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Rosanne Altshuler



Tax Extenders and Tax Reform

February 2nd, 2012

On Tuesday, I testified before the Senate Finance Committee at a hearing titled “Extenders and Tax Reform: Seeking Long-Term Solutions.” I was already depressed about the state of our tax system before I started preparing. As I drafted my testimony, I became distraught.

Our tax system is a mess and unless we send a clear signal to Congress to do something about it, it’s just going to get messier and messier. As Bruce Bartlett writes in his book, The Benefit and The Burden, the tax system is like a garden. It gets overgrown and chaotic unless you regularly clean it. Well, we’ve got an eyesore now and need to bring in a bulldozer.

Here’s what leaves me distraught.

Sixty temporary tax provisions expired at the end of 2011. Congress enacted each with an expiration date and has subsequently extended almost every one. Most of these “temporary” provisions—nicknamed “extenders”—have been repeatedly extended.

Congress created the vast majority of extenders to provide special treatment for a particular activity or investment. They vary widely from special depreciation rules for NASCAR race tracks to subsidies for commuting. Unlike other tax provisions that provide targeted tax benefits, however, extenders have a limited shelf life. Much like the dairy section of the grocery store, our tax code is now littered with expiration dates.

For many taxpayers whom these extenders affect, the recurring ritual of enduring a tax code death watch only to be saved by last minute clemency — or, in cases like this year, resurrection — creates tremendous volatility and uncertainty. It creates a perception that our tax code is unfair and reinforces the view that the current legislative process is dysfunctional and our elected representatives are unwilling or unable to choose among competing priorities.

It’s time to take a stand on extenders and on tax reform. I recommended at the hearing that the extenders be considered within the context of fundamental tax reform.

We seem to have forgotten that the fundamental purpose of our tax system is to raise revenue to fund government. The current system is riddled with tax provisions that favor one activity over another or provide targeted tax benefits to a limited number of taxpayers. Whether permanent or temporary, these provisions create complexity, impose enormous compliance costs, breed perceptions of unfairness, create opportunities to manipulate rules to avoid tax, and lead to an inefficient use of our economic resources. The tax code has become less stable, increasingly unpredictable, and more and more difficult for taxpayers to understand.

A reform that broadens the base would not only raise revenue but would also simplify the system, increase transparency, make it less distortive by reducing tax-induced biases towards certain activity, and improve the fairness of the system. Broadening the base requires deciding which special tax provisions to keep in the code and how best to design them.

Our current fiscal situation demands that we refrain from our habit of kicking the can down the road on tax reform and face the challenges ahead. It’s time to bring in that bulldozer.

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Where are the profits, and why?

March 18th, 2010

Marty Sullivan of Tax Notes magazine has documented the location of profits of U.S. pharmaceutical companies for years. Each article he writes contains eye-popping figures. Last week’s was no different. In the March 8 issue, Marty used annual reports to chart the before-tax profits of seven large U.S. drug companies over the last decade or so. Here’s the story: between 1997 and 2008, foreign profits of Abbot Laboratories, Bristol-Myers Squibb, Eli Lilly, Johnson & Johnson, Merck, Pfizer, and Scherling-Plough quadrupled from about $9 billion to $37 billion. Over the same period, their U.S. profits fell by a third from $17 billion to $11 billion. Bottom line: the share of U.S. pharmaceuticals’ profits earned abroad has grown dramatically—from about one-third in the late 1990s to nearly four-fifths in 2008.

What’s going on? Do taxes play a role? In a recent working paper, Treasury’s Harry Grubert, who has studied the location of U.S. multinational profits at least as long as Marty has written on the topic, sheds some light on the issue.

Harry uses tax return data to look at all U.S. multinationals (except financial companies), not just pharmaceuticals. He documents a 14 percentage point increase in the foreign share of U.S. multinationals’ worldwide income from about 37 percent in 1996 to 51 percent in 2004 (the most recent year of available data).

Harry considers five possible explanations for the dramatic increase in profits abroad: 1) the globalization of sales; 2) the growth in domestic losses; 3) the decrease in taxes abroad and consequent pressure to shift income to low-tax locations to take advantage of those lower rates; 4) the higher growth rate of companies already doing more business abroad at the beginning of the period than other other companies; and 5) changes over the period in how the U.S. taxes international income. 

