TaxVox: the Tax Policy Center blog

Tax Credits for All

Bob Williams — Thu, 05 Nov 2009 14:37:00 -0500

Contrary to all the advice TaxVox offered, the Senate last night voted to extend the Homebuyer’s Tax Credit for seven months and expand it to include many people who already own homes. The House will likely follow suit today.

I have clearly misread the mood of Congress and the country. And I should have known better. Ever since the Tax Reform Act of 1986, Congress has larded the revenue code with credits and deductions to encourage retirement saving, college attendance, homeownership, and healthcare. This year’s stimulus bill created new tax benefits to boost demand for housing and autos, and President Obama’s 2010 budget would expand tax credits for retirement savings. And just this past Tuesday, voters resoundingly chose two new governors who promised to cut taxes to encourage economic development.

Now that I understand the thinking of Congress and the country, may I suggest a few new tax credits that will help the economy recover from its recent doldrums? Any member of Congress may freely adopt one or more, preferably without attribution.

New Stock Buyers Tax Credit: Despite its recent rebound from last year’s lows, the Dow Jones Industrial Average remains 30 percent below its high just over two years ago. The credit would go to new stock buyers (defined as people who have owned less than $100,000 of common stock during the past six months) and equal 25 percent of up to $50,000 of the cost of stock purchased between now and October 1, 2010 (the third anniversary of the Dow’s record high). No income limits would apply but college students on scholarships could not claim the credit. Nor would the credit have any age restrictions although children could claim the credit only if they can count to twenty with shoes on.

Real Books Tax Credit: The sale of real books is plummeting, as former buyers shift to electronic books or borrow paper copies from the library in an effort to cut costs in the slow economy. And bricks-and-mortar bookstores have suffered further from price-cutting by on-line booksellers. A refundable tax credit equal to the full suggested retail price of eight books per eligible taxpayer purchased from retail bookshops with average annual sales over the past six years of no more than 500 copies of the year’s top 25 fiction best sellers would generate a rapid increase in demand for struggling booksellers. Qualifying purchases would have to occur on weekdays between now and the conclusion of the 2010 National Reading Week next May. People whose libraries contain more than 125 books published since 2001 could not claim the credit.

Santa Claus Tax Credit: Retailers predict desultory holiday sales this year. The Santa Claus credit would pump up purchases by reducing the after-tax cost of gifts purchased and given by the end of 2009. The non-returnable credit would equal half the cost of any gift bought in person by people using handwritten letters to Santa from children under age 15 who live with relatives at least nine months during 2009 and still believe in Santa, the tooth fairy, and the Easter bunny. Alternative credits would benefit people who celebrate Hanukkah, Kwanza, or the winter solstice.

My list of possible tax credits is hardly exhaustive but it clearly addresses the mood of Congress and the country: no foundering market should lack its own personal tax stimulus.

Will Tax Credits Sell Long-Term Care Insurance?

Howard Gleckman — Tue, 03 Nov 2009 15:32:00 -0500

Long-term care insurance has been a model of market failure. The need for care in frail old age or disability seems to be the ideal insurable event. Two-thirds of those over 65 will need some assistance before they die and 20 percent will need it for more than five years. Yet only about 6 million people own this insurance, and few seem interested in buying.

To boost sales, the industry has pushed for all sorts of government assistance. A federally-funded marketing effort called the Own Your Own Future campaign has tried to raise public awareness of the need for coverage. A joint state/federal program called the Partnership Program attempts to more closely link private long-term care insurance with Medicaid. And about three dozen states now offer tax incentives for the purchase of insurance (30 provide a deduction, 7 give credits, and 3 give both).

Now, in the context of health reform, carriers are pushing for new federal tax subsidies—either a credit or inclusion of long-term care insurance as part of an employer’s overall benefit plan. Making this insurance a benefit in such a “cafeteria plan” would allow workers to buy coverage with pre-tax dollars, significantly reducing their costs.

The question is: Do tax subsidies encourage people to buy insurance? The answer seems to be: Not much. In a forthcoming paper, David Stevenson and others at the Harvard Medical School compare purchase rates in states that have tax subsidies with those that do not. They found sales are about 10 percent higher where buyers can get a tax break. Credits increase the participation rate by about 20 percent while deductions make no significant difference at all. Oddly, people are more likely to buy in states with low level credits than in those with more generous credits.

Their results track an earlier paper by Anne Cramer and Gail Jensen, and another by my Urban colleague Rich Johnson that also found that demand for this insurance does not respond very much to lower prices.

The purpose of these subsidies is to reduce Medicaid costs, which states share with the federal government. The idea: Private insurance can at least delay the time when someone needs to go on to Medicaid by picking up some nursing home or home care expenses.

