. As Stewart reports:

“Can you imagine the outcry when they open their (tax notices) in August to find that while their market value may have decreased, their taxable value increased?” Nikolits stated in the letter.

Nikolits (and other appraisers around the state) have plenty of reason to be politically nervous about the impact of the recapture rule, but that doesn't make this rule wrong.

Put another way, anyone who thinks the recapture rule is "unfair" has got it exactly backwards. The true "unfairness" is in the Save Our Homes break, which creates a huge gap between market value and assessed value. The recapture rule is a perfectly acceptable way of mitigating that unfairness.

This lesson holds true, of course, in any other state that has similar caps on assessed value. Caps inherently create inequities, and require mechanisms like the Florida recapture to help reduce these inequities. Complaining about the recapture process amounts to missing the forest for the trees. That means you, Michigan!

Illinois: Shortest Special Session Ever?

2008-08-13T09:44:00.002-04:00

Yesterday the Illinois legislature held what was scheduled to be a one-day special legislative session on education funding. The goal, in theory, was to come up with new money for pay for the state's chronically-underfunded education system.

But, as it happened, the session lasted all of 20 minutes in the state House, and not much longer in the Senate. And all the legislature agreed on was that they probably shouldn't get a pay raise at this time.

Why the sham special session? The short answer: Governor Rod Blagojevich called the session with very clear ideas about which solutions are permissible-- and which solutions are forbidden. The former camp includes privatizing the state's lottery; the latter camp includes, well, just about every sensible tax reform one might wish to enact. Blagojevich has maintained in the past, and reiterated in advance of the special session, that increasing the state's low, flat-rate, loophole-ridden income tax is not an option he will accept. This is especially absurd given that, as some brave observers have noted, lawmakers could make the Illinois income tax fairer and more sustainable without increasing tax rates at all.

It's no wonder, then, that state lawmakers see no particular point in holding a special session: if the governor plans to veto any income tax hike, why should lawmakers take the political risk of enacting one?

Check out the weekly updates from the Center on Tax and Budget Accountability for ongoing info on the state's budget crisis.

Cutting through the Tax Rhetoric Clutter

2008-08-12T11:30:00.004-04:00

Some great fact checks have recently been run by several news organizations and watchdog groups decrying the distortions of Obama's tax plan in several advertisements run by the McCain campaign.

First from FactCheck.org and Newsweek:

A TV spot claims Obama once voted for a tax increase "on people making just $42,000 a year." That's true for a single taxpayer, who would have seen a tax increase of $15 for the year – if the measure had been enacted. But the ad shows a woman with two children, and as a single mother, she would not have been affected unless she made more than $62,150. The increase that Obama once supported as part of a Democratic budget bill is not part of his current tax plan anyway...

The TV ad claims in a graphic that Obama would "raise taxes on middle class." In fact, Obama's plan promises cuts for middle-income taxpayers and would increase rates only for persons with family incomes above $250,000 or with individual incomes above $200,000.

And on separate Spanish and English-language radio ads:

A Spanish-language radio ad claims the measure Obama supported would have raised taxes on "families" making $42,000, which is simply false. Even a single mother with one child would have been able to make $58,650 without being affected. A family of four with income up to $90,000 would not have been affected...

The [English-language] radio ad claims Obama would increase taxes "on the sale of your home." In fact, home-sale profits of up to $500,000 per couple would continue to be exempt from capital gains taxes. Very few sales would see an increase under Obama's proposal to raise the capital gains rate.

Lots more analysis from FactCheck and Newsweek here (under "analysis").

Really, this graph from the Urban/Brookings Tax Policy Center analysis is probably one of the best illustrations of the presidential candidates' tax proposals because it illustrates the stark difference in priorities.

Sen. Obama's tax relief is overwhelmingly focused on the lower and middle brackets while raising taxes on the wealthy (over $250,000). Sen McCain's tax plan is sharply regressive, lowering taxes the most in percentage terms for the wealthy and the least for lower and middle-income brackets.

And how will the candidates' respective proposals affect the federal budget deficit? The Washington Post ran an analysis under the misleading title "Obama's Tax Plan Would Balloon Deficit, Analysis Finds." While the article does discuss an interesting debate over whether it's better to evaluate a spending proposal against a budget baseline (assuming current fiscal policy remains unchanged) or just compare proposals to one another in terms of their effect on the national debt, the headline will leave a misleading impression for casual readers who do not delve into the details of the article. This is because it's actually the case that if all McCain's tax proposals were implemented, they would balloon the national debt significantly more than Obama's proposals.

As Media Matters for America notes:

The article stated in its third paragraph that "[a]ccording to a recent analysis by the nonpartisan Tax Policy Center, Obama's tax plan would add $3.4 trillion to the national debt, including interest, by 2018." The 10th paragraph stated that "[a]ccording to the Tax Policy Center, McCain's tax plans would increase the national debt by at least $5 trillion over the next 10 years."

