In testimony before the Senate Committee on Finance this morning, I discussed what federal tax reform would mean for state and local governments and how Congress could help by coordinating tax law across states. Here are my opening remarks. You can find my full testimony here.
With increasing concerns about the federal deficit, fairness, and the complexity and inefficiency of our tax system, the need for fundamental federal tax reform is critical. Often overlooked, however, is the fact that any such reforms will also affect the tax and fiscal policies of state and local governments. Although the country’s economic condition is improving, state and local governments are still struggling to balance their budgets. They also play an important role in our economy, running about half of all domestic public programs and with state and local spending making up about 15% of gdp.
Decisions about changing federal policy should take into account the potential effects on state and local government budgets in both the short and the long run.
I will make 4 points today.
Federal tax policy and reform can help or hurt states. Federal policy affects how attractive specific taxes are for state and local governments and, therefore, how those governments organize their tax and revenue systems. State revenue sources—especially income taxes—often piggyback on federal rules. More specifically, statutory changes in federal law can result in significant increases or decreases in state revenue. For example, state income tax revenue increased after the 1986 tax reform expanded the federal income tax base, and allowed states to also reduce their rates. In contrast, the elimination of the state and local tax deduction could increase the cost to state and local governments of providing services.
Unstable federal tax policy trickles down to the states and uncertainty is especially problematic for state and local governments. State and local governments are required to pass balanced budgets every year. This requires being able to accurately forecast revenues. Problems with state tax systems are exacerbated by uncertainty in federal tax rules. Temporary extensions of credits, deductions, and tax rates complicate state forecasting. Policy changes and uncertainty can directly affect state tax bases through changing definitions of income or indirectly due to changes in taxpayer behavior. Especially problematic has been uncertainty about future federal estate taxes and tax rates on dividends and capital gains, sources of volatile income for states.
If fundamental tax reform is undertaken, transition relief might be important for state and local governments. Tax changes can help or hurt states, but understanding the short-run effects will be important and may require slower adoption of policies or some fiscal relief. Understanding the state of the economy and the fiscal health of state and local governments will be important.
Due to our federalist system, Congress has a role in helping to coordinate or protect the existing state and local tax base. State and local governments’ ability to raise revenue can be hobbled by limitations that Congress could remove. Most notably, Congress could enact legislation that could help coordinate action across states and would help enable state and local governments to collect taxes on internet and mail-order sales.
Other panelists explored the costs of current federal tax preferences—the state and local tax deduction and tax-exempt municipal debt—that affect state and local governments as well as how federal legislation could help state and local governments coordinate tax policy in the face of changing technology. The hearing was lively and a good mix of both considering long-term reform and more practical measures that Congress is more likely to act on.
Opening statements from Senators Baucus and Hatch and the other witnesses are here.
My Tax Policy Center colleague Eric Toder and I are mystified by how unRepublican the House GOP’s Small Business Tax Cut Act really is. Sure, cutting taxes for businesses and high-income individuals is very much part of the Republican playbook these days. But the mechanics of this one seem to fly in the face of what many in the party have been saying lately.
The bill would allow both C corporations and pass-through businesses with fewer than 500 employees to deduct 20 percent of their income from federal income tax for one year. The proposal was wrapped in rhetoric about job-creators and small businesses. But, in fact, it is exactly the sort of anti free-market, short-term industrial policy that Republicans rightly decry when Democrats try it.
To see how, let’s pull the bill apart:
It favors some businesses over others: By limiting its definition of eligible businesses to fewer than 500 workers, this bill would penalize firms that rely on labor instead of capital—quite the opposite of what you’d expect from a jobs-creating bill.
For instance, the measure would benefit hedge funds, real estate partnerships, and law firms—many of which are unlikely to hire many more workers as a result of the new tax break.
Even Mitt Romney’s former investment firm Bain Capital might be eligible for this “small business” subsidy. Although it manages an estimated $66 billion, Bain employees only 400 professionals. With a lean enough support staff, it might be one of those lucky small businesses.