But this benefit to states may not outweigh the costs of providing the tax breaks. Harvard’s Gopi Shah Goda finds consumers may be more responsive to tax subsidies than other research concludes, but still estimates that $1 in state tax expenditures produces just 84 cents in Medicaid savings, half of which go to the federal government.

Because federal tax rates are much higher than state rates, a federal subsidy might be worth more to consumers. And including this insurance in a cafeteria plan may increase worker awareness of the product. On the other hand, these incentives are most likely to encourage wealthy consumers to buy, the very population least likely to qualify for Medicaid. And, like most tax subsidies, a big chunk will end up in the pockets of people who would have purchased the insurance anyway.

The apparent failure of these state tax breaks is something Congress should keep in mind as it weighs whether to expand federal tax breaks for this insurance.

Taxing Private Ryan

Eric Toder — Mon, 02 Nov 2009 16:33:00 -0500

My colleague Howard Gleckman has summarized the tax plan that Congressman Paul Ryan (R-WI) presented at the Tax Policy Center on October 29. He describes it as a consumption tax, but that’s not what it is. It is actually mostly a tax on wage income that would treat those who work for a living very differently from those living off the income from inherited wealth.

Many of the questions for Mr. Ryan at the October 29 event focused on one of the plan’s features – letting individuals choose between being taxed under a simple low rate schedule with a broader base or continuing to pay tax with the current rate schedule, while retaining tax preferences. But my main concern is how the changes in the tax base would affect people differently, depending on their sources of income.

Mr. Ryan’s plan is modeled on the “flat tax” proposal of Professors Robert Hall and Alvin Rabushka, but with two key differences. The flat tax is a tax on consumption because it taxes all receipts (either at the business or personal level) at the same rate, while exempting the return to saving. But in Mr. Ryan’s plan, the business tax rate is only 8.5 percent, compared with a 25 percent top rate on earnings. And Mr. Ryan’s business tax, unlike Hall-Rabushka, does not allow a deduction for wages, so it is identical to a separate VAT and works effectively as an additional tax on labor.

Let’s see how Mr. Ryan’s plan would work for someone who earns her bread by working – that is, most of us – and someone who lives off income from inherited wealth. The worker bee would pay a 25 percent tax on her last dollar of earnings. And the VAT would raise prices or, if the Fed doesn’t allow that, force wages down. Either way, that’s another 6.4 percent hit on real wages (75 percent of the 8.5 percent tax because the VAT would be effectively deductible from the earnings tax). The real total top marginal tax rate on earnings would be 31.4 percent – only a few points lower than the current 35 percent top income tax rate on earnings. And if the worker chooses to retain her deductions and keep using the current system, she will see her top marginal income tax rate on earnings (excluding payroll tax) rise to 40.5 percent (35 percent plus 65 percent of the sales tax).

If you include state income taxes, the effective rate cut for the workers is even smaller because state income taxes are not deductible under Mr. Ryan’s alternative tax system. Suppose the state income tax rate is 6.75 percent (the current top rate in Wisconsin). Then the combined state-federal marginal rate on wages is 37.6 percent under the Ryan plan, compared with 39.4 percent under current law. (The 37.6 percent is the sum of the two income taxes, 31.75 percent plus 68.25 percent of the 8.5 percent sales tax. The 39.4 percent figure is the sum of the 6.75 percent state tax and a federal tax of 35 percent of the 93.25 percent of earnings left in the base after deducting the state tax.)

The taxpayer living off income from her inheritance would be treated very differently.. She would absorb a one time and permanent hit to her wealth from the 8.5- percent business tax, which would reduce the value of her investments (though Mr. Ryan hinted in his speech at “transition” rules that could ease even this small burden). That would be all the federal tax she would pay. There would be no tax on her interest, dividends, and capital gains and no estate tax reducing the value of her inheritance. (She would, in theory, still pay some state income tax on her investment income; but, in practice, states would find it hard to tax interest, dividends, and capital gains without the link to federal enforcement.)

Under the Hall-Rabushka tax base, with Mr. Ryan’s individual rates, the worker would face a top rate of 25 percent (the wage tax rate) because the business-level tax would exempt wages. The taxpayer living off inherited wealth would face the same one-time and permanent hit to her wealth from the business side of the consumption tax, but (absent favorable transition rules) that rate would now be 25 percent, the same rate as the wage earner. Even though people would never report or remit tax on their interest, dividends, and capital gains, advocates of the Hall-Rabushka flat tax can claim that they “paid at the office” on their investments in businesses. But supporters of Mr. Ryan’s plan can make no such claim.

Ronald Reagan was often accused of favoring the rich. But his main beef about the federal tax seemed to be how high marginal rates affected work incentives -- a view informed by personal experience when taxes deterred him from making more movies. He endorsed a major tax reform that reduced the top tax rate on income to 28 percent and equalized the taxation of capital gains and ordinary income. But the tax reformers in his party seem to be moving in a very different direction now. Don’t tax any income or consumption from wealth, they are saying, and shift the entire tax burden to wage-earners.

