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.
Yesterday, by doing nothing, the U.S. Supreme Court took a giant step towards ending the decades-long dispute over whether states can require online retailers to collect sales taxes. In effect, the High Court ruled that, absent congressional action, states have broad authority to require Internet sellers to collect those levies just as their Main Street competitors must. And, in a delicious bit of online irony, the justices did it on Cyber Monday.
Twenty years ago, the High Court tentatively resolved the same dispute by placing a stiff burden on states that wanted to require mail order firms to collect those taxes. This time, the Court refused to even hear legal objections to New York State’s efforts to impose such a requirement on Internet sellers. As a result, it completely flipped the legal and political dynamics. Now, the burden will be on online sellers to prove that states cannot make them collect taxes.
But the justices had another audience yesterday: By refusing to hear the New York case they sent a strong signal to their across-the-street neighbor on Capitol Hill: Fix this. It is your job.
By allowing the New York law to stand, the High Court appeared to recognize that the commercial and technological landscape has changed in unimaginable ways since it last tackled this issue in 1992. Two decades ago, in a case called Quill v. North Dakota, the Court ruled that a state could not require mail order companies to collect those levies from their customers unless sellers had a “substantial” physical presence in its jurisdiction. Back in the day, the Court worried that it would be too onerous for an out-state seller to comply with a myriad of local tax rules.
How much as the world changed? Quill Corp was an office supply company that mailed 24 tons of catalogs and flyers into North Dakota each year. That state was trying to make the firm collect tax on products such as yellow legal pads. In 1992, physical presence—or nexus in legalese—meant a factory, a warehouse, or a sales office.
Today, Quill sells downloadable software and tech services. And anyone with a smartphone can download an electronic book from an Internet seller headquartered 3,000 miles away. The concept of physical presence seems almost quaint.At the same time, sophisticated software makes it relatively easy for sellers to calculate tax, even from thousands of different jurisdictions.
And there is another way things have changed. Just a few years ago, cutting-edge online retailers such as Amazon.com led the charge against state laws that would require them to collect taxes.
Not anymore. Many online sellers long ago began collecting sales taxes without waiting for states to require it. Even, Amazon, long a champion of the status quo, changed its tune just as it began to revise its own business model.
No longer would it try to compete with big box stores by merely implying people could buy “tax-free” (though they never really could legally avoid tax). Now it is promoting same-day delivery of goods, and even promising drone-based shipments.But drone-ports (or whatever they are called) require old-style presence.
As a result, as more online sellers face state laws requiring them to collect, they’ll increasingly want Congress to create a relatively simple, consistent set of rules. Main Street businesses have demanded equity for years. And states, even many headed by Republican governors, are hungry for sales tax revenues.
The Senate has figured it out. The roadblock now is the House, where some GOP lawmakers are holding up clarifying legislation because they see it as a tax increase.
It is not, of course. Buyers owe tax already on online purchases. Even if sellers don’t collect it, consumers must pay what’s called a use tax, though few do and states rarely enforce their own laws. Still, it is tough to argue that making people pay a tax they already owe is a tax increase.
Back in 1992, the Supreme Court had this to say in its Quill opinion:
…The underlying issue is not only one that Congress may be better qualified to resolve, but also one that Congress has the ultimate power to resolve. No matter how we evaluate the burdens that use taxes impose on interstate commerce, Congress remains free to disagree with our conclusions….Accordingly, Congress is now free to decide whether, when, and to what extent the States may burden interstate mail-order concerns with a duty to collect use taxes.
After yesterday’s decision, the equation has changed dramatically. Congress still has a responsibility to act. But this time, it will be online sellers, not states, who will suffer by its inaction.
The Obama Administration is trying to untangle the controversy over the growing role of 501(c)(4) social welfare organizations in politics by creating a new category of banned candidate-related activity. I wish it all the luck in the world.
Treasury and the IRS will propose regulations that aim to clarify what these groups may and may not do. The agencies are asking for public reaction and say, with remarkable bureaucratic understatement, “The Treasury and IRS expect to receive a large number of comments.”
The proposal would prohibit an organization from qualifying for tax-exempt 501(c)(4) status if it engages in several activities, including:
•Advocating for a candidate.
•Engaging in communications within 60 days of a general election or 30 days of a primary that identify a candidate or political party.
