Because Apple is so profitable, the dollars involved will certainly attract attention (this is a Senate committee after all, so that is the point). The report alleges Apple reduced its U.S. corporate income tax by an average of $10 billion-a-year for the past four years. Since the corporate levy generated only about $240 billion in 2012, $10 billion foregone from one company is a very big number indeed.

But while it added a few interesting twists, Apple cut its taxes  with the same tools multinationals have been using for years to minimize their worldwide tax liability. And if there is a scandal, I suppose it is the very ordinariness of these transactions. Apple’s tax avoidance shop, it seems, is a lot less innovative than its phone designers.  

The tactics are complicated but the strategy is simple: A company designs its business to locate as much income as possible in those countries where taxes are low. At the same time, it allocates as many costs as possible to those high-tax jurisdictions (like the U.S.) where deductions are especially valuable. A deduction is worth 35 cents on the dollar in the U.S. but only one-third as much in Ireland, where the corporate rate is only 12.5 percent.  

To achieve these twin goals, Apple mostly relied on the three golden goodies of international tax avoidance: deferral, transfer pricing, and check-the-box.

What on earth am I talking about?

Deferral allows U.S. firms to avoid paying U.S. tax on foreign income until earnings are brought back home. In practice, companies can keep these earnings offshore indefinitely and never pay U.S. tax.  Transfer pricing and check-the-box make the system even more beneficial.  

Transfer pricing is the way firms use internal bookkeeping to allocate expenses among various affiliates. For a company like Apple, nearly all the value of its products is in its patents and other intellectual property.  By charging a relative pittance to a foreign subsidiary for use of that IP, it can maximize that affiliate’s profit and minimize its IP income in the U.S.

Firms are supposed to price these assets at market value. But what does that mean when it comes to, say, proprietary computer code?

Check-the-box has been around for 15 years. Originally aimed at simplifying filing, these Treasury rules allow firms to classify themselves as one of several different entities—corporations, partnerships and the like. One category, however, is a “disregarded entity”—an affiliate not subject to U.S. income tax.

Normally, firms might be subject to rules (called Subpart F) meant to prevent abuse of deferral.  But multinationals avoid these strictures by designating foreign corporations they control as disregarded for tax purposes. All they have to do is, you got it, check a box.

There is some cost to deferral. Apple, for example, recently chose to borrow $17 billion to finance U.S. investments even though it has $100 billion stashed overseas.  But if the benefits didn’t outweigh the cost, companies wouldn’t keep holding all that money offshore.

How did Apple do it? It set up two entities in Ireland through which it was able to funnel two-thirds of its pre-tax worldwide income. Of its $34 billion in total 2011 pre-tax income, $22 billion was allocated to these two firms. True, the Irish love to talk. But it is unlikely they bought enough phones to generate $22 billion in pre-tax income.  

Remarkably, while these firms were physically located in Ireland, they were not Irish companies for Irish tax purposes. Thus, they produced what Harvard University tax professor Steve Shay describes as “ocean income.” That is, revenue that simply disappears into the deep blue.

As my Tax Policy Center colleague Chris Sanchirico notes, the committee staff found that while the income from those Irish subs was not repatriated to Apple (which would have triggered U.S. tax) it did apparently did make its way back to the U.S., where it is sitting in bank accounts of those Irish subs.  

What’s the problem with all this? There is the revenue loss to the U.S., of course. But perhaps worse is  the incredible inefficiency driven by the tax code. The price of high corporate rates is the raft of deductions and credits that encourage corporations to lower their taxes rather than produce great new products.

Just imagine if Apple could replace all those tax lawyers with creative new software geeks or industrial designers. It might win back some of the market share it has been losing to Android in recent years.

True, the agency bungled its scrutiny of conservative political groups seeking tax-exemptions. But should it even be deciding which political organizations should get favored tax treatment and which should not? Why is a tax collection agency regulating political speech at all?

That this is happening at all is an accident of history. The section of the law political organizations are using to win tax-exempt status was never intended for this purpose.  Section 501(c)(4) has been around for a hundred years, but its purpose was to grant tax-exempt status to social welfare organizations such as community groups and citizens associations.

In the wake of the Supreme Court’s 2010 Citizens United decision, (c)(4) status became a popular mechanism for bankrolling political campaigns. Citizen’s United made it possible for unions and businesses to spend unlimited amounts of money on politics, but the vehicle they used for funneling cash to campaigns, Sec. 527 organizations, required public disclosure of their gifts.

501(c)(4)s are different. They can collect massive amounts of money anonymously.

But they have one restriction. Their primary purpose must be social welfare, not financing political campaigns.

And this has thrown the IRS into a cesspool. What does primary purpose mean? And what does campaigning mean? Where do you draw the line between social welfare and politicking? The law demands that the IRS make those distinctions. It must, in other words, define political speech—a role for which is seems particularly ill-suited.

IRS agents don’t have much help. The statute is murky. Case law is vague. The agency’s own guidelines require that these applications be decided on a case-by-case “facts and circumstances” basis.

So the IRS is put in an untenable position. On one hand, it has been under pressure to crack down on what some see as abuses (I wrote a Tax Vox blog urging the agency to act back in 2010). Yet, when it tried, it was rightly accused of political partisanship. True, it could have avoided much of the current mess if it was more even-handed in its investigation of these groups. But can the IRS ever define what is a permissible political activity and what is not? Should it even try?

Worse, no politician will ever defend the agency from criticism. Whatever the IRS does, elected officials of both parties will throw it under the bus at the first hint of criticism.  Just watch President Obama.

What’s the answer? Alan Viard at AEI urges Congress to write rules that better delineate political activity by tax-exempts. The New York Times has called on Congress to retain (c)(4) status but only for groups that have no political activity.

I’d get the IRS out of the political speech business entirely.  If Congress wants to regulate campaign finance, it ought to do so explicitly rather than through an ad hoc structure built around an obscure section of the tax law governing citizens associations. Congress could, for instance, simply pass a law requiring public disclosure of all campaign gifts, no matter how they are delivered. That one step would largely dry up requests for (c)(4) status.

Congress could reserve tax-exempt status for those organizations that completely eschew politics. We’d all be free to say what we want and give money to whom we want. But this activity would be entirely disconnected from tax-exempt status.  Fellow Forbes.com blogger Peter J. Reilly made a similar argument yesterday. So has Bloomberg’s Josh Barro.

I know, you’re going to ask what agency would regulate this, the Federal Elections Commission? Well, you’re right, the FEC is a punchline today.  But Congress could fix that. Besides, the FEC’s failures don’t justify dumping this mess into the lap of the IRS. Honestly, I’d rather have the Transportation Dept. regulating political speech than the IRS.

In effect, Congress and the Supreme Court have thrown the IRS into a lose-lose situation. And the agency has lost. Why are we surprised?

That any report by TIGTA is much anticipated says something about Washington these days. This one, a detailed look at how the IRS seemingly targeted tea party and other conservative groups for special scrutiny, found bureaucratic bungling and a troubling bunker mentality up and down the agency.

The cost to groups seeking tax-exempt status was not insignificant, and is troubling. TIGTA confirms that some conservative organizations were singled out for special scrutiny and faced burdensome requests for information and long delays before approving requests (though it should be noted that delays are common at the IRS).  At the very least, this raises questions about fairness and impartiality from an agency that must be above reproach.

Yet, despite dark conspiracy theories, TIGTA found no evidence of political meddling. Despite allegations that the agency singled out tea party groups for special scrutiny, of the nearly 300 cases the IRS labeled  potentially political, only one-third were identified as tea party or other conservative organizations. And not one of those 300 cases, including the conservative groups, had its application for tax-exempt status denied, though some are still pending.

However, the TIGTA report also seems to confirm a long-standing unwillingness by top IRS officials to publicly acknowledge the mess.  As often happens in Washington, the coverup may turn out to be far more problematic than the “crime.” There is some irony afoot when the same government agency that demands full transparency from 150 million taxpayers stonewalls requests for information about its own operations from Congress and news organizations.

Here is the outline of the story: From 2010 to 2012 the number of applications for 501(c)(4) tax-exempt status  doubled, from 1,700 to 3,400.

While (c)(4) status was created 100 years ago for civic leagues and other community organizations, it became a valuable tool for political organizations in recent years. One reason: It allowed groups to collect money from contributors without disclosing the source of those funds.

The test for (c)(4) status is a difficult one: A group’s primary purpose must be enhancing the social welfare. It may engage in some political activity, but this may not be its primary role. The law does not clearly describe political activity.

In March and April of 2010, mid-level IRS staffers began screening groups with names that sounded “political” such as tea party. By May, agency staffers were told “to be on the lookout” for, among other applications, requests by groups with political-sounding names, such as tea party or patriot.

When the director of the Exempt Organizations office, Lois Lerner, learned of these activities in June, 2011, she ordered that the criteria be changed. The guidelines were somewhat revised in July, but then largely restored by the team reviewing the cases. In the end, it took 18 months for the agency to finally get staff to change its policy of focusing on political views of organizations.

The result: Conservative groups were required to answer wide-ranging and often unnecessary questions, 80 percent of applications were open for a year or more, and some were open for as long as 3 years and across two election cycles. The questions appeared to be an attempt to determine how political the organizations were (which, after all, is the test for (c)(4) status). But some were frankly weird: Whether an officer of the group will run for public office in the future, or what the roles were of audience members in group programs.

In sum, TIGTA found an IRS staff scrambling to keep up with requests for tax-exempt status in an area it did not understand well.  The staff seemed unaware of the political implications of what it was doing, and was poorly managed. Senior officials seemed to be aware of the problem as early as 2011, yet could not fix it for a year and a half.

