Relevant and even prescient commentary on news, politics and the economy.

Taxes for States in Trouble?

by Linda Beale

[Excerpted from an earlier posting on ataxingmatter]

On ataxingmatter, I considered Michigan’s tough problems and proposed a solution that could offer a way to deal fairly with the many issues the State faces. Michigan, as everybody knows, is a depressed state these days. High unemployment, high foreclosure rates, and even the Red Wings can’t win it all. As two of the Big Three auto companies go into bankruptcy, Michigan is shedding jobs as fast as ice melts on a sidewalk on a hot summer day in Mississippi. Michigan, in other words, has real problems, and real needs that the state government should address.

My suggestion? It’s time to change Michigan’s income tax. Michigan has its share of very wealthy people–just look at the millionaires’ homes in the wealthy suburbs of Detroit, from the Grosse Pointes to those new ‘burbs to the Northeast. But the wealthy in Michigan pay the same flat income tax rate that the middle class pays–4.35%. A family of four starts paying that on wages above the personal exemption of $13,200 (after other deductions, if any). But a family of four with a salary of $500,000 pays the same rate.

Obviously, those few dollars mean a lot to the poor family and hardly anything to the wealthy one. That’s why the federal income tax has had a progressive rate structure since its inception. It’s also why almost all of the states that have a broad-based income tax, have a progressive tax rate structure, generally ranging between 3 and 8 or 9% of adjusted gross income (sometimes as modified under state rules). Only seven have a flat rate structure. See this chart from the Federation of Tax Administrators for a synopsis of state rate structures and exemptions. (Note–apparently, the tables to which I linked yesterday are not accessible at the link at this time. Wikipedia has some of the same information, at this link.)

Michigan should enact a progressive rate structure. How about a zero bracket for the first $25,000 in income, and then a progressive rate structure moving from the current 4.35% on the first $100,000 above that, to 5.35% on the next $200,000, to 6.35% on the next $400,000, to 7.35% on the next $2 million, to 8.35% on anything above $2,725,000. (Look at this study, which has information on city and state tax burdens, including income, property and sales taxes, and you’ll see that Detroit has very high tax burdens–because of the flight of its industrial base and the white flight to the suburbs; so most of the wealthy who work in Detroit don’t live in the city and don’t pay those higher taxes–they live in the surrounding suburbs that can’t be annexed to the city.).

Would people move out of Michigan because of the income tax change? Sure, some in the upper brackets would. (They’re already doing so, of course, because of the Great Recession, which has hit Michigan particularly hard.) But most other states already have a progressive income tax, often reaching 6% on fairly low incomes–so many of those states’ effective tax rates would be much higher than Michigan’s current flat rate and maybe higher than the proposed change. So those that move because of the tax would have to choose a state that had a lesser tax than Michigan’s new one–and states with lower rates may also have a troubled economy. But a reasonable tax of less than 7% on the first $725,000 would make a difference in the ability of Michigan to help create a sustainable economic environment through expenditures for human capital infrastructure (i.e., for K-12 through university funding) and physical public infrastructure. Not to mention that it would also be much fairer, by taxing people on their ability to pay.

Is this a “pie in the sky” proposal or one that has some chance of enactment in the current political climate. A big negative factor that operates at the federal and state level is the anti-tax rhetoric on the right. Tax increases have been an incessant target of the libertarian “think tanks” that oppose most government programs for vulnerable populations and most tax increases, as a matter of faith. Tthese groups have blanketed the internet with PR pieces proselytizing for their faith. See, for example, my various critiques of the the Cato Institute’s Dan Mitchell’s videos for the “Center for Freedom and Prosperity”: CFP’s Laffer Curve Video (Feb. 18, 2008) and The Laffer Curve II–proof? (Mar. 10, 2008) and More Class Warfare from the Cato Institute’s Dan Mitchell (June 17, 2009).

