“See, we can agree on certain things,” Pennsylvania Governor Tom Wolf (D) quipped during his State of the State Address, when members of both parties applauded his proposal to phase out the Commonwealth’s Capital Stock and Franchise Tax. It may be one of the few areas of agreement the Governor can find with a Republican-controlled legislature as he pushes his a budget containing $4.7 billion in new and higher taxes, which the Harrisburg-based Commonwealth Foundation estimates would cost an average family of four an additional $1,450 a year.
In broad strokes, Wolf’s plan involves reductions in property taxes and corporate taxes, but these are more than offset by increases in the individual income tax, the sales tax, and a proposed severance tax on the state’s booming natural gas industry.
At 9.99 percent, Pennsylvania’s Corporate Net Income Tax (CNIT) is the second-highest state corporate income tax in the nation, and it's an enormous factor in Pennsylvania's abysmal 46th place ranking on the corporate tax component of our 2015 State Business Tax Climate Index. Only Iowa has higher corporate income tax rates, and then only on corporate income above $100,000, whereas Pennsylvania’s 9.99 percent corporate tax falls on all income, from the very first dollar. There is much to be said for a flat rate, but one this high has a substantial adverse effect on economic growth. The Wolf budget proposed halving the rate over three years, reducing the rate to 5.99 percent for 2016 and 2017, then to 4.99 percent after that.
Wolf also proposes the phase-out of the state’s Capital Stock and Franchise Tax—or rather, the completion of a phase-out begun by then-Governor Tom Ridge seventeen years ago, one that has been delayed again and again. The Wolf budget would eliminate the tax effective January 1, 2016. As we noted last week, eighteen states levy some sort of capital stock tax, though several are in the process of eliminating them. As a tax on net worth, franchise taxes penalize business growth, with companies that invest in capital expansion experiencing a higher tax burden than those that do not.
At the same time, Wolf proposes limiting the ability of corporations to write off losses in two ways. Firstly, he proposes a reduction in the cap on net operating losses, from $5 million or 30 percent of income to $3 million or 12.5 percent of income. Pennsylvania is one of only three states to cap NOL carryforwards, and the Governor’s budget represents further retrenchment on that issue. Doing so penalizes companies with greater volatility across the business cycle. Secondly, the budget includes “combined reporting,” which entails calculating a business’s profits, for Pennsylvania tax purposes, by adding up the profits and losses of all of its subsidiaries, even if those subsidiaries operate outside of and lack nexus with Pennsylvania. This is arguably a means of broadening the corporate tax base by ensuring that all business income is taxed, but it adds a great deal of complexity and can lead to multiple taxation of business income.
Pennsylvania is the largest natural gas-producing state without a severance tax, and as the state continues to experience a boom in hydraulic fracturing of the Marcellus Shale layer, levying one has been a source of continued controversy. In his budget address, Wolf declared, “Natural gas production is growing faster in Pennsylvania than anywhere else in the country. Yet, we are the only major producer of natural gas that does not ask drillers to pay their fair share or provide a return on our resources.” The choice of conjunction might be disputed; perhaps the lack of a severance tax is a contributing factor in the growth of the industry in Pennsylvania. In any event, it has helped offset the impact of the state’s extremely high corporate tax, although Wolf’s proposal does include rate reductions to the Corporate Net Income Tax, as discussed above.
Sales tax expansion is one of the key revenue drivers in Wolf’s budget, which proposes both eliminating 45 existing exemptions and raising the state sales tax rate from 6.0 to 6.6 percent. The base would be broadened to include currently exempted goods such as candy, newspapers and magazines, personal hygiene products, non-prescription drugs, textbooks, investment coins, cable television, and horses. The latter is no small matter; Pennsylvania is, after all, a state where the state supreme court declared unconstitutional a section of the Vehicle Code that addressed animals and animal-drawn vehicles, notwithstanding the lyrical dissent of Justice Eakin (“A horse is a horse, of course, of course, but the Vehicle Code does not divorce its application from, perforce, a steed, as my colleagues said”).
The expanded sales tax base would also include a wide range of services, including legal, accounting, and professional services; finance and real estate; business support and employment services; home health care, nursing, and ambulatory services; transportation; the performing arts, spectator sports, and entertainment venues; and personal care and personal services, among others. Exemptions for food, clothing, and prescription drugs are maintained. The one percent dealer discount would be capped at $300 a year. Consistent with good tax policy, business inputs would remain exempt, which avoids tax pyramiding.
Personal Income Tax
Wolf campaigned on a progressive income tax, but in an attempt to comply with the Uniformity Clause of the state’s constitution, settled on a twenty percent increase in the flat rate, from 3.07 to 3.7 percent, coupled with exemptions for low-income taxpayers. There may be some question about the constitutionality of even his revised proposal, however; the Pennsylvania Supreme Court struck a progressive income tax in 1935, then in 1971 struck down a flat-rate income tax on the grounds that its deductions and exemptions “offend[ed] the constitutional requirement of uniformity.” A 1968 amendment to the state constitution waives the uniformity requirement for exemptions specifically targeted the impoverished or disabled; whether Wolf’s proposal exceeds those limitations is disputed.