This is a huge embarrassment for the IRS and likely to make it more difficult for the agency to police groups that have stepped over the political line.  But based on what we know so far, this is no Watergate scandal.

1. Is it improper for IRS to target specific groups? 

   Almost every contact the IRS makes with select taxpayers derives from targeting. Because  its  resources are constrained, the IRS conducts only limited audits, examinations, or requests for information. For instance, if you give more than the average amount to charity, you’re more likely to be audited since there is more money at stake. If you run a small business, you have a greater ability to cheat than someone whose income is reported to IRS on a W-2 form. The only way  the IRS can  enforce compliance at a reasonable administrative cost is by targeting.

   This is especially true for the tax-exempt arena. Because audits yield little or no revenue, the IRS tax-exempt division examines very few organizations. Therefore, the IRS  must use some criteria to “target” which tax-exempt organizations to approach.

2. Does the IRS discriminate?

   Picking out which organizations or taxpayers to examine meets the definition of statistical discrimination. Firms do this when they consider only college graduates for jobs; political parties do this when they offer selective access to their supporters. Discrimination is wrong when it implies unequal treatment under the law, such as when unequal punishment is meted out for the same crime, or when people of color have less access to the mortgage market.

3. Why then did IRS say it erred in targeting Tea Party and other organizations?

   We don’t have all the data yet but organizations with a strong political orientation have a higher probability of pushing the borderline for what the law allows. The groups at the center of this controversy  generally applied for exemption under IRS section 501 (c)(4) which requires, among other things, that its primary purpose cannot be election-related and cannot overtly support political candidates.

   However, the IRS could have  identified  election-related activity as a  practice  worthy of extra attention without  specifying  “tea party” or similar labels to identify such organizations. Had it done so, it might not be facing  a problem now.

   IRS apparently initially thought it was just using these labels as a shortcut for such an identification. Had it been engaged early on, the national office might have been quicker to warn against this practice since it would tend to identify more Republican organizations than Democratic groups with similar motives. Who decided what when is still under investigation.

   Remember  IRS was under pressure  to  examine those c(4) organizations after applications grew rapidly in the wake of the  Supreme Court’s 2010 Citizens United decision. If IRS waits until after an election, it’s generally too late to make any difference.

4. Why did IRS start with the exemption process rather than wait and see how the organizations behaved?

   Because  IRS audits so few tax-exempt organizations,  noncompliance is a major problem.  But often noncompliance is inadvertent. Organizations trying to do “good” fail to understand legal technicalities or why IRS should be worried about them at all. If the IRS can get these organizations to comply with the rules from the start, it has a better chance of minimizing future problems.

5. Well, then, why the heck is IRS even in this game in the first place?

   A question asked by many. Unlike some other nations with charities’ bureaus or other government regulatory agencies, tax-exempt organizations in the U.S. are monitored mainly by IRS at the national level and the state attorneys general at the state level. The IRS efforts generally derive from the Congressional requirement that charitable dollars (for which there are deductions and exemptions) go mainly for charitable purposes and not others such as electioneering.

6. But c (4) or social welfare organizations don’t benefit from the charitable deduction, so why don’t those with political orientation just operate without tax exemption or c(4) status?

   They could, but the tax exemption  provides several benefits. The least important may be non-taxation of income from assets since many of these organizations don’t have that much in the way of assets to begin with. However, many contributors interpret (often incorrectly) tax exemption to mean that the organization has satisfied  legal hurdles, thus making it easier to raise money. Some c(4) organizations are closely connected to charities or c(3) organizations that can accept charitable contributions, and sometimes there’s a synergy between the two. My colleague Howard Gleckman reminds us that c(4)s quickly became favored over an alternative “527” tax-exempt political designation because the former does not need to reveal its donors. Finally, tax exemption provides an easy way  to insure that any temporary build-up of donations in excess of payouts is not interpreted as  taxable income to the organization or its  contributors.

7. What will be the end result of this flap?    

   Success at agencies like IRS is often measured by their ability to stay out of the news rather than on how well they  do their job.  I’m guessing this episode will only will increase the bunker-like incentives within the organization. It would be good if Congress used this as an opportunity to  figure out how better to monitor tax-exempt organizations, or whether IRS has the capability under existing laws, but that isn’t likely to happen.

But this unsavory episode should also shine a light on the law that gives tax-exempt status to political groups of all ideological stripes, often described by the code section that grants their exemption—501(c)(4)s.  That is especially true since one outcome of this scandal will be to give these partisan groups even more freedom to operate outside of at least the spirit of the law.

The only way to stop the proliferation what are often-secret campaign money laundries is for Congress to change the law that grants these groups this form of tax-exempt status.

As I wrote in a blog post back in 2010, the tax law is relatively clear about what a (c)(4) can and cannot do. The IRS defines these groups as “civic leagues, social welfare organizations, and local associations of employees.” Their net earnings are supposed to be used for charitable, educational, or recreational purposes. They may lobby and participate in political activities but their primary purpose must not be campaigning.

Thanks to smart lawyers who have exploited an outdated law, the tax-exempt status of many groups may be perfectly legal. But others simply do not pass the smell test.  Does anybody really claim the primary activity of these organizations is anything other than getting their favorite candidates elected to political office, or defeating those they disagree with?

If you have doubts, here is what one group, teaparty.org, says about itself on its website:

We are going to build on the foundation of success we used to elect more governors, grab more seats in the House of Representatives and force the Washington establishment to respect the demands of “We The People.”

In contrast to public charities organized as 501(c)(3)s, contributions to (c)(4)s are not tax-deductible. So why would they want (c)(4) status? One reason: It allows them to hide the names of their donors.

In the past, these groups would have claimed tax-exempt status as Sec. 527 organizations. There are no contribution limits, no restrictions on who may give, and no limits on how they spend their money (except they cannot advocate for a specific candidate). But 527s must disclose the names of the fat cats who use them to finance political campaigns.  And groups that thrive on political dark money will do almost anything to avoid transparency. So they walked through the (c)(4) door opened by the Supreme Court’s 2010 Citizens United decision.

Because the law is so ambiguous and because IRS scrutiny of these groups is so fraught with political landmines (as the recent unpleasantness proves), the IRS had been reluctant to review this issue all.  Now it seems, the agency took a much-needed hard look at some groups, but did so in a clumsy and seemingly partisan way.

Regrettably, by apparently focusing only on conservative (c)(4)s, the IRS has only succeeded in making all these groups—on the political right and the left– even more immune from investigation.

The solution, then, is for Congress to change the law. Many of these groups are not social welfare organizations by any reasonable standard. They clearly exist for political purposes. Many are unabashedly partisan—supporting only Democrats or only Republicans.

Last month, Sen. Tom Coburn (R-OK) introduced a bill to eliminate the tax-exempt status of professional sports leagues, such as the NFL (yes, Virginia, the NFL is tax-exempt).  That’s an excellent idea, but maybe he ought to expand it to include practitioners of America’s other favorite sport—politics.

However, the best health economists in the country are deeply divided about #2. And the implications of this disagreement are profound. If the recession was the major driver of lower health cost growth, there is a good chance that medical spending will bump up again as the economy improves, once again putting great pressure on the deficit. But if the slump was only a small part of a broader secular trend, the U.S. may have found the key to solving its long-term budget problems.

Keep in mind that all health care costs are growing more slowly, not just government-funded programs such as Medicare and Medicaid. But since TaxVox focuses its attention on fiscal issues, I’ll concentrate on the budget effects.

In a new article in the journal Health Affairs, Harvard University economists David Cutler and Nikhil Sahni estimate that medical costs grew by only 1.2 percent from 2009-2012, far below the 5.9 percent rate of 2000-2009. If the recent spending trend could somehow be sustained for the next decade, they estimate the deficit would be $770 billion less than the Congressional Budget office forecasts.

But that assumes the present trend can continue. And that in turn assumes that more is going on than  consumers beaten down by the recession buying less medical care.

How deeply do economists disagree about this diagnosis? At first glance, quite a lot. But a closer look suggests that even skeptics of the secular change argument see some hope that the worst years of health spending increases may be behind us.

For instance, while Cutler and Sahni lay only about one-third of the slowdown in health costs at the feet of the recession, an April study by researchers at the Kaiser Family Foundation and the Altarum Institute estimated that more than three-quarters was driven by the Great Recession.

In their own just-released paper, my Urban Institute colleagues John Holahan and Stacey McMorrow  focus on yet a third cause.  They agree that medical cost growth has slowed in response to economic trends, but they focus on changes that are broader than, and predate, the recession. They blame a combination of falling real incomes and the loss of insurance benefits as employers offer less generous coverage, people lose coverage entirely, or  get coverage through public programs. They argue both trends are drawing money out of the medical system and forcing providers to operate more efficiently.

But here is where it gets interesting.  While their analyses differ on causes, the authors of all these studies agree that there is at least the potential for secular changes to slow costs in the future. And none are especially certain about the magnitude.

Even the authors of the Kaiser/Altarum paper, Kaiser’s Larry Levitt and Gary Claxton; Altarum’s Charles Roehrig; and Thomas Getzen of the Fox School of Business at Temple University, say changes in practice patterns, driven by both the ACA and economics, could slow future cost growth. Their main argument is it far too soon for cost changes from the payment and delivery reforms of the 2010 Affordable Care Act to show up in current cost statistics, not that these reforms won’t eventually slow spending by measurable amounts.

Of course, cost savings from more efficient delivery of care is likely to be partially offset by an increase in the demand for medical care driven by the ACA’s major goal–increasing the number of consumers with health insurance.