Harry’s analysis suggests that it’s taxes and not the globalization of sales that play an important role in explaining the jump in the foreign share of U.S. companies’ profits. Low and falling average tax rates abroad—they fell by about 5 percentage points between 1996 and 2004—have led U.S. companies to shift their profits overseas. And U.S. tax policy has also played a role. Marty’s story and Harry’s analysis both suggest that the U.S. needs to change its tax policy towards multinationals.

Taxes do matter for the location of profits.  How many more Tax Notes stories and careful studies do we need before we engage in a thoughtful discourse on international tax reform? The problem is not the absence of options: we could lower the corporate tax rate and tax all foreign profits as they are earned, we could exclude foreign profits from U.S. taxation (though that could make the income shifting problem even worse), we could make incremental reforms (and, to his credit, President Obama has suggested some in his budgets), or we could use formulas to allocate profits (although Harry and I caution against such a move in recent work). The point is that we need to engage in a serious dialog on international taxation soon —before U.S. multinationals have shifted all of their profits abroad.

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Will the Real Marginal Tax Rate Please Stand Up? by Rosanne Altshuler and Jacob Goldin

October 21st, 2009

Suppose that a taxpayer earns an additional dollar of income. How much tax would she owe on that dollar? A natural way to answer this question would be to look up the taxpayer’s statutory tax rate – the rate corresponding to her tax bracket and filing status.

But that approach often gives the wrong answer and can mislead not only taxpayers but policymakers. Many tax preferences are phased in or out according to income, and as a result, those who earn extra income may face either a hidden tax or a subsidy as their tax benefits change in value. For example, for those in the phase-in range of the earned income credit earning an extra dollar increases the credit and reduces their tax liability, driving their actual rate below their statutory rate. But once they make enough so the EITC begins to phase out, the opposite happens and the rate they actually pay climbs.

Altogether, half of taxpayers in 2009 face actual tax rates on additional earnings that differ substantially from their statutory rates. The tax on that last dollar –  what economists call the effective marginal tax rate – is higher than the statutory rate for 32 percent of taxpayers and lower for almost 18 percent. Moreover, the difference between the two rates can be huge. For taxpayers whose effective rate is higher, the average discrepancy is almost 6 percentage points. For those with lower effective rates, the difference averages 11 percentage points (we pointed out these differences in this week’s Tax Fact column in Tax Notes).

This distinction between effective and marginal rates sounds like the kind of technical mumbo-jumbo only economists can love, but it is a very big deal. It changes – or at least it should change – the way lawmakers look at how tax policy affects economic behavior. Take, for instance, President Obama’s proposal to restore some of the pre-Bush tax rates. Simply looking at the change in the statutory rates may not tell a very accurate story. The effective marginal tax rate is what should shape incentives to work, save, and comply with the tax system.

Although differences between effective and statutory rates are significant for all groups, the discrepancy is especially striking for those subject to the Alternative Minimum Tax (AMT). More than 80 percent of AMT taxpayers face an effective rate above their statutory rate because they gradually lose the full benefit of their personal exemptions. The statutory rates for the AMT are 26 and 28 percent. But the phaseout of the personal exemptions raises the effective marginal rate to 32.5 and 35 percent. So while the AMT is an unpleasant surprise for many, this higher effective rate is the real shock. AMT taxpayers making between $200,000 and $500,000 (about two-thirds of all AMT taxpayers in 2009), are socked, on average, with a whopping effective rate of 34 percent. Ouch.

Yet many don’t even know it. Statutory and effective rates differ so haphazardly that most taxpayers probably have no idea how much tax they owe on an additional dollar of income. What does this say about our current tax system? First, the phase-in and phase-outs of provisions really do bite. Second, in case you needed more proof that our current system is complex, here you have it.  Finally, it suggests that many individuals are making decisions based on incorrect notions about the tax consequences of their behavior.

People lose confidence in a system that leaves them in a fog about the tax rates they face. And considering that we are going to have to rely on this revenue-raising structure more than ever in the coming years, that it not a good thing at all.

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Stuck in the Middle with our International Tax System

August 18th, 2009

President Obama took aim at multinational corporations last May at a press conference on international tax policy. I’ll leave out the details here, lest I put you to sleep or explode your brain. Let’s just say that the current system is a mess that drastically needs fundamental reform.  

