TaxVox: the Tax Policy Center blog

Gotcha!

Bob Williams — Fri, 20 Nov 2009 08:00:00 -0500

IRS Commissioner Doug Shulman reports that nearly 15,000 taxpayers turned themselves in under the service’s amnesty program for people who had failed to report overseas bank accounts on their federal income tax returns. A major inducement was the government’s settlement with Swiss bank UBS, under which the bank promised to hand over information on about 4,500 American account owners. More than 80 percent of the amnesty filings came after the IRS announced that settlement.

So why did more than 12,000 people fess up after they learned that UBS would report fewer than 5,000 of them? The key was that the IRS didn’t reveal the criteria UBS would use to pick accounts. Not knowing whether they were on the UBS list likely induced a lot of people to take advantage of the limited-time deal the IRS offered.

In a November 17 briefing, Shulman spelled out the UBS criteria, which surely exempted lots of accounts. UBS limited its list of accounts to those with balances of at least 250,000 Swiss francs (about $248,000) or annual revenue of at least 100,000 francs (about $99,000). But even for those accounts, owners had to have engaged in “fraud and the like” before the bank ratted them out—and UBS appears to have defined that phrase rather tightly. Hiding ownership through off-shore shell companies or using debit or credit cards to disguise withdrawals got you on the list. Simply owning an account did not. (Read more detail on the UBS criteria in David Hilzenrath’s story in the Washington Post.)

Last month Shulman said that people applying for amnesty reported account balances ranging “from just over $10,000 to over $100 million.” UBS apparently won’t report taxpayers—or should I say non-taxpayers—with accounts toward the lower end of that range. Some, perhaps many, of those who turned themselves in could have continued to hide their overseas assets without fear of being revealed, if only they’d known the UBS rules.

It’s likely that many people took the amnesty option to help them stop doing something they knew was wrong, even if they didn’t think their banks would report them. And others may have felt that UBS was only the first of many foreign banks that the U.S. will force to reveal account owners and decided to get in under the amnesty.

But because neither UBS nor the IRS explained the criteria during the amnesty period, a lot of people must have reported themselves for fear they’d show up on the UBS list.

Good move, IRS.

The Tummy Tax & More: How Senate Dems Would Pay for Health Reform

Howard Gleckman — Thu, 19 Nov 2009 15:22:45 -0500

Senate Majority Leader Harry Reid (D-Nev.) has pulled together a health bill that relies on three major revenue sources (and many smaller ones) to help support the cost of new insurance subsidies for those with low- and moderate-incomes.

Redi proposes $370 billion in new tax revenues over the next decade. $150 billion would come from a 40 percent excise tax on high-cost employer-sponsored insurance. Fees on makers of branded drugs and medical devices and on insurance companies would raise another $100 billion. Boosting the Medicare payroll tax by 0.5 percent on wages in excess of $200,000 ($250,000 for couples) would bring in another $55 billion. Among the cats and dogs: $15 billion from an increase in the floor on deductible medical expenses from 7.5 percent to 10 percent, and $6 billion from an excise tax on cosmetic surgery (the tummy tuck tax).

Reid picked very different revenue sources than the House. It would raise far more in taxes—about $540 billion through 2019. And 85 percent--$460 billion-- would come from a 5.4 percent surtax on incomes in excess of $500,000 ($1 million for couples).

A few thoughts on these proposals:

As I have written in the past, the House bill troubles me because it requires a few hundred thousand taxpayers--fewer than 1 percent--to pay for the bulk of health reform. That is bad economics and even worse governance. The Senate bill divides the burden somewhat more. While insurers would pay the excise tax on expensive employer-sponsored insurance, they would pass on much of the cost to workers. And the JCT estimates that middle-class employees would bear a substantial share (at least in an earlier version of the bill). Similarly, those taxes on drug and device makers as well as insurers will also be passed on, at least in part, to their customers, who are us.

The higher Medicare rate in the Senate bill is merely another way to tax the wealthy. I’m a bit surprised that senators who so strongly opposed the income surtax are so quiet about the Medicare surtax. Thus, we’ve learned that the Senate is OK with a $55 billion tax hike on the wealthy but not with a $460 billion increase. It doesn’t take a rocket scientist to figure that the tab for the top brackets will come in somewhere between those two numbers when the final law is written. The neighborhood of $200 billion sounds about right.

