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Friday, May 30, 2003
The meaning of fairness
Brad makes the valid point that I should be careful about calling tax cuts fair or unfair (or mean) without explaining the underlying concern.
To clarify, I am not arguing that the child credit should be fully refundable so that we redistribute more wealth to families with children. In fact, I'm not even sure I agree with the underlying policy that -- assuming equal levels of income -- childless taxpayers should subsidize families with children.
What I am saying is that the Republicans' stated rationale for denying the credit to those who earn between 10,000 and 26,000 --- that they have no federal tax liability, and so should not get "tax relief" -- is factually inaccurate if one takes a broader view of the tax system so as to include payroll taxes. This is a tax policy question and not just a distributive justice question.
My other point is that to the extent possible, when we do debate these questions, we should consider the tax-and-transfer system as a whole, including hidden taxes like payroll taxes and sales taxes, and other government distributions like refundable credits (e.g. the EITC), welfare payments and AFDC payments, and so on. These too are sometimes tax policy questions and not just distributive justice questions.
Sorry if I sound grumpy today. I guess I'm just frustrated by how difficult it is for the political system to accommodate some of the basic ideas that all of us tax policy types would agree on -- e.g. that social security taxes are, in fact, taxes (and not "deposits into the system") and should be viewed as such.
The Onion's take on the Bush tax plan can be found here.
Fairness and the refundability of the child credit
This debate reminds me a of when a student asked whether the tax cut in 2001 was "good." I said you can't answer that question without having an opinion about the preexisting "fairness" of the distribution of wealth and the tax burden in this country. There may be some administrative concerns in making credits fully refundable, but otherwise it seems like a purely political judgment. The discipline of tax policy (if there is such a thing) has nothing meaningful to offer. Similarly, I don't think one can address the "fairness" of the refundability of the child credit without having made the same judgment about the distribution of wealth and tax burdens. One's answer to that question answers whether not making the credit fully refundable is "unfair."
More on Refundable Credits and Meanness
Thanks to Jeffrey, I at least understand the issue now and the potential justification for limiting the credit. (No thanks to the Times, which made it sound like people with federal tax liability were not getting the full credit). I also saw in the papers this morning that Ari Fleischer (no relation to yours truly) defended the credit limitation on the grounds that Jeffrey articulated.
To be clear, the Republican justification is that this is a tax relief bill, so families may reduce their tax liability, but not below zero --- no one should receive a cash distribution from the government.
Of course, the econ-type in me finds this absurd. First, and perhaps most significantly, these workers do not have zero tax liability. They pay social security taxes, so it's not like their tax liability is, in fact, close to zero. Not to mention state and local income taxes, property taxes, and sales taxes. So I'll stand by my allegation that the Republicans are being mean.
Second, even assuming that these workers had zero tax liability, it would still make more sense conceptually to make the credit refundable. Instead of isolating tax questions, it makes more sense to devise a tax-and-transfer system for redistribution. As it stands, the child tax credit redistributes income from childless taxpayers to families, but only families with incomes above a certain amount. I fail to see a principled justification for this.
Some Republicans would argue that we should not use the tax system to redistribute income. But taken literally that is a rather extreme position --- think of a "head tax" system that simply charges every taxpayer $20,000 regardless of ability to pay --- and leads to a degree of social inequality that I think all of us would object to. So given that some redistribution has to occur, the remaining question is whether we should do so through a tax-and-transfer system or through other methods, like personal injury lawsuits. Economists argue, convincingly, that it is more efficient to redistribute income through the tax system than through the tort system, as it is thought that there is more "deadweight loss" (e.g. plaintiffs lawyers) in the tort system. Republicans should not be allowed to have it both ways. If we are going to limit redistribution through tort reform -- which I agree is a good idea -- then we should explicitly allow redistribution through the tax system.
The NYTimes has an editorial on the issue that Victor discusses below. However, one should note that the limitation is only on the amount of the credit that gets refunded to taxpayers . If a family has enough tax liablity, there is no limitation. One can argue that the entire credit should be refundable, but I think it is reasonable for Congress to decide to not increase the refundable portion of the credit. Instead the focus of the relief is on those who pay taxes. Not all credits are refundable. By analogy, I don't think every deduction is unfair because it helps out high bracket taxpayers more than those in lower brackets.
It may appear "mean" that the government is sending $400 checks to some taxpayers, but not sending checks to the poor (the group that probably needs it the most). However, if you view it as Congress returning the $400 to those who overpaid their taxes, there is no reason to send it to those who didn't pay enough federal income tax. For those families, it would be welfare rather than a tax refund.
On another note, the WSJ has an editorial today discussing the issue of state estate taxes. Apparently, many states are keeping an estate tax dispute the federal estate tax repeal.
