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 game Sovereign 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????)
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 bravery Clinton’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. Reality CBS 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 News Most Americans believe their taxes are fair Most Americans believe their taxes 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 Policy Present U.S. tax policy follows no compelling logic. Despite that, most people comply Tax 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
Others Double taxation Households pay both payroll tax (FICA, etc.) and income taxes Corporations pay tax on profits And shareholders pay taxes on dividends
Problems State 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 resources Taxes 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 business Britain’s window tax (daylight, anyone?)(daylight, anyone?) …..and 1990 poll tax (that led to Margaret Thatcher’s resignation).
Characteristics of a Sensible Tax System II Easy 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 III Responds to changed economic circumstances Progressive 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 Fair Citizens 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 14 th 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 Imagine Nonprofits Elderly Health Retirement Energy Housing …and on….and on….
Tax Expenditures Budgets 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 equity 62% 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 short As 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
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 support A proposal by
Wyden-Gregg proposal Eliminate 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 deduction Most taxpayers could file a one-page 1040 Eliminate many current tax breaks
Workshop I Form 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.