Leonard Burman is the Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School of Syracuse University. Previously, he served as Director of the Tax Policy Center and Institute Fellow at the Urban Institute. Len was Deputy Assistant Secretary of the Treasury for Tax Analysis from 1998 to 2000, and Senior Analyst at the Congressional Budget Office from 1988 to 1997. He is an affiliated scholar at the Urban Institute, a research associate at the National Bureau of Economic Research, and senior research associate at the Center for Policy Research at Syracuse and president of the Natioinal Tax Association. He is the author of a book, The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed, and numerous articles, studies, and reports.
House Ways and Means Committee Chair Dave Camp (R-MI) has produced an impressive tax reform plan that eliminates most loopholes, deductions, and credits. But the plan also introduces a number of hidden taxes that push marginal rates—mostly for higher-income taxpayers—well above the advertised levels.
For some taxpayers, the effective tax rate under Camp’s plan could be as high as 67 percent, based on my analysis of the section-by-section description of the proposal.
On its face, the new tax schedule appears straightforward: three tax rates—10 percent, 25 percent, and 35 percent. The 25 percent rate starts at taxable income of $71,200 for couples ($35,600 for singles) and the 35 percent rate starts at “modified adjusted gross income” (MAGI) of $450,000 ($400,000 for singles). (MAGI is a broader definition of income than the more common AGI.)
The proposal would end both the individual and corporate AMTs and the phaseouts of itemized deductions and personal exemptions (by abolishing the latter entirely). Most tax policy experts would cheer their demise.
But the plan also introduces a whole raft of new phaseouts and hidden tax rates. First, the 35 percent rate is marketed as a 25 percent base rate plus a 10 percent surtax that applies to a broader base of income (MAGI). This turns out to be important.
The plan resurrects the 1960s era add-on minimum tax—the granddaddy of today’s uber-complex Alternative Minimum Tax. Effectively, the surtax can be thought of as an additional tax on certain preference items such as the value of employer-sponsored health insurance, interest on municipal bonds, deductible mortgage interest, the standard deduction, itemized deductions (except charitable contributions), and untaxed Social Security benefits. Although the list of preference items differs from the old add-on minimum tax, the idea is eerily similar.
Then there are the phaseouts, which all amount to hidden surtaxes. They include:
Return of the TRA86 bubble tax rate. One of the least impressive provisions of the 1986 tax reform was its bubble tax rate of 33 percent on taxpayers with moderately high incomes (higher income taxpayers paid just 28 percent). Camp would do the same thing by phasing out the benefit of the 10 percent bracket—that is, the difference between tax at the 10 percent and 25 percent rates—for higher-income taxpayers. He’d do it via a 5 percentage point surtax for MAGI between $300,000 and $513,600 for couples ($250,000 to $356,800 for singles). The result: effective tax rates as high as 40 percent (the 35 percent top rate plus the 5 percent surtax).
Bubble #2. The standard deduction phaseout equals a surtax as high as 7 percent. The plan phases out the value of the standard deduction for singles and couples at a 20 percent rate between $517,500 and $627,500 of MAGI ($358,750 to$413,750 single returns). In these ranges, $1.00 of additional income translates into $1.20 of additional taxable income, so Camp increases the 35 percent rate to a 42 percent effective rate (35 percent of 120 percent).
Bubble #3. Child credit phaseout. As under present law, the child credit phases out at a 5 percent rate, but Camp would start to reduce the benefit of the credit at the end of the standard deduction phaseout. The size of the phaseout range is $30,000 per kid ($1,500 divided by 5 percent).
Double trouble for heads of household. The plan eliminates head of household status, which benefits single people with children. Camp would add a $5,500 extra standard deduction for single filers with children but then phase it out dollar for dollar between $30,000 and $35,500 of AGI. This effectively doubles these families’ tax rates from 10 percent to 20 percent over that income range (since $1 of additional income raises taxable income by $2).
Giant surtax for higher-income home sellers. Today, home sellers can exclude from their taxable income up to $500,000 of capital gain on the sale of a principle residence ($250,000 for singles). Camp would phase out this exclusion dollar for dollar, starting at $500,000 of MAGI for couples ($250,000 for singles). Since 40 percent of long-term capital gains would be excluded from AGI, an additional dollar of income would increase taxable income by $1.60 ($1 of regular income plus 60 percent of $1 of capital gain that would no longer be excluded). When this provision interacts with the other phaseouts, effective rates for some high-income households would be very high: 64 percent for those in the 40 percent brackets (bubble #1 and #3), 67 percent for those in the 42 percent bracket (bubble #2), and 56 percent for those in the plain old 35 percent bracket.