As part of his budget, Wolf proposes $3.8 billion in property tax relief, though it is more accurate to say that he proposes increasing the state’s share of public education funding to hypothetically reduce the pressure on localities to raise revenues through local property taxes, with different impacts across the Commonwealth. In Philadelphia, for instance, most of the reduction would actually come through the city’s wage tax, not property taxes as such. In Pennsylvania, counties, school districts, and municipalities all have the power to levy property taxes. Wolf also proposes a rent rebate for renters with annual incomes less than $50,000.
Overall Tax Plan
Wolf’s tax plan has positive elements. Expanding the sales tax base is good policy; so is reducing the corporate income tax and eliminating the outmoded capital stock tax. A $4.7 billion tax increase, however, is a bitter pill to swallow, and several of the Governor’s proposals increase tax complexity and further burden economic activity. The Governor says that Pennsylvania needs a “bold and ambitious” budget; that’s definitely one way to describe a 16 percent increase in the size of the state budget. But fights about taxes are nothing new for Pennsylvanians; Ben Franklin’s famous bon mot about liberty and security was, in fact, about the “liberty” of the legislature to impose property taxes. What bears following is whether Tom Wolf can write a new chapter on Keystone State tax policy, or whether this proposal, like so many that preceded it, will be consigned to the bonfire of the vanities.
Check out our recent testimony to the Pennsylvania House Majority Policy Commitee.
The Congressional Research Service recently released a report on the Medical Device Tax in the Affordable Care Act. It fairly enumerated most of the critiques of the tax, which are wide-ranging and substantial. (Here was ours.) It also stated the principal argument for the tax – essentially, that it’s a source of revenue for the government.
The most important economic analysis in the report was the argument that the tax would not be a substantial drag on the medical device industry, because demand for medical devices is relatively inelastic and the cost of the tax could be passed on to consumers. In simpler terms, the CRS argument is that the medical device companies will simply add the tax in to the prices of the goods that they sell, and people will just have to accept the higher prices:
The analysis suggests that most of the tax will fall on consumer prices, and not on profits of medical device companies. The effect on the price of health care, however, will most likely be negligible because of the small size of the tax and small share of health care spending attributable to medical devices.
I have a couple of things to say about this argument. On its face, it sounds kind of reasonable – and I actually don’t dispute the economics at all. I do agree that most – but not all – of the tax will fall on consumers, because consumers have no choice but to buy their medical devices.
But that’s not really a very nice-sounding story, is it? Don’t worry, the consumers will ultimately be hit with the tax, and they’ll just have to deal with it because they need their pacemakers! I don’t think there’s anything wrong with that argument as economics, per se, but it’s a little bit ugly in moral terms.
Furthermore, I take umbrage at the idea that the tax is simultaneously (1) an important source of revenue, (2) passed on to consumers of health care, and (3) “negligible” to health consumers. What the CRS has done, here, essentially, is use language that implies the revenue is an important number when it’s given to the government, but a small number when it’s taken from consumers.
This is, of course, silly. A number is the same size no matter whose balance sheet it appears on – and if anything, American consumers probably feel like $38 billion is a much larger number than the federal government does.
But it’s especially silly in light of what the Affordable Care Act actually does with the money. It taxes medical devices companies, who pass the extra cost onto consumers, raising health care costs. Then it applies the revenue it has earned to subsidies for consumers, to help them with their rising health care costs.
This diagram is by no means complete. There are many taxes other than the Medical Device Tax. And many of the consumers who will ultimately take on the burden of the device tax won’t receive subsidies. But the flowchart above does show the extent to which the law as a whole shifts costs around in a circle. It is a little bit like the public policy equivalent of a perpetual motion machine.
Perpetual motion machines are a long-discredited idea in physics, where people try to construct a free source of energy in the form of a machine powered solely by the energy it creates on its own. This is impossible; it violates the laws of thermodynamics.
In a certain sense, fiscal policy has its own laws of thermodynamics. Passing costs along from businesses to individuals to government back to businesses ultimately doesn’t create money, but it could very well lose it through the same kind of inefficiency or entropy that stops perpetual motion machines from working. Taxes and spending programs have administrative and compliance costs. Some revenue gets lost in the shuffle.