•Spending that must be reported to the Federal Election Commission.
•Making contributions that must be reported under campaign finance law.
•Giving grants to other tax-exempt organizations that conduct candidate-related political activities.
•Participating in voter registration and “get-out-the-vote” drives.
•Distributing material that supports a candidate or a Section 527 political organization.
•Preparing or distributing voter guides that refer to candidates or political parties.
•Holding an event within 60 days of a general election or 30 days of a primary election where a candidate appears.
Treasury seems to be trying to coordinate its rules with federal election law. This seems sensible but its proposal leaves many questions unanswered. For instance, Treasury will have to decide what proportion of an organization’s activity must be to promote social welfare. Would some limited political activity still be permissible? Could a citizen’s association participate in a non-partisan voter registration drive?
By now, most TaxVox readers are aware of the backstory. The century-old law that created tax-exempt organizations granted 501(c)(4) status to social welfare organizations such as neighborhood associations as long as they avoided political activity. But decades ago, the IRS began to blur the lines by allowing groups to engage in politics as long as this was not their primary purpose.
What did that mean? Nobody really knew and the IRS began relying on a facts-and-circumstance test to sort it out. In effect, the agency said, “we know it when we see it.”
Everyone muddled through until the Supreme Court opened the door to political mega-giving in its 2010 Citizens United decision. In the wake of that decision, (c)(4) status became a popular mechanism for bankrolling campaigns. Citizen’s United made it possible for unions and businesses to spend unlimited amounts of money on politics, but the vehicle they used for funneling cash to campaigns, Sec. 527 organizations, required public disclosure of their gifts. By contrast, 501(c)(4)s can collect massive amounts of money anonymously.
Recently, we’ve learned that some (c)(4)s are acting as nothing more than money laundries by collecting millions of dollars in anonymous gifts, then redistributing them to 3rd party non-profits that buy millions of dollars in political advertising.
The IRS tried to get a handle on all this but instead ended up in a nasty political morass. Conservatives accused it of bias last year after several Tea Party groups claimed the agency harassed them when they applied for tax-exempt status. It turned out that the flap was more a matter of tin-ear bungling than a political hatchet job. Still, the episode showed how flawed the current system is.
Now, the Treasury and IRS are trying to clean up the mess. As I have written before, the IRS is the last agency that should be defining political speech. This should be Congress’ job, though, like everything else these days, Congress is unlikely to do it.
Give the IRS and Treasury credit for trying, but I can just imagine the firestorm that’s coming.
For many years, Michael Graetz, now a law professor at Columbia University, has been promoting a national Value-Added Tax (VAT) that would become the principal levy paid by most Americans. VATs–and similar broad-based consumption taxes–are enormously controversial in the U.S. even though they are ubiquitous throughout the rest of the world and enjoy widespread support among many economists.
There is no chance the U.S. will adopt this tax any time soon. Yet, Graetz’s VAT will serve as something of a benchmark for any future tax reform debate, even if that rewrite is far less ambitious than his idea.
By proposing a plan that would vastly broaden the tax base, reduce the number of individual income tax filers by 80 percent, and simplify tax preparation for nearly everyone, Graetz sets a goal. If, in the end, politicians get just halfway there, we could well have a better tax system than we do today.
Michael, who was awarded the Daniel M. Holland Medal by the National Tax Association last week, recently tweaked his plan and the Tax Policy Center ran the numbers. We found that, in 2015, despite the huge changes he’d make to the Revenue Code, his plan would raise the same amount of money as today’s tax law. Just as important, his VAT would not change the overall distribution of the tax burden by very much, and even result in small increase in average after-tax income for low-income households.
Under his plan, those low-income households would enjoy an average boost in after-tax income of about 1.2 percent, while highest-income households would see their average after-tax income fall by about 0.9 percent. Other income groups else would pay pretty much the same tax they do today. Within those groups there would be winners and losers (low income workers without kids would do better than those with children, and middle-income households that don’t itemize would be better off than those that do).
How would his VAT work? It would set a flat rate of 12.9 percent on nearly all consumption (including government purchases of goods and services). TPC estimates that 70 percent of the Gross Domestic Product would be subject to the VAT—a feature that keeps the rate relatively low.