The Senate would raise the floor on deductible medical expenses to 10 percent, except for seniors who’d get to keep the 7.5 percent floor. Anybody want to explain why catastrophic health costs are harder on a retiree than on a working family?

Finding the revenue to pay for health reform was always going to be a huge challenge. It still is, but we are beginning to see the outlines of a deal—a little income tax surcharge here, a dollop of insurance premium excise tax there, and more than a few cats and dogs. It may not really pay for the cost of insurance reform over next decade, but it will pass muster with the scorekeepers. And in Washington these days, that’s all that matters.

Should Government Policies Favor Owners Over Renters?

Ted Gayer — Thu, 19 Nov 2009 13:08:30 -0500

Increasingly generous tax subsidies for homeowners are doing little to help the housing market. The U.S. Census Bureau reported yesterday that housing starts for October were down 10.6 percent from the previous month to a seasonally adjusted annual rate of 529,000. After rebounding from a historical low of 479,000 in April, starts have largely moved sideways and reflect a still-anemic housing market.

Houses are not being built because too many homes remain on the market. This surplus was created by a surge in construction during the housing bubble, combined with a drop in household formation during the recession. There is currently a 7.5 month supply of new homes for sale, down significantly from the January peak of 12.4 months but still elevated by historical standards. The homeowner vacancy rate, which measures the percent of vacant homeowner inventory for sale, was 2.6 percent in the third quarter. This was down only slightly from the peak of 2.9 percent in the fourth quarter of 2008.

Those expecting the recently extended and expanded homebuyer tax credit to improve this situation are likely to be disappointed. As I’ve written previously, most people who will receive the tax credit would have bought a house without it. And, of the additional sales spurred by the credit, most are likely to shift renters into owners, which does not help absorb the excess supply of houses.

Indeed, the credit may unintentionally be weakening the rental market. The rental vacancy rate for the third quarter was 11.1 percent, which is a historical high. The Consumer Price Index showed a decline in rent by 0.1 percent for October. The weak market was also reflected in the housing starts data, as starts with two or more units fell by 34.6 percent in October.

In a timely analysis, the Congressional Budget Office (CBO) just published an overview of all federal programs that support housing. According to CBO, in 2009 the federal government devoted almost four times the amount to support homeowners ($230 billion) compared to renters ($60 billion).

CBO estimates that the homebuyer tax credit will cost $14 billion in 2009. The Joint Committee on Taxation estimates that the extension of the tax credit will cost $11 billion more. But by far the largest tax incentive is the mortgage interest deduction, which cost government coffers about $80 billion in 2009. Aside from the inefficiency of this tax subsidy, it is also not equitable, as over 70 percent of the dollar benefits accrue to households with adjusted gross income greater than $100,000 per year.

Government policies encouraging people to borrow to buy a home partially contributed to our housing and credit market problems. And recent policies that shift renters into buyers have not helped improve housing market fundamentals. The collapse of the housing bubble should lead to a serious re-evaluation of the tax incentives for homeowners.

Making Work Pay Too Much

Bob Williams — Wed, 18 Nov 2009 08:52:43 -0500

The Treasury Inspector General for Tax Administration reports that more than 15 million people could owe more income tax than usual next April, thanks to the 2009 stimulus act’s Making Work Pay credit (MWP). New withholding tables accommodating the credit are overly generous to people who work multiple jobs, pension recipients, and two-earner couples. For them, withheld taxes will drop more than the credit will cut what they owe the IRS.

This revelation apparently caught many by surprise. It shouldn’t have since we warned readers in a March TaxVox post:

Wondering how the IRS deals with married couples? … If both spouses work enough so that each gets that full increase, their withholding would fall by $1,248—more than half again the credit they may claim on their 2009 tax return—and possibly leave them underwithheld.

And what happens for people who work two jobs or some couples for whom the credit phases out? The amount withheld again falls by more than the credit’s value, so some taxpayers may have too little withheld to cover their taxes

I did miss what the revised income tax withholding tables would mean for pensioners. If you get a pension and the payer takes taxes out of your monthly check, the same tables used for workers specify the amount withheld. With less subtracted for taxes, pension payments went up, but, unfortunately, pensions don’t qualify for MWP. Come April, these pensioners could end up having to return that extra money to Uncle Sam and could even owe a penalty if they haven’t met withholding requirements.

Retirees could ask their pension payers to withhold more tax or they could send the IRS estimated tax payments to cover the shortfall. At the least, they should hold onto the extra money in their monthly pension checks so they’ll have enough to pay their tax bills next spring.

