Tax Reform

Tax systems get used for a lot more than raising revenue for the government. They are also often used to help change behavior and to make prices reflect costs of "negative externalities." If you want to discourage something, raise the tax on it.  If you want to encourage something, lower the tax or offer a special deduction or tax credit.

One activity we want to discourage today is greenhouse gas emissions, such as CO2 from burning fossil fuels - like the gas in your car. So, despite some elected officials calling for ways to lower the cost of gasoline, we should really be looking to increase the cost because:

1. The higher cost will encourage people to drive less or find other ways to use less gasoline.
2. What we pay for gas at the pump is not the true cost. When we drive and burn gasoline, we cause air pollution, create GHG emissions that contribute to global warming, wear out roads, and cause congestion. These activities have costs - such as cleaning the air or refurbishing roads. When that cost is not included in the price we pay, the government doesn't get the money needed to deal with the problems - the negative externalities of driving.

Beijing seems to have the idea right. It was reported in several news outlets that on August 13, Beijing announced that there would be a much higher sales tax on large cars and a lower tax on smaller cars (see abcnews.go.com)

I have written about this topic before - policymakers lament trying to find dollars to help get more people health care, yet millions of workers reap overly generous tax benefits when their employer pays all or part of their health care coverage.  These generous tax benefits represent dollars from the federal and state budgets that could be used for other purposes. And, the problem is even worse because having so many insured employees not directly involved in how much their health care coverage costs tends to make them get too much health care at times, which drives up costs for everyone.

Here are prior posts:

• Health Care Spending versus Extending 2001/2003 Tax Cuts - Tough Issues
• Tax Reform and Health Care Reform

On 7/31/08, the Senate Finance Committee held a hearing on Health Benefits in the Tax Code: The Right Incentives.

Each of the three witnesses commented on the exclusion for employer-provided health insurance. Joint Committee on Taxation Chief of Staff Edward Kleinbard noted:

The Department of Transportion announced today that we drove 9.6 billion fewer vehicle-miles traveled (VMT) in May 2008 compared to May 2007. While that is good for reducing carbon emissions, it is bad for the Highway Trust Fund. When we use less gasoline, less gasoline excise taxes are collected.

According to Transportation Secretary Mary E. Peters: "By driving less and using more fuel-efficient vehicles, Americans are showing us that the highways of tomorrow cannot be supported solely by the federal gas tax."

Our current federal gasoline excise tax is 18.4 cents per gallon. It is not adjusted for inflation. It has been known for some time that adjustments would eventually need to be made in the rate or HTF funding approach as MPG of cars increased. Various studies have been done to get an idea of the problem and possible solutions to provide more funds for the HTF to maintain and build roads.

On 6/26/08, the House Ways & Means Committee held a hearing on Individual Retirement Accounts (IRA) due to concern over underutilization and reasons why many small businesses did not offer some type of IRA plan for workers. The GAO report on the topic was highlighted. Subsequent to this hearing, a few other committees held hearing on retirement savings and a report was released by Ernst & Young on people not having enough to live on in retirement.

There are some troubling data and realities about IRA participation and inadequate retirement savings. For example:

California legislators continue to struggle with how to close the $15 billion budget gap even as the year has begun and the budget deadline has passed. On July 8, the Budget Conference Committee developed a plan that restores some proposed cuts and proposed a package of six tax increases. Five of the increases involve the individual income tax and corporate franchise tax while the sixth calls for efforts to collect some of the state's uncollected taxes (reduce the tax gap).

A problem with aiming to close a specified budget shortfall is that it is too easy to look at the amounts various changes could raise and massage it until you hit your needed number. Math wins out over strategy. while the committee has reasons for each of the five tax increases, they are fairly weak, such as - we had these high rates in the past. Why does that mean they make sense for California's economy and society now?  What about cutting back on tax deductions, exclusions and credits that are too generous or poorly targeted such that they benefit taxpayers who don't need a benefit?  What about shaping our tax laws to support our economic, societal and environmental goals? For example, policymakers are working to find ways to get California to reduce its GHG emissions. So, why not enact a carbon tax?

Ease of cross-border business activity has led to what Thomas Friedman describes as a flat world. However, our quagmire of state nexus rules leaves domestic commerce in a non-flat world.