The bill would also reward established, profitable firms rather than new, fast-growing businesses that have little taxable income and would be less likely to benefit from a new deduction.
It encourages franchises and spin-offs rather than direct hiring. While the bill includes some anti-gaming rules, these often can be successfully manipulated. As a result, firms will find ways to benefit from the tax cut merely by changing the way they organize themselves—choices that do nothing to increase employment or economic growth.
In effect, two firms with the same amount of gross receipts would be taxed differently for reasons that seem completely arbitrary. Of course, this happens all the time today. But why make it worse? The GOP rightly criticizes government for picking winners and losers. That’s exactly what this bill would do.
It is a temporary tax cut. Last year, the GOP ripped Democrats for temporarily extending the payroll tax cut. Temporary tax cuts, Republicans argued, do little to boost economic growth. So why did they propose this tax cut for only one year?
Probably for the same reasons Democrats do—so it would appear to increase the deficit by far less than it likely will. The Joint Committee on Taxation estimates the bill would add $46 billion in red ink over 10 years. But in reality, it would add nearly all of it in the first two years (it would take two because of the difference between the government’s fiscal year and the tax years of most companies).
I’m willing to bet this “temporary” tax cut would become just one more in the long list of tax extenders that never die. So the real 10-year cost would not be $46 billion, but hundreds of billions more.
If the tax cut really is temporary, many of the perverse effects I’m complaining about might not occur. For instance, most companies would not change their corporate form to take advantage of a one year tax break. Of course, a temporary tax cut would also be less likely to create any new jobs and instead would be pure windfall to eligible firms.
On top of all of this, TPC finds the measure would overwhelmingly benefit high-income households and do almost nothing for the middle-class.
As everyone knows, this bill will die in the Senate. Thus, it is said, House Republicans wanted to pass it to send a political message. Perhaps, but as public policy, this plan is awfully lame.
It has sometimes been said, even by me, that the easiest way for Congress and the White House to fix the deficit is to do… nothing. Allow the 2001/2003/2010 tax cuts to expire as scheduled in eight months, let the automatic spending cuts enacted in 2011 kick in as planned and, voila, the short-term fiscal problem is pretty much resolved.
There, however, one small problem: Such policy by paralysis would likely wreck a still-fragile economy. A new analysis by my Tax Policy Center colleague Dan Baneman finds that letting the Bush/Obama tax cuts (including the payroll tax cut) fall off the cliff would increase taxes on an average American household by $3,000 in 2013 alone. That’s a steep 5 percent cut in after-tax incomes.
Eighty-three percent would see their taxes rise, and among those making about $60,000 or more, just about everyone would face a tax hike. Those making between $50,000 and $75,000 would pay about $2,200 more, while those making more than $1 million would pay $175,000 more. The top 0.1 percent, whose income averages nearly $7 million, would pay a whopping $480,000 more.
On top of massive spending cuts, this year-end train wreck would result in a deeply austere budget. Taxes would increase by 2.5 percent of Gross Domestic Product in a single year, the Congressional Budget Office estimates. Nominal spending would fall for the first time since 1955. With interest rates already close to zero, the Federal Reserve could do little to offset this fiscal austerity.
The deficit would fall, all right. The Congressional Budget Office figures the deficit would decline from 7 percent of GDP this year to 3.7 percent in 2013 and to a very manageable 1.5 percent by 2015.
It would, that is, if the economy didn’t collapse.
There are, of course, two solutions to this looming crisis. The first, and most sensible, would be for Congress and the president to gradually reduce spending growth and slowly raise revenues through tax reform. The second, and most likely, would be for Congress to extend the current tax rules for yet another year and delay those automatic spending cuts.
What Congress is least likely to do, however, is raise taxes by an average of $3,000 next year. You can take that to the bank.