Here’s an example of that entropy in practice: the CRS report addressed the lower-than-expected collections we covered last year. The main CRS explanation for the revenue shortfall was a lack of taxpayer compliance, which often happens on complex taxes. Particularly, the theory was that general manufacturers who weren’t specifically in the medical device industry (but manufactured some medical devices) were failing to file:
A July 2014 report issued by the Treasury Inspector General for Tax Administration (TIGTA) found that the number of medical device excise tax filings and the amount of associated revenue reported are lower than estimated. According to the TIGTA report, the IRS processed 5,107 tax returns with reported medical device excise taxes of $913.4 million for the quarters ending March 31 and June 30, 2013. The IRS estimated between 9,000 and 15,600 quarterly Form 720 tax returns with excise tax revenue of $1.2 billion for this same, two-quarter period. In other words, actual medical device tax collections were 76.1% of projected collections during this period.
Some firms might not have known that they were subject to the tax. For example, TIGTA noted that the North American Industry Classification System (NAICS) code is unreliable for identifying businesses that may be subject to medical excise tax reporting. While most of the businesses that filed tax payments during TIGTA’s observation period in 2013 were classified as being in the “medical equipment and supplies manufacturing” industry, some manufacturers were in other, nonmedical specific manufacturing categories. TIGTA recommended that the IRS take further actions to reduce noncompliance with the tax, such as issuing notices to potential nonfilers.
There is a certain intellectual bankruptcy in defining an arbitrary category – “medical devices” – and then levying a special tax on that category alone. It leads to definitional games about what goods fall into the arbitrary category and what goods don’t.
The answer is not – as the Treasury Inspector General recommends – to crack down on noncompliance. That’s a second-best solution. The best solution is to repeal the tax.
This blog post also appears on our Forbes contributor page.
Over at AEI, Mark Perry put together a chart that got a lot of attention yesterday. The chart shows that for the first time ever, Americans are spending more money at restaurants and bars than they spend at grocery stores. (For reference, the total numbers are $50 billion each, with the restaurants and bars now ahead by a nose.)
There are many things to say about this development. Mark Perry’s take focuses on the fast-paced pickup in recent months due to low gas prices and high consumer confidence:
The trend towards more spending eating out has been in place for at least several decades, but has accelerated in recent years and especially in recent months, likely due in part to falling gas prices as the WSJ article points out. The year-over-year increases in December 2014 (9.3%) and January 2015 (11.3%) for spending at restaurants were the two largest annual increases on record, which pushed restaurant spending in January above spending on groceries for the first time in history.
An 11.3% annualized growth in anything is a staggering pace, one surely indicative of huge changes in short-term conditions. The collapse of gas prices probably fits the bill.
The long-term trend, though – the trend in which bars and restaurants gain on grocery stores every year – is also worth mentioning, because I think it reveals something incredibly important.
Dining out is almost exclusively more expensive than the traditional grocery store. Yes, McDoubles are cheap, and some chic grocery stores are expensive, but that rule holds nine times out of ten. It’s true primarily because restaurants and bars offer two additional things (besides basic sustenance) that grocery stores often don’t. They provide prepared food on demand, and they do it in convenient locations. It takes additional labor and capital (and therefore, spending from the consumer) to make that convenience happen.
What this chart shows is that more Americans are willing to make that trade than ever before. Yes, my parents’ generation, like mine, had budget constraints. But that generation’s budget constraints really were worse than my generation’s. And one of the ways they made ends meet was to cut back on restaurant spending and prepare more food at home. Lots of people still have to do that, of course, but they have to do that less than they used to.
I think it’s an important point to make because we also often see pieces like this one at FiveThirtyEight: charts that show stagnation through inflation-adjusted economic data. The quality of analysis at FiveThirtyEight is generally strong, and the author, Ben Casselman, is thorough as usual, digging into important things like life cycle effects that are too-often ignored.
The problem is in the inflation adjustments themselves. I agree that growth in living standards has been slow, and I share some degree of pessimism about that. But they haven't been zero.
Inflation measures have to incorporate adjustments for quality. Here are the basics on quality adjustment in the CPI, for example. Those adjustments for quality are probably not strong enough.
No matter what is said about the path of “real” incomes, what is happening in real life is that Americans are buying higher quality goods; for example, they’re dining out more, not less. That’s an improvement in living standards worth celebrating.
Chuck Marr over at the Center for Budget and Policy Priorities seems pretty upset over the new Rubio-Lee tax reform plan. He is calling it a “Huge new windfall at the top.” He is also concerned about the plan not addressing the soon-to-expire temporary expansion of the Child Tax Credit. “The plan creates something that’s even more tilted—outrageously so—in favor of the country’s highest-income people and likely much more fiscally irresponsible.”
He points to two pieces of the Rubio-Lee plan as being large windfalls for high income taxpayers.
First, the plan eliminates taxes on capital gains and dividends.
Second, the Rubio-Lee plan lowers the marginal tax rate for pass-through business income from the current 39.6 percent to 25 percent.
He is correct that just cutting those taxes alone would create a sizeable benefit for high income earners since they earn the majority of investment and business income.