Economists describe two contrasting “pure” approaches to taxing the income U.S. companies earn abroad. A “worldwide” approach would apply our domestic tax rules to all income (with a foreign tax credit to protect against double-taxation). In theory, that system would tax U.S. business income the same, whether it’s earned at home or overseas, so firms shouldn’t care where they invest. In contrast, under a “territorial” or “dividend exemption” system, the U.S. wouldn’t tax active business income earned overseas; American firms would pay only the taxes of the country where they earn income, just like any non-U.S. business operating there. In theory, that puts U.S. businesses that invest abroad on equal tax footing with foreign firms.

Which system do we use? We’re stuck in the middle and it’s not pretty. A 2005 Joint Committee on Taxation Report labeled the current system a “paradox of defects” and recommended that the U.S. adopt a dividend exemption system. The 2005 President’s Advisory Panel on Federal Tax Reform came to the same conclusions. Its November 2005 report said that the current system “likely distorts economic decisions to a greater extent and is more complex than a system that simply exempts active foreign business income from U.S. tax.”

In 2006, Harry Grubert of the U.S. Department of Treasury and I carefully studied three different systems for taxing the cross-border income of U.S. multinational corporations: the current hybrid system, which combines worldwide and dividend- exemption systems; a “burden neutral” variant of a worldwide system that increases the tax base by taxing all foreign source income currently but lowers the rate to keep the burden on foreign source income the same; and a dividend-exemption system. We concluded that either fundamental reform delivers a better system than the current one and recommended the “burden neutral” worldwide system over dividend exemption.

President Obama has proposed several incremental reforms to cut back on deferral—the current policy of taxing foreign earnings only when U.S. corporations bring them home.  If he’s simply looking for revenue, however, the president would do better to move in the other direction. In recent blogs, Bob Williams and I have been examining the revenue and spending options in the new CBO Budget Options report. CBO includes a dividend exemption option—indefinite deferral—that would raise $76.2 over ten years. That’s $11 billion more than the CBO option of ending deferral entirely!  Again, I’ll spare you the details. But you know a tax system is broken when not taxing a form of income raises more money than taxing it today. We definitely need serious, principled, international tax reform.

So what’s the bottom line? We’re in a mess. We’re stuck between two inconsistent systems with no obvious way to get out. We need reform and we need revenue. The two aren’t necessarily incompatible but change will be hard. Many firms benefit from the status quo — the worst of all worlds is the best of all worlds for them. Whatever we do, there will be losers everywhere.

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Why We Won’t Eliminate the Deficit with Corporate Tax Revenues

August 13th, 2009

Yesterday my colleague Bob Williams blogged on how difficult it will be to dig ourselves out of our enormous budget hole. He examined CBO’s biennial Budget Options report, which contains a list of “revenue options” for modifying Federal taxes. Bob focused on the year with the smallest deficit over the ten year budget window which happens to be 2012. In that year, CBO predicts we will run a deficit of “only” $633 billion. The individual income tax raises the bulk of federal revenues, so naturally Bob looked at incremental reforms of those levies.  

But, what about the corporate income tax? Could we raise enough from businesses to make a major dent in the deficit?  The short answer is no. Before looking at ways to broaden the tax base, it is worth noting that, in 2012, the entire corporate income tax is expected to bring in only $339 billion – roughly 11% of total revenues and barely half the projected deficit.

So could we at least take some meaningful steps toward balancing the budget by raising corporate taxes? Once again, the answer appears to be no.

How about boosting the statutory rate, now 35 percent for most corporations?  CBO doesn’t quite tell us how much that would generate, but it provides an important clue. The budget office estimates that lowering the rate by five percentage points would reduce tax revenues by about $45 billion in 2012. Raising the rate to 40 percent would probably generate significantly less revenue than lowering it to 30 percent would lose, but let’s say it would get Treasury the same $45 billion. That would narrow the deficit by roughly 7 percent.  

How about repealing the domestic production activities deduction (also known as the Section 199 deduction)? Enacted to 2004 to cut effective rates for U.S. manufacturing, the deduction is equal to 9 percent of corporate income. Dumping it would raise only $12 billion in 2012.