Not surprisingly, some politicians jumped on the issue. Sen. Charles E. Grassley (R-Iowa) complained that "People will get help this year and have it taken away next year and might even pay penalties. It amounts to a bait-and-switch for these taxpayers, and that's not the way tax policy ought to treat people."

It’s a political tempest in a teapot. The three-quarters of us who get refunds every year will simply get smaller refunds. A few others may have to write bigger checks to the IRS next April. And the IRS promises not to penalize taxpayers whose withholding falls below the required minimum because MWP boosted their take-home pay too much. At worst, lots of people are getting an interest-free loan from Uncle Sam that they’ll have to pay back in April.

In any case, you can’t say we didn’t warn you.

Paying for Health Reform With the Medicare Payroll Tax

Howard Gleckman — Tue, 17 Nov 2009 14:26:08 -0500

In the ongoing search for money to pay for health reform, Senate Majority Leader Harry Reid (D-Nev.) reportedly wants to raise the Medicare payroll tax rate for high earners. It is not the best way to generate revenue, but it is not the worst either.

Today, Medicare collects a 1.45 percent tax on wages (plus an equal amount from employers). Unlike Social Security, there is no cap on wages subject to the Medicare tax. One idea floating around: Raise about $50 billion over 10 years by hiking the Medicare rate by 0.5 percent for those making more than $250,000. You’ll recall that President Obama has foolishly exempted income below a quarter of a million dollars from any tax increases.

On paper some of this money may be allocated to the Medicare Trust Fund (due to be exhausted by 2017, according to the most recent trustees’ report). But with general fund money and payroll tax funds flying between Medicare and the rest of the budget at warp speed, this is mostly an accounting fiction. In truth, raising the payroll tax rate is little more than a backdoor tax hike on the very wealthy.

The idea of making payroll taxes progressive is interesting, to say the least. Today, the highest earning 20 percent pay a lower average payroll tax rate (6.9 percent) than those in the bottom 20 percent (7.3 percent). In recent years, Congress has raised Medicare premiums for high-earning seniors. Now, Reid may try to raise Medicare taxes for high-earning workers.

And he might do even more. For years Democrats have toyed with the idea of imposing the payroll tax on income other than wages--capital gains and dividends, for example. Among other things, this would make it harder for high-earners to avoid the tax hike by changing the way they are compensated. But besides rendering the label “payroll tax” meaningless, this would be a big step towards making social insurance taxes indistinguishable from income taxes.

For years, the idea of hiking payroll taxes has been resisted by many on the left, who fear this step would break the social compact that has protected Medicare and Social Security from the pressures faced by means-tested entitlements. The more Medicare looks like welfare, the more jeopardy it will be in, goes this reasoning.

Now, however, in an effort to save the tax exclusion for employer-sponsored health insurance, unions seem enthusiastic about taxing wages of the rich. They may have noticed in the current health debate that few politicians are willing to risk their skins going after Medicare.

Of course, raising the payroll tax rate today to finance health insurance subsidies for working-age people will make it tougher to raise their tax later for other purposes (such as trimmin the deficit). But that, Reid probably figures, will be someone else’s problem.

The House health bill would pay for reform with a 5.4 percent income tax surcharge on individuals earning more than $500,000. Reid may try to get the cash by raising payroll taxes for many of the same people. No matter how Democrats structure this, they seem intent on making a small number of people pay the cost of health reform. I still think that’s a bad idea.

California Dreams vs. Reality

Tracy Gordon — Fri, 13 Nov 2009 16:30:04 -0500

Last week in my Public Financial Management class, I was explaining the time value of money and why lenders charge borrowers interest. A student asked “Isn’t the state of California increasing the amount of money they withhold from people’s paychecks, and isn’t that like an interest-free loan from taxpayers?” Ah, yes, it would seem that once again my home state had provided a case study in budget dysfunction.

And yet, this may be one of those examples where the real world deviates from the textbook for good reason. Perhaps the only thing worse than California’s balancing its books on the backs of taxpayers would be NOT balancing its books on the backs of taxpayers.

Here’s what happened: Last July, the California legislature was scrambling to close yet another budget gap. Just five months before, it had cut spending and raised revenues by $36 billion. However, a new revenue shortfall opened up only weeks later. Adding insult to injury, voters rejected $6 billion worth of budget solutions in a May special election. So lawmakers confronted a $24 billion gap. As they wrangled over a new budget (the third in eleven months), the state entered a cash flow crisis. It began paying bills with IOUs, shuttered government offices on Fridays, and watched its bond rating drop.