And even Cutler, who sees real secular change in health costs, acknowledges he can only speculate on what’s happening.  For him, while the recession’s role in the health spending slowdown was modest, the true causes remain only ideas for conjecture: Some combination of changing technology, increased cost-sharing by patients, and greater efficiency by providers.

Are we seeing the bow-wave of a permanent trend as Cutler believes?  I see real changes in health care delivery. But will they stick and both save money and improve health outcomes? In truth, no-one knows.

The answers will go far beyond federal budgets, but they are sure to drive the fiscal debate in some important and perhaps unexpected ways.

It is 568 pages long, doesn’t have much of a plot, has no character development (unless you are good at reading between the lines) and sort of peters out at the end. Yet, it is likely to prove an invaluable resource as tax reform moves ahead.

Think of it as the ballpark program you pick up before a baseball game.  You can watch the game without it, but it is much more fun if you can keep score and know a little something about who plays for the visiting team.

The report is divided into three parts. The first is a brief summary of the revenue code. Each provision of the law gets explained in a couple of sentences or, sometimes, a few paragraphs. You’ll learn about everything from adoption assistance to retirement plans, and from the tax treatment of U.S. territories to depreciation of manufacturing equipment.

And, btw, it answers the musical question: How long does it take to describe the federal tax law in this shorthand? Answer: 444 single-spaced pages.  

The second section summarizes a dozen different tax reform plans—ranging from President George W. Bush’s 2005 reform commission report to President Obama’s fiscal commission plan (aka Bowles-Simpson), and including proposals from the liberal Economic Policy Institute to the conservative Heritage Foundation (Full disclosure: the Tax Policy Center provided technical analysis for many of these plans).

The third section attempts to summarize public comments to the House Ways & Means Committee’s tax reform working groups. This section describes, in JCT’s best “just the facts” tone, the wide range of ideas presented to the work groups. They can be summarized like this: Keep the government’s filthy hands off my tax break.

The plot of the JCT tome, then, reads something like this: The tax code is mind-numbingly complicated and economically inefficient. Just about every reform plan from presidents Bush to Obama and across the spectrum of think-tanks would trim or even eliminate many of the tax code’s $1 trillion+ in preferences. Yet, pretty much every lobbyist who commented to the Ways & Means working groups echoed the long-ago doggerel of former Senate Finance Committee chairman Russell Long—“Don’t tax me, don’t tax thee, tax the fella behind the tree.”

And there we stand.

Nonetheless, download the JCT’s report. You’ll find yourself looking at it often.

That non-dynamic approach works well for most legislation CBO and JCT consider, with occasional concerns when large tax or spending proposals might have material macroeconomic impacts.

That approach makes no sense, however, for immigration reforms that would directly increase the population and labor force. Consider, for example, an immigration policy that would boost the U.S. population by 8 million over ten years and add 3.5 million new workers. If CBO and JCT tried to hold population constant in their estimates, they’d have to assume that 8 million existing residents would leave to make room for the newcomers. That makes no sense. If they allowed the population to rise, but kept employment constant, they’d have to assume a 3.5 million increase in unemployment. That makes no sense. And if they allowed employment to expand, but kept GDP constant, they’d have to assume a sharp drop in U.S. productivity and wages. That makes no sense.

Because increased immigration has such a direct economic effect, the only logical thing to do is explicitly score the budget impacts of increased population and employment. And that’s exactly what CBO and JCT intend to do. In a letter to House Budget Committee Chairman Paul Ryan on Thursday, CBO Director Doug Elmendorf explained that the two agencies would follow the same approach they used back in 2006, the last time Congress considered (but did not pass) major immigration reforms.

In scoring the 2006 legislation, JCT estimated how higher employment would boost total wages and thus increase income and payroll taxes, and CBO estimated how a bigger population would boost spending on programs like Medicaid, Food Stamps, and Social Security. They found that the legislation would boost revenues by $66 billion over the 2007-2016 budget window and would boost mandatory spending by $54 billion; various provisions also authorized another $25 billion in discretionary spending subject to future appropriations decisions.

I remember that estimate well since I was then CBO’s acting director. At the time, I thought this was a pretty big deal, doing a dynamic score of a major piece of legislation. I expected some reaction or controversy. Instead, we got crickets. It just wasn’t a big deal. The direct economic effects of expanded immigration—bigger population, bigger work force, more wages—were so straightforward that folks accepted this exception from standard protocol. I hope the same is true this time around.

Note: The approach CBO and JCT will use in scoring immigration legislation is only partially dynamic. It accounts for the direct effects of increased immigration, such as a bigger population and labor force, but not indirect effects such as changing investment. In other words, it follows the standard convention of excluding indirect changes in the macroeconomy; the innovation is accounting for the direct effects. We used the same approach in 2006, analyzing indirect effects in a companion report separate from the official budget score. CBO and JCT will take the same approach this time around.

In an attempt to surmount those hurdles, two highly-respected international tax economists have proposed an intriguing solution—a corporate minimum tax that allows firms to immediately expense the costs of their foreign investments instead of depreciating them over a period of years.

The proposal was devised by Rosanne Altshuler of Rutgers University (a former director of the Tax Policy Center) and Harry Grubert, a career economist at the Treasury Dept. While Grubert works for the Treasury, the proposal in no way represents the views of the Treasury or the Obama Administration which, in fact, has proposed its own, quite different international tax plans.

There are two basic problems with the taxation of multinational corporations:

U.S.-based multinationals face a 35 percent statutory rate, the highest in the world when combined with the average state corporate tax. They must pay this tax on profits they earn in the U.S as well as on overseas earnings returned home. Yet they must compete with overseas firms that pay low tax rates on their own domestic investments and no additional home country tax on active profits from investments in other countries (including the U.S).

At the same time, U.S.-based multinationals have lots of ways to drive down their effective tax rates. To oversimplify a bit, they pile as much income as possible into foreign subsidiaries that are located in very low-tax jurisdictions. At the same time, they load as many expenses as they can on to their U.S. entities where tax deductions are more valuable (a deduction is worth 35 cents on the dollar here, but only one-third of that in Ireland, where the rate is 12.5 percent).

This all works because the U.S. allows companies to defer U.S. tax on foreign earnings until those profits are returned to the U.S. And many multinationals never bring the money home. By some estimates, $2 trillion in foreign profits are stashed overseas.

Rosanne and Harry estimate that nearly half of this foreign income is subject to tax rates of less than 10 percent. And, they calculate that the marginal effective tax rate on investment by a U.S. firm in a low-tax country is, remarkably, a negative 24 percent.

How can the U.S. stop this erosion of the corporate tax base while keeping U.S. based firms competitive in international markets? There is no simple solution. Obama has proposed a couple of plans. House Ways & Means Committee chair Dave Camp (R-MI) has laid out three options. But each idea has problems, including great complexity that itself opens the door to more gaming.

Grubert and Altshuler have devised what many think is an elegant solution to both the competitivesness and the base erosion problems. They’d do it through a series of trade-offs. U.S. firms could effectively exempt from U.S. tax their normal profits from actual overseas investments by deducting their capital costs. They could also avoid tax on the dividends they bring home from foreign subsidiaries. But they’d have to pay a 15 minimum tax on the income of their overseas affiliates. As a result, they’d lose some of the tax benefits of artificially shifting income to low-tax countries by, say, moving patents or the value of their brand to offshore subsidiaries.

They’ve developed two versions of the minimum tax. One would require firms to calculate their tax separately for each country in which they do business. The second would allow firms to aggregate their tax liability across all countries.

Either way, the minimum tax dramatically increases effective taxes on foreign investment—money that could be used to buy down U.S. corporate tax rates, reduce the deficit, or both. Grubert and Altshuler figure the rate on investment in a low-tax country would rise to a negative 4.4 percent under the per-country version, far higher than the negative 24 percent under current law.

Strange as it sounds, their goal is to raise the effective tax rate on foreign investments by U.S.-based multinationals to zero, or close to it.

This is complicated stuff and international tax experts will surely identify problems with Grubert-Altshuler plan. At a conference last week cosponsored by the American Tax Policy Institute and Rice University’s Baker Institute, General Electric’s tax guru John Samuels raised a long list of concerns. But even John praised their idea as a “fresh look” at a vexing problem.

We are just beginning what will be a very long and complicated discussion. But the Grubert-Altshuler paper makes the conversation much richer.

The congressional Joint Committee on Taxation estimates the mortgage interest deduction will cost $380 billion over the next five years, making it one of the largest individual tax preferences in the Internal Revenue Code. The Urban-Brookings Tax Policy Center estimates that 40 million taxpayers will benefit from the deduction in 2015.

In spite of its widespread use and large fiscal cost, the deduction does little to promote home ownership. It provides no subsidy to the nearly two-thirds of taxpayers who do not itemize and only a modest subsidy to those in the 15 percent bracket.

The subsidy’s value is largest for families in high tax brackets who are most likely to own a home even without preferential tax treatment. Instead of promoting more home ownership, the deduction mostly encourages those who already own homes to buy larger and more expensive houses with borrowed money.

If Congress wants to encourage homeownership, it could direct more of the tax subsidy to prospective homebuyers who straddle the line between renting and buying. Two ways to better target the subsidy: Replace the deduction with a uniform percentage tax credit for mortgage interest, or provide an investment credit for first-time home purchases.

Replacing the deduction with an interest credit has enjoyed bi-partisan support. It’s been endorsed by the federal tax reform panel appointed in 2005 by President George W. Bush, the National Commission on Fiscal Responsibility and Reform appointed by President Obama, and the Debt Reduction Task Force of the Bipartisan Policy Center.