Graetz would retain a federal income tax but use a generous system of allowances to sharply reduce the number of people who’d pay it. For married couples, the first $100,000 in income would be exempt from income tax (the exemption would be set at $50,000 for singles and $75,000 for heads of household). TPC figures these allowances would slash the number of income tax filers from 153 million to just 31 million.
Those who would still pay would face three rates (up from two in an earlier version)–14, 27, and 31 percent. Joint filers, for example, would pay a 14 percent rate on taxable income up to $100,000 (that is, the amount in excess of their $100,000 allowance). The 27 percent rate would apply to taxable income between $100,000 and $500,000 (after the allowance), and the top rate kicks in at $500,000. Graetz would also cut the corporate tax rate from 35 percent to 15 percent.
Graetz isn’t the only tax expert who likes some form of consumption tax. At last week’s National Tax Association meeting, Michael was joined on a panel by my TPC colleague Len Burman and by Alan Viard and Bob Carroll—all of whom described other plausible consumption tax models.
Len discussed the 2010 Bipartisan Policy Center plan that would also graft a VAT on to a smaller, radically simplified income tax. BPC rebranded its consumption tax as a Deficit Reduction Sales Tax or DRST. Alan and Bob discussed a plan that would fully replace the income tax with the progressive consumption tax created more than two decades ago by the late David Bradford.
Not everyone loves a VAT, of course. Conservatives worry that rates could be raised too easily and dislike that in some forms it would accompany an income tax. Liberals distrust what they see as the regressive nature of a consumption tax, though the TPC estimates of the Graetz and BPC plans show those fears can be addressed.
The nice thing about being an academic, as opposed to say, the chairman of the Senate Finance Committee, is that Graetz has the freedom to suggest ideas that are unconstrained by politics and the often dreary realities of policymaking. The result: an ambitious tax reform plan that is, at least, worthy of serious consideration.
For those of you keeping score, the Congressional Budget Office now figures the next showdown over the nation’s debt limit will occur in March, or maybe as late as May or early June. That means up to six more months of fiscal uncertainty, unless Congress decides to kick the can further down the road before the next government shutdown–now scheduled for mid-January.
You may recall that our last fiscal crisis concluded a month ago when Congress and President Obama agreed to reopen the government they had closed and suspend the debt limit until February 7.
But, as it happens, February 7 doesn’t really mean February 7. In your nation’s capital, February really means March. Or May. Or possibly June.
Thus, May, or possibly June, is the same as February here, only hotter.
June may become fiscal February because the Treasury Department has the ability to take what are called extraordinary measures to keep borrowing for months after the law says it can’t. This is somewhat of a euphemism, however. I say this because Congress turns the debt limit into a political crisis practically every year. And each time Treasury takes the same steps to continuing borrowing long past the supposed deadline. At some point, an annual event probably stops being extraordinary.
It is something like, say, Arbor Day. This holiday comes along pretty regularly and for some people I’m sure it is extraordinary. But for the rest of us, Arbor Day falls somewhat short. Besides, at the Treasury Department they try to avoid extraordinary at all costs.
During the last debt limit crisis, Congress briefly considered barring Treasury from taking these once-extraordinary-but-now-routine measures. Those in the know call this the anti-OEBNR statute.
This law would have made the debt limit a real, meaningful deadline, forcing congressional action before a breach. And this year, it would have let February be February, with no opportunity for seasonal adjustment. But let’s face it, February pretty much stinks (except for the 2nd, which is both Groundhog Day and my wife’s birthday).
Of course, CBO can’t give an exact drop-date today. Though the level of spending over the next several months is fairly certain, tax collections are not. And the very uncertainty of a distant date makes it even less likely lawmakers will pay attention any time soon.
The only real consequence of the delay, of course, is that it gives Congress and the White House the opportunity to drag out the next fiscal crisis through spring, thus making it impossible to accomplish anything of consequence between now next November’s elections. After all, with campaigns in full swing you don’t think anybody will be in Washington after June, do you?
Fiscal stalemate gives Republicans more months to rail against Obamacare. And it gives the President more opportunities to turn the whole health exchange thing over to amazon. But, mostly, it means as many as six more months of dreary, February-like, budget stalemate. I, personally, can’t wait.