But, Rubio-Lee’s plan does not just cut those taxes. His analysis misses almost every other part of the tax plan. Specifically these three pieces:The elimination of most itemized deduction, which is a large tax increase on high-income earners A new, expanded $2,500 child tax credit that cuts taxes for most taxpayers The elimination of the standard deduction and personal exemption for a new refundable tax credit. Potentially worth as much as $1,750, this is a large tax cut for the lowest income earners.
If you take all the pieces of the Rubio-Lee tax plan together, it actually produces the largest increase in after-tax income for the lowest income earners, not the highest.
According to our analysis, the bottom decile of taxpayers will see an increase in after-tax income of 44.2 percent, a percentage increase in income nearly four times larger than the top 1 percent’s increase in after-tax income. But the plan doesn’t just increase the after-tax income of the top and the bottom. All taxpayers will see higher after-tax incomes due to this plan.
And if you account for the increased economic growth that the plan will produce, income for all taxpayers will increase even more. The bottom decile will see a 55 percent increase in after-tax income.
Distributional analysis is important. It gives us insight into who is currently paying taxes and how proposals will change that distribution. But when doing that sort of analysis, you should incorporate all relevant changes. Otherwise you may end up making the wrong conclusion.
India’s finance minister this week released a budget that includes, among other things, a five per cent reduction in the corporate income tax. Narendra Modi, the Prime Minister of India, won a landslide election last May on a pro-growth agenda.
The proposed budget would move India, one of the world’s largest economies, from a 30 per cent base rate to 25 per cent. (There are some surcharges that push the rate a few points higher by some measurements, including the ones we use at Tax Foundation. We measured the rate at 34% in our last report.)
While Indian tax news is not directly relevant to U.S. policy, it’s important to remember that this fits into a broader picture: the rest of the world has built a sort of consensus that corporate income is a poor tax base, and corporate income tax rates around the world have been steadily falling.
I expect this trend to continue with time. There’s nothing wrong with taxing income people earn from investments in corporations. But there’s a right way and a wrong way to do it. The 401(k) structure, for example, taxes investment income in a fair and elegant way. The corporate tax doesn’t. And that’s why it is in a long, steady decline throughout the world.
More Research against the Texas Margin Tax, New Kansas Pass-Through Carve Out Data, and Capital Gains Taxes in Washington
Here are some great links from this week:The Texas Public Policy Foundation has a new report about repealing the Texas Margin Tax. They find repeal would produce $10.8 billion in new real personal income in the first year and $16 billion over 5 years. The state would be one of just four states without direct business tax or individual income tax. We have some similar findings in our paper on the Texas Margin Tax here.
Barbara Shelly at the Kansas City Star has a review of the Kansas income tax exclusion for pass through entities that blew a hole in the budget. Kansas expected 191,000 people to take advantage of the exclusion, but 333,000 people ended up taking it, for a loss of $207 million in revenues. I testified today to the Ohio House Ways & Means Committee on a similar provision being considered by Gov. Kasich.
Jason Mercier of the Washington Policy Center noticed that the Washington Department of Commerce has pulled “no capital gains taxes” from its list of reasons to live in Washington. Gov. Inslee and others have proposed taxing it, and the Commerce Department doesn’t want to be “disingenuous.” More on Washington from my colleague Jared Walczak.
Earlier today Senators Rubio and Lee released their “Economic Growth and Family Fairness Tax Reform Plan.” We have modeled the economic and budgetary effects of the plan and will release our full results Monday, but the following is a preview.
On the business side, the plan is strongly pro-growth by design. Instead of taxing net business income at our current high rates, it taxes business cash-flow at a top rate of 25 percent. This is the essential way to reduce the most growth-slowing aspects of our federal tax code:It cuts the corporate and non-corporate (or pass-through) business tax rate to 25 percent. It eliminates the double-tax on equity financed corporate investment, by zeroing out capital gains and dividends taxes. It allows businesses to immediately write-off their investments, instead of requiring a multi-year depreciation.
It also takes interest out of the tax code for non-financial businesses, neither allowing interest deductions nor taxing interest income. This is a dramatic simplification.
On the individual side, it simplifies the income tax code by reducing the brackets from 7 to 2, with a top tax rate of 35 percent and bottom tax rate of 15 percent. It also introduces a generous child tax credit of $2,500, on top of the current $1,000 child tax credit.
On both the business and individual side, the plan eliminates a number of tax preferences.
After modeling the plan, we find it to be indeed strongly pro-growth. As the table below shows, it would grow GDP by 15 percent by the end of the adjustment period, roughly 10 years. That means the economy would be 15 percent larger than CBO predicts under current law. As well, relative to a current law, we find the capital stock would grow by almost 50 percent, wages by almost 13 percent, hours worked by almost 3 percent, and jobs by 2.7 million.
Second, the growth in the economy would eventually boost tax revenue, relative to current law. We find after all adjustments (again, about 10 years) that federal tax revenue would be about $94 billion higher on an annual basis. This is our dynamic estimate. Our static estimate, i.e. assuming the economy does not change at all, shows a tax cut of $414 billion per year. We believe the dynamic estimate is much closer to reality.
