The question predated Mr. Iksil’s misadventures, of course. Ever since the U.S. financial crash of 2008 and the beginnings of the pending Euro-zone financial collapse, governments have been debating whether financial services should be subject to a new tax.

Such a levy could, in theory, accomplish at least three goals: It could raise revenue for countries under great fiscal stress, assure that the financial sector (which often avoids tax) pays a “fair and substantial” share of taxes, and discourage bad behavior and thus stabilize markets.

These last two aims are especially important since the cost to governments of bailing out stupid (at least) financial institutions has run into hundreds of billions of dollars over the past four years.

Of course, such a tax could also have damaging unintended consequences that would damage financial markets.  

If they should be taxed, the really interesting question is: How? There are at least three major alternatives—and lots of variations on the theme.

The first option is a financial transactions tax (FTT) that imposes a levy on each trade without regard to profits or losses.  Thus, if I buy a share of stock for $10 and then sell the same share for $10, I’d be taxed on the value of both transactions even though I made no money. The European Commission recently proposed such a tax for the EU, and Sen. Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) proposed one in the U.S.

The second option is a financial activities tax (known, sadly, as a FAT). This tax, which has been proposed by the International Monetary Fund staff, is levied only on net proceeds of securities transactions. You could think of it as a Value-Added Tax on financial transactions—which are normally exempt from the VAT.

Just to make things even more interesting, some versions of the FAT would not tax all profits, only those that are very high. They might, for instance, have taxed some of the big derivatives bets that Wall Street placed in the early 2000s.

The third idea, which has been proposed by the Obama Administration, is a direct tax on the balance sheets of large, financial institutions. The idea is that a firm should pay a tax that reflects its contribution to systemic risk—and, thus, its likelihood of needing a taxpayer bailout.

The differences between even the FAT and FTT can be pretty arcane. As New York University law professor Dan Shaviro, who has written a terrific paper for Tax Notes on the subject, says, “It is difficult to imagine a question that initially sounds as tedious as whether we should tax financial transactions or activities.”

But this choice is a very big deal. For instance, taxing every transaction could generate an enormous amount of money, even with a very low rate. A 0.01 percent tax would collect $16 billion Euros annually and the Harkin-DeFazio 0.03 percent tax could raise $350 billion over 9 years. Because the FAT taxes only profits, it would take a much higher rate to generate as much revenue.

And there are other questions: What is a financial transaction? How, in fact, would those derivatives that created so much unpleasantness for J.P Morgan in recent days, be taxed?

Then, there is tax competition. Even if all the world’s major developed countries adopted the levy, what would prevent financial markets from decamping to some warm Caribbean island to avoid the tax?   

If you’d like some answers to these timely questions, the Tax Policy Center is sponsoring a panel on the subject on Friday.  Panelists include Dan Shaviro, IMF Deputy Director for Fiscal Affairs Michael Keen, Tax Notes contributing editor Lee Sheppard, and AFL-CIO special counsel Damon Silvers. TPC visiting fellow Steve Rosenthal will moderate.

Well– you know, I have to tell you, as I’ve said, I’ve– I’ve been going through an evolution on this issue. I’ve always been adamant that Americans should be treated fairly and equally. I do believe we ought to have a revenue code that raises enough money to fund the government we want. And we should do it in a way that interferes as little as possible in the market economy.  

I’ve stood on the side of tax reform. But I had hesitated– in part, because I thought tinkering around the edges would be sufficient–something that would close a few loopholes and raise taxes on the rich. And– I was sensitive to the fact that– for a lot of people, you know, the– the phrase tax reform is something that evokes very powerful reactions, brings out the lobbyists, and so forth.

But I have to tell you that over the course of several years, as I talk to friends and family and neighbors. When I think about members of my own staff who pay very high tax rates, who are raising kids together but are thrown into the Alternative Minimum Tax…. When I think about new businesses that are unable to take advantage of the same tax subsidies that their bigger, more established competitors can and cannot commit themselves to expanding their business….