When the president first announced his Buffett Rule–that millionaires should pay at least 30 percent of their income in tax–in the State of the Union address in January, I had a strong sense of déjà vu. It is another alternative minimum tax, and its provenance is very similar. Congress created a minimum tax back in 1969 when people were up in arms about 155 high-income people who hadn’t paid tax a few years earlier. The logical response would have been to close the loopholes that let rich people avoid tax, but that would have been politically costly, so instead we got the thing that evolved into the AMT–one reason millions of upper middle-class Americans hate tax day.
The new AMT, called the Fair Share Tax, is anathema to tax reform (and I opined on that in Tuesday’s New York Times). It will be one more complication for people who are affected. For example, if you’re on the cusp of paying FST, you won’t know whether your capital gains will be taxes at 15 or 30 percent. And it will generate enormous marriage penalties.
And it’s unnecessary. If Congress is not willing to fix the underlying defects in the tax code, they don’t need a new AMT. One is really enough. If capital gains and dividends were fully taxed under the AMT, as they used to be before the Tax Reform Act of 1986, the Buffett Rule would be satisfied without a new levy. Moreover, I suspect that would raise enough more revenue that Congress could use the savings to finally index the thresholds for the AMT so that it doesn’t have to be patched every year.
Some people, however, see the Fair Share Tax as a good start on tax reform. The Times also had a nice article about two economic rock stars, Emanuel Saez and Thomas Picketty, who have been extremely effective at putting together data and analysis on rising economic inequality. The article is titled, “For Two Economists, the Buffett Rule Is Just a Start,” so the question is whether the Buffett Rule is a first step towards tax reform and a fairer, more progressive tax system, or a dead end.
The president has said that the Buffett Rule is not a specific proposal, but a principle for tax reform. The actual specific proposal, the Fair Share Tax, which the president supports, includes language saying that tax reform is the goal (thanks David desJardins for reminding me of this):
It is the sense of the Senate that–
(1) Congress should enact tax reform that repeals unfair and unnecessary tax loopholes and expenditures, simplifies the system for millions of taxpayers and businesses (including by eliminating the alternative minimum tax for middle-class Americans), and makes sure that the wealthiest taxpayers pay a fair share; and
(2) this Act is an interim step that can be done quickly and serve as a floor on taxes for the highest-income taxpayers, cut the deficit by billions of dollars a year, and help encourage more fundamental reform of the tax system
The question is whether the Fair Share Tax is a complement to tax reform, or a substitute. The president has been talking about individual income tax reform for several years. The president commissioned Paul Volcker to put together a tax reform plan. The Volcker Commission issued a report, but the plan went nowhere. The president said that his Bowles-Simpson commission, which would have simplified taxes (although not made them markedly more progressive), had a lot of good ideas, but none of those ideas actually made it into his budget. President Bush actually did commission a credible tax reform plan, but once completed, he acted like it was never his idea.
If the president and Congressional leaders really want tax reform, they should propose tax reform and throw their weight behind it. I understand this might not be a winning strategy in an election year, but we could lay the groundwork by putting together a serious proposal. President Reagan commissioned his Treasury to quietly put together a tax reform plan behind closed doors during the 1984 election year and then he pushed it to passage in 1986.
I don’t, however, think it’s in Democrats’ long-term interest to further undermine an already dysfunctional tax system. The Fair Share Tax might be good politics, but it’s bad policy.
Like many of you, I just finished my 2011 tax return. Counting worksheets, it was 59 pages long.
It occurs to me that our current insanely complex tax rules are made possible by technology. Yes, computer software makes filing easier (both for professionals and civilians). But that may be the problem.
Have you ever read, for example, Form 6251, the paperwork millions of middle-class households must complete just to figure out whether or not they owe the dreaded Alternative Minimum Tax? The IRS instructions for the form are 12 pages long.
Here, in part, are the instructions for Line 11:
Your ATNOL for a loss year is the excess of the deductions allowed for figuring the AMTI (excluding the ATNOLD) over the income included in the AMTI. Figure this excess with the modifications in section 172(d), taking into account your AMT adjustments and preferences (that is, the section 172(d) modifications must be separately figured for the ATNOL).