In my written testimony, I provided estimates for the effects of four potential reforms:

• Eliminating the deduction.
• Limiting it to interest on the first $500,000 of home acquisition debt.
• Replacing it with a 15 percent refundable credit on the first $25,000 of eligible interest.
• Switching to a 20 percent non-refundable credit for interest on the first $500,000 of home acquisition debt.

All these options would raise taxes and reduce the subsidy– mostly for upper-middle income taxpayers. Replacing the deduction with a credit would reduce tax burdens on average and increase the housing subsidy for those in the bottom 80 percent of the income distribution.

The revenue gains from all these options would be smaller if they are part of a broader tax reform that lowers marginal individual income tax rates. In that case, some options would even lose money. With lower rates, eliminating deductions raises less money, but new credits would cost just as much.

It is important to recognize that proposals to pare back the mortgage interest deduction could adversely affect housing prices, though how much of a hit they’d take is uncertain at best. Introducing reforms gradually would reduce risks to the housing market, though such transition rules would delay both the revenue gains and the improved incentives from the reforms.

The current mortgage interest deduction is hard to justify on policy grounds. Implementing policy reforms such as those I presented to the committee would encourage more homeownership at a lower fiscal cost. But designing appropriate transition rules that reduce market disruptions while simultaneously retaining the benefits of reforming the mortgage interest deduction will be challenging.

The upbeat argument goes like this: By announcing that he will not run for reelection in 2014, Baucus is free from the pressures of being a Democrat in a very red state. No longer will he fear tilting too far from his conservative constituents—a concern that helped drive his well-known caution when it came to Democratic priorities such as the 2010 Affordable Care Act and, more recently, background checks for gun buyers, taxes on Internet sales, and even the party’s own budget.

In addition, the optimists say, tax reform would be a wonderful political legacy for both Baucus and House Ways & Means Committee Chairman Dave Camp (R-MI), whose own chairmanship is term-limited after 2014. Thus, the two have both the freedom and the sense of urgency needed to drive politically-challenging reform.

All that may be true, but here’s why it may not result in a tax code rewrite. 

Being a lame duck may be liberating, it also makes a politician a rapidly-depreciating asset. Baucus’s clout with his committee and the Senate leadership (already weak) will fade. His senior staff, looking to leverage its connections while the boss is still around, will rapidly decamp for K St. or other Senate offices. And Senate liberals may think they’ll get a better hearing from the panel’s next chair, most likely Ron Wyden of Oregon.

The biggest challenge, though, remains the nitty-gritty of tax reform itself.

At a Ways & Means hearing today, economists and housing industry representatives weighed in on reworking the housing subsidies that litter the tax code. To the surprise of no one, most of the economists (including my Tax Policy Center colleague Eric Toder) urged the panel to at least restructure the Mortgage Interest Deduction and other housing-related preferences. The industry…well, the industry did not.  

Then, there is the matter of revenues. Baucus, like Camp, prefers a reform that lowers rates and scales back tax preferences but raises the same amount of money as the current Revenue Code. This base-broadening, revenue-neutral reform was the model of the 1986 Tax Reform Act, but it is not the goal of President Obama and many Senate Democrats. They insist on using reform as a vehicle for raising hundreds of billions of dollars in new revenues.

Camp, by contrast, must answer to a GOP caucus for whom this idea is toxic. And House Republicans seem to be digging ever more deeply into their ideological trenches.

Just yesterday, rank and file Republicans forced their own leadership to pull a bill aimed at making it easier for people with pre-existing conditions to buy health insurance. The leadership wanted to show it recognizes the need for this population get coverage. The rank and file wants only another vote to repeal Obamacare.

Similarly, few see a path through the House for either immigration reform or the Internet sales tax bill, though both have broad bipartisan support in the Senate. All this means that the great dividing line of tax reform—new revenue or no new revenue—grows ever-sharper. And it is hard to imagine that Baucus and Camp can bridge it, even if they want to.

However, there is a kind of tax reform Baucus might be able to help pull off before riding off into the Montana sunset. It isn’t a full-blown rebuild of the Code. It is, rather, a major spring cleaning.

Baucus and Camp might be able to engineer a measure that simplifies key elements of the tax law. For instance, they could improve the operation of refundable credits for low and moderate income families as my TPC colleague Elaine Maag has proposed. They could rationalize the dozens of tax-favored savings vehicles that confound workers, improve tax breaks for education as TPC’s Kim Rueben has proposed, or restructure the subsidy for charitable giving in a way that generates new revenue while not discouraging philanthropy as TPC’s Gene Steuerle has urged.

Baucus and Camp do have an opportunity here. It may not be a once-in-a-generation rewrite of the tax code, but it is a chance to vastly improve what we have. And that’s a pretty good legacy.

It is not a tax increase. In most states, if you buy a good or service subject to sales tax you already owe the tax whether you purchase online or in a store. The dispute is merely over who collects it. If you buy on Main Street or in the mall, the seller collects the tax and remits it to the state. If you buy online and the seller does not collect the tax, you still must pay an equivalent use tax when you file your state income tax return.

True, almost no one does this and states rarely enforce their use tax laws, but that’s not the point. Legally, you already owe the tax. Fundamentally, this is a matter of tax compliance, not tax levels.   

It is a back-door way for states to collect more tax revenue. While it isn’t a tax hike, it clearly will generate more revenue for states. But if you think taxes are too high or government is too big, then you should try to get states to lower or even repeal taxes. Indeed, making online sellers collect taxes ought to make it easier to lower tax rates.   

It is not an “Internet tax.” The bill does not give states the power to tax access to the Web, the cloud, or even securities transactions, as some fear. All sorts of interests have raised the specter of a digital camel sticking its nose under the tax tent. But there is nothing in the bill that gives state the authority to tax this other stuff. In fact, the bill’s Section 3 explicitly bars states from using the law to try to impose new levies on products or services that are not now taxed.

It will not complicate life for buyers. In fact, it will simplify their lives. Those few of us who pay the use tax will finally be able to throw away our receipts. And while today almost no one can keep track of what is taxable and what is not, the law encourages states to participate in a multistate effort to simplify sales taxes.   

It will not burden online sellers. The law exempts firms with less than $1 million in sales from collecting sales taxes. It requires states to provide sellers with the information they need to determine rates in multiple jurisdictions. It even requires states to give sellers free software to calculate the tax. And, if that isn’t enough, credit card companies and payment firms such as PayPal can easily do this at practically no additional cost. There may, in fact, be no tax that is easier to collect.

Remarkably, Congress has failed to solve this problem for nearly a half-century. The Supreme Court first recognized tax complexity problems for interstate sellers in 1967. In 1992, in a case called Quill v. North Dakota, the High Court practically begged Congress to sort out the mess. In 1999, Congress responded by doing what it often does when it doesn’t want to tackle a problem. It created a commission.

Finally, 21 years after Quill, the Senate may finally address the issue. It remains to be seen whether the  House, dominated by tax-phobes, will do the same. But after two decades, it is long past time for Congress to sort this out—and get past the myths that delayed action for so long.           

It was different this time.  State and local governments addressed looming budget gaps by cutting expenditures. Instead of contributing to growth, their budget cuts dragged down the recession even further. And when the economy turned a corner in mid-2009, state and local government consumption (i.e., current spending on government programs like police and fire departments, education, and health) and investment remained depressed—a big reason why the recovery has been so weak.

In a new paper, my Tax Policy Center colleague Yuri Shadunsky and I show what happened. Never before had the state and local consumption and investment been negative three years into a recovery, but in 2009, it was down by about 4 percent (see chart immediately below).

What was different? First, the Great Recession was longer and more destructive than any other post-war recession. The severity meant that many state rainy-day funds, which had been replenished after the 2001 recession and are designed to help states weather downturns, were insufficient to protect against the slump.  Second, state and local governments were reluctant to sufficiently raise taxes to cover the decline in revenue (many states did raise taxes through higher rates or base broadening, but these measures replaced only a fraction of the lost revenue due to the recession). And third, the steep decline in housing prices meant that property tax revenues collapsed, though this took a while because assessments often lag changes in market value.

Like the decline in state and local consumption and investment, this fall in property tax revenue was unprecedented. In prior recoveries, inflation-adjusted property tax revenue typically grew by 10 percent three years after the recession had ended. But in 2009, property tax revenue was down by 1 percent (see chart below).

These trends reinforce what millions of homeowners and the long-term unemployed already know: This recession and subsequent recovery are very, very different.

This is big news.  Two years ago, Senate Finance Committee Chairman Max Baucus (D-MT) refused to send the bill to the Senate floor.

So this year, Reid is bypassing the committee.  The idea has growing bipartisan support among the nation’s governors–many of whom are strapped for tax revenues. A few weeks ago, 75 senators voted to include it in the non-binding Senate budget resolution, and an identical version in the House appears to have support. That sounds promising.

This year’s bill doesn’t differ much from the 2011 version, but it does increase the threshold for covered businesses to firms with sales over $1 million, making it easier for small business groups to stomach. And if it really does bring in the millions of dollars promised, it might make up for the sequester’s cuts in just about every program that helps states.

Let’s see what the Senate does and, if the Senate OKs the bill, what happens in the House.  As I said in February, this might be the year the decades old impasse over taxing remote sales is finally resolved.

According to new estimates by my colleagues at the Tax Policy Center, nearly everyone making $1 million and above would pay more in 2015. Obama’s tax changes (including individual, corporate, estate, and excise tax hikes), would boost their taxes by an average of almost $83,000. Such a change would trim their after-tax income by 3.8 percent.

Obama would boost their average federal tax rate to a hair above 41 percent, an increase of 2.3 percentage points from today’s law.