In an effort to jumpstart moribund tax reform efforts, Senate Finance Committee Chairman Max Baucus (D-MT) is suggesting major changes in the way U.S.-based multinational corporations are taxed on their overseas income.
The plan is quite specific (even including legislative language and a 90-page technical summary) but it is not a formal proposal and leaves many controversial issues unresolved. Normally, the chair of a tax-writing committee would release a “chairman’s mark” for the panel to consider. Baucus calls today’s document a “staff discussion draft” and is asking for public comments by mid-January.
According to the plan, passive income from overseas activities would continue to be taxed at U.S. rates. Most income from the sale of goods and services overseas would also be taxed at full U.S. rates. The draft would end the practice of deferral that allows firms to avoid U.S. tax on foreign earnings until they bring those profits home. However, income that is currently parked overseas would be taxed at a 20 percent rate payable over 8 years.
Baucus would move the U.S. closer to a territorial system favored by many multinationals and GOP lawmakers. Under such a system, income is taxed in the jurisdiction where it is earned rather than by the firm’s home country. While the plan does not fix a specific tax rate, staffers say Baucus is aiming to reduce the corporate rate from 35 percent to about 30 percent.
But in the Baucus plan, this shift closer to a territorial tax comes at a price. To limit the ability of multinationals to game the system, the plan would impose a stiff minimum tax on income earned overseas by foreign affiliates of U.S. parent companies. Firms would be eligible for U.S. tax credits to offset taxes they pay to other countries, as they are today.
The minimum tax has generated widespread interest among independent tax experts and multinationals. My former Tax Policy Center colleague Rosanne Altshuler, now at Rutgers University, has co-authored one idea. President Obama and House Ways & Means Committee Chairman Dave Camp (R-MI) have proposed others. However, Baucus did not settle on a single plan. Rather he suggests two alternative versions.
Unfortunately, the draft does not fully resolve other international tax issues, including the ability of firms to avoid tax by arbitraging the differences between U.S. and foreign tax law. Some of these techniques, which involve licensing intellectual property in low-tax jurisdictions, have made it possible for firms such as Google and Apple to largely avoid paying tax. The minimum levy would impose some tax on income multinationals shift to tax havens but the rate would still be lower than on domestic income.
The Baucus plan would make big changes to international tax law, and is sure to be extremely controversial. It creates big winners and losers in the corporate world. And while it appears to have support of Finance Committee Democrats, Republicans are unenthusiastic. The panel’s senior Republican, Orrin Hatch (R-UT), said he urged Baucus to delay even releasing the draft until after budget talks conclude next year. It is not clear how Baucus plans to proceed with the proposal though it seems unlikely that Congress would be willing to tackle international reform as a free-standing bill any time soon.
In the House, Camp has been working for years to develop his own reform plan and had vowed to roll out his own version this fall. However, the House leadership appears to have put the measure on the back burner, unwilling to let tax reform distract from its top priority–ongoing opposition to the Affordable Care Act.
It is not clear how Baucus will proceed from here. He is expected to offer some additional staff drafts for other pieces of reform in the coming days, including some domestic business tax changes. Baucus says business tax reform should raise the same amount of money as current law, and is not intended to boost federal revenues over the long-run. However, the tax on money now sitting overseas could generate new revenue inside the 10-year budget window.
Today’s draft is an important step forward by advancing the discussion about how to fix the very broken international tax system. It remains to be seen whether it will move us closer to real tax reform any time soon.
What if we bought individual health insurance through our tax preparers? At first, the idea seems bizarre, but give me a minute to explain.
Given the well-known problems of HealthCare.gov and many of the state health exchanges, people seeking insurance coverage need a better way to buy. And commercial alternatives to government sites seem an obvious portal to Affordable Care Act coverage.
You can buy directly through insurance company websites, but the Obama Administration worries that would make it impossible to compare policies offered by different carriers in the way you could on a well-functioning exchange. For instance, if I go the Blue Cross site, I’m not likely to learn much about Kaiser Permanente’s offerings. On the other hand, commercial online health insurance marketplaces allow for comparison shopping, but raise issues of privacy (and perhaps even fraud from fake sites).
Or, you could make your purchase of health insurance a relatively seamless part of filing your tax return.
