House Ways and Means Committee Chairman Dave Camp (R-MI) has proposed requiring most derivatives investors to pay tax on their annual returns even if they don’t realize their gains by selling their securities. This proposal, which requires investors to mark-to-market the value of financial derivatives, has ramifications far beyond the heady world of high-tech finance. It implicitly challenges our most basic and firmly held beliefs about why we tax investment gains the way we do.
Camp’s plan raises two key questions: First, should mark-to-market be required for all investment assets, not just derivatives? Second, does his proposal fracture one of the main justifications for taxing long term capital gains at roughly half the rate on ordinary income?
Ask most tax experts why, in a nutshell, rates should be lower for capital gains, and you’re liable to get a mini-lesson on the “lock-in effect.” There’ll be other reasons too. But the lock-in effect is going to be pulling some serious weight.
What the lock-in effect is and how it relates to mark-to-market—and why Camp’s proposal calls it into serious question—is best explained by way of analogy. ( Continue… )
Just as Congress allowed the 2011-12 payroll tax cut to expire, new research by the Federal Reserve Bank of New York suggests that such tax breaks may significantly boost consumer spending. As a result, raising workers’ take-home pay this way might play a bigger role than many thought in reversing economic slumps.
The study by Grant Graziani, Wilbert van der Klaauw, and Basit Zafar of the New York Fed staff was based on two surveys of about 200 workers. The first (in February and March, 2011—just after the tax cut kicked in) asked what they planned to do with their extra take-home pay. The second (in December, 2011) asked the same workers what they actually did with it. The results: While workers on average said they planned on spending only about 14 percent of added income, they reported months later they actually had spent 36 percent.
One especially interesting finding: High-income workers were more likely to spend the extra cash than their lower-paid counterparts. This contradicts the widely-held theory that cash-strapped low-income households will spend a tax cut while high-income workers will save those extra dollars. If these results turn out to be correct, they suggest that payroll tax cuts may do a better job stimulating demand than many economists think.
The Obama Administration designed the payroll tax cut as a temporary one-year stimulus (though it did extend it for an extra year). It cut taxes by as much as $2,200 per worker and by an average of about $1,000 for a middle-income household. The study found that those workers who thought the tax cut would last longer than a year were somewhat more likely to plan to spend the extra income than those who believed it was only a one-year break. ( Continue… )
Last week’s draft plan by House Ways & Means Committee Chair Dave Camp (R-MI) to reform the taxation of financial products includes two key changes that would simplify rules, reduce manipulation, minimize compliance burdens, and improve tax administration.
The first would require investors to use the “mark-to-market” method of accounting for all derivatives, other than business hedges. The second would require them to use average basis to calculate gains and losses from the sale of stock or mutual fund shares, and not first-in-first-out (FIFO), specific identification, or any other method.
Camp has proposed a unified approach to the taxation of derivatives: the mark-to-market method of accounting. Derivatives are contracts that are valued by reference to other assets or indices. They include swaps, forward contracts, futures, options, structured notes, security lending, and many other arrangements.
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The current taxation of derivatives is complicated and inconsistent. There are different rules for different derivatives, for different uses of the same derivative, and for different taxpayers. As a result, two derivatives that are economically the same may be taxed quite differently. Investors often use these tax differences to manipulate the character, timing, or source of their income to reduce their tax liability. ( Continue… )
As tax filing season approaches, the IRS is reminding low-income families about the Earned Income Tax Credit (EITC). The EITC provides a wage subsidy for low- and moderate-income families and is an important income support for many.
In 2012, a family with two children could receive an income boost of 40 cents for every dollar earned, until they reached the maximum credit of $5,236 (which happens once earnings reach $13,090). The credit begins to phase down when income exceeds $17,090 ($22,300 if married) and disappears entirely for families with two children when income hits $41,952 ($47,162 if married). A smaller credit is available for smaller families and a larger credit is available for families with at least three children (see chart), but that larger credit is scheduled to expire after 2017.
The Tax Policy Center estimates that almost 36 percent of all EITC benefits for 2012 will go to families in the lowest fifth of all incomes, and an additional 51 percent will go to families in the second income quintile. Almost no benefits flow to families in the top 40 percent of the income distribution. Because incomes at the bottom end of the distribution are highly volatile, EITC receipt status is often temporary with families typically receiving the credit for only one or two years.
Research consistently finds that the EITC encourages work, especially among single moms. One study found that the EITC lifted over 6 million people out of poverty in 2009. The credit also improves infant health. In 2012, 24 states and the District of Columbia have an EITC which supplements the federal EITC by as much as 45 percent.
It is not known how many people are eligible for the EITC and fail to claim it, though widely accepted estimates based on the 1990 tax year suggest between 16 and 20 percent of eligible families fail to claim the credit. Given the value of the credit, it is important to remind low-income families that it is a big reason why they should file a tax return. Kudos to the IRS for today’s EITC Awareness Day, which serves as an important reminder.
If their leaders’ public statements are to be believed, the fiscal chasm between the political parties is widening. And it is hard to see how it can be bridged.
Congressional Democrats and Republicans have agreed to put off the next budget crisis for a month or so. This is a good thing, especially considering the alternative. And they’ll try to write a budget through the formal legislative process rather than starting with high-level negotiations with the White House. This is euphemistically known as regular order though it is hardly regular (it has not been used since the George W. Bush Administration) and there is nothing orderly about it.
The trouble is, Republicans and Democrats are setting out fiscal goals that are light-years apart. Maybe these are merely opening bids. But without huge concessions, budget talks will be futile. Here are five stumbling blocks to a deal:
The Next Crisis. While the House GOP agreed to delay the battle over the debt limit until summer, it will try to use two March deadlines–a package of automatic across-the-board spending cuts and a looming government shutdown– as leverage to slash government . Democrats prefer March’s automatic spending cuts to the even deeper reductions Republicans are aiming for. ( Continue… )
“We must make the hard choices to reduce the cost of health care and the size of our deficit. But we reject the belief that America must choose between caring for the generation that built this country and investing in the generation that will build its future.”