Overall, those making a million and up would pay 60 percent of the tax increases, and those in the top 5 percent (who make more than $227,000) would pay 85 percent of the new taxes.

Middle-income households would also pay more than under today’s law, but not much more. Those making between $50,000 and $75,000 would face an average tax hike of about $60 in 2015, trimming their after-tax income by 0.1 percent. Overall, these households would pay about 2 percent of all the new taxes though they represent about one-sixth of all taxpayers.

Those making between $100,000 and $200,000 would also pay a bit more—about $150 on average—and their after-tax income would be cut by about 0.1 percent. While these households represent about 14 percent of all taxpayers, they’d pay roughly 4 percent of Obama’s proposed tax hike .

The story would be a bit different by 2023. A key provision of Obama’s plan—changing the way the income tax is indexed for inflation to a system known as the chained Consumer Price Index—would slowly but steadily raise taxes. Thus, middle-income households would pay a larger share of their incomes in taxes in a decade than in 2015. At the same time, Obama would extend his 2009 tax cuts for low-income families with children and those going to college beyond their 2017 expiration date, reducing taxes for those households.

Those households making between $100,000 and $200,000 would end up paying an average of about $380 more in 2023, up from $150 in 2015. And their share of the total tax hike would nearly double to a bit more than 7 percent.

Obama’s budget included dozens of changes to the revenue code–raising some taxes and cutting others. They include tax increases for high-income households and both tax cuts and tax hikes for others.

His proposed increase in the tobacco tax would disproportionately affect low- and moderate-income taxpayers, who spend a bigger share of their income on cigarettes than the wealthy. However, middle-income households would benefit from two other tax changes: a more generous child and dependent care tax credit, and Obama’s proposal to extend those relatively generous rules for the earned income credit, child tax credit, and education credit.

For high-income taxpayers, the news is nearly all bad. Obama would limit the value of itemized deductions and some other tax preferences to 28 percent, limit the benefits of large tax-favored retirement accounts, adopt a version of the Buffett Rule by imposing a Fair Share minimum tax of 30 percent of adjusted gross income over $1 million (less a charitable credit), and raise taxes on estates, gifts, and certain family trusts.

For the most part, Obama’s tax plan would do exactly what he promised: It would raise taxes by about $1 trillion (at least by his measure) over the next decade. And most, but not quite all, of those new revenues would come from those making $200,000 or more. The president stepped over his no-taxes line-in-the-sand for those making less, but not by much more than the length of his big toe.

But by Tax Day, two of those governors, Jindal and Heineman, had abandoned their plans, at least for this year. In North Carolina, McCrory and House Republicans appear to be scaling back their ambitions.

What happened? Pretty simple really. The chief executives thought they could pay for abolishing their income taxes by boosting sales tax revenues. They’d do it by raising sales tax rates and eliminating exemptions. For instance, many services that are now exempt from sales tax would become subject to the levy.

Instead, the exercise became an object lesson in special interest politics. Much of the business community (especially those firms whose goods and services are now exempt from the sales tax) rose up in revolt. So did local governments that saw their own sales tax revenues jeopardized by a big new state levy. 

Even in theory, replacing an income tax with a sales tax is controversial. The idea, which has been heavily promoted among GOP governors by the American Legislative Exchange Council (ALEC), as well as economist Arthur Laffer and Wall Street Journal editorial writer Steve Moore, attracted a lot of initial attention. Backers argued it would boost state economies and produce more revenue than the existing system.

However, critics strongly objected, arguing that such as swap would raise taxes for low-income households, lower them for the wealthy, and reduce state revenue overall.  

There is little evidence that eliminating state income taxes boost economic growth, or that such a step would generate enough revenue so the tax cut would pay for itself.

In general, consumption taxes are regressive since low-income households spend more of their income and thus would pay a larger share of their income in sales taxes. In systems that include both consumption and income taxes, this problem can be addressed with an income tax credit. Without an income tax, it is harder to provide such a rebate.

The costs and benefits of an income-for-consumption tax swap are worth debating. But the states never got that far. Without the offsetting hikes in sales taxes, repealing the corporate and individual income tax is nothing more than a huge, revenue-losing tax cut. And that seemed to be where states such as Louisiana and Nebraska were heading before their governors pulled the plug.

Last year, Kansas found itself in a similar situation. Governor Sam Brownback proposed an income tax reform that would have cut rates while eliminating most tax preferences. This too was intended to be a first step towards eliminating the income tax. One of the most controversial provisions exempted income of pass-through entities, such as partnerships, from the state income tax.

The legislature happily passed the rate cut but stripped out the base-broadeners, leaving the state with a $231 million fiscal hole in 2013 and an $803 million gap in 2014. Legislators vowed to fill the hole with spending cuts, but they have not yet identified them. Now, Kansas is taking another run at cutting income tax rates but critics are again balking at efforts to find offsetting revenues. Thus, Kansas-style tax reform could once again be little more than another tax cut.

The lesson for tax reformers seems clear: It is much easier for politicians to cut rates than it is to finance them with offsetting tax hikes. As a result, the road to reform can too easily detour into a tax cut for all (or, at least, for most).       

Here’s how the child care exclusion and CDCTC work. The exclusion allows me to set aside up to $5,000 from my salary to pay for child care expenses (regardless of the number of children I have) and exclude that from taxable income. However, I can only take the exclusion if my employer offers this benefit.

The credit applies to as much as $3,000 of child care expenses per child, to a maximum of $6,000. Unlike the Child Tax Credit (CTC) – which is refundable, the CDCTC is nonrefundable. It only benefits families with child care expenses who owe federal income taxes. The actual amount of the CDCTC depends on my adjusted gross income (AGI), and ranges from 35 percent of expenses for parents with AGI up to $15,000 down to 20 percent for those with AGI over $43,000.

Higher income parents tend to benefit more from the exclusion while middle-income parents are the primary beneficiaries of the credit. Because the credit only goes to families who owe taxes, very low-income families benefit more from the exclusion (because they don’t owe payroll taxes on the excluded income). However, relatively few of these workers  have access to the exclusion because their employers are less likely to let them put aside pre-tax child care dollars.

I can receive benefits from both provisions. However, I must count different expenses for both s and when I calculate my child care credit, I must subtract the expenses already excluded from my income from my maximum allowable child care credit expenses. In my case, I exclude the maximum $5,000 of child care expenses from my taxable wages and claim the credit on $1,000 of expenses.

Sound confusing? It is. But it doesn’t have to be. Congress could set the same maximum allowable expenses for both benefits and limit parents to using only one. Congress could simplify more by eliminating the exclusion that provided $1.5 billion in tax benefits in FY2012 and keep the credit that provided $3.4 billion in tax benefits in FY2012. People currently using the exclusion would likely shift to the credit. .

On one hand, the exclusion makes sense if one considers child care a cost of earning income. But in practice, the credit is more popular, the plans allowing the exclusion are offered to less than one-third of employees, and eliminating the exclusion would simplify child care tax benefits for both parents and employee benefits’ offices. My own tax liability would increase.

Making expense limits uniform or getting rid of at least one provision It would be a good way to declutter the tax code, even if we can’t get broad tax reform.

After some digging into the weeds, I pulled together the following summary to answer that question:

 
The proposal would increase revenue by $750 billion over the next decade. Much media coverage has been incorrectly suggesting an increase of either $580 billion (revenue from limiting tax breaks for high-income taxpayers and implementing a “Buffett Rule”) or $680 billion (adding in the revenue that would come from using chained CPI to index parameters in the tax code).

But there’s another $67 billion in additional revenue. Almost $47 billion would come from greater funding for IRS enforcement efforts that lead to higher collections. To get that funding, Congress must raise something known as a “program integrity cap.” The administration thus lists this as a spending policy, but the budget impact shows up as higher revenues (assuming it works—such spend-money-to-make-money proposals don’t always go as well as claimed, although there is evidence that IRS ones can). Several similar administrative changes in Social Security and unemployment insurance add almost $1 billion more.

Another $20 billion would come from increasing federal employee contributions to pension plans. That sounds like a compensation cut to me and, I bet, to affected workers, and would be implemented through spending legislation. Under official budget accounting rules, however, it shows up as extra revenue as well.

In total, then, “spending” policies would generate more than $67 billion in new revenue.

Taken as a whole, the president’s deficit reduction proposal includes $750 billion in revenue increases, $808 billion in programmatic spending cuts, and $202 billion in associated debt service savings. The proposal thus involves about $1.1 in programmatic spending cuts for every $1 of additional revenue.

At least according to traditional budget accounting. If you believe (as I do) that many tax breaks are effectively spending in disguise, the ratio of spending cuts to tax increases looks much higher. From that perspective, much of the $529 billion that the president would raise by limiting deductions, exemptions, and exclusions for high-income taxpayers should really be viewed as a broadly-defined spending cut. I haven’t had a chance to estimate how much of that really is cutting hidden spending, but even if only three-quarters is, the ratio of broadly-defined spending cuts to tax increases would be 3.5-to-1.

Under current law, annual defined-benefit distributions are limited to $205,000 per plan. The president’s proposal extends the limitation to defined-contribution accounts like 401(k)s and IRAs and recognizes that, unlike in the past, individuals may have multiple pensions. If the combined value of a worker’s retirement accounts exceeds the amount necessary to provide a $205,000 annuity, they can no longer receive tax benefits for retirement saving. As under current law, the maximum benefit level would be indexed to the cost-of-living and would be sensitive to interest rates, which determine the price of an annuity. This year, the cap would affect individuals with defined-contribution account balances exceeding about $3.4 million.