You know, Malia and Sasha, they’ve got friends whose parents make the same income and even do the same kind of work, but who pay very different effective tax rates.  And I– you know, there have been times where Michelle and I have been sittin’ around the dinner table. And we’ve been talkin’ and– about their friends and their parents. And Malia and Sasha would– it wouldn’t dawn on them that somehow their friends’ parents would be treated differently. It doesn’t make sense to them.

And– and frankly– that’s the kind of thing that prompts– a change of perspective. You know, not wanting to somehow explain to your child why somebody should be treated– differently, when it comes to– the eyes of the law.

At a certain point, I’ve just concluded that– for me personally, it is important for me to go ahead and affirm that– I think the tax code needs a major reform. Now– I have to tell you that part of my hesitation on this has also been I didn’t want to politicize the issue. There’s a tendency when I weigh in to think suddenly it becomes political and it becomes polarized.

And what you’re seeing is, I think, Members of Congress working through this issue– in fits and starts. Different policymakers are arriving at different conclusions, at different times. And I think that’s a healthy process and a healthy debate. But this is an issue upon which the President must lead, and that is what I will do.

That is why I have asked Treasury Secretary Tim Geithner to develop a detailed, specific tax reform plan in consultation with congressional leaders of both parties, business leaders, and others. I will present this plan to the American people next January and will strongly urge Congress to complete action on the bill by the end of 2013.

Thank you Robin, for letting me get this off my chest.   

Budget experts are waging a spirited battle over the Medicare changes that helped pay for 2010’s health reform. In April, Chuck Blahous, one of two public trustees of the program, released a study arguing that the Affordable Care Act (ACA) would increase the deficit by at least $340 billion by 2021, a sharp contrast from the $210 billion in deficit reduction estimated by the Congressional Budget Office (CBO).

Chuck bases his estimates on several factors, but the item that has garnered the most attention is his charge that the ACA’s spending cuts and revenue increases in Medicare Part A are being double counted: once to help pay for the ACA’s coverage expansion and a second time to improve the finances of the Part A trust fund, whose predicted exhaustion was delayed by several years.

Chuck notes that those resources can be used only once: They can either offset some costs of health reform or strengthen Medicare, but not both. He believes those resources will ultimately finance additional Medicare spending and thus can’t offset any health reform costs. For that reason, he concludes that the ACA would increase deficits, rather than reduce them.

That argument inspired a host of commentary from leading budget experts, ranging from denunciation to affirmation. See, for example, Jeffrey Brown, Howard Gleckman, Peter Orszag, Robert Reischauer (as quoted by Jonathan Chait), and Paul Van de Water, and a follow up by Chuck and Jim Capretta.

Why does this dispute exist? It can’t just be politics. If it were, we’d have double-counting disputes about every program. But we don’t. We thus need an explanation for why this debate has erupted around Medicare Part A, which provides hospital insurance, but not around other programs. Part A is not unique in controlling spending by a “belt and suspenders” combination of regular program rules (the “belt”) and an overall limit (the “suspenders”). Such budgeting also applies to Social Security, Medicare Parts B and D (which cover physician visits and prescription drugs), and the National Flood Insurance Program. The federal debt limit acts as “suspenders” for the entire budget. But none of those give rise to double-counting disputes.
That suggests that there is something unusual—perhaps flawed—about budgeting for Medicare Part A. To see what that is, it helps to boil the dispute down to two basic questions about programs subject to “belt and suspenders” budgeting.

First, can spending reductions or revenue increases in the program offset spending increases or revenue reductions in other programs? In short, can budget savings pay for other programs? Or must they stay within the program itself?
Second, would hitting the overall budget limit affect program operations? In other words, do budget savings extend the period during which the program can operate at full capacity? Or is the limit operationally toothless?

As shown above, policymakers have answered these questions differently for different programs (for further details, see the appendix).

This comparison reveals the unique feature of Medicare Part A: It is the only one of these programs that allows budget savings to pay for other programs and has a trust fund with real operational teeth. It alone answers Yes to both questions. That is why Medicare Part A is the only program that creates the possibility of double counting and suffers from the reality of a double-counting dispute.

Double counting isn’t possible in Social Security or the NFIP because budget rules require that savings stay in the program. It isn’t possible for the budget as a whole since there are, by definition, no other programs to fund. And double counting isn’t possible in Medicare Parts B and D because its trust fund does nothing to limit operations.