This anti-tax propaganda has made it politically difficult for any person in Congress to address tax increases in a deliberate, thoughtful way. Especially in the Senate, the anti-tax groups’ rhetoric–about corporate taxes, capital gains taxation, and rate structures, in particular–has made it hard to have an open and in-depth discussion of alternatives. As a consequence, the tax agenda in Congress continues to be dominated, to a considerable extent, by objectives that favor those in the top distributional quintile. Take the alternative minimum tax (AMT) as one example. Congress continues to pass annual “patches” to the AMT to prevent the clawback that would otherwise result from the interaction between the lower rates of the regular tax as amended under Bush and the AMT, which was left without corresponding changes. But these “patches” are not limited to much smaller amount needed to keep whole the below-$100,000 crowd. They instead cost many tens of billions annually to keep taxes lower for those most affected in the $200,000 to $500,0000 range. (The AMT generally doesn’t result in additional tax liability for the “super-rich”, since they are ordinarily in the highest tax brackets so their AMT calculation is still less than their regular tax liability.) Yet the patch is urged by the anti-tax rhetoric and touted as preventing tax increases for the middle class. Those same influences are at play in the several states, making it just as difficult to enact progressive tax changes at the state and local levels.

But state legislatures are, for all that, somewhat more exposed to and perhaps even more aware of their local constituencies. The populist distaste for the amount of government money going to financial institutions (and bankers) in the bailout–and the high bonuses for bankers in banks on the public dole–has made an impression. States often have more stringent requirements about running deficits, which has the potential for forcing more decisive action, for good (setting taxes at the right amount to fund needed programs) or for worse (refusing to increase taxe, to ‘starve the beast’, and axing government programs of high importance). The problems are growing more visible, as California’s hobbling by Proposition 13 and its inability to enact needed tax increases has put it in a state of crisis that is shutting the doors to essential state services. See Krugman, State of Paralysis, NY Times (May 24, 2009).

There is some movement in some states. As a commenter noted on the original ataxingmatter post, Wisconsin’s governor proposed an added 1% on joint filers’ income in excess of $300,000 ($225,000 for individual filers), bringing Wisconsin’s top rate to 7.75%. (The budget also proposed dropping the exemption for capital gains, taxed at the same rate as ordinary income, from 60% to 40%.) See Wisconsin Tax Summary 2009-2011, Wisc. Estate Planning and Tax law Blog (Mar. 13, 2009). Meanwhile, Pennsylvania, which increased its personal income tax rate from 2.8% to 3.07% in 2003 in the first change since 1991, is considering at least a temporary income tax increase to 3.57% to avoid cutting state employees and Medicaid reimbursements to hospitals. See, e.g., Hamill, Proposal to Raise Income tax in Pennsylvania, NY Times (June 16, 2009) (noting proposal for a 16% increase for 3 years); Bumsted, Tax increase needed to erase state’s $3.2 billion deficit: Evans, Pittsburgh Tribune-Review, June 5, 2009.

Addendum: California’s Democratic leaders announced today that they intend to send a partial budget fix amounting to $23.2 billion to the governor that will include massive cuts to public education and health and human services, along with $2 billion in new taxes–$1.50 per pack on cigarettes ($1 billion annual revenue projected) and 9.9% tax on each barrel of law ($900 million projected). According to BNA Daily Tax RealTime (June 17, 6:54 pm), Senate President Pro Tempore Steinberg said that “Our biggest argument [with the Republicans] is over the $2 billion in taxes.”

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Health Reform: does limiting the exclusion for employer-provided insurance make sense?

by Linda Beale

[also posted on ataxingmatter]

Both President Obama and Senator Max Baucus, key players in the health reform debate, have now indicated that one source of funding for health care reform on the table is a possible limitation in the exclusion from income of employer-provided insurance. See, e.g., Connolly, President Pivots on Taxing Benefits: Obama is Willing to Consider Move to Gain Health Reform, Washington Post, June 3, 2009.

