In the realm of needless complexity, the work and family tax credits for low-income households rank near the top. The problem is especially challenging for immigrant families whose children’s legal status and residency determine eligibility for these credits.
A few weeks ago, the National Taxpayer Advocate in her Annual Report to Congress joined many others in calling for separating the work and family incentives in the tax code. This approach could make tax filing simpler and more efficient for low-income families.
Currently, the three largest child related provisions – the dependent exemption, the Child Tax Credit (CTC), and the Earned Income Tax Credit (EITC) – have three sets of rules governing eligibility. These inconsistencies in the law create confusion and prevent people from claiming deductions or credits for which they are eligible. Here are a few examples of how the rules differ: ( Continue… )
Can the income tax fund the government we seem to want? Probably not.
Will lawmakers create a revenue system that will? Not anytime soon.
That was the consensus of four tax policy experts at an Urban Institute panel I moderated Tuesday afternoon. The panelists–historian Joe Thorndike, Urban Institute economist and tax reform veteran Gene Steuerle, Tax Policy Center co-director Eric Toder, and IRS taxpayer advocate Nina Olson– agreed that the current Swiss cheese of a revenue code is not up to the task, at least not in the long-term.
And they agreed that someday, the federal government will turn to some form of a consumption tax to help make up the difference. It may be a broad-based levy such as a Value-Added Tax or an energy tax. It might replace the current income tax, or might be added on to the existing system. But given political gridlock, any form of major reform is years away.
As they were speaking, the Congressional Budget Office released its own fiscal update for the next decade. And, by CBO’s estimates, the panelists are self-evidently correct. While a growing economy will bring the annual deficit down to about 2.4 percent of Gross Domestic Product by 2015 (assuming, among other things, that discretionary spending remains capped in the way Congress and President Obama have agreed), the red ink will begin flowing faster again. By 2023, the deficit will be back to 3.8 percent of GDP and rising. ( Continue… )
With state finances gradually improving, some Republican governors are turning their attention to fundamental tax reform. Louisiana Governor Bobby Jindal has proposed replacing his state’s personal and corporate income taxes with higher sales taxes. Nebraska’s Dave Heineman and North Carolina’s Pat McCrory would do something similar, broadening the sales tax base and perhaps including some previously tax-exempt services.
With Washington apparently stuck in gear on taxes among other issues, it may be tempting to see the states as leading a way to reform. Unfortunately, some of the proposals currently circulating – and the idea of states as laboratories for a fundamental federal tax reform —are fundamentally flawed.
First, as my Tax Policy Center colleague Ben Harris has noted, income-sales tax swaps would be regressive – or hit low income household the hardest. This is because low income households must dedicate a greater share of their income to consumption to achieve a basic standard of living and more of their consumption tends to go toward goods (which are taxed) versus services (which are typically not). These households also often benefit from income tax rebates which presumably would be wiped out along with the tax.
Another key issue is whether states would go after currently untaxed services. Most states have already picked off easy targets like tuxedo rentals and tattoo parlors. As pointed out by the Tax Foundation’s Joe Henchman, it’s a much heavier lift politically to tax professional services of lawyers, accountants, and real estate agents. Just ask lawmakers in Maryland, Michigan, and Florida who enacted new sales taxes on some services but were forced to repeal the levies in the face of industry backlash. ( Continue… )
For years, the battle over carried interest has focused on how to tax the compensation of private equity managers. But a careful reading of the law suggests that all the business profits of these investment firms, not just the pay of their managers, are ordinary income, and should be taxed that way.
Until now, the analysis of this issue has simply accepted the funds’ profits as capital gains. But when researching a newly-published article, “Taxing Private Equity Funds as Corporate Developers,” I discovered that Congress intended capital gains to be defined narrowly so that ordinary profits—those that arise from the everyday operation of a business—would be taxed at regular rates.
Private equity funds earn sizable profits, largely from acquiring companies, improving them, and reselling them (and they now manage much greater amounts of money: $2.5 trillion in 2010, up from $100 billion in 1994). The funds report these profits as capital gains, and allocate a large share to their managers as reward for their services (which is how Mitt Romney achieved 14% effective tax rates). But what if these profits are not capital gains at all? And what if our tax rules have been incorrectly subsidizing the growth of these funds for the last two decades?
Our tax laws generally treat the profits of taxpayers that develop and sell property in the course of a trade or business as ordinary income. For example, real estate developers often take many years to buy, develop and resell property, and they report their profits as ordinary income. So, why should private equity funds that buy, develop and resell companies (or their stock) treat their profits as capital gains? ( Continue… )
In one of the more dangerous fiscal developments of recent months, some on the left are defining successful deficit reduction as merely stabilizing the federal debt at about 70 percent of Gross Domestic Product by 2022. While there is no magic target, this one is far too modest and threatens to leave future fiscal policy perilously constrained.
Under current assumptions this goal can be achieved with combined reductions in spending growth and/or increases in taxes of $1.4 trillion over the 2014-2022 period, far less than the total deficit reduction provided by the 2011 Budget Control Act (BCA), which resolved the 2011 debt ceiling debate, and the American Taxpayer Relief Act of 2013 (ATRA), which recently avoided the fiscal cliff.
Richard Kogan of the Center on Budget and Policy Priorities, supported by Martin Wolf of the Financial Times makes the case for more modest deficit reduction. The editorial page of the Washington Post shares my concern that their goals are dangerously modest.
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Imagine facing the next recession with a debt-GDP ratio already above 70 percent. It is almost certain that we shall have another slump before 2022. If not, it will be the longest period without a decline in the recorded history of U. S. business cycles. Add a modest stimulus to the recession-driven reduction in tax revenues and increases in social spending and the debt-GDP ratio would top 100 percent in the blink of an eye. But it is harder to argue for a stimulus with the debt already soaring, and without one, a future recession would be more severe than necessary. ( Continue… )
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.
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… )