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The Future of Children in an age of inequality

The Future of Children, a Princeton-Brookings publication that "translate[s] high-level research into information that is useful to policymakers, practitioners, and the media", published an entire issue in the fall of 2006 on "Opportunity in America."  Isabel Sawhill and Sara McLanahan's "Introducing the Issue", 16 Future of Children 3 (Fall 2006), provides an important overview of the concerns facing women, children, and minorities in a United States that is more and more divided along class lines in a culture that transmits poverty across generations.

We pride ourselves in being "a place where with hard work most people can succeed, whatever their family background," a place that "is often presumed to be a less class-based society" than the older European democracies, where "the dominant ideology ... has been a deep-seated belief in equality of opportunity" in spite of the aberrations of slavery and racial and gender discrimination.  Id at 3.

This pride, and belief in individuals' ability to pull themselves up by their bootstraps, has made Americans less willing to redistribute income and more willing, apparently, to live with large income disparities between the top and bottom of the income distribution.  This journal issue asks whether those beliefs comport with reality--is America really a classless society, and if not, what should be done to help the country meet its ideals.  The authors note that the articles "examine opportunity in the United States today, how opportunity has changed over time, and how it varies by race, gender and national origin.  They also explore how education, health and culture affect social mobility for children born in different circumstances and what government might do in each of these domains to make opportunity in the United States more equal."  Id. at 3.

Here's an example of the kinds of specific topics addressed in the papers-- a study of the "poverty-prevention paradox" by Jens Ludwig and Susan Mayer.

"Ensuring that all children are healthy and well educated is a goal that most people would support, although they might disagree agbout how much the public should invest and how best to use the money.  Much more controversial are programs that aim to change family behaviors.  Nonetheless, much of today's political rhetoric and many of today's policy initiatives are aimed at encouraging parents to marry, work, and participate in faith-based programs.  ....Ludwig and Mayer argue that the effect is unlikely to be large, for two reasons.  First, the evidence for a causal link between these parental behaviors and children's chances of growing up poor is relatively weak.... Second, most children who become poor as adults do not grow up in a single-parent family, a family with no full-time worker, or a family that does not attend religious services.  Therefore, even if the effects of family behavior on intergenerational poverty were causal, getting all parents to marry, work, and attend church would have only a minor effect on the poverty rate in the next generation."  Id. at 12-13.

These questions about opportunity and appropriate government policy are particularly important now, the authors assert, because "income and wealth are more unequally distributed in the United States than at any time in the past half century."  One statistic, among the many that can be gathered in support of this statement, is the Congressional Budget Office (CBO) data showing that the average after-tax income of the top 1% rose by 129% in the period from 1979 to 2003, while that of the bottom 20% rose a measly 4% during the same period.  Similarly, although economic "growth can go a long way toward neutralizing any negative effect of low mobility," "family income growth has slowed in recent decades. From 1953 to 1973, median family income rose swiftly, an at annual rate of 2.8 percent. Since 1973, however, median family income has grown an anemic 0.6 percent a year."

Once we acknowledge that income and wealth disparity are limiting opportunities for many, the question is what can be done.  Children of higher-income parents may have some advantages becuase their parents had good genes or because their parents simply worked very hard to give them advantages.   How can children born without that edge be helped to succeed?  The authors note that "public policies can ... do quite a lot to compensate children for what their parents cannot provide [and].... government should be doing more."

It's worth quoting a few paragraphs from the conclusion to the article which bring home the connection between tax policies and the kinds of opportunities our society will provide.

"Growing income inequality in the United States would be less troublesome if all U.S. residents had the same chance to get ahead.  But the fact is that family background matters.  Americans need to pick their parents well.  Moreover, the United States does not have a higher degree of mobility than other industrialized countries.  Increases in income inequality and wealth inequality in recent decades are likely to persist from one generation to the next.  Some observers believe the appropriate policy response is to adopt more progressive income or benefit programs.  Others argue for redressing the balance by improving opportunities for all citizens to get ahead.  This volume focuses on the latter...  [b]ut we believe that both approaches are needed."

"The persistence of wealth across generations is high, and children who grow up in affluent families are greatly helped by the advantages associated with wealth.  The current estate tax curbs at least some of this persistence and enables each generation to start on a slightly more even playing field than would otherwise be the case.  ...The current (2006) exemption of $2 million per person (or $4 million per couple) provides more than adequate motivation for parents to save and a rich legacy for their children."