Raising corporate rates would increase the tax burden on corporations substantially without meaningfully reducing our deficit. And since the U.S. already has the highest statutory rate among developed countries (except for Japan), we really should be thinking about lowering the rate, not raising it. And remember, corporations are really all of us since, in the end, only individuals pay taxes

What if we simply broadened the corporate tax base instead of tinkering with rates? These options are also a drop in the proverbial revenue bucket. Cutting back on the deductions that firms get for depreciation by requiring longer lives for plant and equipment might raise $18 billion in 2012. Ending a provision that subsidizes exports (called the source-rules exception for exports) might produce $4.5 billion.

Finally, President Obama has targeted multinational corporations for big tax changes. In his 2010 Budget, President Obama proposed to cut back on deferral – the current policy of only taxing foreign earnings of US corporations when those profits are repatriated to the US.  What if we simply eliminate deferral and tax all income as soon as it is earned, regardless of where it is produced? That would be a radical reform, but would raise a measly $6.0 billion in 2012.

Dramatic changes to the corporate income tax system – including big increases in the tax on firms – would do very little to close the budget gap. That doesn’t mean we shouldn’t be looking seriously at corporate tax reform. But as far as making a dent in the deficit, Bob summed it up in yesterday’s post: back to the drawing board…

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The $250,000 Question

May 26th, 2009

During the 2008 presidential campaign, much was made of candidate Obama’s proposal to boost taxes on “high-income” taxpayers. Campaign attack ads warned those folks—couples with income over $250,000 and others with income over $200,000—that a big tax increase was on the way. Joe the Plumber complained that the tax increases would stifle his unborn entrepreneurial dreams.

Well, it turns out that many people with incomes well over a quarter million are not “rich” by Obama’s definition.

You see, it all depends on the definition of “income” which was unclear until last week.  Does the $250,000 refer to adjusted gross income, taxable income, wages and salaries, or something else? The 2009 Treasury Green Book, a detailed guide to Obama’s tax proposals, finally answers the question. Obama has defined a whole new income concept.

The Green Book explains that the administration’s tax proposals will increase the top two rates from 33 and 35 percent to 36 and 39.6 percent and raise the threshold to get into the new 36 percent bracket. For couples, that bracket would start at taxable income of $250,000 minus the standard deduction and two exemptions. For singles, the starting point for the new 36 percent bracket would start at taxable income of $200,000 minus the standard deduction and one exemption. The changes would not take effect until 2011, but for illustrative purposes, Bob Williams calculated the cut-offs for 2009. For married taxpayers the taxable income cutoff would be $231,300 ($250,000 minus the standard deduction of $11,400 and two exemptions of $3,650 each) and for a single taxpayer that cut-off would be $190,650 ($200,000 minus the standard deduction of $5,700 and one exemption). If your taxable income is below those limits, you will not be subject to the higher rates under Obama’s plan.

But most of us don’t consider our income in terms of what’s taxable. We calculate that value on our tax returns, starting with a broad measure of income and then subtracting various exclusions, exemptions, and deductions. We first total wage and salary income, taxable interest and dividends, business income (after expenses), capital gains, rents, royalties, taxable pension and individual retirement account distributions, unemployment compensation and some Social Security benefits. Already we’ve left out tax-exempt interest and some Social Security income. But then we subtract other items, including alimony payments, moving expenses, some retirement savings (IRA contributions, for example), and, if we’re self-employed, health insurance premiums and one-half of the self-employment tax.

What’s left is “adjusted gross income” (AGI), the basic measure of income on a tax return. But you’re not through yet—you next deduct one exemption per family member and larger of the standard deduction or itemized deductions to calculate taxable income. Most high-income people itemize, and their itemized deductions, which include income and property taxes, mortgage interest, charitable contributions, are usually far greater than the standard deduction.  As a result, most people won’t be hit by Obama’s tax increases until their incomes are well over the advertised levels.

Our tax model shows that for 2009, average taxable income for married taxpayers with AGI between $250,000 and $300,000 is about $215,000, well below the $231,300 cutoff for Obama’s proposed tax increase. Average deductions and exemptions for this group of taxpayers is $58,000. A whopping 98 percent of taxpayers in this income range itemize their deductions. This means that a lot of married folks with adjusted gross income in excess of $250,000 (and singles with adjusted gross income in excess of $200,000) don’t need to worry about their taxes going up.

What’s more, many taxpayers in this income range are on the alternative minimum tax (AMT).  They’re not affected by the new tax increases unless the rate increases push them off the AMT.  (Indeed, many get a tax cut since Obama proposes substantial cuts in the AMT).

