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Howard Gleckman
Howard Gleckman is a Resident Fellow at the Urban Institute and editor of TaxVox. He is author of “Caring for Our Parents,” (St. Martin’s Press), a book on how we deliver and finance long-term care to seniors and adults with disabilities. He was formerly senior correspondent in the Washington bureau of Business Week, a Media Fellow at the Kaiser Family Foundation, and a Visiting Fellow at the Center for Retirement Research at Boston College.
Budget Gimmicks Are Alive and Well in the Payroll Tax Cut
February 21st, 2012The other day, I criticized the unwillingness of Congress to finance the latest extension of the payroll tax cut. Since that blog, the Congressional Budget Office released its estimates of the cost of the entire mini-stimulus, including the so-called “doc fix” and changes in unemployment compensation. And the games were even worse than I feared.
Congress made no pretense of paying for the payroll tax cut itself. But it did claim it would pay for the rest of the package. Hint: It didn’t.
There are two bits of legerdemain happening here. Both are functions of the 10-year budget window the Congressional Budget Office and the Joint Committee on Taxation use to score legislation.
The first gimmick allows Congress to pretend tax cuts or new spending are temporary, when it is obvious to all they are not. The second is a sort of congressional lay-away plan. Lawmakers get to buy politically popular policies today but avoid paying for them until years from now.
There is nothing new in all this. Congress has been playing games with the 10-year budget window (or its cousin the 5-year window) for decades. But the mini-stimulus showed business as usual is alive and well on Capitol Hill, despite the best efforts of the tea party caucus.
The doc fix is a perfect example of Gimmick #1. Even though Congress has been temporarily protecting physicians from scheduled Medicare cuts for a decade, CBO must score only what Congress proposes.
So when lawmakers protect docs for only a year (or in this case 10 months) at a time, CBO has no choice but to score only the one-year cost. Thus, the limited fix appears to add only about $18 billion to the deficit over the 10-year budget window when the true 10-year expense of keeping the doc fix going would far exceed $200 billion.
Perhaps the payroll tax cut, which is supposed to be a stimulus measure, really will be allowed to expire at year’s end (though I doubt it). But the doc fix is not countercyclical economic policy. Like old man river, it just keeps rolling along. A year at a time. Since 2002, if you can believe it.
Here’s Gimmick #2. Most of the cost of the doc fix comes in fiscal years 2012 and 2013, as you’d expect with a “temporary” extension. But the measures to pay for them—a reduction in Medicare payments for hospitals’ bad debts and a cut in a preventive care program, don’t kick in until 2014 and beyond. One provision–a hike in federal employee retirement contributions for new workers–won’t start raising real money until 2016.
Will any of these pay-fors actually happen? Don’t bet on it. Already, Senate Democratic Leader Harry Reid (D-NV) has promised to restore the preventive care money. That took, what, four days?
In theory, this kind of budgeting makes sense. After all, while the economy seems to be recovering, it remains sluggish. Why not inject additional fiscal stimulus now and arrange to pay for those initiatives in a couple of years when the economy presumably is stronger?
The problem: Many of these pay-fors never quite seem to happen. Instead, Congress just creates more “doc fixes.” Remember, the first fix was aimed at blocking cuts in Medicare physician payments that were included in the Balanced Budget Act of 1997.
Yes, Virginia, Congress promised that cutting reimbursements to docs would help eliminate the deficit. And, as Sarah Palin, might ask, “How’s that workin’ out for ya?”
Perspectives on Tax Reform from Rudy Penner and Donald Marron
February 17th, 2012In the current issue of the journal The International Economy, ten economic thinkers shared their views on how best to restructure the tax system. Their opinions crossed the political spectrum, ranging from House Budget Committee Chairman Paul Ryan (R-WI) to the Economic Policy Institute’s Andrew Fieldhouse. Two of my Tax Policy Center colleagues—TPC director Donald Marron and Urban Institute fellow Rudy Penner—wrote for the special section and TaxVox is reposting their short essays here. But read the entire debate on The International Economy Website. It is well worth it.