In a famous campaign speech in the 1930s, FDR referred to his opponents as “economic royalists”. Does this shoe fit now if virtually the entire federal tax base shifts to earnings? The fictional Private Ryan in Steven Spielberg’s film may have been saved by a special order from the top military brass, but we grunts would bear the full weight of Representative Ryan’s plan.

Health Care: Taxing That Fella Behind the Tree, Again

Howard Gleckman — Fri, 30 Oct 2009 08:01:00 -0400

The House leadership seems convinced that a relative handful of people should pay for health reform. In the plan released yesterday by Speaker Nancy Pelosi, Democrats would fund most of the cost of insuring millions more people in two ways: cutting subsidies to Medicare Advantage plans and imposing a stiff 5.4 percent surtax on individuals making $500,000 and couples making more than $1 million.

TPC figures that just 400,000 taxpayers will pay that increase in 2011, less than three-tenths of one percent of all taxpayers. However, because the millionaire’s surtax is not adjusted for inflation (at least not yet), within a decade many more are scheduled to fall victim to the tax hike. By 2019, TPC figures nearly 800,000 would be in the bulls-eye, although that is still fewer than 1 percent of all taxpayers. Over the decade, the surtax is projected to raise nearly a half-trillion dollars. But because income subject to the surtax does not increase with inflation, annual tax revenues would grow from about $30 billion in 2011 to $70 billion in 2019

I am bothered by two elements of this. First, do we really want to put most of the cost of a national priority such as health care on the backs of a relatively few people? My concern has more to do with our social compact than economics, but wouldn’t it make more sense if we all had a horse in this race? I know, those hit by the surtax are the same people who benefitted most from the Bush tax cuts in 2001 and 2003. But there is still something wrong with pretending that health reform is a free lunch for 99.7 percent of us.

And I have another problem. My guess is the levy would become another Alternative Minimum Tax deal. That is, despite what looks like surtax-creep, there is a pretty good chance Congress would get cold feet somewhere along the way and protect many of those who would otherwise face the extra tax over the next decade. This would add tens of billions more to the deficit.

I can hear lawmakers now. “This tax was never intended to hit these hard-working Americans earning just $500,000,” some pol will thunder in the run up to the 2014 elections. And on some level, I fear, that will be quite right.

By the conventions of budget scoring, of course, it doesn’t matter if many never pay the tax. The scorekeepers (JCT in this case) must assume the law will apply for 10 years. So, if this provision survives the next few months of congressional debate, Congress will be able to give itself credit for paying for health reform, never mind that would do so in a way that is irresponsible and very likely phony.

Paul Ryan’s Consumption Tax

Howard Gleckman — Thu, 29 Oct 2009 16:10:00 -0400

Representative Paul Ryan (R-WI), one of Congress’ most interesting members, was the guest at this morning’s session of TPC’s Tax Reform 2.0 series. He came to talk about his Roadmap for America’s Future—a comprehensive plan for dramatically restructuring both entitlement spending and the tax code. Ryan is nothing if not ambitious.

I’ll leave his proposals for Medicare, Medicaid, and Social Security for another day. But on revenues, Ryan has embraced the idea of a consumption levy to replace the current income tax. (which is really a clumsy hybrid of both).

On the business side, Ryan goes for the Full Monty. He'd dump the corporate income tax for a subtraction method value-added tax. As in similar models, he’d allow businesses to fully expense all capital investment, but firms would no longer deduct their interest costs. The tax, which he’d set at a very low 8.5 percent, would be border adjustable so it wouldn't affect exports. Ryan is hardly the first person to come up with such a tax structure. Years ago, Rudy Penner and others proposed the very similar USA Tax.

But Ryan gets credit for taking the leap on any form of VAT, usually anathema to his fellow Republicans and much of the business community. Bruce Bartlett, another often-heretical Republican, also endorses the VAT in a recent Forbes piece.

When it comes to individuals, however, Ryan loses his nerve. He proposes a full-blown consumption tax, all right, but then makes it voluntary. This is similar to what GOP presidential hopeful Fred Thompson talked about in the 2007-2008 primaries. Taxpayers would be given a choice: They could switch to a simplified income tax with almost no credits, deductions, or exclusions or keep today’s system with all its subsidies and complexity.

Ryan is convinced that taxpayers would flock to the new tax. It would have two rates—10 percent for income up to $100,000 and 25 percent on earnings above that level. It would include a big standard deduction and personal exemption ($39,000 for a family of four). Interest, capital gains, and dividends would be tax free. So would all estates.

The problem, as Rudy noted this morning, is that the wealthy would avoid taxes on their investments by migrating to the new system while middle-class itemizers (many of whom are hooked on their deductions for mortgage interest and the like) would stick with the current mess. The result: A huge revenue sink.