So not until the 10th paragraph of the article did the Post see fit to tell its readers that McCain's plan is actually worse for the national debt. There's some "fair and balanced" journalism.

Tax Foundation Debunks Anti-Obama Tax Smear

2008-08-01T17:12:00.002-04:00

You don't have to have a thousand unread messages in your inbox to believe that sometimes email is a bad thing. An example: apparently an anti-Barack-Obama screed has been circulating via email that lists a dozen of Obama's alleged tax proposals, all of which (in the email) amount to taxing basically every American. Each of these proposals makes it sounds like he's going to go after everyone's firstborn son.

But as the Tax Foundation helpfully points out, basically every assertion made in this email is false.

Some of the assertions in the email ("Obama would tax all capital gains on home sales at 28 percent") can't possibly be reasonably construed from anything Barack Obama has ever said or written. In other words, it's not a matter of some knucklehead doing his best to understand Obama's plan and just mis-interpreting it. Somebody went out and just lied-- made up a bunch of the nastiest stuff they could think of about Obama and called it the truth.

Hard to say how far afield this email has traveled. A quick Google search on specific phrases within the email reveals that it can be found on some very entertaining websites. For example, next time you find yourself poking around on "forums.gunbroker.com," you can find the email here. The Iowa John Birch Society is all over it too. While it's distressing to see it posted approvingly anywhere, the good news is that each of these web forums allows readers to comment, and sensible folks have already pointed out that the email in question is completely unsubstantiated.

More pernicious is a website with the harmless-sounding name www.before-you-vote-2008.info/ that has posted the offending email in its entirety, in apparent approval of its contents right here. As long as this idiot wants to keep shelling out $20 a year to own this web domain, he can leave the anti-Obama email in all its unexamined glory as long as he wants.

Of course, in the end, if any American voter reads the anti-Obama email and believes it uncritically, that's their fault for being lazy. And one could optimistically hope that no one would be that lazy. But the underlying problem is that tax policy is complicated enough that it's not all that easy to verify or (as is universally true in the case of this email) disprove assertions about candidates' tax plans.

And even if people don't explicitly believe the specific assertions made in the email, the theory animating the sender was probably that if you tell a lie enough times about someone, it does affect your perception of them-- even if you don't explicitly believe it's true.

Someone I respect greatly, who is nonetheless a pessimist about human nature, once gave me the following metaphor for how elections are won and lost: presidential campaigns are like a picture window. One party has a red magic marker and the other candidate has a blue magic marker. Every time the Republicans run an ad, they're putting a red dot on the window, and every time the Dems run an ad they're putting a blue dot on the window. If, on election day, there are more blue dots than red dots, the Democrats win.

If my friend's metaphor is wrong, then this scurrilous anti-Obama email doesn't matter. But if he's right, maybe it does.

Which is why the Tax Foundation deserves kudos for taking the email apart point by point and showing that it's full of lies.

Taxing Amazon.com Complicated by Tangled Forest of Tax Laws

2008-07-24T15:08:00.002-04:00

Should states be able to collect state sales tax on internet purchases and catalogue sales that cross state lines? That’s the issue that’s currently confronting state governments around the country desperate for revenues in these poor economic times. In theory, it is grossly unfair for a purchase that is made online to be taxed less than an identical item purchased at a “bricks and mortar” store (individuals are technically subject to use tax on their internet purchases but it is almost impossible to enforce). But in practice, taxation of remote sales falls victim to legal barriers as well as decentralized tax policies.

To this day, a company in question must be benefiting from the services which the state provides in order to be subject to sales tax levies. The Due Process clause has been interpreted for tax liability purposes as meaning the state must “give something for which it can ask return.” The Supreme Court has ruled that taxation of remote retailers is unconstitutional unless they have nexus or a physical presence within the state’s boundaries. But in the era of widespread e-commerce, the lines between a physical and virtual presence are blurring. Companies that buy and sell goods within a state are making use of that state’s infrastructure whether or not they physically own operations in the state.

The most recent Supreme Court decision to address this issue, Quill Corp. v. North Dakota in 1992, upheld previous limitations to the circumstances under which the state may collect taxes from a remote retailer. According to the Court, the Dormant Commerce Clause prevents states from placing undue burdens on interstate sales which was violated by North Dakota’s sales tax of Quill Corporation. Tax laws are so complicated and widely divergent between the 7,400 tax jurisdictions in the U.S. that the Court ruled it unreasonable for retailers to have to account for all the technicalities. It’s important to mention, however, that many observers including the chief executive of Netflix note the improvements in tax software in recent years have dramatically reduced the practical complexity of accounting for different tax policies.