So, in July the Legislature cut spending by another $15 billion, mainly from education (although some of this would be replaced by federal stimulus funds). And it decided to accelerate tax collections starting in November to the tune of $2.3 billion by increasing personal income tax withholding and changing how individuals and corporations calculate tax payments throughout the year.

Just to be clear: this was not a tax increase – the legislature had already been there and done that in February. As my student surmised, this was an interest-free loan from the Bank of Taxpayers. Indeed, taxpayers were not the only involuntary creditors to the state – the legislature borrowed $2 billion in local property taxes and diverted another $2 billion from local redevelopment agencies (who are suing). State employees will kick in their share by taking June 2010 paychecks in July (a new fiscal year).

Sure, the state could have done something about the deep structural problems with its tax code, including an income tax that relies too much the volatile incomes of high earners, a sales tax with high rates and a narrow base, and a property tax eviscerated by Proposition 13. And, as Milton Friedman used to say about federal income tax withholding, “temporary” changes to expedite revenues have a way of sticking around. Moreover, taking an additional $20 or $30 per month out of workers’ pockets could counteract the Making Work Pay Tax Credit in the federal stimulus package.

On the other hand, the state needed some money fast and voters had shown little appetite for tax hikes or deep cuts to popular programs. In any case, California may get another bite at the apple soon. The state Controller recently announced that revenues are already coming in $1 billion below projections and the governor says he expects to face at least a $12 billion gap come January.

Government Subsidies for Newspapers: Say It Ain’t So.

Howard Gleckman — Thu, 12 Nov 2009 09:00:00 -0500

It has become fashionable for high-profile establishment journalists to call for government subsidies to save the newspaper business. It is a terrible idea.

In a 100-page paper commissioned by The Columbia Graduate School of Journalism, former Washington Post executive editor Len Downie and J-school professor Michael Schudson argue for a package of government aid for newspapers, including both tax breaks and direct subsidies.

The Downie argument, echoed by many others, goes this way: Democracy requires independent reporting, but this news gathering is jeopardized by the Web-driven technological revolution, dramatically changing readership patterns, and the decline of corporate journalism (my phrase, not theirs). As a result, newspapers, in the words of John Nichols and Robert McChesney of the media reform group Free Press, “deserve” government subsidies.

No they don’t. Indeed, I can’t think of any business that deserves government subsidies simply because of what it does. Policymakers obviously disagree since I’d be hard-pressed to think of an industry that is not, in some way, subsidized by government. But this sense of entitlement is both troubling and costly.

When it comes to getting news, the market is speaking—rather loudly. It wants blogs, web-based and cable news, and even direct access to government documents. (Read the bill!!) Increasingly, it doesn’t want daily newspapers, weekly news magazines, or local broadcast news.

There is no doubt that much of what consumers are getting is rubbish, and I share Downie’s concerns about the effect of trash news on democracy. Opinion, lies, and comedy are not news, even though they masquerade as such these days. But none of this is new. The history of American journalism is replete with scoundrels, partisan hacks, and country-club publishers taking care of advertisers and fat-cat pals.

I may be a blogger now, but I have spent most of my career writing for traditional print media—newspapers, magazines, wire services, and books. On some level, I find the decline of newspapers very sad, but government can no more stop it than it could save Big Steel or the domestic auto industry. For a similar take, see this piece by Seth Lipsky in the Wall Street Journal.

Downie and Schudson still want to try a menu of subsidies. Among them: making it easier for news organizations to organize themselves as non-profits, and requiring the Federal Communication Commission to create a “fund for local news” that would work something like the endowments for the humanities and arts.

This is TaxVox, so let’s just look at the idea of tax subsidies.

The authors would make “news reporting” an exempt purpose under the Internal Revenue Code. Do we really want the IRS defining “news reporting?” This gives me serious chills.

While Downie and Schudson want tax subsidies to encourage start-ups, the reality is that such incentives almost always limit competition. The lobbyists for the big players get to help write the rules. The guy with a creative new way to disseminate news from his kitchen table has no lobbyists. As a result, there is little evidence that this sort of industrial policy ever encourages either innovation or job creation.