Ryan believes his new system would generate federal revenues of about 18.5 percent of GDP—close to the post World War II average. But TPC found the Thompson plan would cut federal revenues by a staggering $6 trillion to $7 trillion over 10 years, assuming everyone chose the version that most minimized their tax bill. The biggest benefit would go to those making between $100,000 and $500,000. The TPC estimate was static, so actual revenue losses might be more moderate, but still…

In the longer run, young people might go for simplicity before they get hooked on tax preferences and may end up on the consumption tax. But in the long run, as they say, we are all dead.

Ryan’s reason for giving people the choice seems more political than economic. He understands that tax reform usually creates losers as well as winners. So he figures his winners-only option may make a consumption tax more appealing to voters. Still, it is too bad he blinked. But give Ryan credit for at least confronting the failure of the income tax. It is a lot more than most of his colleagues are willing to do.

Behavioral Economics and the Conservative Critique of VAT

Ted Gayer — Wed, 28 Oct 2009 09:23:00 -0400

Our grim fiscal outlook has led to renewed calls for a value added tax (VAT). As discussed by Greg Mankiw, conservatives have conflicting feelings about a VAT. The main appeal is that a VAT taxes consumption, so shifting from our current income tax system (which is actually a hybrid of an income tax and a consumption tax) to a VAT would remove existing disincentives to save, which in turn would promote long-term economic growth.

Yet many conservatives fear that a VAT, which taxes each stage of production, will lead to bigger government. As Milton Friedman wrote in 1980, “Because it would be collected by business enterprises, VAT would be concealed in the total price the consumer paid and hence not perceived as a direct tax burden. That is its advantage to legislators – and its major defect to the taxpayers.”

Friedman’s concern is now very much at the center of the new field of behavioral public finance. In the most recent edition of the American Economic Review, Raj Chetty, Adam Looney, and Kory Kroft, examine the effect of tax transparency – what economists call salience – on economic efficiency.

Traditionally, economists view the structure and application of a tax as unimportant. All that matters is the change in relative prices. But Chetty, Looney, and Kroft find that structure and application do matter. For example, they find that consumers are less likely to buy an item if a sales tax is explicitly listed on the product than if the same tax is instead added at check-out.

This simple finding has great political economy implications. With the traditional view that the magnitude of the tax is all that matters, the left/right debate among economists has focused on how responsive people are to a given tax. For example, would taxing labor lead to a small or large reduction in hours worked? The bigger the response, the more economically harmful the tax. But the new behavioral studies suggest that policymakers can actually manipulate the reaction to a tax. By making a tax less transparent, policymakers can trick consumers or workers into non-response, thus reducing the economic harm.

Chetty, Looney, and Kroft’s theoretical model indeed shows that efficiency increases as a tax becomes less salient. However, their model also shows that reducing the salience of a tax will necessarily harm consumers (albeit not by as much as it helps the government). In other words, tricking consumers into thinking a tax does not exist has two effects: 1) it leads them to poor consumption choices; and 2) it increases tax revenue because more transactions are taxed. In dollar terms, the harm to consumers is less than the increase in revenues. But whether or not you view an opaque tax as a useful policy instrument depends on whether you think the gains to government coffers are worth the reductions in consumer welfare.

As Friedman feared, government can go a step further. If complicated and opaque taxes can dull consumer response, they can also dull the political penalty associated with higher tax rates. An optimizing government could then increase tax rates by more than fully-informed voters would like. Amy Finkelstein, in the most recent edition of the Quarterly Journal of Economics, finds that drivers are less aware of tolls paid electronically and that switching from toll booths to electronic tolls led to a 20 to 40 percent rate increase. In other words, as salience goes down, tax rates go up.

The flourishing field of behavioral economics is improving our understanding of how psychological factors influence economic responses. But the risk is that policymakers will use these insights to deliberately temper healthy economic and political constraints on the growth of government.

Who’d Get Hit by an Excise Tax on High-Cost Insurance?

Howard Gleckman — Tue, 27 Oct 2009 17:18:00 -0400

As House and Senate leaders struggle to design their health reform bills, they remain at loggerheads over how to pay for broader access to insurance. The Senate Finance Committee’s plan to tax insurance companies that sell high-cost medical policies would generate over $200 billion in revenue over the next decade. But the excise tax is hugely controversial, mostly because influential unions oppose it.

A recent Joint Committee on Taxation analysis explains why. The JCT report, outlined in a letter to Representative Joe Courtney (D-Conn.), concludes that the Finance panel measure would increase taxes by an average of about 0.5 percent in 2013. But those making between $30,000 and $75,000 would face the biggest tax hike, just under 1 percent.