It actually makes a lot of sense. After all, the Affordable Care Act subsidies are tax credits and the information you need to figure out your subsidy amount is based on the income tax you pay. The penalty you’d owe for not buying insurance is a federal tax. Tax preparers already have—and are legally required to protect—nearly all the personal information they’d need to help figure the subsidy.
Storefront tax preparers can connect customers to health insurance markets through in–person contact. Or people could link electronically through a website such as Intuit’s TurboTax.
Brian Haile, Jackson Hewitt’s senior vp for health policy, predicts more people could end up buying through their connection with tax preparers than any other portal. “It’s a no-brainer,” he told me, “The Affordable Care Act is a series of amendments to the Internal Revenue Code and we help customers with their taxes. We can make this far more accessible for folks.”
I’m hardly the first person to think of this. My Urban Institute colleague Stan Dorn has been exploring this idea since 2011—long before the HealthCare.gov site crashed. And now tax prep outfits are taking steps in this direction.
Tax preparers won’t act as insurance brokers themselves. Instead, they are partnering with commercial online health marketplaces to ease enrollment.
For example, Jackson Hewitt is working with the online marketplace Getinsured to enroll people. Jackson Hewitt will calculate subsidies and potential penalties and, if customers choose, transmit that information to Getinsured. If the Jackson Hewitt customer wants to buy coverage, all she’ll need to do is pick an insurance plan. Jackson Hewitt can even fill out all the paperwork for people to enroll in Medicaid. It says it will not charge for any of these insurance-related services.
Because Jackson Hewitt has 2800 locations in Walmart stores, it could be an especially important link to the uninsured.
H&R Block announced in September that it is partnering with the commercial online health exchange GoHealth to help people enroll through Block-branded online chat and phone support. Block also announced that it will have insurance agents located in its Arizona tax offices as part of a pilot program.
Intuit has created a product called TurboTax Health to assist buyers and has entered into its own partnership with the commercial online marketplace eHealth Inc.
Combined, these three firms alone claim to help file nearly 50 million returns—making them a huge potential portal for insurance buyers. The IRS estimates that about two-thirds of low-income taxpayers use paid preparers–many use walk-in firms such as Block and Jackson Hewitt. And Haile estimates that 90 percent of the uninsured get refunds. He predicts these individuals will be far more interested in buying insurance with those refunds in-hand than they are today, when they are focused on holiday shopping.
Using tax prep firms as a link into the health insurance market won’t solve all the problems of the Affordable Care Act. For instance, the Obama Administration still needs to make sure the back end of its electronic system works, including the government data hub needed to verify buyer information. But Haile is right: For many people-especially those eligible for subsidies—the tax filing season is a perfect time to enroll and tax preparers are a great way to connect them to plan options.
Given its problems with the government site, the Administration ought to be promoting these commercial alternatives. And tax prep firms ought to seize the opportunity.
Senate Democrats are circulating a list of a dozen tax “loopholes” they’d like to close as part of a budget package. It is unlikely that Republicans will agree to any of them except as part of broad tax reform, but it is worth taking a quick look at a few on their merits.
Some represent good tax policy and should be approved, regardless of what happens to the budget talks. Others sound good but won’t accomplish much after the tax lawyers root out new ways around them. And some are little more than headline-mongering.
As always, I wish lawmakers would stop calling them loopholes. Most are, in fact, explicit subsidies approved by Congress with full knowledge of the consequences. They are not the sort of accidental tax breaks that “loopholes” implies.
One of the best ideas on the Democrats’ list is taxing derivatives contracts on a mark-to-market basis, thus making investors pay tax on annual returns even before they sell these securities. This is sensible, easily done with today’s technology, and would reduce the deficit by about $16 billion over 10 years. House Ways & Means Committee Chairman Dave Camp (R-MI) raised this idea in an early tax reform draft, though he got lots of pushback from the financial community.
There are a couple of proposals that make sense at first blush but are unlikely to accomplish much in the real world. One would tax the compensation of private equity managers (carried interest) as ordinary income. Another would end the practice called check the box, where firms can choose their legal form for tax purposes by, yes, simply checking a box on a tax form.
Carried interest is now taxed as capital gains. It ought to be treated as ordinary income since it is nothing more than another form of compensation. The private equity industry has been fighting this change for years, but seems pretty blasé about the shift these days. I suspect that’s because they’ve already figured how to restructure compensation to avoid expected new rules.