Here is Rudy’s essay:
Were it not for the growth in spending on Medicare, Medicaid, and Social Security, the United States wouldn’t have much of a budget problem. The two biggest programs—Social Security and Medicare—are retirement programs that are extremely popular politically. Both need to be reformed, but they cannot be cut abruptly and they cannot be cut drastically. Consequently, it’s hard to avoid concluding that some revenue increases will be needed to solve our fiscal problems.
Once that need is accepted, we have to ask, “What kind of revenue increases?” The least desirable approach would raise income tax rates in the current system without fixing its complications, inefficiencies, and inequities. If raising rates is rejected, we must either create a new tax— such as a value-added tax or an energy tax—or design a significant, revenue-raising tax reform.
A VAT or an energy tax is probably a nonstarter politically. Republicans see a new tax as a money machine that would finance a much larger government. Democrats worry about the complexity of making such taxes sufficiently progressive
The Bowles-Simpson presidential fiscal commission showed that there are income tax reforms that can raise revenues progressively and efficiently. In one option, they got rid of a host of special tax provisions while limiting, but not eliminating, some of the most politically sensitive, such as the charitable and mortgage-interest deductions. That allowed them to lower the top rate for individuals to 28 percent while still raising $80 billion more in 2015. With three rates—12.7 percent, 21 percent, and 28 percent—the top 0.1 percent of the income distribution lost 11.8 percent of its after-tax income and the top 1 percent lost 7.8 percent. The middle three quintiles lost less than 2 percent.
Erskine Bowles and Alan Simpson achieved a high degree of progressivity by taxing capital gains and dividends at ordinary income tax rates. That imposes a very high double tax on corporate profits. A more radical option would limit the double tax by integrating the corporate and individual tax systems. An even more radical change would move toward a progressive consumption tax. Capital gains and dividends wouldn’t be taxed if reinvested, but would be hit if used to finance consumption.
None of this discussion implies that radical tax reform is easy. The revenue-neutral reforms of 1986 were anything but. A revenue-raising reform greatly increases the ratio of losers to winners. Accomplishing reform seems easy only when compared to persuading Americans to accept a VAT or new energy tax.
Here is Donald’s:
America’s tax system is a mess. It’s needlessly complicated, economically harmful, and often unfair. And it doesn’t raise enough money to pay our bills. That’s why almost everyone agrees that tax reform should be a top priority. Democrats, Republicans, and independents. Accountants, lawyers, and economists. Elected officials and ordinary citizens. All know our tax system is deeply flawed.
Unfortunately, they don’t agree on how to fix it. Some want revenue-neutral tax reform, while others want higher revenues to cut deficits and pay for rising entitlement spending. Some want to fix the income tax, while others want to tax consumption. Some want to cut tax rates across the board, while others would lift rates for high earners.
Public discourse, meanwhile, is hung up on the idea of attacking “loopholes” when the real action is in tax breaks that benefit millions of taxpayers. Tax reform isn’t just about corporate jets or carried interest. It’s about the mortgage interest deduction, the tax exemption for employer provided health insurance, and generous tax incentives for debt-financed corporate investment. Those policies have major flaws, but they are not loopholes. They reflect fundamental economic and social choices, and they benefit well-defined constituencies.
Tax reform will thus involve a prolonged political struggle, as reformers seek some compromise that can attract enough support to overcome the inevitable inertia against change. That won’t be easy, but given our sky-rocketing debt, weak recovery, and flawed tax system, it’s clearly worth the effort.
Even as they seek a reasonable compromise, reformers should continue to articulate their visions of an ideal tax system. Mine would reflect five principles. First, the government should raise enough money to pay its bills. That likely means higher revenues, relative to GDP, than we’ve had historically. Second, it’s better to tax bads rather than goods. That means greater reliance on energy and environmental taxes. Third, it’s better to tax consumption than income; policymakers should thus limit how much they tax saving and investment. Fourth, the tax burden should be shared equitably both across income levels and among people of similar means who make different choices (for example, renting versus owning a home).
Finally, the best tax systems have a broad base and low rates. Policymakers should thus emphasize cutting tax breaks rather than raising tax rates. Indeed, some rates, like the 35 percent rate on corporate profits, should come down.