The absence of a cap on defined-contribution accounts allows some high-income workers to shield large amounts of saving from tax. A worker and his employer can contribute up to $51,000 each year to a workplace retirement account (a worker can contribute up to $17,500 on their own) and a worker without a retirement plan can generally contribute $5,500 annually to an IRA. Limits are higher for workers over age 50, and contributions can be made regardless of an account’s balance. The president’s plan would disallow new contributions if account balances exceed the limit, although balances could still grow tax-free.

One analysis estimated that the cap would apply to only one in a thousand current account holders aged 60 and older and would eventually affect just one in a hundred current workers later in their careers. While there are caveats with the analysis—the data are for 2011 and do not include defined-benefit pensions—the point remains that the proposal would affect few workers now or in the future.

Wouldn’t the president’s limit discourage saving? Probably not. Research has found that tax incentives for retirement saving have only miniscule impacts on overall net saving—contributions to retirement accounts mostly represent saving that would have happened anyway.

Besides, whether the president’s limit would reduce incentives to save is the wrong question. We should be asking whether it’s worth nearly $10 billion in tax breaks over the next decade—the amount of revenue this provision would save—to encourage wealthy, mostly elderly households to save perhaps a little bit more. The answer, especially for those who think the tax code is too riddled with tax expenditures, is that it’s not.

The first repeats his proposal to cap at 28 percent the value of itemized deductions and specified exclusions, which would raise $530 billion over ten years. The president has pushed this idea in each of his five budgets, expanding it last year to include selected exclusions ranging from interest on municipal bonds to employer-paid health insurance premiums.

This year’s new wrinkle would extend the limitation to some taxpayers with income below Obama’s threshold for being rich—$250,000 for couples and $200,000 for singles. That will surely elicit howls from Obama’s critics on the left and the right, but it does recognize implicitly the budgetary need to raise taxes on more than just the top 2 percent of households.

Obama’s other bite on the rich is a Buffett Rule that would ensure that high-income households pay at least a minimum percentage of their income in taxes. Until now, the president has only spoken aspirationally about this idea. But his budget includes a concrete plan, dubbed the Fair Share Tax, or FST, that would collect $53 billion over ten years (and $99 billion if Congress doesn’t raise taxes on the rich with the 28 percent cap).

Obama’s goal is to keep the rich from taking advantage of tax preferences that allow them to pay low effective tax rates. Billionaire Warren Buffett raised this issue with stories about his secretary paying a higher tax rate than he does, and it resurfaced during the 2012 presidential campaign amid complaints about Mitt Romney’s 13 percent effective income tax rate.

But it turns out that setting a floor on the taxes rich people pay is not so easy. It is complicated and messy, and might not even accomplish its intended goal.

The FST would be a new minimum tax that requires rich taxpayers to pay at least 30 percent of their adjusted gross income (AGI) in federal taxes, with the rule phasing in between $1 million and $2 million of AGI (indexed for inflation).

But it would have exceptions. To protect charitable contributions, affected taxpayers could claim a credit equal to 28 percent of their deductible gifts. They could also count any alternative minimum tax liability, the 3.8 percent Obamacare tax on investment income, and the employee share of payroll taxes toward the 30 percent minimum tax.

And there are at least two other problems. First, the rich—particularly those who benefit from reduced tax rates on dividend and capital gains income—pay a disproportionate share of the corporate income tax, which is not included in the Buffett Rule calculation. TPC estimates that the corporate tax boosts the effective tax rate of the highest-income 1 percent by 7.5 percentage points, more than five times the rate for the bottom 90 percent. Excluding that tax understates the taxes the rich already pay.

But worse, the FST would be a new alternative tax with all of the problems of the one we have now. If the president does not like the fact that certain tax preferences allow rich people to pay less tax, he should reform the preferences, not layer on another tax of people who use them. That not only complicates the tax code but also makes the whole system less transparent.

We can disagree about whether Congress should raise more revenue and, if so, whether it should do so by raising taxes on the rich. But even if you think the answer to both question is yes, adding another minimum tax is not the way to do it.

But what about the bottom line? How does Obama’s latest tax and spending plan compare to the versions already passed by the Democratic Senate and the Republican House?  There are massive differences between the President and the GOP over the size of government and its spending priorities. But, remarkably, for the all the heated rhetoric, the gap between the 2014 revenues in Obama’s budget and those of the House is vanishingly small.

To be sure, that fissure widens significantly over the years. But for 2014 at least, the amount of money Obama and the House would raise is surprisingly similar.

The real differences between Obama and the GOP, at least in the short run, are not about total revenues at all. They are about who would pay those taxes.

To avoid inevitable and ultimately fruitless arguments about baselines, I didn’t compare how much these budgets would change spending or revenues. Instead, I looked at how much money each would collect in revenues and how much it would spend in 2014 and in 2023, in nominal dollars and as a share of the Gross Domestic Product.

First, take a look at what happens in 2014:

Since there is almost no chance of a fiscal Grand Bargain, Obama and Congress will spend most of the coming months arguing over the budget for the coming fiscal year only. In 2014, Obama would spend almost $3.8 trillion or 22.2 percent of GDP and collect $3.034 trillion or 17.8 percent of GDP in revenues, creating a deficit of 4.4 percent of GDP.

By contrast, the House budget would spend about $3.5 trillion, or 21.2 percent of GDP in 2014, and it would collect $3.003 trillion in revenues, or about 18 percent of GDP, creating a deficit of about 3.2 percent of GDP, or $530 billion.

The Senate budget framework would spend about $3.7 trillion, or 22.3 percent of GDP, and raise $3.023 trillion, for a deficit of about $700 billion.

Instead of rounding the revenue estimates, I used the exact numbers in each budget to make the obvious point: For 2014, at least, the revenue differences among the three fiscal plans are a rounding error –the federal equivalent of lost change in the sofa cushions.

At least when it comes to the budget for 2014, Obama and the House Republicans have gone to the mattresses over $21 billion–a tiny fraction of the $3+ trillion the government will collect.

There is a real difference when it comes to spending, of course.  Obama would spend about $250 billion more in 2014 than the House GOP and about $60 billion more than the Senate.

Now, take a look at 2023:

The picture is very different when you look out 10 years. By 2023, Obama would raise and spend far more than the House GOP. He’d raise a bit more and spend a little less than the Senate.

By 2023, Obama would spend about $5.7 trillion or 21.7 percent of GDP, while raising about $5.2 trillion or 20.0 percent of GDP, leaving the nation with a deficit of about $440 billion or 1.7 percent of GDP.

Most economists would say that’s pretty manageable, if it could be sustained. But the House budget describes a very different vision. It would wipe out the deficit. But more important, it would slash spending in 2023 to just 19.1 percent of GDP (with revenues obviously the same).

The Senate would more or less split the difference. It would raise about 19.8 percent of GDP in revenues—more than the House, but not wildly more. Here too the biggest difference is in spending, where the Senate  calls for 21.9 percent of GDP in 2023 outlays, almost three full percentage points or about $800 billion more than the House.

It appears that none of these three budgets is going anywhere. Yet they tell an important story about where the big differences lie between Obama and congressional Republicans—and where they do not.

Liberal Social Security advocates are furious. By shifting to a measure called the chained Consumer Price Index, the retirement system would boost benefits by a bit less each year than under the current formula, a gradual change whose bite would grow over time. These advocates are vowing to kill the idea dead. This is something of a conversation-stopper.

Here’s a better idea: Use this technical change as an opportunity to redesign the retirement program. Most Social Security experts, no matter their political persuasion, know this must be done. Why not do it now?

While there may be broad disagreement on the solutions, there is a fairly strong consensus on the nature of the problem. Social Security has done a remarkable job of reducing poverty among the elderly. But its design is badly outdated, better reflecting the nature of work and family structure in 1935 than in 2013. And it has insufficient resources to pay all promised future benefits.

Here are just four of its design problems:

Benefits are insufficient for long-time low-wage workers, never-married and divorced women, and many widows.

Benefits are insufficient for the very old, who often face significant long-term care needs not covered by Medicare.

Social Security encourages many people to stop working at age 62 when they could–and probably should—work longer.

Social Security Disability is both a policy and administrative catastrophe. It encourages fraud and discourages people who could work from doing so.

Overall, Social Security provides about 37 percent of all income for Americans 65 and older. For those in the bottom 20 percent of incomes, it accounts for nearly 85 percent. Yet the Center for Retirement Research at Boston College estimates that even with Social Security, 61 percent of low-income households were at risk in 2010 of not maintaining their (already low) standard of living once they turned 65. Why not do something about that?

There are literally dozens of ways to fix the problems of financing and benefit adequacy.  Melissa Favreault and her colleagues at Urban Institute’s Retirement Policy Program have described many of these ideas and their consequences:

There are the bumper-sticker solutions such as chained CPI or raising the amount of wages subject to the payroll tax. And there are more complicated ideas such as creating a new minimum benefit for poor seniors or reforming the Supplementary Security Income (SSI) program. They all deserve a good debate and some action.

Bob Greenstein at the Center on Budget and Policy Priorities suggests bundling the chained CPI inflation adjustment with protections for very poor and very old seniors. And the White House hints Obama may do that. But the discussion should not stop there.

The curious thing is that progressives support many of these changes. But they don’t want to engage in a Social Security debate at all. They see Obama’s offer as a one-sided concession on a line-in-the-sand issue.  And, some fear it will open the door to private accounts—an approach many on the left simply hate.

There are even private account solutions many Democrats would embrace, such as add-on savings to supplement traditional benefits. But let’s say Obama and Congress really don’t want to go there. They could still take some big steps to modernize an important program that does not work nearly as well as it should.

Obama has opened the door. Why not walk though?