All those surtaxes also apply to capital gains and dividends. Camp would exclude 40 percent of long-term capital gains and qualifying dividends from taxable income, creating effective tax rates of 6 percent, 15 percent, and 21 percent for those in the 10, 25, and 35 percent brackets. But the phaseouts would add 5 percentage points for those in bubbles #1 and #3 and 7 percentage points in bubble #2 (creating effective capital gains rates of 26 percent or 28 percent for high-income taxpayers).
Finally, add the 2010 Affordable Care Act surtaxes of 0.9 percent on compensation and 3.8 percent on investment income, which the plan would retain.
Congressman Camp’s tax reform proposal includes many simplifications, like the consolidation of education tax incentives. But its effect on rates would be far from simple.
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Enrollment in the new health care exchanges begins today and the government is partially shut down in protest—never mind that Obamacare funding is largely immune to the shutdown.
The Republicans in the House appear to be getting most of the blame for the shutdown because they insist that continued government funding be tied to at least a temporary delay in the implementation of the President’s healthcare law, a nonstarter in the Democratic controlled Senate and the White House.
I wondered how the debate might be different if 2008 had produced a President Romney rather than Obama. Candidate Romney would have campaigned on the success of the Massachusetts health reform, arguably his greatest accomplishment as governor. The system of subsidies, mandates, and a regulated health insurance marketplace were the model for the Affordable Care Act.
If we had Romneycare, the White House and Republicans would be trumpeting the remarkable success of the free (but regulated) market in providing a wide range of choices of insurance plans in most markets and pushing prices down. That is what choice and competition do! (And, exactly what seems to be happening now under Obamacare.)
Democrats might complain that many of the affordable health insurance plans have high deductibles that could create significant hardships for middle-income families if they get sick. The Republicans would remind us that high deductibles help constrain medical spending by making health insurance consumers cost conscious. (In the alternative reality that is Obamacare, Republicans bemoan the high deductibles and the Democrats mostly remain silent.)
Democrats, chafing under Romneycare would hate the individual mandate and the burden it puts on middle-class workers unlucky enough to work for an employer that doesn’t provide health insurance. Republicans would call it individual responsibility; people should be discouraged from eschewing insurance only to put the burden of paying for their care on others when they get sick. Conservative think tanks would point out that the mandate is the lynchpin of any free market solution.
Republicans might not have included the employer mandate—they are more hesitant to put new burdens on businesses—but Obama suspended the mandate for a year and it’s likely an area where the two parties might find common ground if they were on speaking terms. Unions would howl in protest that, without a mandate, employer-sponsored insurance might go the way of the dodo bird. Republicans would say “good riddance.” Companies should focus on producing better products and services and leave health insurance administration to others.
The surtaxes on those with high incomes probably wouldn’t be in Romneycare. President Bush’s historic expansion of Medicare to cover prescription drugs mostly borrowed to cover the cost.
So a key difference is that Republicans really hate the new taxes. As is often the case, what seems to be a fight about spending is really much about taxes.
But another difference is that absent a landslide victory in Congress, President Romney would have needed a significant number of votes from Democrats to pass health reform since many Republicans don’t believe the federal government should be in the health insurance business. A bipartisan bill would surely have muted Democratic criticism.
The bottom line is that the main problem many Republicans have with the Affordable Care Act is that it is Obamacare rather than Romneycare. (Well, actually, it is Romneycare.) They’re not invested in the law since it passed with only Democratic votes. And they really hate the taxes.
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I’m celebrating today’s Supreme Court ruling on the Defense of Marriage Act (DOMA) with my friends and relatives whose marriages are today, finally, accorded equal status to mine.
But I am a tax geek and couldn’t help but think about the consequences of a hundred thousand or so married couples who will now file joint returns rather than as singles or heads of household. My Tax Policy Center colleague Bob Williams has pointed out that while the tiny fraction of couples with wealth high enough to be affected by the estate tax will be unambiguously better off, the income tax is more of a mixed bag. Gay couples will now get to experience the joys and agonies of marriage bonuses and penalties.