With those words in his 2nd inaugural address, President Obama perfectly defined what will be the great domestic policy debate of not only the next four years but the next decade.
There is a simple answer to Obama’s core question: Can the U.S. pay for the health and retirement costs of its seniors while also supporting its children? Sure it can, but not without raising taxes or fundamentally changing the way it provides health and long-term care for the elderly.
This is much more than an argument about deficits. It is at the heart of a profound debate about the nature of government and its relationship to its citizens. Government that provides for nearly all medical care of seniors and low-income children, even as it invests heavily in education, technology, and infrastructure, is government that probably needs to collect at least 40 percent of the nation’s Gross Domestic Product in federal, state, and local tax revenues. That’s the Obama vision of government. ( Continue… )
In the alphabet soup of Washington, ATRA fixed the AMT, sort of. In English, the newly enacted American Taxpayer Relief Act of 2012 will permanently protect millions of taxpayers from having to pay the alternative minimum tax without Congress having to approve a temporary patch every year or so. It even knocks a few hundred thousand people off the AMT this year. But it still doesn’t really fix the dreaded tax.
Since the first Bush tax cuts in 2001, Congress has protected millions of taxpayers from the AMT with one- or two-year patches. Each patch boosted the amount of income exempt from the tax, saving millions of households from having to pay the levy. The 2011 patch, for example, left just 4.3 million taxpayers owing AMT, down from 29 million who otherwise would have paid the additional tax. Congress never approved a permanent fix because it deemed the revenue loss too high.
With ATRA, Congress bit the fiscal bullet, which the Joint Committee on Taxation pegged at $1.8 trillion over the next decade. It set a higher permanent exemption for 2012 and indexed that and other AMT parameters for inflation. New estimates from TPC show what those changes—in combination with other ATRA provisions—will mean.
- More than 30 million taxpayers who would have owed AMT for 2012 won’t be dinged by the alternative levy. The higher exemption will save them and the 4 million who will still pay AMT more than $85 billion.
- The combination of a larger AMT exemption and higher thresholds for the exemption phaseout and top AMT tax bracket will further reduce the number of taxpayers owing AMT to just 3.4 million in 2013. Without ATRA, nearly 27 million more people would owe AMT this year.
- ATRA’s restoration of the 39.6 percent bracket and the return of the limitation on itemized deductions (aka Pease) and the personal exemption phaseout (PEP) will raise regular taxes enough to push some high-income taxpayers off the AMT. Of course, not owing AMT is small consolation for those folks, who I’m sure would be happy to pay the lower AMT bill. ( Continue… )
Weird Tax Fact of the Day: The fiscal cliff deal (aka the American Taxpayer Relief Act of 2012) created what may be the world’s tiniest tax bracket. Under the new law, singles face a rate of 35 percent if their taxable income falls between $398,350 and $400,000. The bracket covers a grand total of $1,650.
The Tax Policy Center figures fewer than 500 taxpayers fall into this group, which makes it a very exclusive club indeed.
Given the amount of money these folks make, it does create some interesting social opportunities. Perhaps all of the singles in the 35 percent bracket could be invited to a nice dinner for the upcoming inauguration. They’d easily fit in a hotel ballroom.
Or a cruise might be in order. Of course, it does seem a little odd to create a tax bracket solely for a group of people who could fit onto the love boat (with plenty of room left over for a few of the hoi polloi). ( Continue… )
Last week Japan announced a massive stimulus package designed to jumpstart its slumping economy, which is in the midst of its fifth recession in 15 years. The stimulus initiative, heavy on infrastructure spending and disaster preparedness, includes $117 billion in central government spending. Add in local government and private-sector support and spending could top $200 billion. It’s a smart move if implemented quickly and effectively.
The Japanese cabinet claims the package will boost real GDP by 2 percent and create 600,000 new jobs; this sizable increase may be an understatement. In Japan’s $5.87 trillion economy, a $200 billion stimulus package could raise the short-run level of GDP by around 3 percent, assuming a dollar-for-dollar relationship between government spending and economic growth. (Government investment raises GDP when the outlay is made. Subsequent economic effects depend on the productivity of the investment—which can raise its net impact—and the effect on taxes and interest rates—which can reduce the net benefits.)
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Moreover, research shows that when interest rates are at or near zero as is the case in Japan, the ability of government spending to stimulate economic growth is particularly acute. One economist estimated that each government dollar spent when interest rates are zero leads to over $3 in economic growth. If this is right, Japan’s stimulus will be a remarkable shot in the arm for a struggling economy. ( Continue… )
There is an obvious solution to Washington’s perpetual budget crisis. But it is unlikely to happen because all the incentives—both political and economic—are completely wrong.
First, the solution: The core of a deal was framed last December, when President Obama and House Speaker John Boehner were on the verge of a long-term fiscal agreement that would have cut spending by about $1 trillion and raised revenues by roughly the same amount. Sure, Ds and Rs were quibbling about the last few hundred billion, but this, more or less, would have been the compromise.
In the end, the American Taxpayer Relief Act of 2012 raised revenues by about $600 billion (at least as the negotiators counted it) and didn’t cut spending at all (in fact, it may have slightly increased outlays). The obvious next step: Finish the job by agreeing to combine another $400 billion in new taxes with $1 trillion in spending cuts.
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To avoid the debt limit crisis, Congress could also extend federal borrowing authority for one year to give lawmakers time to turn those goals into law, then increase it for another year once the spending and tax changes are adopted. ( Continue… )