Legal realities haven’t kept states from trying to tap this potentially large revenue source, upwards of $18 billion per year according to an estimate from the University of Tennessee. An organization of more than 20 states known as the Streamlined Sales Tax Project (SSTP) created in 2000 has been trying to streamline their tax codes enough so that determining tax liability is less burdensome. This will help convince Congress to change the law and allow states to tax internet sales, bypassing the Court decision. It’s probably fair to say they’ve only had limited success so far. This is due both to the difficulty of adopting a commonly accepted definition of taxable goods and services that doesn’t benefit some states while disadvantaging others and the difficulty of getting such a bill through Congress.

Thus presents the Amazon.com dilemma. Its “wholly owned subsidiaries” own thousands of square feet of distribution facilities in several states according to the Wall Street Journal. Although they are legally separate, there is a debate as to whether they constitute a nexus. It’s fairly common practice for companies to establish “shell companies” to take advantage of tax loopholes that allow them to expand operations without expanding tax liability. Several states, including Texas, are reviewing whether Amazon’s in-state operations should really be exempt from taxation.

Unfortunately, the prospect for expanding the tax base has dimmed as the State Board of Equalization in California has ruled that entities that refer customers by links to Amazon do not trigger nexus under California law. This is true even though the sites benefit financially from their relationship with Amazon, garnering a percentage of the sales made from the sponsored links.

New York has already passed a law requiring remote retailers to collect sales tax on purchases made in the state which Amazon has challenged, saying it unfairly targets Amazon. Amazon has a number of affiliates and advertisers that benefit financially from Amazon sales within the state (other companies such as Overstock.com cut ties to its New York affiliates rather than have to face sales tax liability). New York law states that companies that enter into financial arrangements with Amazon are considered Amazon vendors for sales tax purposes. The question is whether they are acting as agents of Amazon or whether they are primarily out for their own financial interests. It will be up to the courts to decide whether affiliates trigger nexus in New York or whether it’s back to the drawing board for advocates of equal tax treatment of e-commerce.

On Social Security, McCain Redefines "Middle Class"

2008-07-16T19:14:00.003-04:00

In an entertaining interview with the Pittsburgh Tribune-Review this week, presidential candidate John McCain makes it clear that he won't fix Social Security through payroll tax hikes. In particular, McCain argues that it's a lousy idea to increase the cap (currently $102,000) on the amount of any individual's wages that can be subject to payroll taxes in a given year:

Trib: Do you favor raising the cap?
McCain: Pardon me?
Trib: Do you favor raising the cap?
McCain: No, and I think by doing so, as Sen. Obama wants to do, you are obviously putting a very, very big increased tax on ... middle income Americans who filing jointly and in other ways will be paying a very big increase.

McCain's response here is wrong in two important ways. First, as a CTJ analysis showed a couple of years back, only about 6.5% of Americans would be affected by a proposal that simply eliminates the cap on the federal payroll tax.

But more importantly, McCain's characterization of Obama's position on Social Security is flat-out wrong. What Obama has said is that he'd allow the payroll tax to apply to an individual's wages above $250,000, which is a very different thing from simply removing the cap and taxing wages above $102,000. Here's the Washington Post's nice explanation of Obama's position:

Under current law, income up to $102,000 a year is taxed for Social Security. Obama would create a "doughnut hole" by not imposing new Social Security taxes on income between $102,000 and $250,000. His aides said income exceeding $250,000 would be taxed at a rate of 2 percent to 4 percent, rather than the 6 percent tax that people pay toward Social Security on income below the $102,000 cutoff, which is matched by their employer's paying a 6 percent tax.

And as a recent CTJ analysis points out, the Obama proposal would only affect 1 percent of Americans-- none of whom could be described as "middle class." As for the alleged "very, very big" tax increase on these middle-class Americans... well, suppose you have a "middle class" friend whose salary was $275,000 (remember, income from sources other than wages don't count toward the payroll tax, so what matters is each individual's salary). That means that under Obama's plan, he would face a tax on his wages exceeding $250,000. His income exceeds $250K by $25,000, so his tax hike would be 2% of $25,000. That would be a $500 tax hike. If this sounds like somebody you know-- and if you consider this person "middle class"-- then McCain's characterization seems apt. Otherwise, his description of the Obama plan is screamingly, almost libelously wrong.

The $500 tax hike described above certainly would count as a "very, very big" tax hike for an average middle-income family-- but, unfortunately for McCain's truthiness, there's simply no way the Obama plan would ever apply to anyone who could reasonably be considered middle-class. Period.

To be perfectly clear about the way the Obama plan would work, a two-earner married couple would not pay more tax just because their combined income exceeded $250,000. Each spouse's salary must exceed $250K to get hit by the Obama plan. And capital gains, dividends, etc., don't count toward the $250K: what matters is your salary.

One could charitably attribute McCain's false statement to fuzziness in his understanding of exactly how the Obama plan would work. One could also say charitably that perhaps "middle class" has a very different meaning in Arizona than in the rest of the nation. But a more realistic interpretation would be that candidate McCain is willfully misrepresenting the truth in the hope that scare tactics are still a good substitute for honest policy debates.

McCain on Social Security: Everything on the Table?