But for about 75,000 married same-sex couples, the Supreme Court’s ruling could come with a very nice (though belated) wedding gift: Nearly $200 million in refunds.
As Bob and others have pointed out, today’s ruling means that many newly recognized couples will now be able to file amended returns to claim the marriage bonuses they might have enjoyed for the past three years were it not for DOMA. .
We can’t know exactly how many couples will benefit and by how much because there is currently no way to identify legally married same sex couples on individual income tax returns.
However, making some heroic assumptions, one can come up with a very rough ballpark estimate.
Josh Keller of the New York Times estimated that “At least 82,500 gay couples have married since Massachusetts became the first state to legalize gay marriage in 2004 [through 2012].” This total probably reflects some under-reporting. It also doesn’t include the second half of 2012 in New York and doesn’t include those legally married outside the United States like Edith Windsor, the woman who challenged DOMA.
Let’s assume that 100,000 additional couples would have legally filed as married in 2012 were it not for DOMA. A question is how many of them would have received marriage bonuses—i.e., paid lower taxes.
Let’s assume that half of the newly recognized couples receive bonuses, which means that roughly 50,000 couples might benefit from filing amended income tax returns for 2012, 2011, and/or 2010. If all 50,000 filed amended returns for an average of 1.5 years out of the three this would yield 75,000 amended returns.
The IRS is doubtless unenthusiastic about adding to their workload at a time when they are suffering the effects of the sequester and budget cuts, but this number is relatively small compared with the total number of amended returns (Form 1040X) that the IRS processes every year. The IRS projects 5.5 million amended income tax returns in 2013, so 75,000 additional returns would represent only a 1.4% increase. If some couples choose not to amend their returns, the IRS’s workload will be even more manageable.
To estimate total income tax refunds these new filers will claim, assume that the average bonus is $2,500, which is slightly less than the bonus a couple with $50,000 of income and one earner would receive in 2012 according to the Tax Policy Center’s nifty Marriage Bonus and Penalty Calculator. This would yield total refunds of $187 million. That sounds like a lot of money, but it amounts to rounding error compared with projected income tax receipts of $1.3 trillion.
Of course, this is just the tip of the iceberg. My cousin Andrew points out that he will no longer have to pay tax on his husband’s health insurance. The IRS allows a tax-exempt health insurance plan to cover a federally recognized spouse and qualifying children, but not a same-sex partner. Andrew’s employer may choose to pay all or part of the cost of his husband’s coverage, but the employer’s contribution was until today considered taxable income. Now, Andrew’s family plan can cover his spouse Tom.
And the DOMA ruling will affect much more than taxes. The GAO estimated in 2004 that 1,138 federal statutory provisions treat married couples differently from singles. Social Security, for example, can provide very large marriage bonuses.
There’s a bigger question about how today’s ruling affects federal outlays and receipts. Bob talks about this a little about the tax consequences here. The short version is “it’s complicated.”
We will have more to say about this when we have actual data.
Meanwhile, back to the celebration already in progress.
The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration. [U.S. Constitution, 16th Amendment]
On February 3, 1913, Delaware became the 36th state to ratify the 16th amendment to the Constitution, which authorized the US Income Tax. With 75 percent of the states in agreement (at the time, there were 48 states in the U.S.), the amendment became the law of the land.
Many legal scholars think that the Supreme Court erred when it struck down an earlier income tax and that it would have reversed itself if Congress had tried again. So it’s possible that the 16th amendment was unnecessary, but it did settle once and for all that the income tax is constitutional (except for a small group of tax protesters, who willfully ignore an overwhelming body of case law).
Immediately after ratification of the amendment, Congress created the first income tax. The declaration form was four pages long, including instructions, and the top rate was 7 percent. The tax applied only to rich people: The personal exemption for single filers in 1913 was $3,000, equivalent to almost $70,000 in 2012; the exemption for couples was $4,000, or $93,000 in 2012$.
Incomes were also much lower back then. In consequence, only 358,000 returns were filed in 1913. (The IRS has a wealth of historical statistics about the income tax here.)
Nobody held tailgate parties to celebrate the income tax centenary nor did anyone lip sync the National Anthem on its behalf. People do not love the income tax–at best they tolerate it. It is complex, inefficient, unfair, and it is the biggest tax in a federal revenue system that has not come close to paying for federal spending for more than a decade.