But double counting is possible in Medicare Part A. That happens whenever someone claims that the health reform legislation both reduces deficits and provides additional resources to Medicare Part A. I will leave it to others to adjudicate whether any health reform proponents committed that error. I will note, however, that every budget expert, including Chuck Blahous, agrees that CBO didn’t do so (its baseline ignores the trust fund, so savings reduce deficits and have no effect on program operations).

Bottom line: The peculiar budget rules for Medicare Part A make it possible for analysts, pundits, and policymakers—whether willfully or inadvertently—to double count budget savings in Medicare Part A. That needless confusion is a significant flaw. To correct it, Congress could adopt the budget practices it uses in Social Security, Medicare B & D, or the NFIP. In a follow-up post, I will examine the pros and cons of these alternatives.

 Appendix: How “Belt and Suspenders” Budgeting Works

In Medicare Part A, spending is determined by rules about benefit eligibility and provider payment rates. If the Hospital Insurance (HI) trust fund balance falls to zero, however, spending faces a separate, hard limit: payments can’t exceed receipts. Program operations would thus be disrupted if the trust fund became exhausted. Congressional budget rules ignore the trust fund and assume that spending will continue at scheduled levels regardless of its balance. Under that approach, any spending reductions or revenue increases in Medicare Part A generate new budget resources that can be used to pay for changes in other programs.

Social Security operates differently. It faces the same operational limitations as Medicare Part A if its trust fund balance falls to zero. But Congress enacted special rules that forbid any Social Security spending cuts or revenue increases being used to pay for other programs. Such savings therefore accrue in the trust fund. The trust fund thus matters for operations, and savings cannot be directed to other parts of the government. (Social Security actually involves two programs, one for retirement and one for disability, and two corresponding trust funds; these comments apply equally to both.)

Medicare Parts B and D operate in a third way. Like Part A and Social Security, their spending is determined by eligibility and payment rules and gets paid out of a trust fund (the Supplementary Medical Insurance or SMI trust fund). But that fund has unlimited right to draw on general tax revenues. A zero balance thus results in general revenue transfers, not operational disruptions. Reforms don’t increase the life of the trust fund (since it can never go broke), and savings can be used to finance other programs.

The National Flood Insurance Program operates in yet another way. The NFIP is required to finance itself out of its insurance premiums; if its costs exceed those premiums, it can borrow from the federal government up to a specified limit. Once that limit is reached, payments can’t exceed its revenues, and operations are disrupted. The borrowing limit thus acts like the trust fund balance in Medicare Part A or Social Security, except that it allows the program to go a fixed amount into the red.

Congressional budget rules treat the borrowing limit as a fundamental restraint on NFIP spending. If the program is expected to run annual deficits, as it is today, those deficits exist only until the borrowing limit is reached. After that, the NFIP is projected to break even, with spending restrained to equal revenues. If Congress reduces the annual deficits in the NFIP (e.g., by increasing premiums), those savings allow the program to operate longer before reaching its borrowing limit. Any temporary budget savings thus get offset by increased NFIP spending in later years. Those temporary budget savings thus cannot be used to offset spending in other programs (unless hitting the borrowing limit is pushed beyond the budget window).

The debt limit, finally, acts as a “suspenders” restraint on deficits incurred by the entire federal budget. As we saw last summer, the debt limit threatens real operational restraints. Spending reductions and revenue increases can delay when the debt limit is reached. But they cannot be used to pay for other programs. Why? Because there are no other programs. The debt limit thus operates like the Social Security trust fund: it imposes an important operational restraint, and budget actions used to avoid it cannot pay for other programs.

Caught in the wake of deep recession, painfully high unemployment, bank failures, and growing demands for fiscal austerity by the bond markets, governments across the continent are collapsing.

