Be Afraid…You’re About To Cross Into…

THETAX

ZONE

In the Tax Zone….Taxes aren’t just a way of raising revenue….they aim to change the behavior of people and companies

In the Tax Zone…..….households may have the same “income” and pay very different tax bills to Uncle Sam.

….and only in the Tax Zone….

…could a system designed to benefit high income households be “fixed” so that middle-income households become ensnared in the dreaded AMT.

Ok, now for the serious stuff

I. The Basic Problem

“Free riders” have no incentives to contribute to public goods.

Government must use its sovereign powers, through the political system and other means, to compel citizens to pay tax to support programs with collective benefits

What is the line between taxation and confiscation or theft?

“Taxes are the price we pay for a civilized society” Oliver Wendell Holmes

Although taxes are compulsory, in free societies citizens have some choice:

--over where they will live, and thus which jurisdiction will tax them

--over the amount of effort they will expend

Tax is a gameSovereign jurisdictions have

incentives to “compete” with other jurisdictions over….

investment and sales of products and services, by fiddling with tax rates on sales, property, income

High income households, by offering different mixes of taxes and services

But….. …..the rules are generally weighted toward

high income and wealth households and corporations.

Federal income tax system mildly progressive

CW is that high marginal tax rates discourage effort, drive mobile earners elsewhere in a globalized economy

System consciously discriminates based on the source, use, and level of income

(But why shouldn’t it????)

A Laffer of a curve….

What do we pay?U.S. tax system Federal: income (personal and

corporate); payroll (Social Security)

State: income, sales, and property taxes

In 2007, these taxes provided 92 percent of federal income and 51 percent of state and local government income

II. A Ridiculously Brief U.S. Tax History

Tax issues have been central to the American Experience--remember the Boston Tea Party?

Tariffs greatly heightened tensions prior to and during the Civil War

1913 passage of the 16th Amendment, creating the federal income tax. Moved the federal government from reliance on customs duties and excise taxes; allowed withholding

Cuts! Cuts!The Kennedy Tax cut of 1961; Revenue Act of

1964 (lowered top rate from 91 to 70 percent)The Reagan tax cut act of 1981 (Economic

Recovery Tax Act) lowered rates by 23 percent over 3 years; accelerated depreciation for business; lowered taxes on capital gains; indexed income tax rates. Huge deficits resulted; counteracted by TEFRA (’82) & DEFRA (’84)

1986 tax act: an attempt at simplification. Reduced top rate to 34 percent; broadened base, equalized taxes on income and capital gains; eliminated loopholes. “Transition” rules (e.g. the infamous Gallo clause) a giveaway to business.

Clinton’s braveryClinton’s 1993 tax act: raised top tax rate to

39.6 percent. Along with the Internet boom and a stock market bubble, this eliminated the federal deficit.

Federal revenues hit 20.5 % of GDP by end of century (18.2 % in 1990)

Bush II tax cuts pulled them down to about 16% of GDP, a post war low. His legislation cut individual income tax rates, repealed the estate tax, and reduced taxes on capital gains and dividends. They also expanded the child tax credit and created a 10 percent bracket. These cuts, however, are due to expire at the end of 2010.

President Obama….Socialist or…Tax Cutter in Chief???

Obama’s Tax Cuts Tax cuts for individuals in The ARRA Total: $237 billion $116 billion: New payroll tax credit of $400 per worker and $800 per couple in

2009 and 2010. Phaseout begins at $75,000 for individuals and $150,000 for joint filers

$70 billion:  One year increase in AMT floor to $70,950 for joint filers for 2009. $15 billion: Expansion of child tax credit: A $1,000 credit to more families

(even those that do not make enough money to pay income taxes). $14 billion: Expanded college credit to provide a $2,500 expanded tax credit

for college tuition and related expenses for 2009 and 2010. The credit is phased out for couples making more than $160,000.

$6.6 billion: Homebuyer credit: $8,000 refundable credit for all homes bought between 1/1/2009 and 12/1/2009 and repayment provision repealed for homes purchased in 2009 and held more than three years. This only applies to first-time homebuyers.

$4.7 billion: Excluding from taxation the first $2,400 a person receives in unemployment compensation benefits in 2009.

$4.7 billion: Expanded earned income tax credit for families with at least three children.

$4.3 billion: Home energy credit to provide an expanded credit to homeowners who make their homes more energy-efficient in 2009 and 2010

$1.7 billion: for deduction of sales tax from car purchases, not interest payments phased out for incomes above $250,000.

Image vs. RealityCBS News/NYTimes poll question: “In general, do you think the Obama Administration has increased taxes for most Americans, decreased taxes for most Americans or have they kept taxes the same for most Americans?”  

Hmmm….?Crime in the U.S. has dropped…..…..but about ¾ of Americans

believe that crime became worse in 2009

The Good NewsMost Americans believe their tax

es are fair

Who is to blame?WHO IS RESPONSIBLE FOR

FEDERAL DEFICIT? All Tea Partiers

Bush admin. 41% 16%

Obama admin. 7 19

Congress 24 33

All 10 15

The Challenge to Rational PolicyPresent U.S. tax policy follows no compelling

logic.Despite that, most people complyTax gap: the difference between what taxpayers

pay in taxes voluntarily and on time and what they should pay under the law

2007 IRS estimated that in tax year 2001, taxpayers paid about 84 percent of the taxes that should have been paid

Estimated gross tax gap of $345 billion IRS estimated that it would eventually recover

around $55 billion through late payments and IRS enforcement actions, leaving a net tax gap of $290 billion

OthersDouble taxationHouseholds pay both payroll tax

(FICA, etc.) and income taxesCorporations pay tax on profitsAnd shareholders pay taxes on

dividends

ProblemsState tax systems reflect the

differing political cultures of each state.