Check the box is a similar story. Originally created to simplify the choice between corporate form and partnerships for domestic firms, in recent years it has gained enormous popularity among multinationals as a mechanism to avoid U.S. tax on their foreign subsidiaries.
Eliminating check the box would reduce the deficit by $80 billion over 10 years, according to an official congressional estimate. More likely, it would give lawyers lots more lucrative business. Given the money involved, many firms would pay for the extra paperwork. Besides, check the box is going nowhere absent broad international tax reform.
Then there are the tax-the-rich proposals. For the most part, they won’t raise much money but sound good to the Democratic base. These ideas include: Imposing less generous depreciation rules on owners of corporate jets (an idea that has been in every Obama budget since he moved to the White House), eliminating the mortgage interest deduction for second homes, and limiting corporate deductions for very generous options payments to senior executives.
The deduction for options is a great example of how piecemeal changes to the code do little more than encourage new ways to avoid tax. Years ago, Congress limited deductible executive compensation to $1 million. But it didn’t take long for the lawyers to figure out the rule applied only to cash comp. Curbing the deduction for options would close that loophole (yes, this one qualifies for the “L” word). But don’t be surprised if firms find other ways to deduct the pay of their top execs.
Finally, the Democrats’ list includes a couple of individual tax changes that are long past due. One would limit the use of mega-IRAs for estate planning (a gimmick that got Mitt Romney lots of unwanted attention). Another would bar business owners from characterizing income as profit rather than salary (a trick to avoid payroll tax that surfaced in the tax returns of Newt Gingrich and John Edwards).
Power washing many of these from the revenue code is a perfectly fine idea and ought to happen sooner rather than later. But it isn’t likely to occur as part of the ongoing budget talks.
There is lots of buzz around Washington about whether a laundry list of expiring tax provisions could be the key to a modest budget agreement.
Sadly, it is hard to see how.
The theory goes like this: Democrats might agree to some cuts in programs such as Medicare if Republicans swallow some new revenues. There is no chance that GOP lawmakers will accept tax increases, but maybe they would accept revenue by passively conceding the quiet death of scores of temporary tax cuts that are due to expire at the end of this year.
In effect, Congress could include some revenues in a fiscal package by doing what it does best—nothing. Simply letting these tax cuts expire would produce those new revenues. This would replay on a smaller scale the events of last year, when Congress allowed the Bush-era tax rates to revert to higher levels.
The logic fails on two counts: dollars and budget scoring.
First, the dollars. While congressional Joint Committee on Taxation counts no fewer than 64 separate tax breaks that are due to expire on December 31, most are very small in budget terms. The budget effects would occur starting in 2014 and we only have official estimates for 2013 and beyond so these are rough. But on the individual side, the sunsetting provisions add up to just $5.9 billion in fiscal 2013 and about $12 billion over 10 years.
Corporate extenders are bigger—JCT expects them to cost Treasury about $63 billion in 2013. However, because so many of the temporary business preferences do little more than encourage firms to change the timing of their decisions, they lose a net of only about $46 billion in revenue over the next decade.
Of course, these estimates assume all these breaks are allowed to die. But some of the biggest are likely to survive the budget process. On the individual side, two that won’t go down without a big fight are the temporary deduction for state and local sales taxes and tax-free distributions from IRAs to public charities. These two provisions alone represent more than half of the revenue cost of all the individual extenders.
Among the business extenders, three of the biggest are the seemingly immortal research and experimentation tax credit, a provision that allows multinationals to defer tax on income they earn from their finance arms (Subpart F), and the provision that allows small businesses to write off in one year the full cost of Sec. 179 business equipment (computers and the like) up to $500,000. Combined, those three provisions account for nearly $24 billion of the $63 billion in business extenders in 2013.
Then, there is the budget accounting problem. Because these tax breaks are already scheduled to expire at the end of the year, their future revenue cost is already excluded from the budget baseline. In other words, since JCT and CBO already assume they will expire, Congress won’t get any revenue by letting that happen.
A year ago, lawmakers of both parties spun their way out of this problem—at least in the public debate (the official budget score did not change). This may have been because the dollars involved were so big and because most people were flummoxed by the multiple budget baselines floating around. It isn’t clear how it would all play out this time.