In November, voters in Spain dumped a Socialist government for the conservatives. Last weekend in France, voters replaced conservative President Nicolas Sarkozy with a Socialist. In the past year, governments have fallen in Portugal, Italy, and Denmark, just to name a few. In Greece, voters tossed out just about everyone and at the moment the nation has no government at all. In Britain, PM David Cameron’s ruling conservatives are polling at about 32 percent

It is easy to look at all this and see a massive rejection of fiscal austerity. Certainly, many Democrats in the U.S. take that message even as they fret over a multinational “throw the bums out” tidal wave (There are some exceptions such as Russia, where the bums enjoy the unfettered ability to rig elections).

But is the left in the U.S. right, er, correct? Is the lesson from Europe that deficit reduction is a loser and the key to political success is short-term economic growth? If it is, Republicans may find themselves on the wrong side of history in the coming election.

I suspect, however, that the story is more complicated than that. In Europe, economy is in worse shape than here, spending cuts are deeper, and tax increases steeper.  We are not Europe, at least not yet.

For instance, overall unemployment in the European Union averages 10.1 percent, two full percentage points higher than here. In Spain it is a staggering 23 percent. In Greece, nearly 21 percent.

It is the same story with taxes. Ireland has raised its Value Added Tax rate to 23 percent. Spain has raised its VAT to 18 percent. In the U.S., GOP rhetoric notwithstanding, we have been cutting taxes throughout the Obama years, not raising them.

And spending cuts? The sort of budget cutting going on in Europe is far more draconian than what the U.S. has seen. In Greece, for instance, government spending as a share of the economy is projected to drop by nearly 6 percentage points from 2009 to 2012. By contrast federal outlays in the U.S. are expected to fall by about 2 percent of GDP over the same period, nearly all from the expiration of one-time spending programs such as the TARP and other stimulus.

Even the 2012 House Republican budget would have made relatively modest cuts. For example, it would have reduced all discretionary spending by about $40 billion from 2011 levels—a cut of about 0.4 percent of GDP.

Am I suggesting that austerity could be a winning campaign platform in the U.S.? Hardly. Even in the best of times, Americans oppose most spending cuts(with the exception of foreign aid and “earmarks”) and favor raising taxes on only rich people (of whom there are, conveniently, relatively few).

But the parameters of the fiscal debate are far narrower here than in Europe, and the economy is much healthier. Oddly, the only true short-term austerity budget on the table is the end-of-the-year do-nothing option. That’s where congressional gridlock lets the 2001/2003/2010 tax cuts expire, the automatic spending cuts Congress approved in 2010 kick in, and Congress fails to increase the debt limit.

But short of that, there is only real lesson for us to learn from the recent European experience:  The U.S. needs to fix its long-term budget problem as soon as it can, and on its own terms. Because you never, ever, want to find yourself at the mercy of the bond vigilantes. If y0u don’t believe me, just ask the Greeks.

But that $5 billion revenue estimate assumes a reality that most critics of the Buffett tax reject. If you think the 2001/2003/2010 tax cuts should be extended—an idea most opponents of the millionaire tax support—revenues would increase by a much more significant $162 billion over the decade. And that’s hardly the chump change they imply.

As usual, it is all about the baseline. The Joint Committee on Taxation (JCT) says that the Buffett Rule as proposed by Senator Sheldon Whitehouse (D-CT) would increase revenues by $47 billion over the coming decade, assuming that the 2001-2010 tax cuts expire as scheduled. Why? If those tax cuts disappeared, more millionaires would pay higher taxes and thus be exempt from the Buffett Rule’s minimum tax.

But those who oppose the Buffett Rule also demand that Congress make permanent most, if not all, of the expiring tax cuts. The resulting lower tax bills would make more millionaires subject to the Buffett Rule, boosting the revenue gain to $162 billion over the decade according to JCT, more than three times the increase under the expiration scenario. The problem is that extending the tax cuts pumps up the deficit too—more than tripling its size in 2022, according to the Congressional Budget Office. In effect, the Buffett tax would make a very bad fiscal situation slightly less awful.

Politicians can argue all they want about how and how quickly we should close the deficit. That’s their job. But they should be consistent in the bases for their arguments. Using different assumptions depending on the point they want to make weakens everything they say.

Is the tax code fair? Should it be?

It all depends on what you mean by fair, of course, but at an Urban Institute panel this week, two economists, a tax historian, and a philosopher agreed that in many important ways, it very likely is not.