But it’s not as unpopular as Congress. AEI economist Karlyn Bowman has produced a fascinating compendium of surveys of public attitudes toward taxation dating back to 1937. The last time Americans were asked about the fairness of various federal taxes, 53 percent rated the income tax as fair to very fair. Only payroll taxes and sin taxes (excise taxes on beer, wine, and cigarettes) rated higher.
What’s more, most people’s complaint is not that they pay too much federal income tax, but that the rich do not pay their fair share. And most people think that the federal government wastes a lot of the money it collects. In a 2005 survey, people were asked, “What bothers you more – how much you pay in taxes or how your taxes are spent?” 71 percent said that they were more concerned about spending than their tax burdens. Nonetheless, in September 2011, only 26 percent of respondents said they would favor lower taxes if it meant fewer public services.
The fact is that people mostly like the things that the income tax helps pay for–roads, courts, national defense, national parks, clear air and water and safe food, and a significant share of health programs for the elderly–even if they wish all those programs could be provided more efficiently.
A case in point: the major expansion of the income tax occurred because we needed to finance World War II. Americans supported that unprecedented rise in tax burdens–when the income tax went from a “class tax” to a “mass tax”–because they overwhelmingly supported the war against fascism. Although there’s no way of knowing this with certainty, World War II might have come out much differently if the United States were still reliant on excise taxes and tariffs as its primary source of revenue.
Americans mostly seem to favor a progressive tax system–and the income tax is highly progressive. And they mostly do not want to leave a huge pile of debt for their children and grandchildren.
Winston Churchill once said that “Democracy is the worst form of government, except for all those other forms that have been tried from time to time.”
The income tax is like that. So I guess it’s appropriate that our very imperfect democracy has a very imperfect individual income tax as its primary source of revenues.
Happy birthday, income tax.
Len Burman is coauthor with Joel Slemrod of Taxes in America: What Everyone Needs to Know.
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Huffington Post reports on this tweet/warning from former Bush press secretary, Ari Fleischer:
I increased donations to charity in 2012. This deal limits my deductions so I, & many others, will likely donate less in 2013.
Mr. Fleischer is referring to the phaseout of itemized deductions, which had temporarily expired but was reinstated by the Tax Relief Act of 2012 (the official name for the deal that averted the fiscal cliff). Fleischer expanded on this point in an op ed in the Wall Street Journal.
Fleischer is wrong, but it’s easy to understand why he might be confused since the phaseout is designed to obfuscate. Here is the main point: Even though it is called a phaseout of deductions, it’s really just a sneaky way to raise marginal tax rates by a little over 1 percentage point on high-income people.
The phaseout works this way. Singles with incomes over $250,000 and couples with incomes over $300,000 lose 3 cents of itemized deductions for every dollar of income above the threshold. If Mr. Fleischer is married and makes $500,000, his itemized deductions are reduced by $6,000 (3% of the $200,000 of income above $300,000). If he earns more money, his deductions will continue to be reduced. The law limits the phaseout to 80% of deductions, but almost nobody hits that limit because deductions tend to increase with income. Think state and local taxes and charitable donations, which are much more than 3% of income for almost everyone with higher income.
But what does this do to the tax benefits of charitable giving? If Mr. Fleischer is considering giving another $10,000 to some worthy cause (or even an unworthy one, so long as it’s a 501(c)(3)), his deductions will increase by that $10,000. The amount of the phaseout is unaffected, since it depends only on income, not the total amount of deductions (except for that miniscule fraction of taxpayers at the limit).
Assuming he is in the 39.6% bracket, he will save $3,960 in federal income taxes (and more in state income taxes). That is an increase of $460 from 2012 when the top rate was 35%. So the new law increases the tax incentive to give by raising his marginal tax rate (and making deductions more valuable).
The phaseout is really a sneaky way to raise marginal income tax rates. Suppose Mr. Fleischer earned another $10,000. He would lose $300 of itemized deductions (3% of $10,000), so his taxable income (AGI minus deductions) would increase by $10,300, not $10,000. Again, assuming he is in the 39.6% bracket, his additional tax would be $4,079 (39.6% of $10,300), so his effective tax rate is 40.8%, not 39.6%.
So he might decide to pass up on a speaking gig because he thinks the tax hit is too high. Or he might decide to work a little more so he can maintain the same level of consumption that he did before the tax increases.
But he has a stronger incentive than ever to give to charity.
Disclaimer: I have no idea what Ari Fleischer’s income or marital status is. The numbers above are simply provided as an example.