The immediate reaction (seen in the comments section on the cited article) is rejection of this alternative. After all, many of us rely heavily on the fact that we have health insurance through work, and those of us in the lower income brackets probably would not be able to afford health insurance (at least, under the current privatized system) without that benefit.

But is the populist response the right one? We should not lose sight of the fact that the employer-provided insurance exclusion is the biggest tax expenditure in the Code that, like most tax expenditures, also tends to benefit most the highest income individuals. The Center on Budget and Policy Priorities has put out a new report titled Limiting the Tax Exclusion for Employer-Sponsored Insurance Can Help Pay for Health Reform that addresses this question directly. The Center notes that the tax expenditure is “poorly targeted” and benefits most the high income group who “least needs help paying for health insurance.” Lower-income taxpayers get less from the benefit because they may not have jobs, even if they have jobs they may choose to forego participation because of the cost of their share of the premium, and even if they participate, they get less of a benefit (in absolute dollar terms) because their tax rate is lower.

Here’s the graph showing the benefit relative to the income group.

CBPP suggests that the exclusion can be reformed without eliminating the value of employer-provided health insurance. One of the concerns is that employers will no longer provide the benefit if it becomes taxable, but a “play or pay” requirement could discourage that option and mitigate its effects. CBPP suggests that concerns about a rigid cap that would apply in all cases can be mitigated by adjusting the cap when a firm is relative small (so that more goes to administrative costs) or has more older and sicker workers (so that more health care costs must be covered) and for other, similar issues. The paper provides three specific alternatives for structuring the limitation in order to promote the goal of universal health coverage.

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Watch What I Do…..

This is my first official posting on Angry Bear. Let me start with a “thanks and delighted to be here.” I look forward to a productive interchange and expansion of the work I have been doing through ataxingmatter, my blog on tax and economic issues. I will continue to maintain the tax blog, and post here about once a week (usually with simultaneous posting on ataxingmatter).

There has been quite a bit said about Obama’s proposals for international taxation. If you read ataxingmatter, you know that I think the proposals to tighten up the way the rules work to prevent abuses are important starts in the right direction. Not surprisingly, multinational corporations have suggested that any change to the international regime that increases their taxes will make them even less competitive internationally (implying that they already have too little money to compete well) and ultimately, even quickly, lead to the demise of U.S. jobs. See, e.g., Donmoyer, Ballmer Says Tax Would Move Microsoft Jobs Offshore, Bloomberg.com, June 3, 2009.

One would think from such talk that US multinationals are just hanging on by the sheerest strings, unable to reduce costs further, leaving very small profits (if any) for their shareholders, and barely managing to pay their managers enough to keep decent talent aboard. But is that what Ballmer really means? Isn’t it more likely that it is a question of Microsoft hoping to retain all that money for its managers and owners rather than see a penny of it go to government purposes (like education, basic research)? How do we get any idea about what differences taxes make to companies when what managers say can’t really be trusted to shed much light on actual plans for the future?

Well, there is some real data on this issue that comes from the 2004 tax legislation–the corporate pay-back bill that was sold to the public with the same old claim that tax cuts would create millions of new jobs. The 2001-2003 tax bills cut revenues, but primarily lowered tax liabilities for individual taxpayers. (As I recall, Bush himself saw about a $37,000 tax cut from the 2001 legislation and Cheney more than double that.) Corporate lobbyists had agreed to this plan–ram the individual tax cuts through first and then pass a big bill fulfilling the multinationals’ wish list. The Bush administration and Congress came through in blazing colors for the corporate lobbyists, passing a host of corporate-friendly provisions under the guise of “job creation tax incentives for manufacturers, small businesses, and farmers.” (That’s the heading for Title II of the so-called American Jobs Creation Act of 2004. Even the names of the various bills ultimately passed in 2004 represent a veritable smorgasbord of propaganda–the “Homeland Investment Act”, the “American Jobs Creation Act”, and, the same year, the “Working Families Tax Relief Act”. )