Thursday, May 29, 2003
Republicans are Just Plain Mean
NYT article explains how most low to middle income families do not benefit from the increase in the child tax credit from $600 to $1000. The Times explains:
The gap in the number of families who receive the child credit occurs because of how the formula was arranged in 2001. Congress decided then to give refunds of the credit to low income families, but just to a maximum of 10 percent of the amount they made over $10,000, or a refund of $600, whichever was lower. The $10,000 amount was indexed to inflation and is now $10,500.
I don't even know what the justification for denying the credit for low-income families would be, other than meanness. These folks pay taxes, just like the families that make more than $26,500, who (mostly) fully benefit from the increase. (The credit also phases out at the high end, so maybe it's supposed to be a weird tradeoff or something.)
Mr. Mom Legislation
I did some research on the provision in the new tax bill that shifts revenue from the 2003 fiscal year into the 2004 fiscal year (by delaying the due date for estimated taxes). Jeffrey Kummer, a senior manager at D&T, sent the following explanation:
"It is a simple gimmick designed to move some government receipts from fiscal year 2003 into fiscal year 2004, which begins on October 1. The revenue table shows $6.325 billion subtracted from the tax act's estimate in FY 2003 and $6.325 billion added to the FY 2004 estimate. My favorite explanation is the House Ways and Means Committee "reasons for change" section which states: 'The Committee believes that it is appropriate to modify these corporate estimated tax requirements.'
There are revenue losses in FY 2003 due to the retroactive nature of the bill, however, the most expensive year of the 10 year budget window is FY 2004. JCT estimates that it will cost nearly 150 billion for next year alone -- compared to $60 billion in FY 2003. Finally, to prove the fickle nature of this provision, the tax act as approved by the House would have allowed for the deferral of 52 percent of the estimated tax payment. When the conference agreement first came out, it read 17 percent. When the conference agreement was finally approved by the House and Senate, the number changed again to 25 percent. I call this Mr. Mom legislating. In the movie Mr. Mom, Michael Keaton is the house husband when his wife's boss (Martin Mull) comes over to the house. To prove he is worthy, Keaton grabs a chain saw and talks about rewiring a room. When Mull asks him if he is going to wire it with 110 or 220 amperage, Keaton says '220, 221 whatever it takes...' 52%, 17% or 25% -- whatever it takes..."
Lunch and Taxes Update
Yesterday's "Public Law" lunch here at Columbia was pretty interesting. The audience was non-tax except for Larry Zelenak (the main speaker) and myself. There wasn't a supporter of the tax bill in the room, which is not terribly surprising. I think of myself as moderate left in my politics, and I'd guess I was the second most conservative person in the room. In fact, at Columbia I often find myself on the right side of the aisle.
For me, the most interesting part was the discussion about why we might want a more progressive tax system. Larry Z referenced Nagel & Murphy's recent book, "The Myth of Ownership," which Larry described as really being about the myth of pre-tax income. The argument, greatly oversimplified, is that because in the absence of a well functioning state, one's income is valueless (your property gets pillaged, you can't buy anything useful, etc.), it is silly to talk about pre-tax income as if every bit of tax takes something away from its rightfully deserving owner. We should not talk about the distribution of tax burdens -- which make it seem like the rich bear too much of the burden --- but rather we should talk about the distribution of after-tax incomes.
Another way to put this: Would you rather be rich today in Sweden or Baghdad?
The counterargument is that we would never subject rights other than property rights to this sort of analysis. After all, in the Hobbesian state of nature no one has a right to free speech, freedom of religion, or due process of any kind, and yet we would not say "ergo it is silly to speak of these rights without the burdens that come along with a well functioning state."
I'd rather be rich in Sweden than Baghdad, but at the same time I don't find the "myth of ownership" a very useful way to frame the question. When it comes to progressivity, I think it makes sense to look not just at the tax system, but the "Tax and Transfer" system as a whole, and to think carefully about the most efficient way to raise revenue and redistribute it to those who need it while distorting market behavior as little as possible.
Wednesday, May 28, 2003
Lunch and Taxes
Today, Columbia Law kicks off its "Public Law" lunch series with Larry Zelenak leading a discussion about the recent tax cuts. I'm interested to see what the non-tax crowd thinks about all this. I'll report back later.
Fix a Real Tax Problem
In an editorial that will warm Gregg's heart, the Washington Post begs Congress to fix the AMT.