Len Burman is coauthor with Joel Slemrod of Taxes in America: What Everyone Needs to Know.
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Part of the election debate is about who can be trusted to tame the debt. Both candidates promise to be fiscally responsible and both provide maddeningly little detail on exactly how they would accomplish that. They argue, with some reason, that election season is not the time to get into the hard choices that the nation must confront.
There is historical evidence on the spending proclivities of the two parties, and it might surprise you. My former Urban Institute and Tax Policy Center colleague Gene Steuerle has put together a fascinating time series of spending change by presidency, measured as a share of GDP. The chart above shows the data for domestic spending–that is, excluding defense and interest on the debt. Through the Clinton years, the top four presidents are Richard Nixon, Herbert Hoover, Dwight Eisenhower, and George H.W. Bush–all Republicans.
The most fiscally responsible president by this metric is a surprise: Franklin Delano Roosevelt. Here is Gene’s explanation:
[T]he liberal New Dealer, Franklin D. Roosevelt, is at the bottom of the list. Domestic spending actually fell by 3.6 percentage points of GDP during his tenure. How can this be? The massive World War II defense build-up crowded out domestic spending. … Perhaps more importantly, FDR’s New Deal programs were primarily short-run or counter-cyclical in nature, and focused on unemployment compensation and jobs. Much of the spending was not intended to be permanent [and disappeared when the economy recovered from the Great Depression] … Non-cyclical programs, such as retirement and health, remained quite small. Even at the end of the Truman administration, domestic spending was 1.6 percentage points lower than it had been when FDR took office two decades earlier. Finally, much of the increase in domestic spending in response to the Depression occurred prior to Roosevelt’s presidency, under Hoover.
The only Republican true to spending-cut stereotype is Ronald Reagan, who cut domestic spending by 2 percent of GDP. The other big post-World War II spending cutter was Bill Clinton, who cut domestic spending by 0.6 percent of GDP.
Gene also gave me data for George W. Bush and Barack Obama, whose spending records are complicated by the response to the Great Recession. From beginning to end of President Bush’s term, spending increased by 5.6 percent of GDP. which would give him the all-time lead if included in the chart. But even if we stopped the clock at the end of fiscal year 2007, before the recession hit, he increased domestic spending by 0.7 percent of GDP.
Through FY2011, President Obama actually cut domestic spending slightly from the very high levels at the end of the Bush administration, and spending has been cut further since then. Given the slowness of economic recovery, that was probably a mistake, but it certainly suggests that the image some paint of the President as a fiscal profligate is not entirely deserved.
Of course, the effect on the debt depends also on defense, tax revenues, and interest. The chart above shows the debt record of presidents since Eisenhower. (I exclude FDR, who borrowed heavily to finance World War II, and Truman, who benefited from an enormous peace dividend, because they are both outliers by a wide margin.) Four of the five biggest borrowers were Republicans. Ronald Reagan more than made up for his domestic spending cuts with large tax cuts, a defense build-up, and large interest payments on the debt (because interest rates were very high). President Obama wins biggest debtor honors, by a small margin over his predecessor, because of the combination of large outlays to fight the recession and tax revenues at the lowest level since the Truman Administration.
Of course, presidents don’t have full control over spending or deficits. The economy obviously plays a big role, and actual legislation come from Congress, not the White House. Nonetheless, the data suggest that, rhetoric notwithstanding, it may be hard to predict who will be a big spender and who will be a fiscal hawk.
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The Treasury may be losing as much as $5 billion a year from fraudulent tax refund claims—and most of that fraud is entirely preventable.
The New York Times reportedyesterday about the rampant use of identity theft to exploit weaknesses in the IRS’s tax refund processes, sometimes resulting in thousands of fraudulent refunds.
The most common form of fraud simply requires criminals to obtain a valid name and social security number, preferably from someone who won’t be filing a tax return. Then the criminal makes up wage and withholding information, files a tax return electronically (avoiding the need for an actual W-2 form), claims a few deductions and tax credits to produce a larger refund, and waits a couple of weeks for the refund.
Typically, the refunds are deposited electronically—often multiple refunds to the same account. In one especially egregious example, J. Russell George, the Treasury Inspector General for Tax Administration (TIGTA), testified about 4,157 “potentially fraudulent tax refunds … totaling $6.7 million … deposited into one of 10 bank accounts. Each … account had direct deposits of more than 300 refunds.”