Our full analysis will be out Monday, and there we’ll provide a distributional analysis, and also an estimate of the 10 year budget effects.
Table: The Rubio-Lee Tax Reform Plan Would Grow the Economy by 15 Percent
Economic and Revenue Estimates for the Rubio-Lee Tax Reform vs. Current Law (2015 Dollars)
GDP ($ billions)
Private Business GDP
Private Business Stocks (Machines, Equipment, Structures, etc.)
Private Business Hours of Work
Full-time Equivalent Jobs (in Thousands)
Static Federal Revenue Estimate ($ billions)
Dynamic Federal Revenue Estimate after GDP Gain or Loss ($ billions)
Weighted Average Service Price
Source: Tax Foundation Taxes and Growth Model.
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The Supreme Court will today hear arguments in King v. Burwell, a case concerning the insurance premium subsidies in the Affordable Care Act.
The plaintiffs’ argument is that the health care law does not allow the federal government to provide these subsidies in states that failed to set up their own exchanges. This argument is based on the text of the law referring to exchanges “established by the state,” in apparent contrast with the one established by the federal government. In addition to this textual basis, those siding with the plaintiffs have pointed to remarks by Jonathan Gruber, an economist who helped design the law, in which he implied the subsidies were designed as an incentive for states to set up their own exchanges.
Solicitor General Donald Verrilli Jr. will argue on behalf of the federal government that the subsidies were designed for all consumers on individual exchanges, including those established by the federal government. The Affordable Care Act was an attempt to move towards universal coverage, and limiting the subsidies would not make sense in that light.
I’m not a legal scholar and I can’t say how the Supreme Court will rule. What I can tell you about, though, is how these subsidies look as a budget item. They’re not a big one now, but they will be:
By the Joint Committee on Taxation’s most recent estimates, the subsidies were only $15.5 billion, total, in 2014, the first year of their existence. (Most people haven’t even filed their individual taxes for 2014 or determined exactly the final amount.) However, the Committee has that number fast increasing to over $100 billion before the end of the decade. That would make these subsidies the largest refundable tax credit ever.
Despite six long years of argument over the Affordable Care Act, the legislation is actually still in its infancy. The arguments in King v. Burwell are less about what exists now than they are about what is to come.
This blog post also appears on our Forbes contributor page.
Lately, we have seen good job growth numbers which has led to a reduction in the unemployment rate. At first glance, this is an encouraging sign for the economy. But when we have a closer look at data on business dynamics, it is clear that the overall economy has not come back to its full strength. Specifically, the economy is still not creating as many new firms as it did before the recession.
For example, around 560,000 new firms were created in 2006. By 2012, after what was called an “encouraging recovery,” the number of new firms created had declined by almost 37 percent, according to a report from Kauffman Foundation.
While the causes of declining new firm creation still remain a conundrum, it may shed more light on our problem by presenting the geographic distribution of new firm formation rates. New firms measured in this data are less than 1 year old employer firms, no self-employed individuals. New firm formation rates are calculated as the ratio of new firms to the total number of existing firms.
North Dakota is the only state with positive change. This is undoubtedly due to the economic boom fostered by shale gas drilling. At the other end, Nevada, Utah, Idaho, Arizona, Florida, Washington, Colorado were among the 10 states with top new firm formation rates in 2006 and dropped most significantly in 2012.
The anemic growth of new business can be infectious and impact the overall dynamism of the economy. A pro-growth tax code beneficial to promote entrepreneurial activity.
In a new 580-page report, a government advisory panel calls for “bold actions” to “transform the food system” and bring about a fundamental shift in people’s diets and lifestyles. The 2015 Dietary Guidelines Advisory Committee advocates “a diet higher in plant-based foods, such as vegetables, fruits, whole grains, legumes, nuts, and seeds.” It wants people to eat fewer “burgers, sandwiches, [and] mixed dishes,” instructs them to use less salt, recommends more exercise, and suggests placing “limits on sweets and desserts.”
The committee members clearly are displeased with the general public and impatient for change.
“The dietary patterns of the American public are suboptimal… Unfortunately, few improvements in consumers' food choices have occurred in recent decades… [T]he Nation's adverse dietary pattern and physical activity trends must be reversed.”
In addition to believing the changes are for people’s one good, the panel members are troubled by the nation’s high health care costs and mention those costs frequently in their report. They see modifications in people’s behavior as a way to lower those costs.
The panel sees many opportunities for intervention, such as educating people about good dietary habits and asking suppliers to offer more of the foods that nutritionists recommend.
The committee members think part of the solution may also lie in coercive government action, such as taxes and bans, “to encourage the production and consumption of healthy foods and to reduce unhealthy foods.” For example, the new report talks of imposing taxes on “sugar-sweetened beverages, snack foods and desserts high in calories, added sugars, or sodium, and other less healthy foods” and using some of the new tax revenue “for nutrition education initiatives and obesity prevention programs.”