2008-07-16T18:32:00.003-04:00

I don't trust people whose fiscal policy platforms are built around "pledges." When an elected official says that he/she will never, ever raise taxes on anyone, this shouldn't be seen as a principled stand-- it should be understood as a cop-out, a signal that this particular elected official, when he takes office, will have checked his brain at the door. The first principle of fiscal policy should be that you put all the cards on the table, and face budget difficulties as they arise using tax changes or spending changes tailored to fit the specific budget circumstances you're facing. No pledges, no vows, just a nice rational deliberative process.

So I was impressed to see presidential candidate John McCain quoted on the New America Foundation's US Budget Blog as saying that when it comes to fixing Social Security's long-term funding imbalance,"you've got to say, 'Look, everything is on the table, let's sit down at the table.'"

Given McCain's recent tendency to vocally oppose tax increases of any kind, the natural follow-up to a comment like that is "you mean you're open to increasing the payroll tax?" Since the McCain quote came from a much longer interview with the Pittsburgh Tribune-Review, I was interested to see whether, in fact, the Trib's staff asked this follow-up question. And they did, sort of, by asking not whether McCain would support increasing the federal payroll tax rate, but by asking whether he would support a proposal that would increase the annual cap (currently $102,000) on the amount of wages that can be subject to the payroll tax in a given year. Here's the exchange:

Trib: Do you favor raising the cap?
McCain: Pardon me?
Trib: Do you favor raising the cap?
McCain: No, and I think by doing so, as Sen. Obama wants to do, you are obviously putting a very, very big increased tax on ... middle income Americans who filing jointly and in other ways will be paying a very big increase.

So the good news is that McCain isn't taking a no-taxes pledge on this point. But the bad news is that he's talking out of both sides of his mouth on this "cards on the table" approach. He tries to appear conciliatory by speaking the language of rational deliberation, then poisons the well by completely mischaracterizing the impact of a relatively tame tax hike on "middle-income Americans."

In other words, when McCain says "let's put all the cards on the table," what he really means is "let's have an honest discussion of all the ideas I agree with, and tell outright lies about the rest of them." Is this better than a "no new taxes" pledge? I'm not sure it is. Pretending to be reasonable is arguably even worse than just admitting you're irrational. The "no new taxes" gang is irrational at best, but at least they're honest about it.

For more details on why McCain's statement about raising the cap is wrong, go here.
You can read the whole Tribune-Review interview here.

Zipcar Popularity Leads to Taxation Dilemma

2008-06-23T16:31:00.002-04:00

What is the difference between a rental car company and a car-sharing company? That’s the question public officials and tax lawyers around the country are trying to figure out as states and cities begin to apply rental car taxes formerly applied only to companies like Alamo and Hertz onto car-sharing companies like Zipcar (formerly Flexcar). Zipcar is a national for-profit while most original car-sharing organizations were non-profit and locally based.

An article in The Wall Street Journal last Thursday details the increasing prices associated with borrowing a car for a few hours. In many cities, the cost of a 2 hour car-sharing trip has gone up between $2 and $4.

If no exemptions are granted, the fees can add up such that Zipcar loses its cost-advantage. In Philadelphia, Zipcar members must pay a 2% state rental-car tax, plus a $2-per-rental state tax, and the city's 2% rental-car tax every time they reserve a car.

This would seem to make it more difficult for the kind of low-income urban dweller who would like to be able to get around without owning a car (and avoid the associated costs of insurance, gasoline, and parking) to be able to do so. Taxes applied to each car reservation are far more onerous to Zipcar users who tend to use the cars more often than Enterprise renters, for example, rent cars. On the other hand, many rental car companies such as Hertz have begun offering hourly rates for car rentals, essentially the equivalent service of a car share company.

Public policies should be encouraging a reduction in car ownership whenever possible. There are many positive externalities associated with fewer cars on the roads including a reduction in air pollutants, less traffic congestion, and a reduced reliance on foreign oil imports. But are there specific externalities associated with joining a car-sharing service per se?

Zipcar spokesperson John Williams believes so:

"Fundamentally, we believe that car sharing is different from car rental," he said. "The question isn't so much about percentage rates as it is a question about smart policy."

Mr. Williams said that after people join car-sharing programs, "there is a behavior shift" -- they drive 40 percent fewer miles, and eventually many of them…sell their cars.

Zipcar claims that each car-sharing vehicle added to the streets removes approximately 15 privately owned cars off the streets. It also says that about 40% of its members would own a car or second vehicle if it weren’t for Zipcar. About 2 million people participate in car-sharing around the country.

That seems to imply that some particular benefit is derived from having cars placed strategically around urban areas so that most people have access to them without needing a car to get there in the first place.

There’s also added flexibility to the Zipcar program that you cannot necessarily get with rental car companies. New Jersey Transit recently partnered with Zipcar, and it allows you to reserve a Zipcar to bridge the gap between where trains can take you and where you need to go. In other words, if you live far from a train station, you can reserve a Zipcar at the train station so you can make it to all the way home.