The criminals also use debit cards to claim fraudulent refunds. The New York Times reported that swindlers in Florida use addresses for vacant houses (in ample supply), sometimes “even buying mailboxes for them, and collect the refunds there.”
The IRS has taken steps to stem the fraud. For example, it tries not to send refunds to dead people. All told, the IRS claims that it was able to stop $1.3 billion in potentially fraudulent returns through April 19, 2012.
But with massive budget cuts ($300 million this year) and pressure from Congress to process tax refunds quickly, the IRS is fighting a losing battle. Mr. Russell, the Treasury Inspector General, identified 1.5 million additional potentially fraudulent refunds totaling in excess of $5.2 billion that slipped through the cracks.
With appropriate resources and legislative authority, the IRS could prevent most of these refunds. For the past four years, it has sought authority to use the National Directory of New Hires, a database of wage and employment information maintained by the Department of Health and Human Services, to verify that information on tax returns actually corresponds to a real job. This would limit the ability of fraudsters to make up W-2’s, but so far, Congress has not granted the IRS the authority to use that information.
The ideal solution would be for the IRS to be able to match W-2 information with tax returns before processing a refund, but W-2’s are not due until the end of March (if filed electronically, February otherwise) and they go to the Social Security Administration (SSA) rather than IRS, which further delays availability of information to the IRS. If W-2’s were required to be transmitted to the SSA at the same time they were sent to workers and if SSA and IRS computers could talk to each other in real time, most of the refund fraud would be impossible. Obviously, this would put an additional burden on employers and some costly upgrades at SSA and IRS, so using the National Directory should be tried first.
Mr. George also said back in 2008 that “the IRS was not in compliance with direct deposit regulations that require tax refunds to be deposited into an account only in the name of the individual listed on the tax return.” The IRS has resisted that, presumably because of cost, but it seems an unfathomable oversight. George also recommended that the IRS limit the number of deposits into the same account and that the Treasury require financial institutions to verify the identity of debit card purchasers.
Besides for the drain on the Treasury, some identity theft victims suffer real hardship. TIGTA identified 48,357 SSNs that were used multiple times on tax returns. Some of these are simple mistakes—transposing digits, for example—but many if not most represent identity theft cases. The criminal files early and when the legitimate taxpayer files his or her return, the IRS denies the refund. Eventually, the IRS may clear it up and issue a refund, but it has limited resources to handle these complaints and it can be a nightmare for taxpayers. Mr. George testified that only one-fourth of calls reporting identity theft were answered and the average wait time was almost an hour during the 2012 filing season. (The testimony has many more horror stories and is worth reading if you don’t suffer from high blood pressure.)
TIGTA also points out that some thieves are actually unscrupulous tax preparers. The IRS has started to crack down on fly-by-night preparers as part of its effort to reduce EITC fraud, which might help. Some IRS employees have been involved in identity theft, and some thieves have impersonated IRS employees to get taxpayers’ confidential information, which is probably the hardest form of fraud to stop.
One thing that would help is stiffer penalties for fraudsters. The case studies in the TIGTA report involved large scale fraud and only about five years of jail time.
But for now, such fraud is easy as pie. From the New York Times:
Career criminals know easy money when they see it. The police say they run across street corner drug dealers and robbers who have been in and out of prison for years now making lots of money by filing fraudulent returns. Some have been spotted driving Bentleys and Lamborghinis.
“A gentleman, a former armed robber, said: ‘I’m not doing robberies anymore. This is much cleaner. I don’t even have to use a gun,’ ” said Sgt. Jay J. Leiner of the economic crimes unit in the Broward Sheriff’s Office, which has formed a multiagency task force.
Mr. Ferrer, the United States attorney, said he had seen tax fraud overtake violent crime in Overtown, a poor, high-crime section of Miami. He said criminals there were holding filing parties, at which they would haul out laptops and, for a fee, teach others how to run the swindle.
This seems to be an issue on which bipartisan agreement would be simple. It’s theft, pure and simple, and with sufficient resources, the IRS could stop most of it.
When the president first announced his Buffett Rule–that millionaires should pay at least 30 percent of their income in tax–in the State of the Union address in January, I had a strong sense of déjà vu. It is another alternative minimum tax, and its provenance is very similar. Congress created a minimum tax back in 1969 when people were up in arms about 155 high-income people who hadn’t paid tax a few years earlier. The logical response would have been to close the loopholes that let rich people avoid tax, but that would have been politically costly, so instead we got the thing that evolved into the AMT–one reason millions of upper middle-class Americans hate tax day.