The tax would become much more painful over the next decade. By 2019, the Finance Committee plan would drive up average liability by 1.2 percent. But those earning $50,000 to $75,000 would face a stiff tax increase of 2.3 percent.

Here’s why: The cost of plans subject to tax would increase at the overall inflation rate plus one percentage point. But health costs, and thus insurance premiums, rise faster than that. So, gradually, more policies would be taxed. In 2013, the tax would hit roughly 4 percent of premiums. But in 2019, 11 percent would be taxed.

But why should unions like the Communications Workers of America (the outfit that made the JCT report public) care? Isn’t the tax being imposed on insurance companies? It is, but those insurers are not likely to swallow much of the tax themselves. Instead they—and the many large employers that self-insure—would pass the levy on to their workers by increasing the price of coverage. In some cases, workers would pay the higher premiums directly. If employers picked up the higher costs, workers would pay though lower wages. Or, employees may choose less expensive plans.They may get higher wages as a result, but that would add to their taxable income. Any way you look at it, workers will pay at least some of this tax. And their unions are not happy.

The CWA did a little math and concluded that the Finance Committee plan would boost taxes by an average of about $900 in 2013, rising to $1,300 by 2019. For those in the $50,000 to $75,000 range, that tax hike would rise from about $800 to $1,200. However, by CWA’s calculations, only about 10 percent of taxpayers in that income range would pay the excise tax at all in 2013, rising to about 24 percent by 2019.

But keep in mind that these averages can be very misleading. Today, many working-class people have no insurance, either because they can't afford it, are uninsurable because of pre-existing health issues, or because their employers don't offer it. Thanks to other provisions of the reform bills, many of those earning less than $75,000 would enjoy new government subsidies that would make it possible for them to buy insurance for the first time. And low-income workers would get greater access to Medicaid. A chunk of these new subsidies, of course, will be paid by those hit by the excise tax.

So, like most other pieces of health reform, there would be winners and losers even among those earning the same money. The question for the pols: Do they want to tax those with modest incomes and generous health insurance to help those with modest incomes and no insurance?

Is Pay-or-Play Penalty a Tax?

Len Burman — Fri, 23 Oct 2009 02:56:00 -0400

President Obama is under attack for breaking his campaign promise to leave the middle class unscathed by future tax increases. The complaint: The requirement to purchase insurance is tantamount to a tax, because failure to buy incurs a fine. Since many families with incomes below $250,000 would be affected by the penalty, this appears to violate his campaign promise.

Given our financial problems, his campaign promise to exempt 95 percent of Americans from responsibility for deficit reduction was reckless and ill-advised. But the pay-or-play penalty is really a user charge, not a tax.

Here’s why. Under the proposals being considered by Congress, individuals will, for the first time, be guaranteed access to insurance. Everyone in a given age class will be able to buy insurance for the same price in their market, regardless of pre-existing conditions. This corrects a major flaw in the current market. But, for it to work, almost everyone needs to participate. And that is why a penalty is necessary.

But pay-or-play is more than a penalty for "free riders." In the new market, individuals who opt to be uninsured will be getting something very valuable: access to insurance when they become ill. What is that worth? In 2004, the average healthy 35-44 year old spent about $2,300 on health care (including the part paid by insurance), based on data from Medical Expenditure Panel Survey (MEPS). An unhealthy person of the same age spent 6 times as much ($13,800) on average, and is often denied coverage entirely.

We don’t know what premiums would be in the new reformed health insurance marketplace, but the MEPS data allows for ballpark estimates (ignoring the overhead and marketing costs of insurance). Suppose everyone in a given age class pays the same premium regardless of their health status—as would be true under all the major congressional reform proposals. The average 35-44 year old spent about $2,800 (because most are very healthy) in 2004. So, the difference between the community-rated premium and the risk-adjusted premium for comprehensive insurance would have been something like $500. . The extra $500 is basically the cost of access to insurance when you get sick

Because health expenditures increase with age, older workers would see even bigger differences. A healthy 55-64 year old spent about $4,500 on health care in 2004, compared with an average of $6,500. Thus, her cost of access to insurance would be about $2,000. In fact, since people can’t predict their future health status, the value of guaranteed insurability is even greater because having insurance eliminates a major source of risk.

In that context, the $750 penalty on individuals who fail to buy insurance in the Senate Finance Committee bill looks like a reasonable premium to pay for guaranteed access to coverage.

Of course, pay-or-play is a little different from user fees for national parks because you can choose to skip the trip if you think the fee is too high, whereas the insurance penalty would be mandatory (except for those covered by a hardship exemption). However, if you don’t go into Yellowstone, you miss Old Faithful, whereas everyone benefits from guaranteed insurability whether they pay for the option or not. In that context, it seems reasonable to charge everyone for the benefit.