Fairness is one of those concepts that makes economists really nervous. Because it is so subjective and impossible to measure, they usually avoid the idea entirely, preferring to stick with what they can count.

Still, my Tax Policy Center colleague Gene Steuerle, Brookings Institution economist Belle Sawhill, Tax Analysts historian Joe Thorndike, and Howard University philosophy professor Charles Verharen joined moderator Greg Ip, The Economist’s U.S. economics editor, in tackling the issue. The result was a fascinating look at a complicated issue from some very different perspectives.  It is well worth watching.

Gene divided fairness into three categories:  The first, which he calls the king of principles, is equal justice (what economists define as horizontal equity). Are people with equal ability to pay taxed equally?

The second is progressivity (vertical equity in econo-speak). Do the better off pay more tax than those who are less well off?  

The third is individual equity. Are we entitled to keep the rewards of our own work? Is it unfair if we cannot?

To that, one could add a fourth, which Gene and TPCs Rudy Penner have written about extensively. And that is generational equity. For instance, is it fair to burden those not yet born with the bill for the cost of maintaining our standard of living?

Verharen argued that fairness, which he defined as love for those most in need  (others may say individual sacrifice for the greater good), is hard-wired in family relationships and in much religious thought—to say nothing of Karl Marx. But, he noted, the concept of fairness has changed dramatically over the centuries. Once, and still in some cultures, killing a sick child to preserve the rest of a family is considered “fair.”

In a much less profound way, our concept of tax fairness has also evolved over the past two centuries. Joe Thorndike reminded the audience that for much of U.S. history, people were taxed on what they consumed (mostly through tariffs and excise taxes). But from the Civil War though the late 19^th century, tax fairness was redefined as ability to pay. The result: the rise of the progressive income tax.

But, Joe says, the idea was to distribute the tax burden, not to redistribute wealth. And that raises the question about whether today’s tax laws are an effective way to address income inequality. Assuming, of course, that you think it is even a problem.  

Much of the current political debate is over Gene’s concept of equal justice. With a tax code larded with $1 trillion in tax preferences aimed at rewarding some taxpayers and punishing others, we are far from a system where people with equal incomes are taxed equally. As Greg asked, if this concept is so important, why do we do it so badly?

And that raises yet another interesting question: Fair relative to what? Why do we presume that the current distribution of taxes is the right one, and thus judge proposals not on their own merits but compared to what we do today?  

Finally, Belle and other panelists warned that it is dangerous to think about the tax code in isolation. Shouldn’t a measure of fairness also consider who benefits from direct government spending, as well as that $1 trillion in tax preferences?

It probably should. That is, once we decide what we mean by fairness in the first place.

The goal is to make things easier for taxpayers and improve compliance (that is, reduce mistakes, deliberate or not).

This is a laudable aim, but the IRS faces a number of challenges to make this initiative work. Here are five, excerpted from a new article I wrote for Tax Notes, Basis Reporting:  Lessons Learned and Direction Forward.   

1. Congress standardized the information that brokers and mutual funds must report.  It also required taxpayers to either select a basis method (e.g., first-in-first-out (FIFO), average basis, or identification of the specific securities sold) in advance or accept the default choices made by their brokers or mutual funds.  These steps improve the quality and consistency of the information, which in turn will facilitate information matching by the IRS, but they greatly confuse taxpayers, at least in the near term.
2. Taxpayers are permitted too many choices to calculate their gains and losses, which greatly complicates reporting.  So, for mutual fund shares, taxpayers must now decide whether to provide standing instructions to determine the order in which their shares should be sold (e.g., highest basis first), whether to identify specific lots of shares to be sold at the time of sale, whether to elect average basis for their shares (separately for each of their accounts), and whether to revoke or change their average basis elections.   And the mutual funds must capture, maintain, transfer, and report these basis choices.
3. By law, taxpayers are responsible for reporting their gains and losses correctly on their tax returns, regardless of the numbers they received from their brokers.  So, for example, the IRS expects taxpayers to adjust cost basis to reflect tax rules, such as wash sales, which the brokers might not have reflected.   In practice, however, most taxpayers will simply transfer the numbers reported to them by their brokers to their income tax returns, and hope for the best.
4. The IRS expects to match the new information reports to taxpayer returns to identify misreporting.  Whether the IRS can distinguish taxpayer misreporting from system errors in matching is unclear.  However, the mere threat of information matching is likely to improve taxpayer compliance.
5. Technology advances, such as information reporting and tax preparation software (like Turbo Tax), shield taxpayers from the tax determination process, which is both helpful and harmful.  It’s helpful if taxpayers can save time and effort by using the information provided, but harmful if taxpayers cannot confirm or understand the information they have received.