To afford such cuts, policymakers should go after the dozens of deductions, credits, exclusions, and exemptions that complicate the code and narrow the tax base, often with little economic or social gain. Many of these provisions have been sold as tax cuts, but are really spending in disguise. They should get the same scrutiny that policymakers devote to traditional spending programs.
Congress Figures Out How to Finance a Payroll Tax Cut: Borrow the Money
February 15th, 2012It looks like Congress is about to assume its default position: In the face of an intractable partisan dispute over how to pay for a government initiative, don’t. If Democrats won’t cut spending, and Republicans refuse to raise anybody’s taxes, there is always the solution they both can agree upon—just borrow the money and increase the deficit.
The matter at hand is the payroll tax, of course. And after months of squabbling, it looks as if Congress is about to extend a “temporary” tax cut for another 10 months. And it will borrow $100 billion to do it. That would be OK if this was a short-term stimulus. But I don’t think it is.
How did we get here? To briefly review the bidding, in late 2010 Congress backed a plan by President Obama cut the employee share of the Social Security payroll tax from 6.2 percent to 4.2 percent for 2011 only.
Just as the tax cut was about to expire, Republicans and Democrats locked themselves in their usual fiscal death grip. But in a nice bit of political jujitsu, Democrats stole the GOP’s best anti-tax rhetoric. Letting the temporary tax cut expire as planned, they thundered, would raise taxes on 160 million working people.
The talking point was wildly successful. Just before they headed home for the winter holidays, Republicans went into duck and cover mode and Congress voted to extend the payroll tax break for two months—without paying for the extension, of course. The theoretically temporary tax cut is due to expire again in a couple of weeks. And until this week, Ds and Rs were rehashing the same old argument. Except for some tea party conservatives, most lawmakers insisted they wanted to extend the payroll tax break, but nobody would budge when it came to paying for it.
On Monday, the House Republican leadership announced it would support a 10-month extension without offsetting spending cuts. Problem solved. Just put another $100 billion on the tab.
This wouldn’t bother me if I thought the payroll tax cut was really going to expire in 10 months. But I don’t. Given the Democrats’ politically successful claim that allowing the tax break to expire was akin to a tax increase, it is hard to imagine them abandoning the provision–or the issue– anytime soon.
And if Congress can’t agree on how to pay for it now, how will it do so at the end of the year? That’s exactly when lawmakers will be locked in an epic fiscal policy battle over what to do about trillions of dollars of other expiring tax cuts, how to dodge $1.2 trillion in automatic spending reductions that were mandated by Congress’ failed deficit reduction efforts last year, and how to increase the debt limit.
I can imagine the payroll tax extension becoming another version of the Alternative Minimum Tax patch–extended year after year with borrowed money. To make matters worse, a permanently temporary tax cut further damages the credibility of the Social Security system which the payroll levy is supposed to fund. The government can fill the hole by shifting general fund dollars into the system, but this bit of legerdemain is not going to boost confidence in the retirement program.
Perhaps Congress will find a way to sort out this mess without adding trillions more to the budget deficit. Perhaps it will somehow let the temporary payroll tax cut quietly fade away at year’s end. But, somehow, I doubt it.
Taxes in Obama’s Budget: Few Specifics but Some Big Principles
February 13th, 2012When it comes to taxes, President Obama has proposed what might best be called a conceptual budget—a powerful call for tax reform that is long on principles but, at least when it comes to individual levies, woefully short on specifics.
This is understandable with what is effectively a reelection manifesto. In high campaign season, specifics get a candidate in nothing but trouble. Still, this framework is at once disappointing and illuminating.
It sets up a powerful contrast with whomever the GOP nominates to replace Obama: Should tax reform be used to raise revenues, an explicit goal of this budget, or should it be a vehicle to cut taxes and increase the deficit—the specific aim of every remaining GOP presidential contender?
Yet, Obama’s fiscal plan is disappointing because it is so vague. There is simply no chance Congress will make the tough votes necessary to enact any serious tax reform without a president who is prepared to take the heat for specific, deeply controversial cuts in popular middle-class tax preferences.