It will be left to others to decide whether burgers, flavored milk, and dessert should be relegated to a hall of shame. Economics, however, does offer some guidance on whether the special food taxes that the federal panel mentions are warranted.
A basic economic principle is that a good or service may be overproduced or produced inefficiently if it imposes costs on third parties who are outside the market place and unrelated to buyers or sellers. (Conversely, something may be underproduced if it confers external benefits outside the market on unrelated third parties.) A classic example of a harmful externality used by the English economist A.C. Pigou nearly a century ago is “uncompensated damage done to surrounding woods by sparks from railway engines.”
A so-called Pigouvian tax could correct this market failure by internalizing the cost, provided the tax is set equal to the external damage caused by the last unit of the offending product. In Pigou’s example, such a tax could have induced railroads to take account of the fires on neighboring land. (Because of difficulties in measuring external costs and concerns about the political process when it comes to taxation, a more practical alternative in many cases is internalizing the cost through clearly defined property rights, such as by making railroads in Pigou’s example legally responsible if they cause fires on adjoining land.)
For an example related to eating habits, suppose that eating an extra brownie somehow causes one-tenth of a cent of harm to unrelated third parties. The externality-based tax would be one-tenth of a cent. It is important, however, not to impose a higher tax than the external damage, say 10 cents per brownie, or it would reduce both private and social welfare rather than increasing them. (If eating the brownie doesn’t harm third parties or somehow generates external benefits, the externality argument would call for either no tax or a small subsidy.)
A point Pigou and later economists emphasized is that the externality argument regarding market failure and corrective taxation only applies to costs that are truly external. For instance, suppose a train ride is bumpier than passengers would like or a person biting into a brownie anticipates a tinge of remorse when stepping on the bathroom scale the next morning. These are internal costs that buyers already factor into their market decisions. Hence, they do not lead to allocative inefficiency. If the government imposes taxes to “correct” for these internal costs, the effect is to double charge buyers for the same (internal) costs, leading to inefficiently low production and consumption.
Although the federal nutrition report says repeatedly that its recommended dietary and lifestyle choices would reduce “health care costs” and “economic and social costs,” the report never distinguishes between internal and external costs or even once alludes to the concept of externalities. Nor does the report note that the biggest gainers or losers from people’s diet and exercise choices are the people themselves, which means most of the costs the committee refers to are internal costs and are already accounted for in the decisions we make.
In short, the committee’s tax proposal is not based on an analysis of externalities and market failure.
More likely, the committee members feel they know how people should behave, and largely attribute people’s failure to comply to reasons like poor information, poor discipline, and lack of commitment. The committee may view taxes as a means of pressuring people to do what the people would do willingly if only they were smarter and more mature.
To be fair, the report never articulates this paternalistic, authoritarian rationale for taxation. If the panel members are thinking along this line, however, three counterpoints should be made.
First, because of a constant stream of news stories, most people are already aware of many basic diet-related do’s and don’ts. The majority of Americans have made some dietary adjustments, and a minority have undertaken major changes. However, the degree to which people adjust their diets and lifestyles depends importantly on personal preferences. A person may make choices that nutritionists deplore but that are rational given the person’s likes and dislikes. For instance, one individual may skip bacon because of health warnings while another, who has heard the same warnings, may find bacon too satisfying to forsake (although the person may eat a little less than otherwise.)
Second, while people do give weight to dietary advice, they may be hesitant to accord it greater weight, especially when it strongly conflicts with their preferences, because it is not always reliable. For example, after a generation of government advice to go easy on eggs, the new dietary report informs us that, based on accumulating evidence, eggs are not so harmful after all.
Third, the people whose eating and exercise habits seem most self-destructive tend to be the ones least likely to respond to tax penalties. Meanwhile, the taxes would punish everyone else too, which is unfair.
Although it is never articulated in the report, the numerous references to health care costs suggest the committee members may also feel that people’s eating and lifestyle preferences should be overridden to some extent by taxes and other prods in order to economize on government health program expenditures. The panel should have explained what role, if any, government budget considerations played in its recommendations.
In summary, while it is in people’s self-interest to make reasonable dietary and exercise choices, the taxes recommended in the 2015 Dietary Guidelines Advisory Committee should probably be taken with a grain of salt.
IRS delaying tax refunds of thousands enrolled in Affordable Care Act — but why?
What's more, Olson said the IRS told its telephone representatives not to tell callers the reason for the delay. Affordable Care Act enrollees received subsidies based on their estimated income for 2014. Now that they know their actual income, the IRS ...
and more »
The “Notable & Quotable” of Feb. 23, which is from the Tax Foundation’s report “Sources of Personal Income,” correctly points out that middle-class Americans earn substantial capital gain returns from pensions and other retirement accounts. The article doesn’t mention how unfair this is to the middle class. The entire distribution from a retirement plan, including the portion that represents long-term capital gains, is taxed at regular rates which can be as high as 39.6%. This is almost double the 23.8% maximum tax rate on long-term capital gains earned outside of a retirement plan.