With all of these problems, is basis reporting worth it?  I believe the answer is yes, but the transition will be painful.

(Full disclosure:  I advise Wolters Kluwer Financial Services–the publisher of GainsKeeper tax software.  The views I express are my own and not those of Wolters Kluwer Financial Services.)

By the Joint Committee on Taxation’s count, 75 of these tax extenders have already expired this year or will do so before New Year’s Day. That doesn’t include tax breaks related to the Transportation Trust Fund or federal disaster relief.

It is quite a collection: Subsidies for both oil and gas and alternative fuels, enhanced charitable contributions for computers, the infamous NASCAR race track give-away, and special tax breaks for movie and TV producers, mining companies, railroads, rum, and investment companies to name only a few. And, of course, the Research and Experimentation Tax Credit that has taken on mythical status in Washington yet seems to do little or nothing to enhance research.    

The House Ways & Means Select Revenue Measures subcommittee began its review today by hearing from fellow Members of Congress—most of whom wanted to preserve one subsidy or another.

This effort may not only be good government, it also takes certain amount of courage on the part of Committee Chair Dave Camp (R-MI) and subcommittee chair Pat Tiberi (R-OH).  After all, eliminating any tax breaks is heresy in some precincts of the GOP. Yet Camp seems prepared to take some on.

Now, a cynic might suggest that this review, coming in the heat of the election season, is little more than a campaign finance shakedown. The temporary nature of these tax breaks serves two very valuable purposes for Members of Congress. It allows them to misrepresent the true 10-year budget cost of these subsidies.  And, when it comes to campaign contributions, they are the gifts that keep on giving.  

The mere mention that Congress is reviewing an extender is good for a fundraiser or two, to say nothing of helping fill the coffers of the lobbyists who are often themselves ex-members or former Hill staffers.

Still, the only real benefit of making tax subsidies temporary is to give Congress a chance to review them. In a perfect world, lawmakers would consider the economic costs and benefits of each provision and choose whether or not to continue it (of course, in a truly perfect world, Congress  would do this before it ever passed the bill in the first place, but let’s not get carried away).

This review almost never happens. Instead, after much delay and speechifying, Congress mindless extends the subsidies en bloc.

The political pressure to do this is immense. Today, for instance, the Business Roundtable, which represents CEOs of many of the nation’s biggest companies, told Congress   it “strongly supports the immediate and seamless extension of the expired business tax provisions from last year.”

My guess is that if you asked one of these corporate execs to name just three of the dozens of tax breaks the BRT has so wholeheartedly embraced, you’d get a blank stare. Yet, this group—which regularly demands that Congress address the budget deficit–wants all the business extenders extended (it said nothing about individual tax breaks that are also expiring).

So, political cynicism aside, give Camp credit for beginning a process that may lead to a serious review of these tax code subsidies. Now, let’s see if he follows though by proposing to get rid of some of the worst.   

The interactive display of the president’s and Romney’s (preliminary) 2011 tax returns walks readers through each return to show the sources of income, how income from each source is taxed, the components of the candidates’ income and payroll tax bills, and their effective tax rates. We also toss in Vice President Biden’s return as well as one for a typical middle-class couple with children. All four returns are joint filings by the married couples.

The results are interesting, if not surprising. The president’s 2011 income came in almost equal parts from his White House job and his book royalties. The Obamas claimed itemized deductions totaling 37 percent of their adjusted gross income (AGI)—mostly for charitable contributions—and ended up paying 19 percent of their AGI in income taxes and another 4.4 percent for combined employee-employer payroll taxes.