In an effort to better understand the nature of small businesses and the government subsidies that support them, my Brookings colleague Sam Brown and I have reviewed decades of research  in a new paper for the Kauffman Foundation. What we’ve found suggests Congress should tread very carefully as it thinks about  how the tax code drives decisions by entrepreneurs  to start and expand companies.

Being small, in and of itself, does not confer a special advantage to businesses in job creation or innovation. Rather it is young firms, which by definition start as small businesses, that serve these critical roles. Policies that aim to stimulate young and innovative firms may be very different than those that subsidize small businesses.  

Sometimes, the very tax policies and other public programs that are aimed at helping small businesses may discourage their growth. For instance, when pro-small business subsidies or policies are phased out as firm size expands, they may unintentionally discourage businesses from expanding because expansion will lead to loss of those subsidies.

The tax treatment of small business, innovation and entrepreneurship will continue to be a front-line issue in tax reform.  For instance, House Ways & Means Committee Chairman Dave Camp (R-MI) has proposed a package of potential changes in the way small business and other firms whose owners report their business income on their 1040s are taxed.

These reforms deserve a careful review. But Sam and I found that there is often a vast gap between the rhetoric that surrounds the tax treatment of small business and the reality.

The 2010 tax act cut the workers’ rate for the Social Security payroll tax from 6.2 percent to 4.2 percent for 2011 and 2012. Congress allowed the reduced rate to expire as scheduled at the beginning of this year. The Tax Policy Center has estimated that the higher tax rate will take $115 billion out of workers’ pockets this year and cut consumer spending.

The ACA created a new “additional Medicare tax” that kicked in for the first time in January. Individuals earning more than $200,000 and couples earning more than $250,000 now pay a 0.9 percent tax on earnings above those thresholds. Few of us will pay the new tax, but it will nip at high earners’ wallets.

Finally, the cap on earnings subject to the Social Security payroll tax increased from $110,100 to $113,700.

A few examples illustrate the impact on workers (ignoring changes in income tax withholding):

• A worker earning a $40,000 median wage will take home $800 less this year than in 2012, a 2.3 percent reduction caused entirely by the expiration of the payroll tax cut.
• A single high-earner making $120,000 will see her payroll tax bill jump more than $2,400, a 2.5 percent cut in take-home pay. For her, the culprits are the higher tax rate and the higher income cap.
• A high-earning couple with each spouse earning $200,000 will pay about $5,300 more Social Security tax and $1,350 for the additional Medicare tax, reducing their net pay by 1.8 percent. They get hit by all three changes.

Try out our new calculator and see how the higher payroll taxes will affect your bottom line.

Backers of a territorial tax, including CEOs of many multinationals themselves, argue that the current worldwide system puts U.S. firms at a competitive disadvantage since they must pay the high U.S. tax rate on repatriated profits earned by their affiliates in low-tax countries, while multinationals based in territorial countries pay only the local tax rate on these profits. They also argue that since nearly all of the rest of the world uses a territorial system, it only makes sense for the U.S. to follow suit. The United Kingdom and Japan are the latest nations to eliminate their taxes on repatriated dividends.

These are compelling claims but for one problem: Existing territorial systems are in fact hybrids that include elements of a worldwide tax. And the current U.S. system is itself a mix of worldwide and territorial systems, in large part because it allows U.S. companies to defer tax on foreign income until they repatriate those earnings back to the U.S.

Any new system in the U.S. would almost certainly be a hybrid as well. As a result, the benefits to U.S.-based multinationals would vary widely. Some firms would come out ahead, but others would not.

While some worry about relatively high U.S. taxes on foreign source income, others worry that some U.S multinationals pay little tax on their domestic income. Multinational companies can shift their reported income from the U.S. to low-tax jurisdictions by allocating interest expenses and other fixed costs to domestic operations and manipulating the prices they report on intercompany transactions (transfer prices). This erodes the domestic tax base, especially for companies with large amounts of intangible assets such as patents, technical know-how, and brand identification. There is no easy way for tax authorities to determine what price companies should charge their affiliates for the use of these assets.

All countries have rules to protect their domestic corporate tax base. Transfer pricing rules and limits on interest deductibility (“thin capitalization” rules) curb income shifting. Other rules depart from a pure territorial system by requiring companies to pay an immediate tax on passive income accrued in foreign jurisdictions or by imposing a minimum tax on income from tax havens. For instance, the U.S. “subpart F” rules apply accrual taxation to portfolio investments and certain other foreign-source income.

While the United Kingdom and Japan have eliminated their taxes on repatriated income, they are also re-assessing their taxes on foreign accrued income. Japan taxes on a current basis foreign income that is subject to local tax rates of less than 20 percent. The U.K. limits the deductibility of interest expense against U.K income and is considering reforming rules for taxing accrued foreign profits.

U.S. lawmakers are trying to find the same balance. House Ways & Means Committee Chairman Dave Camp (R-MI) has proposed a territorial tax that would exempt 95 percent of foreign dividends received. But he’d also tighten subpart F and enact new thin capitalization rules. In addition, he’s considering three options to prevent base erosion –a tax on excess returns (similar to a proposal by President Obama), a version of the low effective tax rate test used by Japan, and inclusion in subpart F of intangible income from low-tax countries.

In practice, going territorial would eliminate all or most of the tax on repatriated dividends from foreign affiliates. But to counter increased incentives to shift reported profits overseas, the move to territorial could also include new rules to prevent income shifting and increased accrual taxation of some foreign source income.

These changes would eliminate the lock-in for repatriated profits, but could raise the tax burden on profits left overseas. Such a switch could increase economic efficiency because the lock-in of funds overseas imposes costs on multinationals, while producing no revenue for the U.S. Treasury. But would this benefit U.S. multinationals? Some corporations will indeed benefit from the chance to bring back their overseas profits without paying today’s repatriation tax. But others, who have learned how to avoid tax on their intangible profits under the current rules, may find themselves paying more. As with much else, the devil is in the details. Some corporations may regret getting what they wished for.

In Cyprus as well as Stockton (plus San Bernardino, California and Jefferson County, Alabama), the question is:  Who will be left holding the bag?  A common theme is “haircuts,” or possible losses for investors (bank depositors in Cyprus; bondholders in California) to spare wider pain to taxpayers, pensioners, public employees, and other local stakeholders.

One problem with haircuts is that they can impair future market access:  the government in question may have to pay higher borrowing costs to regain investor confidence.  A wider concern is contagion:  If investors fear they won’t get their money back, they might demand higher interest rates from the sector as a whole.  Moody’s Investors Service publicly worried about such contagion last summer, in a report critical of U.S. municipalities and what the organization viewed as changing norms toward bankruptcy.

But there are a few reasons to be skeptical about the contagion scenario applied to munis.  First, although broad (worth about $3.7 trillion in 2012), the municipal bond market is not very deep.  On the supply side, a few large issuers like California, New York, and Texas dominate.  On the demand side, most investors are households or institutions representing households such as money market mutual funds. 

Because of its traditional mom-and-pop structure, muni bonds don’t trade very often and the market is not transparent.  When bonds do trade, different buyers may pay different prices for the same issue, and prices can rise faster than they fall (the “rockets and feathers” phenomenon). Economists have rightly criticized these features as inefficient.  However, some market participants counter that proposed cures might be worse than the disease.

A silver lining of less-than-perfect information and higher transaction costs in muni markets may be that shocks are transmitted slowly through the system.  More educated institutional investors are probably able to sort good apples from bad; other investors simply “buy and hold.”  A recent IMF working paper confirms these predictions:  after a bad credit event, investors apparently shift their money from places like California and the City of New York to safer issuers.  Rather than suffering from Stockton’s misfortune, other states and municipalities will probably benefit, much like U.S. Treasuries after the 2008 financial crisis.

Interestingly, the IMF authors did detect some evidence of contagion, or bad news spreading, but in an unexpected direction from munis to U.S. Treasuries.  One explanation is that investors looked at an Illinois or California and worried about prospects for a federal bailout, analogous to Cyprus and the rest of the Eurozone.  Still, measured effects were small and took time to surface.  The U.S. also has a long history of steadfastly refusing requests for local aid.

In any event, it will take some time to parse through yesterday’s Stockton ruling.  Its most significant effects may be felt within California – where many municipalities pay into the state’s CalPERS pension fund.  The judge ruled that CalPERS was just another creditor, but we still don’t know who will be left holding the bag.

A closer look suggests this may be more wishful thinking than smart analysis. That doesn’t mean reforming the corporate tax is a bad idea. It is not. It does mean that doing so may be harder than either President Obama or key Republicans want to admit—at least in public.

The Wall Street Journal’s John McKinnon wrote a nice piece on Friday on the divisive tax reform politics inside corporate America. John reported on how big business is dividing itself into opposing camps—preparing for what former senator and 1986 tax reformer Bill Bradley calls “total war” over reform. 

Also on Friday, the Tax Policy Center and the American Tax Policy Institute held a program on the economics of corporate tax reform. There, two panels of tax economists described some of the effects of corporate reform.  The participants included Bill Gentry of Williams College, Jim Hines of the University of Michigan, George Plesko of the University of Connecticut, Doug Shackelford of the University of North Carolina, and Eric Toder of the Tax Policy Center. The moderator was Victoria Perry of the International Monetary Fund.

Here are three conclusions:

Lowering corporate rates will have a major impact on individual taxpayers. As Plesko described, The vast majority of businesses are pass-through entities (such as partnerships and S Corporations) that do not pay the corporate income tax.  Rather, their owners report their business income on their 1040s. These firms account for more than half of net business profits in the U.S.—a share that has been steadily growing since the 1980s.