Finally, there are those lawmakers who prefer to use what revenue there is to pay for rate-reducing tax reform rather than a short-term budget deal.
Add it up, and the extenders are not much of a bargaining chip. It is hard to imagine Democrats bending on Medicare in exchange for the paltry few dollars (in budget terms, at least) the GOP might concede by letting the extenders die. Besides, many of these tax breaks have strong Democratic support.
Similarly, it is hard to see Republicans being willing to take a lot of heat from their tea party wing for agreeing to what would surely be dubbed a tax increase—especially with those few dollars at stake. Why get so many people angry for such a small sum of money?
This is not to suggest the expiring provisions are not worth talking about. They are. And many should, on the merits, be floated out to sea on a burning barge. But it is hard to see how lawmakers can build even a mini-deal around their demise.
Thanks to the campaign watchdog organization Center for Responsive Politics and National Public Radio, we’ve learned more about the tactics of some political organizations that enjoy tax-exempt status. The Center has unpacked the dealings of tax-exempt groups that exist merely to funnel political money from anonymous donors to 3rd party non-profits that in turn buy millions of dollars in political advertising.
According to the Center, political non-profits spent more than $300 million on federal elections in the 2012 campaign cycle, three times what they spent in 2008. Increasingly, according to the report, money is being funneled through tax-exempt campaign money laundries.
Many of these groups are 501(c)(4)’s (named after the tax code section under which they are organized). To receive that status, they must serve the social welfare—a purpose subject to a very fuzzy IRS definition. But once they do, they can take advantage of a critical provision of the law: They are not required to disclose the names of their donors when they report to the IRS. This anonymity is key to their business model.
But the activities disclosed today by the Center are an added twist. We’ve known about dark money political groups that use their tax-exempt status to hide their donors. But those groups are generally engaged in political activity themselves and could claim they are enhance the social welfare by educating the public.
The newly-disclosed activity is quite different. These groups do not participate directly in campaigns. They merely collect money from anonymous donors and distribute it to other groups, thus creating additional layers of anonymity for their big bucks contributors.
The treatment of tax-exempt organizations became a hot-button issue earlier this year when conservative groups complained they were being harassed by the IRS after applying for their tax exemption. This turned out to be more a matter of terrible management than a deliberate assault on political enemies. Nonetheless it shined a light on how clever campaign finance lawyers take advantage of an obscure corner of the tax law.
For much of the hundred years Section 501(c)(4) has been on the books, this form of tax-exempt status was used by community groups that did little more than hold bake sales for civic associations.
But after the Supreme Court opened the campaign finance spigot in its 2010 Citizens United decision, businesses, unions and other politically-active entities were looking for a way to contribute big campaign bucks without leaving any footprints. Sec. 501(c)(4) fit the bill perfectly.
That’s because the IRS has interpreted social welfare very loosely for the past half century. As a result, a group is allowed to engage in some political activity as long as it represents less than half of what it does. But no one really knows where to draw the line and the IRS does not seem inclined to enforce the standard in any event.
It is hard to argue that these groups are anything but political. Most exist solely to influence elections. Yet instead of clarifying the law, the IRS engaged in a clumsy effort to screen for political groups as it attempted to sort out which were eligible for tax-exempt status.
Since last spring’s blow-up, neither the IRS nor Congress seems inclined to address this. Indeed, the reason activist groups made a huge fuss over the IRS ham-handedness was exactly to insulate themselves from scrutiny.
Yet, even under the current vague definition, it is hard to see how a group that does nothing other than move money from anonymous donors to 3rd party advertisers serves a social welfare purpose that could pass the laugh test. Unless, of course, you believe that protecting those who seek to buy political influence from public disclosure somehow serves the social welfare.
In the 2012 campaign, conservative groups were by far the biggest proliferators of this technique. The Center estimates that of the 28 social welfare groups that spent $1 million or more on federal political campaigns, 20 were right wing.
But liberal groups are already learning from their opponents and finding their own opportunities to game the system. Soon, no one will speak up against these abuses.
As House and Senate budget negotiators sit down (eight months late), the inevitable issue of new revenues has already raised its head. Predictably, Democrats insist that any fiscal deal include new taxes. Equally predictably, Republicans demand that it must not.