So, moderately rich people, relax. Obama doesn’t really want you. The only problem, of course, is that the expansive definition of income comes at the expense of even bigger deficits. The CBO projects they will be $9 trillion over the next decade. Somebody—likely our decidedly unrich children and grandchildren—will have to pay that back, with interest.

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From Nascar to Nuts: Why Congress Needs to Stop Micro-Managing Cost Recovery

May 8th, 2009

Recently, Senator Jeff Bingaman (D-NM) and Senator Charles Grassley (R-IA) introduced bills that would discourage private investment in toll roads through public-private partnerships (so-called P3s). Notable examples of this type of investment include the long-term concessions for the Chicago Skyway and the Indiana Toll Road that were granted to private toll road operator-investors.

The Transportation Access for All Americans Act (S. 885) would curtail tax benefits for “applicable leased highway property” by extending the depreciation period from 15 years to 45 years. In addition, the amortization period for intangibles (such as goodwill or franchise rights) would be increased from 15 years to the entire term of the lease. These provisions would dramatically lower the after-tax returns on investment relative to other types of road, such as logging roads or private rights of way, and similar investment activity. The bill also would deny private activity bond financing to any projects. A companion bill, the Transportation Equity for All Americans Act (S. 844), would create significant disincentives for States to enter into private investment arrangements by curbing the use of federal highway funds for these roads.

Putting aside the merits of P3 deals, the proposals by Senators Bingaman and Grassley represent a disturbing trend of Congress micro-managing the cost recovery system. Increasingly, lawmakers are using depreciation schedules to reward activities they like and punish those they don’t. This sort of tinkering adds complexity to the code and drags the cost recovery system further away from any connection to economic useful life—which, after all, was supposed to be the point.

Under current law, taxpayers may take depreciation deductions for new investments under the modified accelerated cost recovery system (MACRS). Each asset is assigned a recovery period (the number of years over which depreciation allowances are spread), a recovery method (how depreciation allowances are allocated over the recovery period), and a convention to determine when the asset was placed in service. The recovery period is based upon the class life of the property as originally established by the IRS in 1962. Remarkably, recovery periods have remained largely unchanged since 1986 and most class lives date back to 1962 or earlier.

In 1988, Congress revoked the IRS’s authority to assign class lives. Since then, entire new technologies have been created, such as mobile phones, automated manufacturing systems, and laser printers. Based in part on concerns that the depreciation system was in need of reform, Congress directed Treasury to study the system in 2000. The report concluded that the system was dated and included an evaluation of options for either overhauling or modifying the system. Instead moving ahead with reform or even restoring IRS authority to update class life assignments, Congress has instead chosen to micro-manage the system. Here are just a few examples:

• extending the recovery period of single-purpose agricultural and horticultural  structures from 7-year to 10-year property

• changing depreciation of property used in certain farming businesses to the 150% declining balance method

• changing the classification of fruit and nut-bearing trees and vines to 10-year property

• increasing the lives of municipal sewers from 20-years to 25-years

• adding motorsports entertainment complexes and Alaska natural gas pipelines as seven-year property

• cutting the depreciation period for smart electric meters and smart electric grid equipment from 20 years to 10
The new focus on legislating individual cost recovery periods results in class lives with ambiguous meaning and leads to administrative problems and taxpayer controversies. Congressional meddling increases economic distortions and moves us further from a system that rationally adds new assets and updates existing categories of investments. These problems will multiply if the trend continues. President Bush’s tax reform panel proposed overhauling and simplifying the current depreciation system. Let’s hope the Volker panel will look at depreciation reform as well. Cost recovery isn’t very sexy, but no tax reform effort should ignore it.

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The Case of the “Disappearing” Offshore Subsidiary

May 7th, 2009

When President Obama proposed international tax reforms on Monday, the biggest surprise was a provision that would prevent parent companies from making foreign affiliates “disappear” for U.S. tax purposes. How do you make an affiliate disappear? Since I have not taken the magicians oath, I’ll tell you. But here’s one clue: It is perfectly legal under the so-called “check-the-box” rules.

Is Obama right to try to make these subsidiaries reappear? I think he is.