Tuesday, May 27, 2003
Other state and local tax news
The San Jose Mercury News has continued its articles this week on the continuing reverberations of Proposition 13 in California. This article explores a debate about Prop 13's effect on local control of local government, and this article chronicles the effect of Prop 13 on the funding of California libraries. This morning, NPR's Morning edition ran this story (scroll down to "Boeing Divisions to Bid for Work on New Aircraft," file in Real Audio) discussing the nice tax incentives that Kansas has offered Boeing to locate some of its assembly operations for the new 7E7 in Wichita. (I'm nothing close to well versed in the subject, but my cursory reading of the literature suggests that such targeted tax breaks actually do little to improve a state's economy and end up costing states millions in foregone revenue.) Finally, Democrats in Ohio, in a counter-proposal to the Republicans' budget, want to increase the state's minimum net corporate income tax from $50 to $300. I will not comment on the wisdom of this from a political or tax policy perspective. Regardless, the tax appears blatantly unconstitutional. Applying the Supreme Court's four-part test from Complete Auto Transit v. Brady, 430 U.S. 274 (1977), a state tax must be fairly apportioned, must not discriminate against interstate commerce, and must be fairly related to the taxpayer's activities in the taxing state. (The fourth part is that there must be a "substantial nexus" between the taxpayer and the taxing state.) A flat, minimum corporate income tax fails all three of these prongs of the test. California also has a minimum corporate income tax, and it has never been challenged, perhaps because the amount is low enough to make it not worthwhile to litigate. Regardless, such flat taxes seem plainly unconstitutional.
Internet tax update
Last week, the House Judiciary Subcommittee on Commercial and Administrative Law reported out H.R. 49, which would continue in effect the Internet Tax Freedom Act (currently set to expire November 1, 2003). The bill now moves to the full House Judiciary Committee for consideration. H.R. 49 would do two things: (1) permanently extend the ITFA, and (2) eliminate the provision that has "grandfathered" state and local internet access taxes that were in effect and enforced prior to October 1, 1998. (Those internet access taxes that were not in effect and enforced as of October 1, 1998, are currently prohibited by the ITFA.) A handful of states are opposing the elimination of the grandfathering provision; Wisconsin, for instance, stands to lose $55 million over the next two years.
More Games by the Senate?
On this board, I previously mentioned the individual AMT serving as a phony source of future revenue which Congress used to absorb the cost of the tax cut. A Ways and Means staffer has told me that there was some speculation on the hill that the Senate bill's proposal to repeal the Section 911 exclusion of up to $80,000 of an individual's foreign earned income (which ultimately failed to make its way into the final bill) was intended to create some more phony revenue. The provision wouldn't have become effective until 2005 and the speculation was that there was a wink-wink promise that Congress would never actually allow the provision to be effective (plus just think of the fund-raising opportunities to ensure its repeal!) In the meantime, it would have been a great source of future "revenue".
Sunday, May 25, 2003
Recharacterizing repurchases as dividends
The NYT alleges that "[w]hen repurchases begin to appear routine, though, the government views them as dividends and begins to tax them as such." Here's the full quote:
Equalizing the rates on capital gains and dividends may help diminish another distortion, too. For most investors, the tax rate on capital gains is lower than the rate for dividends. Partly as a result, companies often try to funnel money to shareholders by repurchasing shares — something that might not otherwise be in their interest — rather than paying dividends.
Anyone know if this is actually true? Last time I looked, which admittedly was some time ago, my impression was that under section 302(b)(1) a redemption is treated as an exchange unless the redemption is "essentially equivalent to a dividend," and that it was quite easy to achieve this status so long as the redemption was "substantially disproportionate" with respect to the shareholder, i.e., that the redemption was not made pro rata to all shareholders. I imagine there is an issue if the redemption is offered to all shareholders but only some accept. But I wouldn't think that it would matter if, as the Times alleges, the redemption "appears routine." Is this really an issue in practice?
Why does this matter? I have been assuming that managers will continue to prefer making distributions as redemptions rather than as dividends, even if the rates are the same (15% now), as the value of their stock options will decline if cash is distributed as a dividend, but not if cash is distributed as a redemption.
NYT distorts tax savings, but not the way you think
Angry Bear has a nice post analyzing the NYT's absurd assumption that households with $41,000 in income have yearly income of $500 in dividends and $500 in capital gain. That's an awful lot of investment income, and while it may be a realistic assumption for some significant percentage of seniors; many more people in that income bracket are are younger families with almost no investment income and seniors with income from tax-deferred retirement accounts, for which the new tax cut is mostly irrelevant. Assuming such high amounts of investment income for low income households makes the tax cut appear much less regressive than it is.
Better numbers are here, from Urban-Brookings.
The Times' defense would be that it was just relying on the numbers supplied by Deloitte & Touche. But the Times is a big organization; can't it find someone to run the numbers on more realistic assumptions?
I agree with Angry Bear that the Wall Street Journal provided much better coverage of the tax cut, beginning to end.