In truth, if voters actually had to navigate this gibberish, we’d have a revolution that would make the tea party look like the League of Women Voters. But we don’t. In 2009, 92 percent of us got help, either from a third-party preparer or tax software, the IRS estimates.
We spend $59.95 for software, mindlessly answer questions that often seem entirely disconnected from the specifics of the law, and assume the answer that comes out the other end is correct.
Or we just bundle up of our W2s and 1099s and send them to a professional preparer, who does even more opaque stuff and presents us with a return to sign. Sure, the record keeping is annoying, but we miss the real fun.
In this way, technology both inoculates us from much of the complexity of tax filing and reduces compliance costs. But, more importantly, it immunizes the politicians from the consequences of their decisions that lead to this madness.
Tax complexity isn’t just about the number of forms and their incomprehensible instructions (btw, no criticism intended towards the folks at the IRS who write them. They do the best they can, given the loony law Congress hands them).
The real price of complexity is the very opaqueness of the Tax Code itself. Because we don’t understand the law, we are convinced we are paying more than we owe and that everyone else is paying less.
Yet, tax software allows politicians to add ever more complexity, which we accept with little complaint. Think about the Buffett Rule endorsed by President Obama. The version debated in the Senate this week would create yet another minimum tax that would result in even more complex forms. But, of course, the households making $1 million or more who’d owe this tax would likely never see the forms. They’d just pay the accountant.
Often, critics of tax complexity say the pols themselves should have to fill out their own returns. I disagree. It would be much more effective if the rest of us had to do it. If we did, I predict tax simplification would be more popular than Dancing with the Stars.
So I’m starting a new movement: Ban tax software and professional preparers for just one year. And see what happens.
Happy tax day.
This afternoon, I moderated an interesting Tax Policy Center panel on taxing the rich. With the Senate about to debate a Buffett tax on millionaires, the timing couldn’t be better. Unfortunately for the White House, about the only thing the panelists agreed upon was that the Buffett tax is a terrible idea.
My fellow panelists were Doug Holtz-Eakin, president of the American Action Forum and former advisor to President Bush and the McCain for president campaign; David A. Levine, former chief economist at the Wall Street firm of Sanford C. Bernstein & Co. and a supporter of Responsible Wealth, a group of millionaires who believe high-income Americans can and should pay more taxes; Donald Marron, my boss at TPC and a former acting director of the Congressional Budget Office; and Diane Lim Rogers, chief economist at Concord Coalition.
The group agreed that some new tax revenues will be needed as part of a prudent fiscal plan and mostly agreed that broad-based tax reform should be a sensible part of such an initiative. But there were no fans of the Buffett rule.
After that, we disagreed about as much as everyone else in Washington (though far more respectfully).
The panel couldn’t even agree about what rich means. Is it $1 million-a-year in income? Is it $200,000, a definition proposed—in quite different contexts– by both President Obama and Mitt Romney? Is it those in the top 1% of income, who make more than $500,000 and an average of about $1.5 million? Take your choice.
Donald made the important point that all rich people are not alike. The problem–if you think it is a problem–of rich people paying less tax than their secretaries is largely limited to those with lots of tax preferences or wealthy investors who pay much of their tax at the low 15 percent rate on capital gains and dividends.
People who are paid salaries—even big ones (think professional athletes or doctors) tend to pay effective rates pretty close to the 30 percent minimum rate the White House wants.
Whoever the rich are, Doug thought the whole concept of special taxes aimed at one income group is silly. There is nothing wrong with a progressive tax system, he said. But when you consider who benefits most from spending, government as a whole is quite progressive already.
The other panelists disagreed, though by varying degrees. David took the most aggressive position: The low taxes paid by high-income households are nothing less than shameful, he argued.
How would they reform the tax code? Diane would reduce or restructure credits, deductions and exclusions. To help reduce the deficit she’d reluctantly raise rates on high income households as well. Doug called for replacing the current revenue system with a broad-based consumption tax—an idea many economists love but which turns out to be very hard to do.