But Obama’s budget contains little more than gauzy promises for a “simpler, fairer and more progressive” tax system or, elsewhere, a “simpler, fairer and more efficient’ system. Know anybody against those principles?
There are plenty of proposals to end corporate tax breaks, but when it comes to individual taxes, the Obama budget is the Oakland of tax policy. To borrow from Gertrude Stein, there is no there there.
Yes, he’s proposed taxing dividends at ordinary income rates and found a new way to tax investment firm partners so they could no longer treat their compensation as capital gains. Talking to you, Mitt Romney. But otherwise, the White House has done little more than rehash some Golden Goodies—allowing the 2001/2003/2010 tax cuts to expire for those making more than $200,000, and capping the economic value of itemized deductions at 28 percent.
This adds up to little more than raising taxes on “the fella behind the tree” and ignores those deductions, exclusions, and credits that benefit middle-income households, pervert the tax code, and keep tax rates high.
Even the much-ballyhooed “Buffett tax” is an empty vessel. After making a major fuss in his State of the Union address about requiring those making a million dollars a year to pay their “fair share” in income taxes, President Obama has proposed…nothing.
As a result, the only plan on the table is one proposed by Senator Sheldon Whitehouse (D-RI). With all respect to the senator, a plan by Whitehouse is not the same as a bill from the White House.
Obama’s unwillingness to get down and dirty with legislative specifics seems ingrained in his DNA. He did the same thing with the health reform law, which Congress turned into a mess. And he did it with financial reregulation which, despite whining from Wall Street and the banks, has done little to prevent a rerun of the financial abuses of the past decade.
Still, pay attention to Obama’s principles for tax reform. They set the stage for what could become an epic battle, if Obama gets reelected and is serious about pursuing tax reform (I wouldn’t bet on either at the moment).
Obama laid out five principles. Three–lowering rates, increasing job creation and growth, and cutting “inefficient and unfair tax breaks” –are the mom and apple pie of tax reform. It’s just that nobody can agree on what inefficient and unfair means.
But numbers 3 and 5 will generate a political donnybrook. Number 5 is the Buffett rule. Number 3 is to use tax reform to cut the deficit by $1.5 trillion over the next 10 years.
The last one will do the most to separate Obama from his GOP challenger. Rather than shying from the charge that he’s a tax-hiking Democrat, Obama explicitly vows to use reform to raise revenues—but says he’d get the money almost entirely from rich people. This promise alone will make for an interesting campaign.
Should States Use Tax Breaks to Woo Seniors?
February 9th, 2012We’ve all seen the articles in Forbes, Kiplingers, or U.S. News trumpeting the best states to live in retirement. A key measure for them all: Low taxes. What you may not know is that states actively compete with one another to provide tax breaks to older residents—especially to wealthy seniors.
This competiton is similar to the way states use tax subsidies to woo businesses. It make not make much sense, but it sure is trendy.
For instance, in 2010 the Georgia legislature voted to exempt nearly all retirement income from tax starting in 2016. Last year, the governor of Maine proposed making all pension income tax-free.
Not all states are headed in this direction. Michigan, which is in deep financial distress, recently rolled back some generous tax exemptions for pension income. But nearly every state offers some tax breaks for seniors.
Why? Many seniors have plenty of money to spend including Medicare dollars, and Social Security and pension benefits. Just as important, they use relatively few state and local services: The elderly don’t need K-12 education and spend relatively little time in jail. And their health care is largely funded by the federal Medicare program.
This tax race for seniors is described in a fascinating new paper that Karen Smith Conway of the University of New Hampshire and Jonathan Rork of Reed College presented last week at a Tax Policy Center/UCLA Law School conference on state taxes.
States offer seniors three buckets of tax breaks. They exclude some or all Social Security benefits from tax; grant seniors extra deductions, exemptions, or credits; and exempt at least some pension income from tax. Combined, these preferences cost states more than $24 billion annually. The biggest beneficiaries: middle- and upper-income elders–the very people states want to keep or attract.
For instance, Conway and Rork found that 12 states offer a modest tax exemption for pension income, three exempt income of $70,000 or more, and five exempt all pension income from tax.