There are some problems with the proposal. Penalties should compensate insurers for covering previously uninsured people with health problems. The insurance industry is correct when it says too many people are exempt from the Finance panel’s penalty. And the subsidies are too small to allow many middle-income people to be able to afford insurance.

But pay or play is not a violation of the campaign promise.

For more on the distinction between user fees and taxes, see Eric Toder’s excellent Talmudic discourses on TaxVox a few weeks ago, here and here. Also, see the Urban Institute Health Policy Center's careful analysis of how premiums might vary by age in the reformed marketplace under different assumptions.

The Homebuyer Tax Credit: When Will They Ever Learn?

Howard Gleckman — Thu, 22 Oct 2009 17:45:00 -0400

The early returns are coming in on the First-Time Homebuyer Tax Credit. And it appears to be a bigger boondoggle than even I thought it would be.

At a House Ways & Means Oversight subcommittee hearing today, the Internal Revenue Service inspector general reported that the IRS is auditing more than 100,000 of the roughly 1.4 million returns that included a claim for the credit. This is a staggering audit rate for an agency that usually reviews only about 1 percent of returns.

And what the agency has found is jaw-dropping. Almost 74,000 buyers claimed the credit even though they probably owned a house over the past three years (the credit is only available to those who did not own during that period). One dead give-away: More than 12,000 of this bunch claimed the residential energy credit sometime during the past three years. Another 19,000 filed for the homebuyer credit even though they had not actually gotten around to buying a house, a fairly spectacular exhibition of chutzpah. And 580 credits were claimed on behalf of children, including at least one four-year-old—obviously a budding real estate developer.

Some taxpayers were more confused than crooked. Almost 50,000, who didn’t realize the credit increased from $7,500 to $8,000 in 2009, may have claimed less they deserved. But there was plenty of fraud too. The agency is investigating 167 separate criminal schemes associated with the credit.

And there is more. In a separate study, the Government Accountability Office concluded that in 2008-2009 more than 25,000 credits were claimed by people who reported no income and another 165,000 by those earning $25,000 or less. Care to wager how long it will be before those houses end up in foreclosure? If they were ever actually purchased, that is.

There is a lot more we need to learn about this mess. But it is easy to imagine the recipe. Take a commssion-starved real estate agent, add a buyer looking for a deal, and throw in a huge cash payment from the government. Is it any surprise that 10 percent of those claiming the credit either bungled the transaction or were engaged in a flat-out scam.

Add to all of this the estimate by Ted Gayer at Brookings that more than 85 percent of the projected 2 million people expected to claim the credit would have bought a house anyway. Like the late, unlamented cash for clunkers program, the homebuyer subsidy is very likely doing little more than further running up the national debt to accelerate some home purchases.

Congress is now debating whether to either continue the credit into next year or even expand it to include all home purchases. This program, as they used to say up in the North End of Boston, needs to take two in the hat.

The Incredible Shrinking Estate Tax

Bob Williams — Thu, 22 Oct 2009 08:00:00 -0400

The estate tax is only a faint shadow of its former self. In 2009, less than one-quarter of one percent of deaths—just 5,500 decedents—will leave taxable estates, the smallest percentage since at least the Great Depression. In part, that tiny fraction reflects the current recession’s devastation of assets—the Fed estimates that the total value of household and nonprofit assets fell by about one-sixth between 2007 and the first quarter of 2009. But changes in estate tax rules over the past decade have played a much larger role than economic swings.

The Economic Growth Tax Relief and Reconciliation Act of 2001 (EGTRRA), best known as the Bush tax cuts, phases the estate tax out over a decade. The act raised the effective exemption incrementally from $675,000 in 2001 to $3.5 million in 2009 and dropped the top tax rate from 55 percent to 45 percent. The levy disappears entirely in 2010, only to return in 2011 under pre-EGTRRA law—a $1-million exemption and 55-percent top rate. The Obama administration has proposed making the 2009 parameters permanent and indexing them for inflation. Others would set a higher exemption and a lower tax rate.

So what’s happened?

For decades before 1976, only estates worth $60,000 or more owed estate tax. That threshold remained constant in nominal terms, so more and more estates had to pay the tax as economic growth and inflation boosted household wealth. In 1943, just under 1 percent of deaths led to estate tax payments; by 1976, that share had grown to 7.65 percent (see graph).

Congress doubled the effective exemption to $120,000 in 1977 and raised it gradually to $600,000 in 1987, where it stayed for ten years. As the exemption rose, the share of estates owing tax fell to just 0.9 percent in 1987 before growing again because of the fixed exemption. In 1997, when a bit more than 2 percent of estates owed tax, Congress again enacted a series of increases in the exemption that would have reached $1 million in 2006. Deaths resulting in estate tax liability stabilized until EGTRRA set off the latest inexorable drop in taxable estates.