David had a very different perspective. Bucking the conventional wisdom of nearly all economists, he called for significantly higher rates for top-bracket taxpayers while preserving most current tax subsidies. For instance, he’d keep the current generous tax treatment of owner-occupied housing and charitable giving.
About that Buffett tax: We pretty much agreed that imposing a minimum tax of any kind is an admission of policy failure. If the president thinks the rich don’t pay enough, he ought to restructure the tax code so they do, not stick on yet another Band-Aid.
See, people in Washington can cross ideological lines.
In a new study, Chuck Blahous, who is a public trustee for Medicare and Social Security, concludes that the 2010 health law will add at least $340 billion to the federal deficit from 2012-2021. This is contrary to the official estimates by the Congressional Budget Office, which initially figured the Affordable Care Act would reduce the deficit by about $132 billion from 2012-2019.
Who’s right? Who knows? In truth, unknowable and unpredictable changes in overall health costs will dwarf the variation between Chuck’s estimate and CBOs.
However, Chuck makes some important points in his analysis. One, which TaxVox has written about recently as well, is the potential double-counting of increased Medicare payroll taxes. The 2010 law raises the Medicare levy by 0.9 percent for high-income workers. But, due to CBO scoring conventions, the money it generates appears to both make the Medicare Hospital Insurance (HI) Trust Fund appear more solvent and reduce the general fund deficit.
It can’t simultaneously do both, as Chuck correctly notes. In reality, if the extra tax goes to the general fund to “pay for” health reform, Medicare would be required to reduce its hospital benefits, absent some other new funding source. Chuck argues Medicare would cut benefits. CBO assumes it would not.
Btw, Chuck and TaxVox are hardly the only ones to have raised this issue. Medicare actuary Rick Foster, who is well-known in Washington for calling ‘em as he sees ‘em, has been making exactly the same point since even before the law passed. My Tax Policy Center colleague Donald Marron, a former CBO director, blogged about it all back in 2009. And CBO itself has been upfront about the oddities of this scoring issue.
Some of Chuck’s other assumptions are more controversial. For instance, he projects more people will participate in subsidized health exchanges than CBO estimates, and that Congress will hike those subsidies more than CBO projects in future years. He also discounts anticipated revenues from the “Cadillac tax” on high-value health insurance plans by assuming Congress will roll back this levy before it is ever imposed.
He may be right, of course. But he is merely guessing. CBO at least has the anchor of the actual law to rely on. Chuck is basically expressing an opinion.
And keep in mind that while the spread between the two projections represents real money, it is margin-of-error stuff when it comes to the size of the federal budget and total health spending.
Is Chuck’s analysis valuable? It is, if only to highlight the uncertainty in these estimates (that CBO has already acknowledged) and to remind us all about the dangers of double-counting.
Predictably, the politicians are ranting about the sign: “The law will lower the deficit…No, it won’t. Yes, it will….” But, as usual, they are missing the real message.
The tax code is chock full of credits, deductions, deferrals, exclusions, exemptions, and preferential rates. Taken together, such tax preferences will total almost $1.3 trillion this year.
That’s a lot of money. But it doesn’t necessarily mean that $1.3 trillion is there for the picking in any upcoming deficit reduction or tax reform. In fact, even if Congress miraculously repealed all of these tax preferences, it would likely generate much less than $1.3 trillion in new resources.
Where did I come up with that number? For a short piece in Tax Notes, I simply added together all the specific tax expenditures identified by the Department of Treasury; these were reported in the Analytical Perspectives volume of the president’s recent budget.
Treasury doesn’t report this total for a good, technical reason: some provisions interact with one another to make their combined effect either larger or smaller than the sum of their individual effects. As a result, simple addition won’t give an exact answer. That’s an important issue. In the absence of a fully integrated figure, however, I think it’s useful to ballpark the overall magnitude using basic addition.
In your travels, you may find other estimates that do the same thing but come up with a figure of “only” $1.1 trillion. Why is mine higher? Because it includes some important information that Treasury reveals only in footnotes. Treasury’s main table estimates how tax expenditures reduce individual and corporate income tax receipts; those effects total $1.1 trillion. But they also have other effects. Refundable credits like the earned income tax credit increase outlays, for example, and some preferences, like those for employer-provided health insurance and alcohol fuels, lower payroll and excise taxes. I include those impacts in my $1.3 trillion figure.