Conway and Rork quote Georgia Gov. Sonny Purdue, who said his state’s plan to eliminate taxes on retirement income “will help attract retirees to our state and make our economy even stronger.”
Is he right? Do low taxes attract seniors and are they worth the revenue cost?
Lots of prior research suggests Purdue is engaged in little more than wishful thinking. Last year, fewer than one percent of seniors moved from state to state after age 65 for any reason. And very few appear to do so to reduce their taxes.
This limited mobility may result in another major downside for states. About 70 percent of seniors will eventually require long-term care services in old age, and 20 percent will need this assistance for five years or more.
Many are middle-income seniors who spend down their assets on personal care and eventually become eligible for Medicaid. About one-third of Medicaid dollars are spent on long-term care services and the program is a growing burden on state budgets.
Thus, while states may benefit in the short-run from attracting a few relatively young, healthy, and wealthy pensioners, they may end up paying a substantial price when middle-income seniors become frail, go broke, and require Medicaid long-term care services.
When that happens, states such as Georgia may regret giving up revenue to subsidize seniors. Of course, the price for that mistake will be paid by some future governor who has the misfortune of serving years from now.
What Tax Reform Would Mean for the States
February 7th, 2012What would fundamental changes in the federal tax code mean for state and local governments? Would it limit their ability to raise or borrow money? Would it make their revenue systems more or less progressive or even work more smoothly?
Last Friday, I participated in a joint Tax Policy Center and UCLA Law School conference sponsored by the MacArthur Foundation on what federal reform would mean to governments beyond the Beltway. And the short answer is: A lot.
Some change might be good, while other reforms might be quite disruptive. The bottom line seems to be that Congress could go a long way towards fixing the federal system without destroying state revenue codes—but only if reform is done carefully.
Take, for example, the federal deduction for state and local taxes, which reduces federal revenues by more than $70 billion annually. Policymakers have been talking about repealing it at least since the Reagan Administration.
Since most low- and moderate-income taxpayers don’t itemize, the deduction does them no good at all. Even many middle- and upper-middle class households who do itemize lose the benefit of the deduction if they fall into the dreaded Alternative Minimum Tax.
Still, the system encourages states to rely on deductible levies such as income and sales taxes. The good news is that state income taxes can be progressive (though many are not). The bad news is income and sales tax revenues are sensitive to changes in the economy and their decline is one reason states are in deep fiscal trouble today.
What would happen if Congress got rid of the deduction? To start, while upper-income households would owe more, it wouldn’t matter to the 70 percent of households that don’t benefit now. According to UCLA law vice-dean Kirk Stark and my TPC colleague Kim Rueben, while taxpayers in all states benefit from the deduction, the effects of repeal would be concentrated in a few, high-income, high tax states such as New York and California. Other alternatives, such as turning the deduction into a credit, could benefit lower-income households by reducing their federal tax.
Another item on many tax reform lists is the mortgage interest deduction. Completely eliminating the deduction would drive down home values, at least in the short-run, and hammer state and local property tax revenues. But more modest reforms, such as turning the deduction into a credit, would have relatively modest effects on state and local revenues overall, according to Andrew Hanson of Georgia State University and David Albouy of the University of Michigan.
What about a very broad federal reform, such as creating a national consumption tax? That could turn state tax systems upside down, but the two structures may still be able to live well together. Canada has a national Value-Added Tax, while its provinces operate their own sales levies or piggyback off of the federal tax.
Could the U.S. pull this off? Michael Smart of the University of Toronto felt such a transformation is doable, though not easy. But Stanford University’s Charles McClure, a veteran of Washington’s tax reform battles, was far less confident.
Canada, Charlie noted, was a “best case.” The Canadians replaced a bad tax with a good one and did not have to worry about raising new revenues, yet political opposition to reform was still strong. By contrast, it would be much tougher in the U.S., which suffers from a more toxic political environment, probably would be adding a consumption tax to an income tax, and would likely have to use reform to raise revenue.
While there was lots of healthy debate in LA last week, the participants did agree on one thing: When Congress does get around to federal tax reform, it better not forget what these changes will mean to the states.