So what’s next? The share of estates owing tax is scheduled to drop to zero in 2010, thanks to the one-year repeal. Except Congress won’t let that happen. Smart money says Congress will extend the 2009 law for 2010—a $3.5-million exemption and a 45-percent tax rate—and then consider a permanent fix when they deal with the scheduled 2011 sunset of almost all of the Bush tax cuts. Senators John Kyl (R-Az) and and Blanche Lincoln (D-AR) want to shrink the tax below its 2009 level—they want a $5-million exemption and a 35-percent tax rate.

Few lawmakers now call for total repeal, though such a proposal would surely get lots of votes. Opinion polls show significant numbers of voters saying they would more likely vote for a candidate who favors repeal. Maybe they all think they’ll win the lottery or their next great idea will become another Google. In the real world, we’re spending a lot of time worrying about a tax that fewer than three in a thousand of us will pay. And, when we do, we’ll be dead.

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

Rosanne Altshuler — Wed, 21 Oct 2009 06:00:00 -0400

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.

The Doc Fix and the AMT Patch: Add a Trillion to the Debt and Call Me in the Morning

Howard Gleckman — Tue, 20 Oct 2009 15:47:00 -0400

Congress is absolutely right to end the decade-old fantasy that it wants to trim Medicare payments to doctors. This law has been on the books for 12 years and is annually ignored. Lawmakers should stop pretending. But I fear they will make this change without paying for it--adding $250 billion to the national debt over the next decade.

Failing to pay the bill will only perpetuate the dangerous illusion that we can have unlimited health care at no extra cost. This thinking helped bring us to the health care mess we face today. And at just the moment when it is trying both to reform the medical system and confront a $1.4 trillion deficit, Congress is setting an extremely dangerous precedent by closing its eyes to a huge and very real expense.

Next stop: the Alternative Minimum Tax. The AMT patch is the tax policy analogue to the doc fix. It exists under a similar illusion: Each year the AMT is poised to hammer an increasing number of middle-class taxpayers. And each year, like a latter day Perils of Pauline hero, Congress steps in at the last moment to save those voters by indexing the income levels at which the tax kicks in. But it never makes up a dime of the lost revenue.

I fear that one day soon, lawmakers will permanently index the AMT at a 10-year cost of $450 billion (nearly double the doc fix), and not pay for any of it. President Obama has already started that ball rolling by including the lost revenue from AMT relief in his budget baseline. From there, it will be easy enough for Congress to wave its fiscal wand and permanently index the tax since it will show as costless, at least relative to the Obama’s artificial numbers.

But fiscal legerdemain aside, if those tax revenues are not made up somehow, the nation’s debt will continue to grow. And keep in mind that the 10-year costs of the doc fix and the AMT patch underestimate the long-run price tag. In 2019 alone, the changes would increase Medicare payments by $47 billion, and cut tax revenues by $70 billion.

Pretending money grows on trees is what Washington does. Not so many years ago, President George W. Bush and a Republican Congress passed the Medicare Part D drug benefit, fought two wars, and slashed taxes without worrying about what any of it would do to the national debt. Now it is the Democrats' turn. Led by Senate Majority Leader Harry Reid (D-Nev.), and with the acquiescence of the Obama Administration, Congress is about to make the physician payment mess go away by wiping a decade of proposed spending cuts off the books, much like a business might write down a really bad investment.

But this isn’t just an accounting exercise. Medicare will need real money to pay the docs those additional fees—cash government will have to borrow from somebody.

Senators Kent Conrad (D-N.D.) and Chuck Grassley (R-Iowa) among others are looking for ways to pay for the doc fix. I hope they find one and can sell the idea to Obama and the Congress. Because if they don’t, this business could go viral, like some sort of fiscal swine flu.

Whither Revenues?

Bob Williams — Mon, 19 Oct 2009 18:11:00 -0400

Federal taxes in fiscal year 2009 claimed the smallest share of GDP since 1950—14.9 percent according to the Congressional Budget Office (see top figure). The revenue drop has many causes: tax reductions in this year’s economic stimulus, the collapse of the economy, and the Bush tax cuts from earlier in the decade.

Revenues will rebound to higher levels over the next few years but how high they will go depends on what happens to tax policy. If Congress does nothing and current tax law plays out over the coming decade, revenues will jump in 2011 when most of the Bush tax cuts expire and the alternative minimum tax (AMT) hits more and more victims. By 2019, again according to CBO, taxes would claim 20 percent of GDP, well above the 1961-2008 average of 18.2 percent (see bottom figure).

The Obama administration asserts a different revenue baseline from current law. It would make the Bush tax cuts permanent, set the estate tax at 2009 levels (indexed for inflation), and permanently patch the AMT. Those changes would substantially reduce future revenues, leaving taxes at 18.0 percent of GDP in 2019, slightly below the long-run average.