States tend to take broad approaches in finding multistate sellers subject to income or gross receipts tax in the state. The 1959 federal law known as PL 86-272 provides guidance for sellers and states regarding when a state can impose income tax obligations on a seller of tangible personal property. A lot more businesses today, relative to 1959, sell something other than tangible personal property and so have no federal statute to rely on to know when they may owe income tax in a state.

Some states take the approach that an economic connection is enough - that a physical presence in the state is not needed before a seller is subject to state income tax. And, rules can vary from state to state leading to the possibility of double taxation of some income.

The 1959 law needs to be updated. It was intended to be temporary (!), but was never updated. Congress has looked at a few possibilities over the past several years, but nothing has come close to enactment.

When today's forms of taxes were created decades ago, there wasn't any technology to consider in making computations and collection easy. But that is not true today. While some states are slowly modernizing their laws to address new ways of living an doing business that are partly due to changes in technology, the technology as a tool of tax compliance and administration is often overlooked.

Tennessee enacted various tax law changes which the governor signed on June 5, 2008, including expanding its sales tax to include most digital goods provided the tangible equivalent is something already subject to sales tax. [SB 4173 enacted as Public Chapter Number 1006]

"The retail sale, lease, licensing, or use of specified digital products transferred to or accessed by subscribers or consumers in this state shall be subject to the tax levied by this chapter on the sales price or purchase price thereof at a rate equal to the rate of tax levied on the sale of tangible personal property at retail by the provisions of § 67-6-202."

The law defines various types of digital goods and notes a few exemptions. To determine where the buyer resides, the new law provides:

On June 16, the Senate Finance Committee sponsored a Health Reform Summit.  The presentations focused on costs and possible improvements to the delivery and insurance system.

CBO Director Peter Orszag's first part of his testimony helps put the immense financial problems facing us in the next few years in perspective.  He says:

"The single most important factor influencing the federal government’s long-term fiscal balance is the rate of growth in health care costs. The Congressional Budget Office (CBO) projects that, without any changes in federal law, total spending on health care will rise from 16 percent of the gross domestic product (GDP) in 2007 to 25 percent in 2025 and 49 percent in 2082, and net federal spending on Medicare and Medicaid will rise from 4 percent of GDP to almost 20 percent over the same period.1 Many of the other factors that will play a key role in determining future fiscal conditions— including the actuarial deficit in Social Security and a decision about extending the 2001 and 2003 tax legislation past its scheduled expiration in 2010—pale by comparison over the long term with the impact and challenges of containing growth in the cost of federal health insurance programs." 

We hear lots of talk about tax reform and lots about health care reform, but rarely hear about the two together. While there are proposals to change the exclusion for employer-provided health care, such as President Bush's proposal to remove it and provide a standard deduction for health insurance, they typically don't consider either the entire health care or tax reform picture.

There are significant dollars in the tax code that should be on the table in reforming health care. All of the government dollars should be in the picture in looking at how to fund any change, such as universal coverage. The largest federal tax expenditure is the one where employees are not required to include in taxable income the value of the health insurance their employer provides to them. The estimated cost of this expenditure in 2007 was $134 billion.  There are other health care tax breaks as well such as the itemized deduction for medical care and health savings accounts.

Last week, the Center for Disease Control and Prevention (CDC) reported that life expectancy has gone up, hitting a "record high in 2006 of 78.1 years."

This kind of trend data is relevant to tax reform discussions, but not often highlighted. Tax reform discussions could be better focused if we spent more time looking at how the world has changed since most of our current rules were enacted and how it will likely continue to change.

Several years ago I started gathering data on trends and using it to show where our tax law was outdated or working contrary to a trend, that is - contrary to reality. A few simple examples:

1. Longevity - this is clearly relevant in considering our Social Security system. When Social Security was created in the 1930s, life expectancy was lower than retirement age. That is clearly not the case today.

2. Who lives in poverty - In 1959, 35.2% of people age 65 and older were in poverty. In 1996, that percentage had dropped to 10.8%. (Leatha Lamison-White, Poverty in the United States: 1996, U.S. Department of Commerce, Bureau of the Census, Table C-2, page C-5). The federal tax law (as well as some state income tax laws) include exemptions and credits for being old. Years ago it may have been appropriate to assume that most elderly needed a tax break, but that is not true today.