The new AMT, called the Fair Share Tax, is anathema to tax reform (and I opined on that in Tuesday’s New York Times). It will be one more complication for people who are affected. For example, if you’re on the cusp of paying FST, you won’t know whether your capital gains will be taxes at 15 or 30 percent. And it will generate enormous marriage penalties.
And it’s unnecessary. If Congress is not willing to fix the underlying defects in the tax code, they don’t need a new AMT. One is really enough. If capital gains and dividends were fully taxed under the AMT, as they used to be before the Tax Reform Act of 1986, the Buffett Rule would be satisfied without a new levy. Moreover, I suspect that would raise enough more revenue that Congress could use the savings to finally index the thresholds for the AMT so that it doesn’t have to be patched every year.
Some people, however, see the Fair Share Tax as a good start on tax reform. The Times also had a nice article about two economic rock stars, Emanuel Saez and Thomas Picketty, who have been extremely effective at putting together data and analysis on rising economic inequality. The article is titled, “For Two Economists, the Buffett Rule Is Just a Start,” so the question is whether the Buffett Rule is a first step towards tax reform and a fairer, more progressive tax system, or a dead end.
The president has said that the Buffett Rule is not a specific proposal, but a principle for tax reform. The actual specific proposal, the Fair Share Tax, which the president supports, includes language saying that tax reform is the goal (thanks David desJardins for reminding me of this):
It is the sense of the Senate that–
(1) Congress should enact tax reform that repeals unfair and unnecessary tax loopholes and expenditures, simplifies the system for millions of taxpayers and businesses (including by eliminating the alternative minimum tax for middle-class Americans), and makes sure that the wealthiest taxpayers pay a fair share; and
(2) this Act is an interim step that can be done quickly and serve as a floor on taxes for the highest-income taxpayers, cut the deficit by billions of dollars a year, and help encourage more fundamental reform of the tax system.
The question is whether the Fair Share Tax is a complement to tax reform, or a substitute. The president has been talking about individual income tax reform for several years. The president commissioned Paul Volcker to put together a tax reform plan. The Volcker Commission issued a report, but the plan went nowhere. The president said that his Bowles-Simpson commission, which would have simplified taxes (although not made them markedly more progressive), had a lot of good ideas, but none of those ideas actually made it into his budget. President Bush actually did commission a credible tax reform plan, but once completed, he acted like it was never his idea.
If the president and Congressional leaders really want tax reform, they should propose tax reform and throw their weight behind it. I understand this might not be a winning strategy in an election year, but we could lay the groundwork by putting together a serious proposal. President Reagan commissioned his Treasury to quietly put together a tax reform plan behind closed doors during the 1984 election year and then he pushed it to passage in 1986.
I don’t, however, think it’s in Democrats’ long-term interest to further undermine an already dysfunctional tax system. The Fair Share Tax might be good politics, but it’s bad policy.
For previous coverage of the Buffett Rule on TaxVox, click here.
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If you read the editorial page of financial newspapers, you might conclude that no aspect of tax policy is more important for economic growth than the way we tax capital gains. You’d be wrong.
The chart displayed above shows top tax rates on long-term capital gains and economic growth (measured as the percentage change in real GDP) from 1950 to 2011. If low capital gains tax rates catalyzed economic growth, you’d expect to see a negative relationship–high gains rates, low growth, and vice versa–but there is no apparent relationship between the two time series. The correlation is 0.12, the wrong sign and not statistically different from zero. I’ve tried lags up to five years and also looking at moving averages of the tax rates and growth. There is never a statistically significant relationship.
Does this prove that capital gains taxes are unrelated to economic growth? Of course not. Many other things have changed at the same time as gains rates and many other factors affect economic growth. But the graph should dispel the silver bullet theory of capital gains taxes. Cutting capital gains taxes will not turbocharge the economy and raising them would not usher in a depression.
Low capital gains tax rates do accomplish one thing: they create lots of work for lawyers, accountants, and financial geniuses because there is a huge reward to making ordinary income (taxed at rates up to 35%) look like capital gains (top rate of 15%). The tax shelters that these geniuses invent are economically inefficient, and the geniuses themselves might do productive work were the tax shelter racket not so profitable. And the revenue lost to the capital gains tax loophole adds to the deficit, which also hurts the economy.