I think this point is worth addressing, especially since I have now seen it twice in the WSJ. (It also appears in one of the responses here.)
The letter-writer introduces two true facts, and the apparent difference in rates is indeed an item for concern. But the reason I didn’t “mention how unfair this is to the middle class” is that, well, it isn’t unfair. There are two key components of the pension system - components omitted from this simple comparison of one rate to another - that make it a good deal.
Pensions and IRAs get (1) an appropriate tax deduction for the contribution and (2) appropriate deferral of the tax until the money is withdrawn. Once the money comes out of the pension system and into the hands of the retiree, it’s finally taxed for the first time – exactly once – at ordinary rates.
This system is both fair and elegant.
In contrast, the income treatment outside the retirement system is neither fair nor elegant. It may get a lower rate, but it gets no tax deduction for contribution, and no deferral on dividend income or realized capital gains. In other words, it gets taxed immediately on the principle (at ordinary rates) and further taxed (at lower rates) when dividends are paid out and capital gains are realized.
This awkward multi-part tax system is worse than the treatment of pensions and IRAs. For example, if an American (say, one in the 28% tax bracket) earns $100 in salary and wants to invest it outside of her retirement account, she pays taxes on that $100 and finds herself able to invest only $72. Then she pays a more favorable rate from here on, but she has to pay it immediately on every dividend or capital gain she gets, even if she just plans on reinvesting. If she had instead invested the original $100 within her retirement account, she would pay no immediate tax on that $100 in salary, allowing her to earn returns on the full $100. This is a huge positive: the more money you start with, the more money you can earn. Furthermore, she gets to defer all the taxes on gains or dividends until retirement. Ask an accountant or a financial planner. Give them the choice between the lower rate on one hand, and the deduction and the deferral on the other. They’ll take the latter every single time.
People usually have the option of keeping their money out of retirement savings accounts. They just don’t take it, because the retirement accounts are better. In fact, the main reason people leave some gains outside retirement plans is that contributions are capped.
I voluntarily contribute to my 401(k) plan here at Tax Foundation, because it is in my best interest. I like my deduction and my saving-neutral tax treatment and my single layer of taxation. It’s not a trick. I promise.
Since we released our report on sources of personal income in 2012, I’ve gotten a lot of questions and comments on pension and retirement income, specifically. This category of income is often weirdly overlooked or forgotten, so I’m glad to comment on it further.
One thing I wanted to underscore is just how much pensions and IRAs are a middle-class phenomenon in this country. I touched on this in my report when I showed that tax filers earning $50,000 to $100,000 in a year – in other words, pretty ordinary Americans – are most reliant on retirement income of all of the income classes.
But let’s look at it another way. Of all of the pension and IRA income in the U.S. (in total, there was $843 billion of it on tax forms in 2012) how much of it accrues to different income classes?
Here are the results, again using the same source (IRS Statistics of Income) that I’ve used previously. This chart includes all private-sector retirement savings vehicles, but not social security. Once again, the middle class really stands out.
I’m very aware of the limitations of sorting people into precise income buckets, and the complex interactions between life cycle effects and income data. So to some degree, this simple distributional table doesn’t tell a lot of the story.
But there’s an important fact here: the majority of private-sector retirement income ($485 billion out of the $843 billion) goes to people making less than $100,000 a year. In other words, it goes to everyday people. If you count people making less than $200,000 a year as middle class as well, then $717 billion of the $843 billion goes to everyday retirees.
I’m wary when other think tanks make vague noises about how the private sector retirement system needs to be taxed more heavily. It doesn’t; it’s taxed in a fair way at ordinary rates at the point that the income actually hits the pocketbook of the retiree.
But if your biggest concerns are distributional concerns, rather than neutrality concerns, I’d look one more time at the chart above. The system looks, on paper, exactly like what it is supposed to be: a way for people to live well, but not extravagantly, in their retirement.
By David DeKok HARRISBURG, Penn. (Reuters) - Pennsylvania Governor Tom Wolf proposed a $29.9 billion budget on Tuesday that includes $2.5 billion of net tax increases for fiscal 2016. Wolf's sweeping revamp of the state's tax system would raise sales and personal income taxes while lowering property and corporate taxes, he said during his address to lawmakers. "Pennsylvania will not improve until it rebuilds the middle class," Wolf said. Wolf's speech attempted to address myriad problems facing the state, from a sluggish economy to pension underfunding and a $2.3 billion budget deficit.