In its 2010 budget, the administration proposes to raise taxes on high-income taxpayers by taking back the Bush tax cuts granted in its baseline and limiting the value of itemized deductions. Those actions would lift federal revenues starting in 2011 and boost 2019 taxes to 18.8 percent of GDP, a little more than the long-run average.

Strictly in terms of taxes, there’s nothing particularly right or wrong with any of the three future scenarios. Whether we’re above or below our 50-year average has no evaluative importance. What does matter, however, is that all three revenue paths fall far short of the 23.6 percent of GDP that CBO projects the government will spend in 2019. Maybe Congress and the president—and his successors—will manage to cut one-fifth of projected expenditures over the coming decade and balance the federal budget, but that’s a very tall order in the face of baby boomer retirements and soaring health costs. Reaching fiscal balance will take some combination of spending cuts and tax increases. What we don’t need is more tax cuts.

TaxVox is Two Today

Howard Gleckman — Fri, 16 Oct 2009 14:36:00 -0400

If we may be permitted a small bit of self-indulgence, TaxVox would like to wish itself a happy second birthday.

We first went live on October 16, 2007. Len Burman, whose idea this was, said in his initial post:

We started TaxVox to communicate directly and quickly with an online community interested in fiscal policy issues. We’ll be commenting on federal, state, and local legislation; tax administration; and new research on individual and business taxation. We want your comments too. We don’t want TaxVox to be only the voice of the Tax Policy Center. So please help us make it a forum for the entire tax and budget policy community.

TaxVox has succeeded beyond our wildest dreams. This month, we are on track to receive more than 250,000 page views—ten times what we got in our first full month. We’ve published nearly 400 articles and received hundreds more comments.

Journalists, editorial writers, and fellow bloggers have tapped our posts for story ideas. Lawmakers have used us to make the case for--or against-- various pieces of legislation. And TaxVox has been a window into the wealth of data generated by TPC.

As Len hoped, TaxVox has also been a wonderful forum for a healthy, passionate, but respectful exchange of views on tax and fiscal policy. The blog is at its best when we debate the pros and cons of tax proposals.

No celebration is complete without a few thank-yous. So, thanks to all the TPC staff for their ideas, support, and their own blog postings, and to Dana Campbell and her team of computer gurus who keep TaxVox up and running. Thanks to Len Burman, who is probably now freezing his butt off in Syracuse. Thanks to our regular commenters, who keep us honest and provide lots of great ideas of their own, and to those who lurk. Finally, my boundless appreciation to politicians everywhere. Without your ideas—sometimes useful, sometimes zany—we’d probably go dark.

Finally, it is probably worth noting that my first post was about taxing carried interest—an issue that was red-hot two years ago yet remains unresolved to this day.

Now, as a two-year-old, TaxVox intends to celebrate by throwing cake and screaming for attention.

Disappearing Revenues

Bob Williams — Fri, 16 Oct 2009 08:00:00 -0400

Last week the Congressional Budget Office quietly released its October Monthly Budget Review showing preliminary 2009 budget numbers. The $1.4 trillion deficit more than tripled the previous record of $459 billion set just last year (see top table). More than half of the increase was due to a $530 billion jump in outlays but 44 percent came from a 17 percent drop in revenues. That decline resulted in the federal government collecting a smaller share of taxes than at any time in the last half century.

A bit of the $420 billion decline came from tax cuts in the stimulus bill but six out of seven lost dollars were due to the recession. CBO estimated that the 2009 stimulus reduced revenues by $61 billion in 2009, almost the same as the $62 billion revenue loss from the 2008 tax rebates.

THE stimulus bill mostly cut individual income taxes. The Making Work Pay credit reduced wage withholding starting in April. The new homebuyer’s credit gave up to $8,000 to people claiming it on their 2008 returns. Most of the other cuts modified existing tax credits—the earned income tax credit, the child credit, and the education credit—and the bulk of their impact won’t come until beneficiaries file their 2009 tax returns next April. All told, the stimulus cuts accounted for only a little more than a quarter of the 20-percent drop in income tax revenue—$230 billion (see bottom table).

Corporate income tax revenues took the biggest hit, down by more than half from 2008. The deep recession wreaked havoc on corporate profits, leaving a large majority of firms with no tax liability. The consequent $165 billion drop in corporate taxes accounted for nearly 40 percent of the total revenue decline.

Social insurance and other federal taxes suffered smaller hits—only about 2 percent, less than $25 billion in total.

Total federal revenue in 2009 amounted to just 14.9 percent of GDP, the smallest fraction since 1950 and far below the 26 percent of GDP spent by the federal government. That gap will narrow in coming years but CBO projects that it will average more than 4 percent of GDP over the next decade, and that’s only if the 2001-2006 tax cuts expire in 2011 as scheduled. Extending those cuts, even only for President Obama’s broad middle class, will mean deficits as far as the eye can see.