But behind the scenes, Washington’s wink-and-nod crowd thinks it has a solution: Raise new tax revenue—at least on paper—without actually increasing taxes. In fact, some of the gimmicks on the table create even darker Halloween magic. They purport to raise revenues by cutting taxes. Here are just a few examples:
Timing Changes: Timing gimmicks are possible because the Congressional Budget Office and the Joint Committee on Taxation—Congress’ official legislative scorekeepers—normally track revenues only within a 5- or 10-year budget window. As a result, Congress writes laws that boost revenues within those periods, regardless of the long-term consequences.
Chye-Ching Huang and Nathaniel Frentz at the Center on Budget and Policy Priorities have taken a nice look at this scam in a recent paper.
One favorite is the Roth rollover. Traditional “front-loaded” IRAs and 401(k)s allow pre-tax contributions but require participants to pay tax on withdrawals. By contrast, Roths require contributions with after-tax dollars—but withdrawals, including investment earnings, are tax-free.
This is itself terrible tax policy, but lawmakers have made it worse. By periodically making it easier to convert traditional IRAs and (k) plans to Roths (and taxing the transfer as if it is a withdrawal from an old-style plan) Congress can create billions of dollars in short-term revenues even as it adds billions more to the long-run deficit.
When Congress liberalized Roths in 2006, JCT figured the plan would raise $6.4 billion over 10 years. But my Tax Policy Center colleagues figured it would add $12 billion to the deficit in the following decade, and another $30 billion in the decade after that.
This, of course, is exactly the opposite of good fiscal policy. But it looks great inside the budget window.
The Phantom Tax Increase: This one lets Congress take credit for ending some controversial “loophole” without ever raising any real money.
Take proposals to raise taxes on carried interest—the compensation of private equity managers that is taxed at low capital gains rates. Plans floating around the Hill would tax this compensation as ordinary income.
But when a final bill is drafted, it is likely to be riddled with highly-technical exceptions. As a result, with a few adjustments to its comp structure, the private equity crowd is likely to continue to enjoy the low capital gains rate. It will be years before congressional tax experts catch up with carried interest 2.0.
The real-world consequences of a carried interest bill could be even worse. Here’s why: While my TPC colleague Steve Rosenthal and others believe that private equity is already subject to ordinary income tax, the IRS is making no effort to collect the additional revenue.
But any carried interest bill is likely to enshrine into law the lower rate for private equity firms and their investors and bar the IRS from trying to collect those extra dollars. This could cost Treasury big bucks in the long run but because the tax isn’t being collected now, the change would never be counted as lost revenue.
The Tax Holiday: This variation of the timing gimmick allows taxpayers who have avoided tax liability to wipe the slate clean by paying now at a temporarily reduced rate.
States regularly enact such tax holidays. And Congress has done the same with the deferred tax liability of multinational corporations that have chosen to keep foreign earnings overseas rather than returning them to the US and paying the 35 percent corporate tax.
If Congress allows those firms to temporarily repatriate the funds at, say, a 5 percent rate, is it cutting their taxes (since they’d be paying at 5 percent instead of 35 percent) or is it raising them (since they were paying no tax on income they stashed overseas)?
Based on its experience with a similar 2004 holiday, JCT has taken the position that it is a tax cut, at least for now. JCT concluded that some firms would indeed return money to the U.S. that they would otherwise have left overseas, thus raising revenues. However, it also projected that others would repatriate earnings they would have returned anyway, and some would shift future investment and profits overseas while they patiently await the next tax holiday.
As a result, in 2011 JCT concluded that even within the 10 year budget window a repatriation holiday would lose revenue. It would raise taxes on multinationals for the first three years but add a net $78 billion to the deficit over a decade. Multinationals, not surprisingly, reject this projection and insist greater domestic economic activity would boost revenues.
And there is another complication. What if this holiday were part of a transition to a new international tax model, as many in the business community want? In that case, those medium-term budget consequences could easily be washed out by bigger changes.
These are just a few examples of how lawmakers can try to game the system. And other ideas the rest of us haven’t even thought of yet will inevitably surface over the next few months. When they do, it might be worthwhile to consider the long-term revenue cost, not just how they’ll look within the narrow budget window.