Leonard Burman is the director of the Tax Policy Center, a professor of public administration and international affairs at the Maxwell School of Syracuse University, a research associate at the National Bureau of Economic Research, and a senior research associate at Syracuse University’s Center for Policy Research. He co-founded the Tax Policy Center in 2002. He served as Deputy Assistant Secretary for Tax Analysis at the Treasury from 1998 to 2000 and as Senior Analyst at the Congressional Budget Office. He is past-president of the National Tax Association. Burman is the author of Taxes in America: What Everyone Needs to Know, with Joel Slemrod, and The Labyrinth of Capital Gains Tax Policy: A Guide for the Perplexed, co-editor of Taxing Capital Income and Using Taxes to Reform Health Insurance, and author of numerous articles, studies, and reports. Burman’s recent research has examined US federal budget dynamics, tax expenditures, financing long-term care, the individual alternative minimum tax, the changing role of taxation in social policy, and tax incentives for savings, retirement, and health insurance. He holds a Ph.D. from the University of Minnesota and a B.A. from Wesleyan University.
Senate Republicans are insisting that the 2.3% excise tax on medical devices, enacted as part of the Affordable Care Act, be repealed as part of the package extending expired tax provisions. Democratic Senate Majority Leader Harry Reid says the proposal to chip away at part of Obamacare is not germane and has refused to allow a vote on the amendment. The stand-off has put the extenders bill in limbo.
It’s easy to lampoon Republicans for voting, yet again, to repeal at least part of Obamacare—the House has voted for full or partial repeal more than 50 times—but they have a point. The medical device tax is dubious policy. And an obvious tax offset exists. Higher cigarette taxes would raise revenue and lower the costs of the Affordable Care Act over time by reducing tobacco-related illnesses.
The medical device excise tax was part of a suite of taxes designed to offset some of the costs of the Affordable Care Act. The rationale was that the health sector would benefit from the higher demand for medical services and the taxes would recapture part of the resulting windfall. There are also taxes on insurers and drug manufacturers.
The tax is small and it exempts exports and direct sales to consumers (e.g., eyeglasses). Jane Gravelle and Sean Lowry of the Congressional Research Service concluded that the tax would mostly be passed on to consumers, having negligible effects on profits. The warnings of a massive exodus of US manufacturers in response to the tax are thus overblown.
But taxes on intermediate production activities are economically inefficient. Compared with broad-based taxes on spending or income, they produce large distortions relative to the revenue collected. And CRS warns that since the tax is relatively small, administration and compliance costs are likely to be large relative to revenues—especially for small manufacturers.
Cigarette excise taxes present a much better targeted alternative. Cigarette taxes discourage youth smoking and ultimately reduce lifetime health expenditures. Given that federal health programs, such as the ACA, ultimately foot the bill for many of these costs, the cigarette excise tax could be viewed as a kind of benefits tax—paying for health insurance that is more valuable to smokers than the rest of us.
The common critique of cigarette taxes is that they are regressive—poor people are more apt to smoke than others. But they would also benefit to the extent that they—or their children—are dissuaded from smoking (assuming that smoking is a choice that they would ultimately regret). And part of the revenue from cigarette taxes could be recycled into programs that help the poor such as the EITC.
The CBO estimates that raising the cigarette excise tax by 50 cents from $1.01 to $1.51 would bring in about $37 billion over the ten-year budget window, more than offsetting the $29 billion in revenues lost if the medical device tax is eliminated. The surplus could be plowed into a higher EITC (or offsetting more of the costs of the extenders) or the cigarette tax could be increased less.
Democrats fear that repealing the device tax would fuel efforts to roll back other ACA taxes, and that’s possible. But establishing the precedent that such changes must be offset would significantly raise the bar for future policy changes.
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Let’s take a break from fake IRS political scandals to consider how the Service handled a real scandal 45 years ago. Randolph W. Thrower was IRS commissioner from 1969 to 1971. The Nixon White House insisted that the IRS audit the president’s enemies. Thrower, a lifelong Republican, refused to do it. According to the Washington Post, he also refused to hire Nixon dirty tricksters John Caulfield and G. Gordon Liddy.
In 1971, Thrower asked to meet with Nixon, believing that the president would be appalled at the attempt to use the nonpartisan agency as a political tool. Instead of a meeting, Nixon aide and future Watergate convict John Erlichman called to tell him he was fired.
After Mr. Thrower was thrown out, Nixon told top aides the kind of IRS commissioner he wanted.
I want to be sure he is a ruthless son of a bitch that he will do what he is told, that every income tax return I want to see I see, that he will go after our enemies and not go after our friends. … Now it’s as simple as that. If he isn’t, he doesn’t get the job. We’ve got to have somebody like that for a change in this place. (Source: White House tapes as reported by New York Times.)