Nearly 100 different rental-taxes have been enacted nationwide and have cost consumers more than $6 billion since 1990. Opponents claim the tax money goes to fund projects that those burdened by the tax derive no benefit from. The popularity of car-rental taxes comes from the theory that they mostly tax visitors to a given city or state, not the voters living there. However, as car-rental taxes are applied to local residents using car-sharing programs, they are no longer quite as politically palatable. Legislation was introduced last year at the federal level banning the implementation of new rental-taxes while leaving the current ones in place. It aims to rectify the unfairness of targeting a particular industry for taxation.

At the end of the day, tax treatment of car-renting vs. car-sharing businesses will likely depend on what exact services are being offered and whether they deserve special treatment in light of their environmental benefits. Localities might consider developing rental-tax exemptions depending on usage. For example, in Chicago the tax applies to daily rentals but not hourly rentals. Bostonian Zipcar users are charged a flat annual “convention center tax” but not taxed each time they reserve a Zipcar.

While Chicago’s system should prevent having to explicitly discriminate between “car-sharing” and “car-rental” companies for tax purposes, it won’t eliminate the potential to game the system. For example, business travelers might be able to take advantage of the hourly rate to complete their business in a rental car without paying the rental-tax. This tax relief wouldn’t be directed at those who need incentives not to own a car. Similarly, those who may legitimately need this tax relief will be penalized for day-rentals if they have errands that take longer than a few hours to complete.

Ultimately, any remedies for the current situation are bound to have imperfections. However, hourly rental tax exemptions are likely to ensure maximum tax-fairness and maximum positive externalities for the rental car and car sharing industries.

Nevada: Special Session Postponed (Sort Of)

2008-06-22T12:05:00.000-04:00

In the wake of news that Nevada's projected budget deficit will be larger than previously estimated, Governor Jim Gibbons has postponed the start of his special legislative session on the budget deficit from next Monday to Friday. The news isn't good:

[T]he new shortfall figure lawmakers must deal with when they convene on Friday is $250 million, more than a $243 million shortfall projected by state Budget Director Andrew Clinger. And far above the $94 million projected by legislative fiscal analysts.

A Gibbons representative made it clear that with the expanded deficit, all policy options were on the table-- except for half of them:

Josh Hicks, general counsel to Gibbons, said every type of potential budget cut is on the table for the session, from 4 percent cost-of-living raises set to take effect July 1 for state employees and public teachers, to cuts to programs. Tax increases, he said, "are not on the governor's table."

Of course, when you've already identified $900 million of spending cuts without a single tax hike, what's another $250 million? The Governor's single-minded approach to resolving the state's fiscal crisis reminds me of this exchange from the John Belushi-Dan Ackroyd classic "The Blues Brothers":

Elwood: What kind of music do you usually have here?
Claire: Oh, we got both kinds. We got country and western.

Virginia: Gilmore Allies Jumping Ship

2008-06-20T11:26:00.004-04:00

In his tenure as governor of Virginia in the late 1990s, Jim Gilmore was notable primarily for one thing: the cut in the state's "car tax" he championed. It got him elected, and it was the issue he rode throughout his governorship. And lawmakers in other states took note: cutting vehicle property taxes has been a frequent bipartisan goal of state lawmakers for the last decade now.

But, as countless Virginia observers (and a bunch of angry lawmakers) have noted since then, supporters of the Gilmore car tax cut were sold a bill of goods. It turned out almost immediately that repealing the car tax was unaffordable, since the short-term surpluses that made the tax cut seem feasible were, well, short-term. And Gilmore's tax cut has been a political football in the state's budgeting process ever since.

Now, Gilmore has decided to make another run at statewide office, and is running against Mark Warner for the US Senate seat being vacated by John Warner. And he's finding out what happens when a snake-oil salesman tries to fool the same people twice: it doesn't work.

The Washington Post reports this week that Vincent Callahan, a Republican lawmaker who was instrumental in the initial passage of Gilmore's car tax cut, is endorsing Gilmore's Democratic opponent, Warner, in this fall's race. The reason, according to Callahan: Gilmore's misleading advocacy of the car tax cut last time around.

Callahan said Gilmore, Warner's GOP opponent, misled legislators and the public about the state's finances and the cost of his signature effort to eliminate the car tax when he was governor from 1998 to 2002. 'The figures Gilmore used were so utterly erroneous and far-fetched that they were mind-boggling,' said Callahan.

Of course, revenue forecasting is often more of an art than a science. But in retrospect, there's little disagreement (from anyone except Gilmore himself, that is) that Gilmore lowballed the cost and the affordability of his car tax cut .