What a Value-Added Tax Would Mean for the Tax Code—and the Economy
January 31st, 2012A well-designed Value-Added Tax could simplify the tax code for most households and finance significant reductions in corporate and individual income tax rates without adding to the budget deficit. And it could be a key piece of a revenue system that is both progressive and less intrusive in economic decisions than today’s law.
That’s the conclusion of a new study by my Tax Policy Center colleagues Eric Toder, Jim Nunns, and Joe Rosenberg.
The VAT, a national consumption levy that would tax household purchases of all goods and services, is hardly perfect—no tax is. But properly structured, it could be a vast improvement over what we have.
In a project funded by the Pew Charitable Trusts, TPC modeled a sweeping reform of the federal tax system that includes a VAT. The plan was authored by Columbia Law School professor Michael Graetz . While there are many forms of consumption taxes (Herman Cain’s 9-9-9 tax included several), Graetz’s is similar in structure to the one used by most other countries. In effect, every business pays tax on its sales and gets a credit for any tax that is included in the price of what it buys from other firms.
Graetz does not eliminate the existing income or payroll tax. This no doubt disappoints some reformers, but helps fix a problem that is common to many consumption taxes—they hit poor people (who spend nearly all of their income) more than rich people (who don’t).
Mike’s solution is two-fold: First, he creates a family allowance of $100,000 ($50,000 for single filers), which wipes out all income tax liability for 8 out of 10 households. To ease the burden of the VAT on low-income families, he also creates a rebate tied to wage and self-employment income. But he does not exempt items such as food or housing from the tax.
Graetz sets two income tax rates–16 percent and 25.5 percent—that apply to all income, including capital gains and dividends. He’d repeal the Alternative Minimum Tax. He’d also eliminate the standard deduction and all family-based provisions, such as personal exemptions and the child credit and earned income credit, which he’d replace with the rebates.
He’d allow deductions for charitable gifts and mortgage interest only if they exceed 2 percent of adjusted gross income. Of course, these wouldn’t matter for those making $100,000 or less, since they’d owe no income tax anyway.
Finally, Graetz would cut the corporate rate to 15 percent, eliminate all business credits except the foreign tax credit, and end many deductions and exemptions.
Eric, Jim, and Joe figure Graetz could do all this with a relatively low VAT rate of 12.3 percent. That would raise the same amount of money as the 2011 tax law and be just about as progressive. People in various income groups might pay a bit more or less on average than they do today, but the changes would be surprisingly small.
Besides fairness, economists always look at how much any tax law distorts economic decisions. The current code is a swamp of subsidies aimed at encouraging or discouraging specific economic behavior. By contrast, a well-designed VAT mostly keeps government out of these decisions. It would reduce effective marginal taxes on labor, thus encouraging people to work. And it would reduce overall effective tax rates on capital.
The VAT does have issues. While it would reduce compliance costs for individuals, it would also create new administrative burdens for businesses that have to collect it.
But the biggest question is whether Congress would ever pass such a levy in anything like its ideal form. Any consumption tax must have a very broad base to succeed and this one does. It would apply to new home construction, health and education spending, and purchases and payrolls of non-profits and state and local governments. If Congress buckles under the inevitable pressure to exempt some or all of this consumption from tax, it would have to raise the rate.
Still, at a time when the campaign trail is awash in tax “reform” plans that are more surreal than serious, it’s nice to see a proposal that has the potential to vastly improve the revenue code without adding trillions to the deficit or providing a windfall to those who need it least.
What the Romney and Gingrich 1040s Tell Us About How We Tax The Rich
January 26th, 2012Ernest Hemingway: I am getting to know the rich.
Mary Colum: I think you’ll find the only difference between the rich and other people is that the rich have more money.
It turns out that when it comes to taxes, at least, Ms. Colum, was mostly—but not entirely–right. To see why, let’s take a quick trip through the tax returns of Newt Gingrich, Mitt Romney and their spouses.