Budget hawks and tax reformers have done a great job of highlighting tax expenditures in recent years. I fear, however, that we have lifted expectations too high. Just because the tax code includes $1.3 trillion in tax preferences doesn’t mean it will be easy to reduce the budget deficit or pay for lower tax rates by rolling them back. Politics is one reason. It’s easy to be against tax preferences when they are described as loopholes and special interest provisions. It’s another thing entirely when people realize that these include the mortgage interest deduction, the charitable deduction, and 401(k)s.
Basic fiscal math is another challenge. Tax expenditure estimates do not translate directly into potential revenues. Indeed, there are several reasons to believe that the potential revenue gains from rolling back tax preferences are less than the headline estimates. One reason is that the estimates are static—they measure the taxes people save today but do not account for the various ways that people might react if a preference were reduced or eliminated; those reactions may reduce potential revenues. Second, most reforms would phase out such preferences rather than eliminate them immediately. That too reduces potential revenues, at least over the next decade or so.
Finally, the value of tax preferences depends on other aspects of the tax code, most notably tax rates. If a tax reform would lower marginal tax rates, the value of deductions, exclusions, and exemptions would fall as well. Suppose you are in the 35 percent tax bracket. Today, each dollar you give to charity results in 35 cents of tax savings—a 35-cent tax expenditure. If the top rate were reduced to 28 percent, as some propose, your savings from charitable donations would be only 28 cents. The 20 percent reduction in tax rates would thus slice the value of your tax expenditure by 20 percent. That means that the revenue gain from eliminating the deduction—or any other similar tax expenditures—would also shrink by 20 percent, thus making it harder for tax expenditure reform to fill in the revenue gap left by reducing tax rates.
My message is thus a mixed one. Tax expenditures are very large—$1.3 trillion this year alone if you add up all the individual provisions – and deserve close scrutiny. But we need to temper our aspirations of just how much revenue we can generate by rolling them back. It isn’t as though there’s an easy $1.3 trillion sitting around. In coming months, the Tax Policy Center will explore how to translate tax expenditure figures into more reasonable estimates of the potential revenues that tax reformers and budget hawks can bargain over.
P.S. For an interesting analysis of how individual tax preferences interact with each other, see this piece by TPC’s Dan Baneman and Eric Toder.
Two Ohio Members of Congress have introduced a bill to allow states to issue tax-exempt bonds to demolish buildings. Not to build them, but to destroy them.
Score this one as a bad solution to a real problem.
The lawmakers, Republican Steve LaTourette and Democrat Marcia Fudge, want to allow state governments to issue up to $4 billion in revenue bonds to flatten abandoned buildings. Half would be divided among all states, the other half would be allocated only to states that Congress designates as hardest hit by the housing crisis (of which, I assume, Ohio will be one). Thanks to The Bond Buyer’s Jennifer DePaul for finding this one.
The problem is serious. Cities in Ohio and Michigan struggle with entire neighborhoods that have been nearly depopulated by the combination of foreclosures and disappearing jobs. Abandoned houses and commercial strips are magnets for crime and blight and may discourage future redevelopment. Tearing down often-gutted structures might sometimes make sense.
But why should the federal government subsidize what is the most local of activities? While teardowns may be the answer in some communities, why encourage the activity even when it is not appropriate?
Grassroots solutions are sprouting. In Flint, MI, the Genesee County Land Bank is acquiring foreclosed properties and returning them to productive use. In some neighborhoods of Detroit, cheap housing and low cost commercial space is beginning to attract trendy artists, designers, and high-tech types. Local markets will sort this out.
But with targeted demolition bonds, it would not be hard to imagine a developer getting a bigger subsidy for nuking a house than restoring it. And, of course, there is the matter of who will benefit: well-connected local construction firms, to say nothing of investment bankers and bond lawyers.