A Washington Post editorial noting Gilmore's razor-thin primary win over a relative nobody for the GOP nomination offers a scathing review of Gilmore's fiscal policy record:

At the heart of the Gilmore legacy was his insistence on ramming through a tax cut whose dimensions dwarfed his cavalier initial estimates, and his simultaneous approval of heavy increases in state spending, a strategy -- if it can be called that -- suggesting that Mr. Gilmore assumed that the boom times in Virginia would never end. He pursued his signature tax cut, a phased repeal of the levy on personal vehicles, even after it became crystal clear that the repeal would drain hundreds of millions of dollars from the budget and cripple state finances. He insisted on his course despite being warned -- by fellow Republicans, among others -- that it would eventually force deep reductions in spending on core state priorities including transportation and education. And he shrugged off specific, repeated and well grounded forecasts that Virginia was heading for an economic slowdown brought on by the bursting of the technology and stock market bubble -- a slump Mr. Gilmore simply denied.
In Mr. Gilmore, Virginia had its very own Herbert Hoover. "State government is in sound financial shape," he declared sunnily in August 2001, even as state lawmakers from both parties predicted a $500 million revenue shortfall in the commonwealth's $25 billion budget -- about 10 times Mr. Gilmore's own projections and, as it turned out, itself an underestimation of the state's actual woes. Mr. Gilmore's allies
sometimes argue that no one could have foreseen the economic effects of the Sept. 11 attacks, which occurred four months before he left office. True enough, but also irrelevant: The problem had swollen to major proportions well before the attacks, and Mr. Gilmore ignored it.
He did so in part by budgetary gimmickry and sleight of hand of the sort seldom seen in Virginia, with its stodgy custom of fiscal prudence. When it became plain that the state's revenue growth had hit a wall, a condition that Mr. Gilmore himself had said would preclude a further rollback of the car tax, he proposed a novel solution: conjuring revenue by borrowing against a one-time legal settlement with tobacco companies. That scheme, which encapsulated Mr. Gilmore's poor judgment and fondness for budgetary trickery, elicited groans from Republican and Democratic lawmakers alike.
Today, Mr. Gilmore innocently states that on leaving office in 2002 he bequeathed a balanced budget and $1 billion in reserves. But the balanced budget was a fiction that papered over a yawning deficit with shenanigans such as requiring retailers to prepay their sales tax and employers to prepay their withholding tax. And the reserves, for which Mr. Gilmore bears no responsibility -- they were statutorily required -- did nothing to forestall the state's fiscal crisis. It fell to Mr. Warner, who succeeded Mr. Gilmore as governor, to fix what quickly mushroomed to a nearly $4 billion problem.

Wow.

President Bush Supports a Tax Hike

2008-06-20T10:40:00.002-04:00

And you thought the day would never come: earlier this week, President Bush signed into law a bill that (gasp) increases federal taxes. The bill, HR 6081, known as the "Heroes Earnings Assistance and Relief Tax Act," creates or extends a host of special tax breaks for military members and their families, which in itself is a move no sane member of Congress would oppose. But heretically, the bill pays for its tax cuts by closing an existing tax loophole.

The tax break in question, which Talking Taxes discussed in detail a few months back, allowed KBR, a former subsidiary of the Halliburton company, to avoid hundreds of millions of dollars in federal Social Security and Medicare taxes by pretending its Iraq-based employees were working for a Cayman-Islands based "shell company."

Just as tax breaks for the military have no enemies (the House voted unanimously on this one), the KBR payroll tax dodge had no friends. So for any head of state not guided by the "no new taxes" mantra, signing this bill would be a no-brainer. But in this case, we'll call it a pleasant surprise.

Now, as the NWLC's Joan Entmacher asks, why can't we get Congress and the President to apply the same logic to the egregious "carried interest" tax break for hedge fund millionaires?

Nevada: Tax Hikes in Special Session Possible

2008-06-19T11:22:00.000-04:00

The Reno Gazette Journal reports that tax increases may be on the agenda for next week's special session of the Nevada legislature. Among the candidates, according to Assemblywoman Sheila Leslie, D-Reno, is raising the business payroll tax and hiking the hotel tax, popularly known as the "room tax."

For those who've followed Governor Jim Gibbons' membership in the dwindling crowd of state executives who are adhering to "no new taxes" pledges, this isn't terribly exciting news because the harsh political realities of the state suggest it doesn't matter what tax hikes the legislature discusses:

Gov. Jim Gibbons has said he would stick to his election-campaign pledge of no new taxes. Democrats are a vote shy of being able to override a veto in the Assembly and are in the minority in the Senate. Lanni’s suggestion to raise the payroll tax from 0.63 percent to 1.23 percent and generate $246 million annually won’t go far in the special session, Senate Majority Leader Bill Raggio, R-Reno, said.“I am aware of it and have also heard from him on that and my indication is that this is not the time to start talking about raising taxes,” Raggio said. “We are in tough times and businesses are hurting and in this special session, it is something that we can’t even consider.”