Admit it: Peeking at a celebrity’s tax return is more than a little voyeuristic. But get beyond the sheer prurience of the exercise and the Romney and Gingrich returns tell us a lot about the way those with incomes of $1 million or more are taxed, and how they structure their lives to minimize taxes. But mostly, they tell us that all those who make $1 million-a-year are not alike. And most of them are surprisingly like the rest of us, only more so.
Gingrich is typical. He made more than $3 million in 2010—mostly through distributions from an S Corporation. This allowed him to avoid double-taxation (since the S Corp is a pass-through entity that pays no tax). He also used this device to reduce his Medicare payroll tax.
But of his $3.1 million in income, only about $35,000 came from investments, and the rest was taxed at ordinary income rates—much of it at the top rate of 35 percent. It is no wonder that he paid close to $1 million in income taxes–an effective rate of about 32 percent.
Despite the rhetoric coming from President Obama and the claims of Buffett and others, that is not at all unusual. Of the slightly more than 400,000 households making $1 million-plus, the vast majority make most of their income from wages or distributions from pass-throughs, and not from investments. Think entrepreneurs, doctors, lawyers, movie stars, and professional athletes.
As my Tax Policy Center colleague Bob Williams has noted in TaxVox, even among those in the more rarified top 0.1 percent of the earnings distribution (households making at least $2.5 million) fewer than 15 percent make more than two-thirds of their money from investments. Perhaps surprisingly, more than half make less than 10 percent.
In 2011, those making $1 million or more paid an average effective income tax rate of about 19 percent of total cash income. If you want to compare the tax they pay to their adjusted gross income (the smaller amount that appears on a tax return), it would be closer to 24 percent.
Then there is that small subset of those whose principal occupation is investing. That’s Buffett. And that was Romney, at least before he took up presidential politics.
Of the $21,646,507 Romney reported on his 1040, $20,792,324 was investment income. And most was taxed at the 15 percent rate reserved for most dividends and long-term capital gains. Romney also gave away almost $3 million in charitable gifts (big contributions such as this are common—through hardly universal– among those making that kind of money). As a result, his effective income tax rate was a Buffett-like 13.8 percent.
Romney’s returns paint a picture of a man who was enormously successful in his business career (good for him) and who has, with the help of lawyers and accountants, carefully structured his income in a way that minimizes his tax liability. The result: a 203-page return and a very low effective tax rate.
If that offends you, don’t blame Romney. Blame the politicians who created this mess of a tax code. And remember that despite what Buffett and Obama say– and you might think–many high-income people do pay a bigger share of their income in taxes than their secretaries.
President Obama’s Tax Deform Agenda
January 25th, 2012For a while there, I thought President Obama was going to embrace tax reform in his State of the Union address. Instead, following the lead of his predecessors, he offered a laundry list of new tax subsidies, bragged about some old ones, and said almost nothing about a top-to-bottom rewrite of the Tax Code.
Here’s just a partial list of the targeted tax breaks Obama promoted: Tax credits for clean energy and college tuition, as well as tax cuts for small business that create jobs, domestic manufacturers, high-tech manufacturers, and companies that close overseas plants and move production back to the U.S.
At the same time, he’d require individuals making more than $1 million to pay an effective income tax rate of at least 30 percent, in part by eliminating their ability to take many deductions. And, he’d use the tax code to punish companies that do business overseas, creating a new minimum levy that is supposed to assure that all multinationals pay some U.S. tax.
Obama’s embrace of the tax code as a vehicle to pick winners and losers sounded more than a little discordant in a speech whose theme was “everyone gets a fair shot and plays by the same set of rules.” Not so much in a tax code where you get special rules for the government’s favored activities.
As Obama was tossing out his tax baubles, I kept wondering about those firms that somehow didn’t get on his gift list. I can just imagine lobbyists’ cell phones abuzz from furious clients wondering why they weren’t getting a tax break of their very own.
For instance, think about a start-up software company that has to compete with an established firm. Because new businesses rarely make money in their first years, extra tax deductions do them no good. By contrast, a more established competitor, especially if it can qualify for Obama’s high-tech tax break, would benefit—perhaps substantially.