The Jobs Act provisions included a host of bad policy choices all in the name of freeing up investment cash so that corporations could invest more in the good ol’ USA: even more section 179 expensing; even more accelerated depreciation for leaseholds, restaurants, aircraft, and syndication property; S corporation expansion; AMT breaks; more cross-crediting of foreign tax credits; more tax expenditures for the Big Oil, Big Timber and Big Pharm. And there was one other tax expenditure that was heavily lobbied for on behalf of multinational enterprises–a (purportedly one-time) provision for very low taxed repatriation of foreign earnings, in new section 965 of the Code. The MNEs claimed that the break would permit them to create thousands of new US jobs by reinvesting tax savings in their US businesses–investments that just couldn’t be managed under the constraints on the current tax burdens on repatriated cash. Repatriation, on the other hand, was supposed to lead to an increase in capital spending in the range of 2-3% over two years (see NBER paper, below, noting J.P. Morgan Securities’ estimate) and firms stated both confidentially and publicly that they planned to use repatriated funds for business purposes like acquisitions, capital spending, R&D, debt repayments rather than to pay out profits to shareholders.

The express purpose of the repatriation tax cut was to increase investment and viability of U.S. operations. Hiring new employees, conducting R&D, increasing capital investment in the US were all good uses, and Treasury guidelines indicated that use to pay executive compensation, dividends or stock redemptions would disqualify the repatriations from the tax benefit.

Did the corporate giants deliver? An NBER working paper by Dhammika Dharmapala, Fritz Foley and Kristin Forbes concludes that they did not. Watch What I Do, Not What I Say: The Unintended Consequences of the Homeland Investment Act, NBER Working Paper No. 15023, June 2009. Here’s the conclusion, as stated in the abstract.

Repatriations did not lead to an increase in domestic investment, employment or R&D—even for the firms that lobbied for the tax holiday stating these intentions and for firms that appeared to be financially constrained. Instead, a $1 increase in repatriations was associated with an increase of almost $1 in payouts to shareholders. These results suggest that the domestic operations of U.S. multinationals were not financially constrained and that these firms were reasonably well-governed.

Furthermore, money is fungible. The paper concludes that firms “were able to reallocate funds internally to bypass the publicly stated goals of the Act.” Id. at 5. So of the $299 billion that companies brought back from foreign subsidiaries (about 5 times the normally repatriated amount), about 92 percent of it went to shareholders in share buybacks and increased dividends. And interestingly, the firms that brought back the most money under the repatriation scheme were the firms that tended to “shield[] foreign income from U.S. taxation by using tax haven affiliates or holding companies.” The study also found that “[f]irms that increased parent equity provisions around the time of the tax holiday … had significantly higher levels of repatriations. This pattern suggests that the domestic operations of U.S. MNEs were not capital constrained and were instead providing liquidity to affiliates. These firms seem to have taken advantage of the HIA by ’roundtripping,’ that is, by replacing retained earnings that would be subject to high repatriation taxes if there were no tax holiday with new paid-in capital.” In fact, the paper includes a comparison of MNE and nonmultinationals on financial constraint indicators, showing that the MNEs are less constrained than nonmultinationals under each of the three important indicators.

At least one result was that good guys–the MNEs that didn’t use as many tax shelters to shield their foreign income and who regularly repatriated it and paid taxes on it–didn’t get nearly as much benefit from this bill as the bad guys–the MNEs that shielded their foreign income as much as they could and held it abroad until they could get this repatriation measure passed through their intensive lobbying pressure. And the bad guys didn’t do much of anything in the way of job creation, the political calling card they used to get their special tax break passed.

Seems to me we ought to at least keep this Jobs Act history in mind in the discussion of President Obama’s efforts to tighten international taxation rules and the already begun whining by MNEs that they are having such a difficult time competing that any further taxation will force them to move out of the US completely.

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