This morning, the U.S. Supreme Court ruled (PDF) for the taxpayers in Direct Marketing Association v. Brohl, a challenge to Colorado’s “Amazon tax.” That law requires Internet retailers to (1) notify their Colorado customers of the obligation to pay state taxes on their online purchases, with dates and total amounts, and (2) provide detailed information to the Colorado Department of Revenue on purchases made by Colorado customers. The Direct Marketing Association challenged the law in federal court as a violation of the Interstate Commerce Clause.
The trial court enjoined the law but the Tenth Circuit Court of Appeals ruled that a challenge was barred by the federal Tax Injunction Act (TIA), a federal law that limits federal courts’ ability to “enjoin, suspend, or restrain the assessment, levy, or collection of any tax under State law where a plain, speedy, and efficient remedy may be had in the courts of such State.”
Today’s Supreme Court decision unanimously reverses the Tenth Circuit and allows the lawsuit to proceed. Justice Clarence Thomas, writing for the unanimous Court, concludes that the Colorado does not involve assessment, levy, or collection. As Justice Thomas writes, “Enforcement of the notice and reporting requirements may improve Colorado’s ability to assess and ultimately collect its sales and use taxes from consumers, but the TIA is not keyed to all activities that may improve a State’s ability to assess and collect taxes.”
The Court further concluded that the Tenth Circuit erroneously expanded the term “restrain” beyond its bounds: “To give ‘restrain’ the broad meaning selected by the Court of Appeals would be to defeat the precision of the list, as virtually any court action related to any phase of taxation might be said to ‘hold back’ collection.” We argued something very similar in our brief to the Court on this case: “Good policy dictates that the TIA must be bound by some limits. The lack of limits suggested by the Tenth Circuit’s decision would provide an absolute bar to a virtually endless list of state actions.”
Justices Ruth Bader Ginsburg, Stephen Breyer, and Sonia Sotomayor write separately to clarify that the DMA’s challenge of reporting requirements is distinct from a taxpayer’s suit for a refund. Ginsburg and Breyer further note that a lawsuit that would have the effect of increasing state taxes would not be barred by the TIA.
The petitioners shouldn’t celebrate too much, however. Justice Anthony Kennedy concurred separately, agreeing in full with the Court’s decision but adding that he believes the Quill and National Bellas Hess decisions establishing the physical presence rule for sales tax are “now inflicting extreme harm and unfairness on the States.” Justice Kennedy cites the growth of Internet commerce, the reality of business presence even in the absence of physical presence, and his view that “it is unwise to delay any longer a reconsideration of the Court’s holding in Quill…. The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”
This is a bombshell, but one that’s not unexpected. States have been pressing for sales tax collection on Internet sales as the size of e-commerce grows, and brick-and-mortar retailers have pressed for equity where they must collect tax while their online competitors don’t. Congress has considered the Marketplace Fairness Act several sessions in a row but have yet to pass anything. States have begun taking the law into their own hands and passing drastic collection mechanisms, inflicting nearly 10,000 sales tax jurisdictions with complicated rules on sometimes small online businesses. Justice Kennedy’s concurrence, despite being a voice of just one justice, strongly signals that the Court will let states collect taxes on Internet purchases if Congress does not.
In our primer on the Marketplace Fairness Act, we talked about the issue, the history, and possible solutions.
The U.S. federal government funds infrastructure projects through the highway trust fund. This trust fund receives revenue from mainly the excise tax on gasoline, and uses the revenue to pay for transportation projects through grants to state and local governments.
The taxes and spending associated with the highway trust fund are based on the benefit principle of taxation, which states that what one pays to the government should be connected to the benefits one receives.
Currently, the federal government levies a $0.184 per gallon tax on gasoline. In addition, state and local governments levy an average gas tax per gallon of about $0.35. This is an average combined rate of about $0.53 a gallon.
The U.S. combined gas tax rate is actually a lot lower than rates in other industrialized countries. According to data from the OECD, the average gas tax rate among the 34 advanced economies is $2.62 per gallon. In fact, the U.S.’s gas tax is the second lowest (Mexico is the only country without a gas tax) and has a rate less than half of that of the next highest country, Canada, which has a rate of $1.25 per gallon.
On top of excise taxes, all OECD countries levy their value added tax (VAT) on gasoline consumption. In the United States, only a few states (Hawaii, Illinois, Indiana, and Michigan) levy an additional sales tax on gasoline purchases. This means that the difference between taxes paid on gasoline in the United States and other OECD countries is even larger than the data on just excise taxes implies.
Without data on what the gas tax revenue is used for across the OECD, it’s hard to make a direct comparison between the U.S. and other countries. For instance, Turkey, which has the highest gasoline excise tax in the OECD ($4.32 a gallon), may only use a small fraction of the revenue for roads. The rest may be used for other government spending. If this is the case, their gas tax doesn't conform to the benefit principle as strictly as it does in the United States. In other words, their gas tax is high not because they spend more on roads, but because they chose to tax gas more.
OECD Gas Excise Tax Rates (Per Gallon), 2013
Tax Per Gallon