The multinationals’ minimum tax would be entirely unworkable. Even if Congress passed the levy, which it won’t, those firms will find ways around it. Minimum taxes are Band-Aides for a flawed tax system. The solution is not to create a new penalty for firms that learn to manipulate the law, it is to fix the basic law in the first place.
If Obama wants to prevent companies from gaming the system, he could lower the corporate rate and eliminate tax preferences. He raised this in last year’s state of the union address but did nothing about it. That’s too bad. With a low enough domestic tax rate, companies would have less incentive to shuffle income overseas.
Or he could go in the opposite direction and eliminate deferral, the practice that allows multinationals to avoid U.S. tax until they bring earnings back to the U.S. But this minimum tax seems to be a half-measure that may play to his populist base but will achieve little.
I suppose it is inevitable that a president beginning his fourth year in office and facing a deeply divided Congress would go small-bore. After all, there will be no fundamental tax reform in the current environment and even proposing such a step would only open him to criticism from the usual suspects in housing, non-profits, finance and other industries that are very happy with the system as it is.
Still, it is a shame that, instead, Obama would make things worse.
The Santorum Plan: Tax Cuts for (Nearly) All
January 19th, 2012Rick Santorum, who may have won the Iowa caucuses after all, favors a huge broad-based tax cut that would massively increase the budget deficit. According to new estimates by my colleagues at the Tax Policy Center, the former Pennsylvania senator would cut taxes for nearly all households making $40,000 or more. But the impact on the deficit would be enormous: He’d cut taxes by roughly $1 trillion in 2015 alone.
Unlike Mitt Romney, who would slash taxes for those with high-incomes while raising taxes for many low- and moderate-income households, Santorum would boost after-tax incomes for the vast majority of Americans. Only a handful would pay more than they do today.
For individuals, Santorum would start by extending the 2001-2010 tax cuts that are due to expire at the end of this year. But he’d go far beyond that. He’d collapse today’s six tax brackets to just two—10 percent and 28 percent. He’d triple the personal exemption for children, cut taxes on dividends and capital gains from 15 percent to 12 percent, and repeal the Alternative Minimum Tax, the estate tax, and the tax increases in the 2010 health reform law.
For companies, he’s cut the corporate tax rate in half, to 17.5 percent, and allow full first-year expensing of capital equipment. Domestic manufacturing companies would owe no taxes at all. Multinationals could bring profits back to the U.S. at a 5.25 percent tax rate. They’d owe no taxes at all on repatriated earnings they invest in plant and equipment.
As always, measuring the effect of the Santorum tax plan depends on whether or not you assume the 2001-2010 tax cuts are extended. But either way, both the tax cuts for high-income households and the increase in the deficit would be enormous.
Even if you assume the 2011 law is made permanent, the top 0.1 percent (who make more than $2.9 million and average $8.4 million) would get an average tax cut of more than $1.3 million in 2015. By contrast, a typical household making less than $20,000 would get a tax cut of $39. Middle-income households making between about $50,000 and $75,000 would get a tax cut of about $2,000. This largess would add about $900 billion to the deficit in 2015.
If you prefer to compare the Santorum plan to a world where the 2001-2010 tax cuts have expired, they look even more generous. The top 0.1 percent would get an average tax cut of $1.7 million. Those making less than $20,000 would see their taxes cut by $265, and those in the middle would get a tax cut of $3,500. Santorum would increase the deficit by $1.3 trillion in 2015 compared to a budget without the Bush/Obama tax cuts.
The TPC analysis of Santorum’s tax plan comes with the usual caveats. It is static, and thus does not include new revenues generated by economic growth. Much of the benefit to high-income households would come from Santorum’s deep cuts in corporate taxes since TPC assumes those taxes ultimately are paid by owners of capital.
One final caveat: Santorum’s plan includes few details. For instance, while he proposes two individual tax rates, he does not say what the brackets are. Normally, TPC works with the campaigns to clarify these specifics, but the Santorum campaign did not respond to TPC’s requests for information. Thus, the estimates include some heroic assumptions.
Still, like his opponents in the race for the GOP’s presidential nomination, Santorum is proposing extremely generous tax cuts at the price of big increases in the budget deficit.