Of course, depending on the outcome of the ongoing brouhaha over the size of Nevada's budget deficit, Democrats may ultimately find it easier to override a gubernatorial veto. And it's always possible that Governor Gibbons will back away from his pledge and start evaluating the state's fiscal jam in a non-judgmental way.

But don't hold your breath.

Alabama case contests discriminatory property tax restrictions

2008-06-19T10:47:00.002-04:00

In a court case filed earlier this year in Alabama, lawyers for several rural schoolchildren and their parents hope to demonstrate that Alabama’s regressive tax code unconstitutionally disadvantages children in poor, rural counties by limiting the ability of localities to raise a reasonable amount of revenue with which to fund education. The plaintiffs’ approach in this case involves a thorough accounting of the history of Alabama’s property tax, with the intent of demonstrating that these policies were purposely enacted to destroy the ability of counties to pay for African Americans’ educations with money raised from wealthier white landholders. If this approach proves itself effective, the requested remedy is a mandate requiring the governor and legislature to work together to rewrite Alabama’s property tax law in such a way as to make it non-discriminatory.

Though there may be reason to question the use of the courts in securing tax policy reform, what is interesting about this case is the way it demonstrates the unsavory original intent behind many of Alabama’s property tax limitations. The district court hearing the case conceded as much in an earlier case when it stated that “constitutional provisions governing the taxation of property [in Alabama] are traceable to, rooted in, and have their antecedents in an original segregative, discriminatory policy”.

According to the plaintiffs’ official complaint, following Reconstruction, Alabama’s white elites exploited widespread racial resentments in order to gain enactment of their favored regressive tax policies. In the post Civil War period, the tax base, which had been focused on the slave trade, was redirected onto land. But when blacks were enfranchised, wealthy whites who owned significant tracts of land in the “Black Belt” feared that if blacks were granted local autonomy, they would vote to raise property taxes (which would hit hardest those well-off enough to afford significant amounts of property) in order to support their own education. Though the idea of funding public services for the poor with money drawn from more fortunate members of society is hardly controversial today, at the time the prospect of privileged whites having to pay for the education of “inferior” African Americans was extremely unsettling. Limiting the amount of tax that could be levied on property thus became a top priority.

One of the earliest manifestations of this sentiment can be founded in the 1875 Redeemer Constitution. Caps on the rate of property taxation were implemented, largely in order to protect wealthier whites from tax increases in predominately black localities. At the time, and for some years after, manipulative assessment schemes served a similar end.

Later, in 1891, the Apportionment Act explicitly allowed for funds to be transferred from black to white schools. This removed any impetus for whites to increase property taxes to fund their own schools, and made property tax caps even more useful.

Subsequent to these policies came the adoption of the 1901 Alabama State Constitution, still in effect today, which the plaintiffs claim was created with the explicit goal of “disenfranchising blacks and maintaining white supremacy” in the state. That claim seems relatively uncontroversial, as the Constitution established a poll tax, as well as literacy and landowning requirements for voting that kept African Americans effectively disenfranchised and segregated from the rest of society until the 1960s. With blacks disenfranchised, the constitution also established a referendum requirement for all local property tax changes.

In addition to the disenfranchisement of blacks was a solidifying of state-level control of local tax issues. The plaintiffs describe state intervention into local property tax policy as an important “fall-back provision for guaranteeing the maintenance of white supremacy in black majority counties”. Unlike some county governments, the state was certain to maintain a white majority of legislators.

Although discriminatory voter laws, segregation, and inconsistent property assessments were eventually struck down in court in the 60s and 70s, the crippling effects of other Alabama tax laws contained in the state constitution continue to this day. In response to a federal district court ruling that struck down the irrational assessment system that had been used in Alabama for decades, the Alabama legislature passed a “Lid Bill” amendment that was ratified by voters in 1972. The amendment (Amendment 325) established fair market value assessment ratios for all kinds of property (30% for utilities, 25% for other business property, and 15% to residential, farm, and forest lands) and imposed an absolute lid on all ad valorem taxes of 1.5% of fair market value. To see why “split roll” property taxes of this type are a poorly targeted way to shift the tax burden from residents to businesses, see this policy brief from the Institute on Taxation and Economic Policy (ITEP).

A second Lid Bill in 1978 lowered the property assessment ratio to 10% for residential, agricultural, and forest land and measured value not as “fair market value” but rather on the land’s “current use.” Requiring land to be taxed on the value of its current use results in a huge tax break for wealthy landowners and speculators. As the court brief explains, “Seventy percent of Alabama’s land mass is forest land, but due to the 10% assessment ratio and current use provisions of the 1971 and 1978 Lid Bill Amendments, forest land contributes only 2% of all property tax revenue.”