First, a bit of history. In 1996, the Treasury issued regulations designed to reduce the paperwork required to classify business entities for tax purposes. The resulting “check-the-box” rules allow corporations to identify an entity as a separate corporation or to “disregard” it as the unincorporated branch of another corporation by simply checking a box on a tax form. While the regulations were targeted at domestic business, they also allowed companies to easily create “hybrid” entities that are considered a corporation by one country but an unincorporated branch by another.

Why would a firm want to create a hybrid entity? It’s complicated, so bear with me.

While American firms don’t pay U.S. tax on profits of their controlled foreign corporations (CFCs) until they bring the profits home, they have to pay U.S. tax immediately on dividends, interest or royalties paid by one CFC to another. That last rule doesn’t apply, however, to payments within a corporation — for example, from a local branch to the home office. That’s the critical point: U.S. tax rules treat payments between related but separate corporations as real, but completely ignore payments from a single corporation’s branch operations to its home office, making the payment “invisible” for U.S. tax purposes.

Check-the-box allows U.S. multinationals to lower their taxes in high-tax countries by shifting income from affiliates in high-tax countries to affiliates in tax havens. Consider a parent company that plans to invest in Germany. Check the-box lets the firm cut its tax bill by routing capital used to finance the investment through a tax haven affiliate.

Here’s how that strategy might work (the diagram should help). The parent company first injects equity (the investment funds) into a wholly-owned Cayman Islands affiliate. That affiliate then lends the money to another wholly-owned affiliate, this one in Germany. The German firm uses the loan for an investment project and pays interest to the Cayman affiliate. The parent “checks the box” on the German affiliate, making it an unincorporated branch of the Cayman subsidiary for U.S. tax purposes, a “tax nothing.” But the Germany government considers it to be a separate corporation.

What happens to the interest payment from the German firm to the Cayman subsidiary? It’s not taxed anywhere! It’s not taxed in Germany because it’s deductible there. It’s not taxed in the U.S. because we regard the combined German/Cayman operation as a single corporation. And it is untaxed in the Caymans, which has a zero tax rate. The interest payment won’t be taxed until it is paid back to the U.S. parent.

Obama’s proposal would impose current U.S. tax on the interest by making sure the hybrid entity remains visible for U.S. tax purposes. Using the tax haven affiliate to finance the German investment would no longer be advantageous from a tax perspective.

These hybrid structures help companies avoid taxes in another important way. They enable them to move income from intellectual property like patents into tax havens by making the intercompany payment of royalties invisible. For example, a Cayman subsidiary can pay part of its parent’s R&D costs and, in return, receive royalty payments for licensing the resulting technology to another foreign subsidiary. If the parent company underprices the license and inflates royalty payments, it can leave a large amount of the resulting income from the parent’s R&D sitting in the Caymans. Just as with interest payments, the royalties are invisible to the U.S. Treasury because the two affiliates can be treated as one consolidated subsidiary. Research by Harry Grubert and John Mutti suggests that significant amounts of intangible assets have migrated from the United States to foreign countries, a trend probably encouraged by the check-the-box regulations.

The Obama administration has decided to crack down on the aggressive tax planning behavior made possible with hybrids. Interestingly, the result could be more investment in low-tax foreign locations relative to high-tax locations abroad as investment in high-tax foreign locations becomes more costly from a tax perspective. Still, many of these hybrid arrangements were designed only to cut taxes. Closing them down makes sense.

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What’s a Green Consumer to Do?

April 17th, 2009

It’s never too early to plan for next year’s taxes. Let’s say you’re thinking about doing some energy-saving home improvements soon and want to know what federal tax credits are available and how they work. How would you find out?  

You might try the IRS website. I did but, unfortunately, couldn’t find any information about energy credits for 2009.

So what’s a green consumer to do? Google, of course. I found two excellent websites. The Tax Incentives Assistance Project provides loads of information on the raft of energy efficiency incentives in the tax code. They even post a matrix of federal energy tax incentives detailing which types of biomass stoves, duct sealing, and other energy-saving purchases qualify for credits. The website also features information on state incentives — a hyperlink takes you to a clickable map of the United States.

Another go-to info source is the Energy Star website– a joint program of the U.S. Environmental Protection Agency and the U.S. Department of Energy.

The Tax Incentives Assistance Project is sponsored by a coalition of public interest nonprofit groups, government agencies, and other nonprofit organizations involved in energy efficiency,the Department of Energy (DOE), and the Environmental Protection Agency (EPA). Energy Star comes to you courtesy of  DOE and EPA.