Reducing the corporate rate to, say 28 percent, while leaving the top individual rate at roughly 40 percent, would encourage owners to restructure their firms to avoid the high individual tax. This would reverse what happened after the 1986 tax reform, when C corporations morphed into pass-throughs to take advantage of lower individual taxes.

Congress could solve the problem by cutting the top individual rate to maintain parity with a lower corporate rate. But that’s hard to imagine with big deficits and a Democratic president who was re-elected on a platform of raising those rates.

Then there is the matter of paying for corporate rate cuts. Last year, the Joint Committee on Taxation concluded that if Congress repealed all corporate tax expenditures it could only bring the corporate rate down to about 28 percent. That means Congress would have to look at trimming other business tax breaks such as deductibility of interest costs or rewriting accounting rules. Many of these changes could hit owners of pass-throughs as well as C corporations.  

Corporate rate cuts may not create U.S. jobs, despite what politicians claim. While lower rates are a net plus for U.S. competitiveness, their economic effects may make many politicians uncomfortable.

Hines predicted rate cuts would boost both more foreign direct investment in the U.S. and greater U.S. investment overseas. Most economists like this. But politicians of both parties get very nervous about foreign ownership of U.S. companies, especially if it doesn’t create more domestic jobs. And they worry about offshore investment by U.S. firms, which they often translate into “shipping American jobs overseas.”   

Lowering corporate taxes can create awkward accounting problems for public companies.  Shackelford, a tax accounting expert at the University of North Carolina, described how a rate cut can have dramatic, and widely variable, effects on reported earnings for publicly-traded firms.  Companies with big deferred tax liabilities, such as depreciation, would report a boost in earnings if their rates were cut. But firms with lots of deferred tax assets, such as pension obligations or unused net operating losses, would report lower earnings.  

As Doug noted, none of this has anything to do with actual cash flow. But executive comp is often linked to reported earnings. Plus, perceptions matter for public companies and some research suggests markets moved when Congress changed corporate rates in 1993.

The consensus of the panelists: Cutting corporate rates is a good thing, but it will inevitably create both big losers and big winners, to say nothing of some significant unintended consequences.

Finland will lower the corporate rate to 20 percent in 2014, down from the current rate of 24.5 percent (and 26.0 percent in 2011). The move follows rate cuts in competing European nations, including the UK and Sweden, and a planned rate cut in Denmark. Finland’s current corporate rate is at about the median in the OECD; dropping the rate to 20 percent will put Finland’s rate close to the bottom for European OECD countries.

Finland plans to pay for part of the rate cut by boosting the effective investor tax rate on dividends paid by companies listed on the Finnish stock exchange. (The reform is not a statutory rate hike, but rather a reduction in preferences for dividends.) Effective taxes will increase only on dividends, not on capital gains.

The swap makes sense.  A lower corporate tax rate should help attract new business to Finland, which maintains an extremely open and competitive economy. As in other countries, a lower corporate rate will reduce distortions—such as the type and financing of business investment—that become more severe with higher rates. Moreover, the swap is likely progressive, and will help mitigate Finland’s rise in income inequality over the past decade.

The plan is not without drawbacks. One chief concern is that taxing only dividends of companies listed on the Finnish exchange will push firms off the bourse. Still, the reform’s benefits appear to outweigh the costs.

A similar reform would make sense in the United States. There is widespread agreement that the U.S. corporate tax rate is too high. Both President Obama and House Budget Committee Chairman Paul Ryan—a pair rarely in agreement—have called for a lower corporate rate. Despite a jump in tax rates in 2013 relative to last year—the top rate on dividends rose from 15 percent to 23.8 percent—tax rates on investment returns remain at historic lows for most taxpayers.

Moreover, trading a lower corporate tax for higher taxes on investors in the U.S. would be progressive. My TPC colleagues and I analyzed a revenue-neutral plan to tax capital gains and dividends as ordinary income while simultaneously lowering the corporate tax rate from 35 percent to about 26 percent; we found the plan would lower the average tax burden for the bottom 99 percent of taxpayers. (Implementing Finland’s plan today would pay for a smaller drop in the corporate tax rate because of the higher rates in 2013 and the fact that the reform would only raise taxes on dividends, not capital gains.)

Corporate tax reform in the U.S. seems to be inevitable, but questions remain over how to pay for it. Finland may have the answer.

However, there is a contrary case to be made: It may be that with both interest rates and prices so low, this could be the ideal time to redesign the tax subsidy for home ownership. Because monthly mortgage payments for many homeowners and buyers are lower than they have been for years, trimming or restructuring the MID might have less impact than we thought.

Last November, a panel of housing experts brought together by the Urban Institute concluded that “current housing conditions reveal several factors that would likely dampen the marketwide effects”  of reforming the mortgage interest deduction.

According to a summary of the session, the roundtable participants concluded that “post-recession housing market conditions have disrupted the normal relationships between user costs, rents, and house prices.”  In other words, the market is such a mess that it is no longer possible to predict what would happen if the MID were repealed today.

Studies of the pre-bust housing market found that eliminating the MID and the tax deduction for property taxes would substantially knock back prices, especially in communities with high housing costs. For instance, in a 2010 paper based on 2007 data, my Tax Policy Center colleague Ben Harris found that scaling back the MID would lower prices significantly.

But new research that looks at the housing market from 2006 to 2010 finds “no discernible relationship” between house prices and the MID, according to the session summary. What was clear to most researchers before the housing bubble burst is now ambiguous at least.

The roundtable included representatives of the U.S. Treasury Dept., the White House, the Federal Housing Finance Agency, Fannie Mae, Congress, the housing industry, the Federal Reserve Board, the Wharton School, and several think tanks including Urban.

Keep in mind that while studies often look at the consequences of eliminating the MID, most proposals would restructure, not repeal, the tax subsidy for home purchases. In addition, any reforms would likely be phased in over a period of years. This could soften any short-term effects.

Among the more realistic alternatives to outright repeal, Congress could cap mortgage debt at $500,000 instead of today’s $1 million, or replace the deduction with a refundable credit.

Such changes would shift the subsidy to people with low- and moderate-incomes who buy in low- and moderate-income neighborhoods. The current deduction mostly benefits the highest-income 20 percent of households.

While these revisions might lower high-end prices, they could stabilize prices for lower-priced homes. The online real estate site Zillow.com concludes that a $25,000 cap on all deductions would most affect zip codes with a mean home value of over $850,000.

The housing market seems to be recovering, and mortgage rates have begun to creep up from their historic lows last summer.  If those trends continue, the politics of the mortgage deduction will surely change again. But one thing is clear: We may know a lot less about the relationship between the mortgage deduction and housing prices than we thought we did.

Because the Defense of Marriage Act (DOMA) denies federal recognition of those relationships, the IRS applies special rules to same-sex couples in the three states, rules that don’t apply to couples—same- or opposite-sex—in other states. Those rules complicate tax filing and can result in higher (or lower) income and payroll tax bills. (I blogged yesterday on more general issues concerning DOMA and taxes.)

Community property law generally requires that married couples split income evenly between spouses. That rule also applies to domestic partners in the three community property states that recognize them.

Splitting income makes little difference for opposite-sex married couples but creates tax issues for same-sex partners because of DOMA. Here are just a few of the problems that the IRS has explained in various publications.

• Same-sex couples with children may or may not be allowed to file as heads of household. The issue revolves around the requirement that a head of household provide more than half the support for a dependent child. Because spending out of community property income comes equally from both partners, neither provides more than half the support, so neither can claim the dependent. Only if some support comes from non-community property may one partner file as head of household.
• Domestic partners in community property states must split the income from a business operated by one partner, even if the other partner has no involvement. In contrast, in the case of opposite-sex couples, earnings from a business are attributed only to a spouse who is actively involved in the business. Further, each domestic partner must pay self-employment tax on her half of business earnings, a situation from which a special provision protects opposite-sex couples. As a result, same-sex couples could pay as much as double the payroll tax that finances Social Security that an opposite-sex couple would pay.
• The IRS applies community property laws inconsistently with regard to tax credits. For example, the earned income credit, the dependent care credit, and the refundable portion of the child tax credit all ignore community property laws in determining a domestic partner’s earnings but split all income in measuring adjusted gross income.

Same-sex couples may also benefit from being denied joint filing status. A person who adopts her same-sex partner’s child may claim the adoption credit, a benefit not available to opposite-sex spouses. And as I explained yesterday, being denied joint filing status protects same-sex partners with similar incomes from incurring marriage penalties.

Taxpayer Advocate Nina Olson has pointed out additional problems for same-sex couples caused not by tax rules but rather by IRS procedures. For example, domestic partners in community property states must split both earnings and the income tax withheld on those earnings. But the IRS has rejected returns filed electronically because its software failed to allocate withheld taxes correctly between partners.

The IRS appears to have first offered guidance for same-sex couples in 2010, three years after California granted community property rights to domestic partners and shorter periods after similar action in Nevada and Washington. At that point, the IRS gave domestic partners the option of filing amended returns reflecting community property laws but did not require them to file new returns. Affected couples could recompute their taxes and file new returns, but in a final kicker, a partner owing more tax would have to pay interest on the underpayment (offset, at least in part, by interest paid on the refund presumably going to the other partner). At least the IRS waived penalties for underpayment.

Finally, the interaction between the federal income tax and California’s tax complicates tax filing for same-sex couples. The state’s tax return requires a couple to enter adjusted gross income from their joint federal return, even though they cannot file that return with the federal government. That means such a couple must prepare three federal returns—one joint for their state taxes and two individual to file with the feds—plus a state return.

Same-sex couples in Nevada and Washington are luckier—neither state imposes an income tax.