Trust me, it won’t often be the couple who want to do a tear-down or the three business partners who want to buy and repair a couple of houses at a time.
In the end, it may not be local taxpayers either. Investors in revenue bonds demand a steady stream of cash to repay the debt, such as a bridge toll. But it is hard to imagine an empty lot generating much revenue.
Supporters of the bill say the funds would come from non-profits, appropriated state and local dollars, or perhaps local land banks. This is not, shall we say, the kind of predictable revenue stream investors like. It will drive up interest costs. And guess who may end up holding the bag if the bonds crater.
State and local governments have been using tax-exempt bonds to pick winners and losers in the housing and commercial development markets since the 1970s. When the abuses became too egregious, Congress cracked down by limiting the purposes for which these revenue bonds can be used or capping the amount of this debt that can be sold.
Still, tax-exempt mortgage bonds for private housing have been so ubiquitous that I can’t help but wonder how many of those now-vacant homes were subsidized with tax-exempt dollars in the first place.
What a deal. First taxpayers pay to build them. Then we pay to flatten them. Then…. Well, you know what will come next.
I’ve finally finished my income tax returns for 2011. The last task—and least pleasant—is figuring my Virginia use tax. That’s the sales tax I owe on our many out-of-state web purchases. It’s a pain to plow through 12 months of receipts to identify untaxed transactions but I do it every year, stubbornly—some say foolishly—insisting on paying what I owe.
But in a couple of years, Amazon will ease my task when it starts collecting Virginia sales tax on things I buy. I can hardly wait.
All 45 states that impose sales taxes also have use taxes that apply to all taxable purchases on which buyers paid no sales tax. Relatively few taxpayers know about use taxes, much less pay them, and most states exert little effort to collect them.
Nearly half of taxing states include a section on their income tax returns where filers can pay use tax. In those states, less than 2 percent of taxpayers ante up, at least in part because paying requires figuring out how much you owe. Nine states simplify the process by providing look-up tables of acceptable amounts based on income. About 3 percent of filers in those states pay the tax, compared with about half a percent of those in other states that collect the levy on income tax returns (which includes Virginia). States with separate collection mechanisms undoubtedly see even less compliance. And most states don’t seem to try very hard to make consumers pay.
States have worried for years about losing revenues as retail sales have moved from in-state bricks-and-mortar stores to on-line firms that rarely collect state sales taxes. The Supreme Court ruled a few decades back that a state cannot force sellers to collect sales tax unless the seller has a commercial presence in the state. That ruling effectively exempts many e-tailers from having to collect sales tax.
But states have recently tried to force some big sellers like Amazon to charge state and local taxes with mixed success. Some, like New York, enact “Amazon laws” that assert that companies with in-state affiliates must collect sales tax, even if the companies themselves have no physical presence in the state. That worked for New York and a few other states: Amazon currently collects sales tax on purchasers who live in Kansas, Kentucky, New York, North Dakota, or Washington (where Amazon’s headquarters give it physical presence).
At least five states have cut deals with Amazon, deferring required tax collection in exchange for not legislating such a requirement. For example, Amazon will start collecting tax on sales to Virginians starting in September 2013. California, Indiana, South Carolina, and Texas will join that list over the next two years.
Congress could short circuit this piecemeal process and require e-tailers to collect state and local sales taxes, as Howard Gleckman noted last fall. The Streamlined Sales and Use Tax Agreement (SSUTA), onto which at least 24 states have signed, simplifies sales tax rules in order to make it easier for out-of-state sellers to collect sales taxes on sales to non-residents. The Main Street Fairness Act, introduced last year in Congress, would authorize states to implement SSUTA with restrictions. But congressional efforts have gone nowhere so far.
Since most of my untaxed on-line purchases are from Amazon, the company’s agreement with Virginia will cut my use tax calculations substantially—for my 2014 tax return. In the meantime, I can only hope that Congress will give states authority to require all e-tailers to collect the sales taxes we are all supposed to pay.