To add yet another layer of unfairness, the Lid Laws revoke local autonomy by requiring a lengthy three stage process if a locality wishes to raise property taxes. First, the locality's commission or council must vote to request that the legislature pass a local constitutional amendment that would raise the locality's property taxes. Then the state legislature must approve the constitutional amendment, with at least 60 percent of both chambers voting in favor. Finally, a majority of the locality's voters must approve the amendment in a referendum. As the icing on the cake, if any member of the Legislature objects to the amendment, then it is sent to a statewide vote (and thus, most people voting on it will not even be subject to the locality’s property taxes). These extremely cumbersome requirements not only undermine local control but also impede the state legislature from promptly dealing with more important state business.

Unlike the debates that had taken place in the late 1800s and early 1900s, the discussion of whether to enact the 1970s Lid Laws was much less openly racist. But with George Wallace, a famous segregationist, in the office of the governor, race was certainly a visible issue. Given the history of Alabama tax policy, it’s not at all surprising that the plaintiffs conclude that,

There is an historical pattern of the racial motives behind the property tax provisions in the Alabama Constitution: There is a direct line of continuity between the property tax provisions of the 1875 Constitution, the 1901 Constitution, and the amendments up to 1978.

But aside from the existence of racial biases in the intent of Alabama tax law, what is more useful to point out is the existence of anti-poor (and as a corollary, anti-black) biases in the effect of the law.

The confluence of anti-tax provisions in effect in Alabama makes obtaining sufficient revenues from property taxes nearly impossible. Alabama property taxes are the lowest in the nation as a share of personal income. According to the court brief, in 2003, Alabama spent $5,908 per K-12 student, compared with a national average of $7,376 per student, making it the fourth lowest ranked state. The correlation between property taxes and school spending is no coincidence and it has serious negative consequences for Alabama schools, and in turn for the state’s long-term economic growth. Many school buildings are old and crumbling, and some are so overcrowded they have been forced to use trailers for overflow classrooms. Alabama is among the bottom ten states in writing scores with 76% of 8th graders writing below grade-level.

But a look only at property taxes and school funding does not provide a view of the full picture. Simply put: low property taxes are not the same thing as low taxes overall. Due largely to unusually high sales taxes and an almost-flat income tax, lower- and middle-income Alabamians actually end up paying a very significant amount of their income in state and local taxes. According to ITEP data, the poorest 20% of Alabama residents (earning less than $16,000 a year) pay about 11.2% of their income in state and local taxes under 2008 tax law. That’s well over two times the percentage paid by the richest 1 percent, or those with average incomes of more than $999,400.

A large contributor to this outcome is the entrenched preference for sales taxes in Alabama’s tax code. Sales taxes are exempted from the referenda requirements in place for raising property taxes, so many localities rely on these to fund schools. Sales taxes run as high as 11% in some parts of Alabama and according to ITEP estimates, the bottom 80% of taxpayers pay over five times as much in sales taxes as they do in property taxes. Sales taxes are also notoriously vulnerable to economic slowdowns. Making matters worse for Alabama’s sales tax is that it is littered with numerous needless exemptions for various goods and services (each of which contribute to the need for such high sales tax rates in the state) while groceries continue to be subject to the tax. Grocery taxes hit the poor the hardest since such a large portion of a poorer family’s income goes to paying for groceries. Alabama is one of only two states where sales tax is fully applied to groceries.

Alabama also has a seriously flawed income tax code. Up through 2005, Alabama required a family of 4 to start paying income taxes on $4,600 of income. This threshold was raised to $12,600 in 2006, but it’s still the fourth lowest in the nation (and a family of four is considered poor if they made less than $19,961 in 2005). Its higher tax brackets kick in at such low income levels (Almost 70% of Alabama taxpayers paid at the top rate in 2006) that the wealthiest 20% of Alabamians actually manage to pay out less of their income in income taxes than the middle 20%. This is in large part because Alabama is one of only seven states that allow a full deduction from state income taxes of federal income taxes paid. Since the wealthy pay much more federal income taxes than the poor and middle class, this sharply reduces the effective tax burden of the state income tax on the wealthy.

How can this be changed? Much of the problem lies with Alabama’s constitution, which has kept Alabama’s tax code among the most regressive in the nation. (Incidentally, the 1901 constitution was only ratified by rigging the vote in Alabama’s Black Belt – the referendum actually lost outside the Black Belt where there was no vote rigging). Entrenching tax policy in the state constitution is never a good idea as it makes it far too difficult to adjust the law to confront new challenges. A movement away from this process would be a great first step.

The legacy of tax unfairness is inexorably linked to the legacy of racial injustice in Alabama. The intentional racial bias in Alabama’s tax system may be less visible today, but effects on low-income Alabamians are still very plain. Aside from all the legal and historical arguments raised by this court case, one thing is clear: the solution proposed by the plaintiffs – that the Governor and legislature work to enact serious reforms to Alabama’s tax system – is absolutely necessary. Alabama property taxes are the lowest in the country and K-12 and higher education have both noticeably suffered as a result. High sales taxes and an essentially flat income tax exacerbate this imbalance. It’s time for Alabama to break away from its humiliating past and enact a tax system designed with 21st century considerations in mind.