Hallelujah that these groups are giving taxpayers this information. But green consumers still need to do some careful searching to figure out who and what qualifies for the credit in 2009. On these websites, it’s hard to answer two important questions: are there income limits on the credits? And do they survive the AMT? After poking around, I did find answers on the frequently asked questions section of the Energy Star website. There is no income limit (though the credit is not refundable), and the AMT poses no problem, at least in 2009. But if Congress doesn’t amend the law, AMT taxpayers won’t get any benefit from the credits in 2010. My “research” on these credits turned up a rule  I wasn’t aware of — while you can now claim up to $1,500 in home energy credits, any credits you claim in 2009 count towards the limit in 2010. But note that the $1,500 cap doesn’t apply to geothermal heat pumps, solar water heaters, solar panels, fuel cells, and wind generators. And don’t forget that the tax credit for fuel cells is limited to $500 per .5 kW of power capacity.

Sound complicated? It is. There must be better ways to encourage energy savings!

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Tax Reform 2.0

March 26th, 2009

President Obama announced yesterday that he has asked former Federal Reserve Chairman Paul Volcker to head a new tax reform panel that will make recommendations by December 4th.  This is great news.  The current tax system is a complicated mess and can’t produce the revenues we will need in the coming years. But there is no reason for Volcker to reinvent the wheel. His panel could start by looking at the work of a bipartisan tax reform panel established by President Bush in 2005. I may be biased, since I served as the staff’s chief economist, but I think we designed a pretty good blueprint.

Unfortunately our report went nowhere, even though it received wide bipartisan praise from both policy experts and the press. I’d suggest you read it, except that our website www.taxreformpanel.gov seems to have disappeared. Our panel, chaired by former senator Connie Mack (and vice-chaired by former senator John Breaux), heard from more than 100 witnesses, from Nobel Prize winning economists Milton Friedman and James Heckman to mayors, governors, former Treasury officials, tax practitioners, leading policy experts (including many of my colleagues from TPC) and ordinary taxpayers. Until recently, you could have found the report, powerpoint slides of the testimony by the witnesses, and transcripts of the hearings on the Web. TPC has posted the report, but we don’t have the supporting materials.

But ours was a much broader mandate than the Volcker panel has. We took a broad view of reform, and even looked at introducing a value added tax and replacing the income tax with a retail sales tax. In the end, we proposed two rather dramatic plans to redesign the income tax. We did have constraints, since President Bush limited us to revenue-neutral options that would simplify the code, distribute the tax burden progressively, recognize the importance of homeownership and charity, and promote long-run economic growth and job creation.

Those limitations didn’t make our job easy, but we were less constrained than Volcker apparently will be. President Obama has said that no one making less than $250,000 could pay higher taxes under any new reform. That means ninety-five percent of taxpayers can’t pay additional tax, even if it would result in a more efficient system, decrease inequities, or make their lives much simpler. At a time of monster deficits, that pretty much rules out any sensible reforms.

In addition, he appears to be asking the panel to focus largely on ways to close the tax gap—that is, taxes owed under the current system but not paid. Politicians and the IRS have talked about the $300 billion pot of gold for years, but no one has been willing to make the tough choices and more intrusive measures needed to bridge the gap through tougher compliance, more audits, and more collection of information. Raising serious revenue will inevitably involve some hard choices. Fundamental tax reform may be the only realistic avenue to collect a higher proportion of taxes owed.

The 2005 panel did make some hard choices, but ones that would have provided real benefits. For example, we already addressed one of the key areas identified for reform by the Volcker panel: simplification of family and work credits. We proposed a new family and work credit to replace the cumbersome hodgepodge of work and family subsidies in the code now. We also eliminated the Alternative Minimum Tax and kept rates no higher than they are today. To do that, we eliminated numerous individual and business tax preferences. Among other changes, the mortgage deduction was capped and converted to a credit, employer provided health benefits above a cap were taxed, and the state and local tax deduction were removed along with other itemized deductions.  Such tough choices are necessary to produce a stable, fair, and efficient tax system.

President Obama would likely make different choices, but our simplified income tax plan would be a great starting point. In future blogs, I plan to highlight some of the ideas put forward by our panel. I hope Volcker & friends will keep our report in mind. To start, they could turn the website, www.taxreformpanel.gov, back on.

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