Mitt Romney’s taxes are another story. More than half of his 2011 income was long-term capital gains and qualified dividends that face a reduced 15 percent tax rate. His itemized deductions reduced the amount of his income subject to ordinary rates by 60 percent. Bottom line: an income tax bill equal to 15.4 percent of his AGI—a percentage point higher than his 2010 rate. And because so little of his income was from working, his payroll tax rate was just 0.6 percent of AGI.

Our typical middle-class married couple paid a slightly higher federal tax rate than the Romneys: 16.7 percent of their $70,000 AGI for income and payroll taxes (again both employer and employee shares). But the breakdown of taxes was very different for the two families: Our typical family paid just a 3.5 percent income tax rate but a 13.3 percent payroll tax rate because virtually all their income came from wages.

Vice President Biden offers yet another situation: Both he and his wife worked and paid payroll taxes. Social Security benefits and a pension boosted them into the next-to-top tax bracket and they had relatively few deductions—just 18 percent of their AGI. That left them paying 22.9 percent of their AGI in income tax and another 7.5 percent in payroll taxes—roughly the same as the Obamas but significantly higher than the Romneys.

Note that these calculations leave out other taxes that all four taxpayers might pay: corporate income tax, excise taxes, and state and local taxes. Including those levies could change the four stories substantially.

Overall the U.S. federal tax system is highly progressive. As a group, high-income households pay much larger shares of their income than those with low incomes pay. But within each group, where income comes from can yield sharply different tax rates. Check out the infographic and see how that works for the candidates.

With increasing concerns about the federal deficit, fairness, and the complexity and inefficiency of our tax system, the need for fundamental federal tax reform is critical.  Often overlooked, however, is the fact that any such reforms will also affect the tax and fiscal policies of state and local governments.  Although the country’s economic condition is improving, state and local governments are still struggling to balance their budgets.  They also play an important role in our economy, running about half of all domestic public programs and with state and local spending making up about 15% of gdp.

 Decisions about changing federal policy should take into account the potential effects on state and local government budgets in both the short and the long run.

 I will make 4 points today.

 Federal tax policy and reform can help or hurt states. Federal policy affects how attractive specific taxes are for state and local governments and, therefore, how those governments organize their tax and revenue systems.  State revenue sources—especially income taxes—often piggyback on federal rules. More specifically, statutory changes in federal law can result in significant increases or decreases in state revenue. For example, state income tax revenue increased after the 1986 tax reform expanded the federal income tax base, and allowed states to also reduce their rates. In contrast, the elimination of the state and local tax deduction could increase the cost to state and local governments of providing services.

 Unstable federal tax policy trickles down to the states and uncertainty is especially problematic for state and local governments.  State and local governments are required to pass balanced budgets every year.  This requires being able to accurately forecast revenues. Problems with state tax systems are exacerbated by uncertainty in federal tax rules. Temporary extensions of credits, deductions, and tax rates complicate state forecasting. Policy changes and uncertainty can directly affect state tax bases through changing definitions of income or indirectly due to changes in taxpayer behavior.  Especially problematic has been uncertainty about future federal estate taxes and tax rates on dividends and capital gains, sources of volatile income for states

 If fundamental tax reform is undertaken, transition relief might be important for state and local governments. Tax changes can help or hurt states, but understanding the short-run effects will be important and may require slower adoption of policies or some fiscal relief.  Understanding the state of the economy and the fiscal health of state and local governments will be important.

 Due to our federalist system, Congress has a role in helping to coordinate or protect the existing state and local tax base. State and local governments’ ability to raise revenue can be hobbled by limitations that Congress could remove. Most notably, Congress could enact legislation that could help coordinate action across states and would help enable state and local governments to collect taxes on internet and mail-order sales.

Other panelists explored the costs of current federal tax preferences—the state and local tax deduction and tax-exempt municipal debt—that affect state and local governments as well as how federal legislation could help state and local governments coordinate tax policy in the face of changing technology.  The hearing was lively and a good mix of both considering long-term reform and more practical measures that Congress is more likely to act on. 

Opening statements from Senators Baucus and Hatch and the other witnesses are here.