Thus, it’s no surprise that there’s no obvious relationship between capital gains tax rates and economic growth. Indeed, the low rates on gains might do more harm than good.
PS, The data in the chart above are available upon request. Email me and I’ll send you the spreadsheet. (And if you find something that I missed, tell me and I’ll post an update.)
On Tuesday, the Senate Finance Committee held a hearing on “Extenders and Tax Reform: Seeking Long-Term Solutions.” It’s about time! The charade of annual or biennial debate about perpetually “expiring” tax provisions is terrible tax policy and a symbol of our failure to come to terms with budget reality.
If you need help sleeping, download the Joint Committee on Taxation’s (JCT’s) annual list of expiring tax provisions—tax laws that have built in sunset dates. The latest list is here. More than 70 provisions expired in 2011. Based on past experience, almost all will be extended after some debate about how or whether to pay for their budgetary cost. They include very popular provisions like the research and experimentation (R&E) tax credit and the so-called “patch” that prevents tens of millions of middle-class taxpayers from falling prey to the AMT. There is a host of tax credits for energy efficiency and alternative fuels. There’s the tax deduction for state and local sales taxes. And the list includes the ethanol tax credit that provides a windfall to Midwestern farmers while contributing to higher food prices here and starvation in the rest of the world.
Given that the merits of some of these provisions are debatable (to put it nicely), subjecting them to periodic review would seem to be the epitome of frugal budgeteering. But pretending that the provisions will only be in place for a year or two makes them appear to be much more affordable than they will turn out to be. The AMT patch and the Bush tax cuts have been extended without offsetting tax increases or spending cuts, in part justified by the relatively modest budgetary cost of a short-term extension.
University of Virginia law professor (and former JCT director) George Yin has argued that all tax breaks should be subject to annual review, as discretionary programs are, so that Congress will have to take an up or down vote on the provisions to continue them. George argues that temporary provisions are the only tax laws where the costs are fully accounted for because permanent tax cuts can cost much more outside the budget window than in the five- or ten-year period considered when the legislation is debated. Temporary measures, in contrast, typically incur all of their cost within a few years.
Even if you buy George’s analysis of the budgetary effects (Howard Gleckman does not), there are other issues. One is that the provisions are continually extended and become a vehicle for more dumb tax laws. When I worked at the Treasury Department, we deliberately aligned temporary measures so that they would come up for renewal at the same time as the R&E credit, because we knew there would be a vote on extending that popular measure. The AMT patch has become another must-pass extender. It seems likely that the less popular measures would have a hard time surviving if they had to be voted on separately. And without the vehicle for mischief, some dubious new measures might never become law.
Furthermore, Congress’s chronic procrastination means that many temporary provisions are not extended until after they have expired. Astute calendar watchers will no doubt have noticed that 2011 came and went while the 70+ expiring provisions waited in vain for action. There will be an extenders bill this year, but the uncertainty means that taxpayers might rationally discount the actual tax breaks and that raises the odds that they will simply provide windfalls rather than affecting behavior. Research expenditures, for example, have a very long lead time. Investors might guess that the R&E credit will be in place when the research occurs, but they can’t be sure that the provision will not change. There’s some evidence that research is relatively unresponsive to the credit, and its ephemeral nature might be part of the explanation. Similarly, taxpayers don’t know for certain whether they can take tax credits against the AMT. (The provision allowing the use of personal credits is up for renewal.) And, of course, all of those green tax incentives are doubly uncertain—they may or may not be extended and if they are, their value will depend on the size of the AMT patch (since business credits are not allowed against the AMT).
If Congress is going to spend the money to provide incentives, it shouldn’t undermine them by making them uncertain.
It might, however, make sense to make new provisions temporary. Congress might even go a step further and mandate data collection so that Treasury or other agencies could study their effectiveness. But temporary provisions should not be extended endlessly.
I propose a “three strikes and you’re out” rule. After a provision has been extended three times, it should either be made permanent (and its cost fully offset) or it should be erased from the books.
A better solution still would be fundamental reform, which is at least hinted at by the hearing title and Chairman Baucus’s statement at the hearing. Many of the expiring provisions would not survive a rational reworking the tax code. RIP.
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[An earlier version of this post appeared on my blog, The Impertinent Economist.]