Technological transformation is scary and while newspapers suffer through their own phase of creative destruction, many good journalists will be hurt. That is very sad, but government intervention isn’t going to help them.

Winners and Losers in the Proposed Two-Tiered System of Health Subsidies

Gene Steuerle — Wed, 11 Nov 2009 10:34:35 -0500

To try to save money on health reform, reformers have proposed to create a two-tiered system of subsidies. Those who remain with employer-provided health insurance would largely be left in the existing system, while others would have access to a new subsidy.

The graph and table below show the size of this difference for the bill recently proposed by the Senate Finance Committee. For more details, see http://www.taxpolicycenter.org/numbers/displayatab.cfm?template=simulation&SimID=343. The recently passed House bill starts with a similar two-tiered structure, but then tries to address some of the difference with a higher charge on employers who don’t provide health insurance.

For households at most income levels, the new subsidy is more valuable than the old one. This creates problems of fairness, and it also can cause large shifts in whether employers provide insurance at all, especially when they can pay their employees more total compensation at no cost to themselves by dropping (or for new firms, never offering) an employer-based health insurance policy. Incentives for outsourcing and for converting full-time to part-time jobs are also increased. For more detail and for a way out of this problem, see http://www.urban.org/url.cfm?ID=901297.

As an interesting twist on who benefits from health reform, unions have generally opposed reforming the existing employer-based subsidy, but, in so doing, they may have set up a situation where they have denied many of their members access to a more generous subsidy. The main exceptions are for higher-paid workers and some moderately higher paid workers with very generous plans. On the other hand, a single, reformed, subsidy might have helped most of their members. Similarly, small businesses have been reluctant to support reform, but many of them would be put at a competitive advantage in hiring employees.

Obama’s Non- Tax Reform Commission

Howard Gleckman — Tue, 10 Nov 2009 12:20:54 -0500

In a month, if White House officials are to be believed, the Obama Administration will unveil the tax reform report of the President’s Economic Recovery Advisory Board. Despite once-high expectations, it is likely to be a waste of everyone’s time.

The Board (the PERAB in Washington-speak) is hardly a bunch of economic lightweights. Chaired by ex-Federal Reserve Chairman Paul Volcker, its members include economist Marty Feldstein, GE CEO Jeff Immelt, venture capitalist John Doerr, former CEA chair Laura Tyson, and other stars of Wall Street, Main Street, academia, and labor. Its chief economist is Austan Goolsbee, a top-notch researcher who has had close ties to President Obama for years.

Yet the reform panel—technically a PERAB subcommittee-- is going to produce…a mouse. From its earliest days, the group was forced to work under impossible constraints. Chief among them: Obama’s insistence that no one earning less than $250,000 should pay higher taxes. Exempting more than 95 percent of families and individuals from tax hikes of any kind essentially shut the door on any serious discussion of reform, which inevitably creates winners and, yes, losers.

Once individual taxes were taken off the table, the panel was charged to look at corporate tax reform, enforcement issues, and simplification. But even on those limited topics, the panel will make no recommendations. A few months ago, we were told it would produce a document that looks something like CBO’s revenue options—listing a narrow range of ideas without actually endorsing any of them.

Now, we learn, the panel may not even do that. Rather, it will merely enumerate possible ways to simplify, improve enforcement, or restructure the corporate tax without even hinting which the Administration favors and which it does not. Other than serving the need to produce something, I can’t imagine why they are even bothering.

It has been abundantly clear since the campaign that Barack Obama has little interest in tax reform. Not to begrudge him, he does have more than enough on his plate without it. And I understand that not everyone shares my fascination with the tax code.

On the other hand, there is that matter of a $1.4 trillion deficit and an income tax that is crumbling under its own weight. Obama is surrounded by economic advisors who understand better than I that reforming the way government collects revenue is both necessary and inevitable. Apparently, their views have been drowned out by his political advisers who, I assume, see the whole issue as a swamp.

So why did the White even bother with a commission such as this? It is not as if anyone was demanding one. And Volcker, Goolsbee et al have better things to do than make lists.

Tax Credits for All

Bob Williams — Thu, 05 Nov 2009 14:37:29 -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 15:32:07 -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 16:33:16 -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 08:01:34 -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.

Paul Ryan’s Consumption Tax

Howard Gleckman — Thu, 29 Oct 2009 16:10:47 -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.

Behavioral Economics and the Conservative Critique of VAT

Ted Gayer — Wed, 28 Oct 2009 09:23:02 -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.