President Nixon was also disappointed with Thrower’s replacement. After rejecting the highly respected John Nolan on the grounds that he had too much integrity to do the president’s bidding, Nixon picked Johnnie M. Walters, a South Carolina tax lawyer who was an assistant to Attorney General John Mitchell. Walters also turned out to have a stubborn streak of integrity. He put John Dean’s enemies list in a vault and didn’t take it out until the Congressional committee investigating Watergate asked for it.
Nixon complained about Walters too: “A lot of our people come in here and they start sucking around the Georgetown set, all of a sudden they’re just as bad as the others.”
There is another possibility, which is that people at the IRS try to do their job—often under difficult conditions—and that flows all the way up to the commissioner (or vice versa).
Thrower died last Thursday at the age of 100. (IRS commissioners seem to be rewarded for their suffering at the hands of opportunistic pols with exceptionally long lives.) According to the Washington Post
A few years after he left his post as IRS commissioner, Mr. Thrower … visited IRS headquarters on business… As word spread that he was in the building, IRS staffers emerged from their offices, spontaneously applauding as Mr. Thrower walked through the halls.
Here’s to IRS Commissioners and their employees, who mostly behave much better than the policymakers who make their jobs impossible.
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Today I testified at a Senate Finance Committee hearing on “Innovative Ideas to Strengthen and Expand the Middle Class.” The middle class certainly needs help. I shared several suggestions, the most important of which is that we replace automatic inflation indexation with regular adjustment of tax parameters to mitigate growing economic inequality.
Some of those productivity gains have paid for increasingly costly fringe benefits, especially health insurance and the employer’s share of payroll taxes. But that cost growth explains only about 10 percent of the gap between wages and productivity.
Much of the productivity gain has gone not to middle class workers, but to wealthy owners of capital. Globalization and machines that are increasingly good substitutes for workers—think of the self-checkout machines that have supplanted many cashiers—are putting downward pressure on workers’ salaries, even as the owners of capital and executives are doing better than ever.
The solutions to middle class stagnation lie mostly outside the tax system. For many, education is the key to a better life. Specialized training of the sort now offered by many community colleges in collaboration with local businesses can prepare workers to operate complex machines. That would make it possible for them to benefit from technology rather than become victims of it. And a college degree is still the surest path to a comfortable upper-middle class life. Policymakers should aim to simplify the bewildering array of higher education programs and subsidies (some of which are in the tax system) and make sure that middle class kids know that a degree is within their reach, without the burden of crushing debt.
Policymakers should also redouble their efforts to control health care costs. If health inflation moderates, employers could raise wages instead of increasing payments for health insurance.
Encouraging saving would help the middle class, who often lack sufficient assets to protect themselves from job losses or other shocks to income. Policymakers should revisit the Universal Savings Account program that the Clinton Administration proposed—a progressive retirement savings vehicle. It is similar in some ways to the current Savers’ credit in that the subsidy is highly progressive and to the President’s MyRA proposal, which allows for automatic enrollment, but USAs would include automatic annual contributions of up to $300 per worker for low- and moderate-income workers along with the matching contributions. The subsidies would automatically go into 401(k)-type accounts. Clinton’s original proposal was targeted at retirement saving, but the accounts could also protect against job loss or help pay for a down payment or education.
Encouraging saving and education would fit well into a bipartisan opportunity agenda—and there seemed to be support for that approach among the senators in attendance. But they are not the only solutions: The progressive income tax plays an important role in mitigating the gap between rich and poor and it could do more
My most “innovative”—some would say “radical”—policy option would replace across-the-board price indexing, which exists under current law, with indexation that reflects changes in economic inequality.
Currently, tax bracket thresholds and some other parameters of the tax law are adjusted proportionately to account for inflation. Thus, if prices rise by 3 percent, the standard deduction, personal exemptions, tax rate thresholds, and certain other parameters also go up by 3 percent.
My alternative would adjust those tax provisions in a different way: If incomes at the top rise while all other incomes stagnate, then the parameters that most affect low- and middle-income households would be adjusted the most. The credit rate for the EITC, the size of the child tax credit (CTC), and the size of the personal exemption and the standard deduction would increase disproportionately, while the top tax rate thresholds might not change at all. I would not raise top marginal tax rates (as I did in an earlier proposal with Bob Shiller and, Jeff Rohaly) and so would not change incentives for those with high incomes. But the plan would push gently against the winds of rising economic inequality.
My alternative would change total tax revenues by the same amount as price indexation. Tax rates would not change and income thresholds for each bracket would never decline in nominal terms—so someone whose income didn’t grow would never land in a higher tax bracket. If all incomes grow proportionately, indexation would operate just as it does today.
Over time, there is a lot of money in play. My Tax Policy Center colleague Amanda Eng estimates that if inflation plays out as CBO predicts, indexation under current law will reduce tax revenues (compared with the current level of tax parameters) by over $200 billion in 2025. Reallocating the money so it most benefits those who suffer most from increasing income inequality won’t solve the problem, but it would help those being left behind.
You can find my testimony here. Feel free to share your own ideas for helping the middle class in the comments section.
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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.