Globalization makes it more difficult to tax corporations, capital, sales. Income is still relatively easy to tax.

Income growth over the past decade has been concentrated in the top 1% of earners.

Characteristics of a Sensible Tax System I“Efficient;” i.e., it should not interfere

with the efficient allocation of resourcesTaxes often change our behavior

relating to vital areas of our lives: ◦work, savings, education, what we buy ◦anyone get married in December?◦ tax decisions on enterprises lead to changes

in their structure, form, lines of businessBritain’s window tax (daylight, anyone?)…..and 1990 poll tax (that led to

Margaret Thatcher’s resignation).

Characteristics of a Sensible Tax System IIEasy and relatively inexpensive to

administer --Complexity places a burden on

individuals --Record keeping can be onerous --Consider the difficulty of collecting

these taxes: 1. property; 2. income; 3. sales/VAT --Eastern European countries are

adopting flat tax systems—to the chagrin of EU states

Characteristics of a Sensible Tax System IIIResponds to changed economic

circumstancesProgressive tax rates help to prime

the economy during recessions; lower incomes lead to lower tax rates

Increase taxes during times of inflation

Portfolio of taxes prevents revenues from collapsing

Transparent and FairCitizens and others should know what kinds of

taxes they are paying, and understand the system Fairness --Horizontal equity: individuals who are the same

should be treated equally: Equal Protection Clause of the 14th Amendment

--Is it “fair” to offer different tax rates for age? Marital status? Disability?

--Vertical equity: individuals capable of paying higher taxes should do so. But: how to determine when one individual is better off than another?

--“tax incidence” describes how the burden of a tax is distributed

But: The top 1% of taxpayers by

income pay 33% of all individual income taxes, and 22.7% of all federal taxes; The top quintile pays 82.5% of all income taxes, and 65.3% of all federal taxes (CBO data, as of 2006).

Basic problems: Complexity

The number of pages in the CCH Standard Federal Tax Reporter.

We Use the Tax Code For Any Intervention You Can ImagineNonprofitsElderlyHealthRetirementEnergy Housing…and on….and on….

Tax ExpendituresBudgets receive very close

scrutiny. Most programs are reauthorized yearly, or every 5 years.

Many tax expenditures go on and on and receive little scrutiny

Joint Committee on Taxation

We over tax income and capital gains….…and undertax consumption

Social Security and equity62% of the elderly receive half or more

of their income from social security benefits.

Women depend more on social security than men; they live longer, earn lower wages, and have more intermittent work histories.

African Americans depend on social security more than whites because they tend to earn lower wages and accumulate less wealth.

Social Security is running shortAs of the 2009 Trustees report,

OASDI program expenses will exceed revenues beginning in 2016

Available assets will be exhausted 21 years later

Income from payroll tax will cover about 75% of benefits

A “fix” is expected to cost about 1% of GDP overall…about $1.4 trillion

Proposals VAT (value added tax) tax on the estimated market value added to a product or

material at each stage of its manufacture or distribution, ultimately passed on to the consumer. 

Essential revenue source in many European countries. France (50% of revenues); 19.6% VAT, Denmark 25% VAT, UK 17.5% VAT

When purchaser is a business, VAT it pays on purchases is deducted from the tax it charges to its customers. The government only receives the difference; in other words, it is paid tax on the gross margin of each transaction, by each participant in the sales chain.

Prevents a sales tax issue: high sales tax rates encourage evasion

And collection costs are borne by business But…oops…all but 5 states (Alaska, Delaware, Montana, New

Hampshire and Oregon) rely on sales taxes.

The Flat Tax!No exemptions! No deductions!Income tax on a postcard!Why am I using all these exclamation points?

@!!Heritage Foundation:“There is widespread consensus that the current

tax system is a complicated failure that hinders the nation's growth while allowing the politically well-connected to manipulate the system to get special breaks that are not available to average workers and businesses.”

24 countries now have a flat tax-based system

What it might look like

The rhetoric“…a flat tax does not impose

special penalties on those who contribute the most to the nation's prosperity by subjecting them to punitive and discriminatory tax rates.”

Hmmm. Do we really want to eliminate IRA’s,

deductions for health insurance, etc?Do we want to (again) redistribute

wealth to the rich? And what rate would be needed for

the flat tax to bring in current revenues? (30%???)

Where would exemption be? Above 20% it fails to gain supportA proposal by

Wyden-Gregg proposalEliminate the Alternative Minimum

Tax Reduce the number of individual tax

brackets from the current six to three: 15 percent, 25 percent, and 35 percent.

Tripling of the standard tax deductionMost taxpayers could file a one-page

1040Eliminate many current tax breaks

Workshop IForm small groups.Discuss the proposition, “The US

tax system is broken and unfair. We should implement a flat tax.”

Workshop II“I’m nervous about Social

Security benefits being available when I retire. We should change the system so people have incentives to save in private accounts.”

Discuss.

ResourcesCBS/NYT Poll:

http://www.cbsnews.com/htdocs/pdf/poll_Tea_Party_021110.pdf?tag=contentMain;contentBody