"As important as the estate tax is, it is small relative to the effects of education on opportunity.  Education, after all, is considered the great leveler, the most important opportunity-enhancing vehicle available to any society.  But the three relevant articles in this volume all conclude that education in the United States tends to reinforce rather than reduce divisions based on class.  This conclusion is supported by three facts.  First, the U.S. education system is not as strong as that in some other countries.  Thus it does less to ameliorate the effects of family background than it might.  Second, much education at the preschool and postsecondary levels is still privately financed, effectively making it unavailable to children from less wealthy families.  Third, poor children tend to go to poor schools.  In short, providing more equality of opportunity requires that schooling at all levels be of higher quality and that children from less advantaged backgrounds have the same educational opportunities as those whose parents can afford to enroll them in nursery school at an early age, live in a high-priced neighborhood with good schools, and send their children to college."

So what should we be doing?  If we heed the research presented in this volume, we should spend a lot less time (and no tax subsidies) on trying to push all Americans into a one-size-fits-all mold of traditional, church-going family.  We should instead spend a good bit of effort trying to ensure that our tax system is sufficiently progressive to tilt the balance, at least at the margins, in favor of redistribution towards equality rather than away from it.  That means, among other things, retaining the estate tax with a sufficiently high rate and a sufficiently low exemption level that it can realistically serve to level the playing field against the enormous estates that wealth permits wealth to accumulate.  Instead of creating more socially wasteful tax subsidies for businesses like restaurants and banks (including a new set of S-corporation expansions just to make it easier for banks to operate in S-Corporation form and pay no corporate taxes), as the business lobby has pushed the Senate for in connection with the necessary passage of a long-delayed increase in the minimum wage, we should create tax subsidies that create opportunities--such as larger education subsidies for postsecondary education for lower-income taxpayers, but phased out rapidly above a reasonable ceiling.

When Congress gets this message, we will be on the way to a better society.  It is important to communicate to them about the need to pay attention to the problems of inequality and the promise of opportunity.  Maybe they'll finally stop throwing tax subsidies to the owners of most of America's assets and start thinking about using the taxing and spending powers to create opportunities for the workers who produce those assets.

Revised Feb. 2, 2007

International tax and Structural Coherence

Reuven S. Avi-Yonah's recent article, Tax Competition, Tax Arbitrage, and the International Tax Regime, is an interesting explanation of his theory of a coherent international tax regime.   Just as I have argued that the Code provisions and the various administrative and judicial authorities interpreting them cohere in a system of rules that are required to be interpreted (and followed) with a view to their structural coherence based on fundamental principles (including, e.g., conservation of basis,  the anti-manipulation value that underlies disallowance of artificial losses, etc.), Avi-Yonah argues that the treaties and domestic tax laws of the major nations involved in global commerce create a coherent international tax regime founded on important underlying norms that amounts to customary international law and is binding even in the absence of treaties.  Those two norms are the "single tax principle" (income should be tax once but not more than once) and the benefits principle" (active business income should be taxed primarily at source, and passive investment income should be taxed primarily at residence).  He notes that the tax competition and tax arbitrage of recent years that violate those norms provide evidence that the norms exist, because of the concerted efforts by the OECD, WTO, EU and various tax administrations (including, sporadically, in the US) to combat those challenges.

The reaction to his assertion of an international regime has been much the same as the reaction to assertions of structural coherence in our domestic tax system--strong skepticism, fed by the apparent variety of rules and mechanisms by which different items are taxed in our domestic system or different categories of income are treated as part of the base in various systems around the world. 

The tax laws of countries vary and the treaties for international taxation vary as well.  Yet the pattern of convernge is pronounced, especially in the area of international taxation where differing domestic regimes must interact and where the network of 2000 treaties based on the UN and OECD models have led to considerable similarity.  Now that "every developed country ...tends to tax currently passive income earned by its residents overseas (thorugh controlled foreign corporations and foreign investment funds... and to exempt or defer active business income, ...the distinction between countries that assert worldwide taxing jurisdiction and those that only tax territorially has lost much of its force."  Id. at 5.  Similar rules exist for non-discrimination, arm's length transfer pricing, and foreign tax credits versusd deductions.  As a result, "the freedom of most countries to adopt international tax rules is severely constrained, even before entering into any tax treaties, by the need to adapt to generally accepted principles of international taxation.  Even if divergent rules have been adopted, the process of integration into the world economy forces change."  at 7.  Avi-Yonah asserts that this international tax regime "rises to the level of customary international law."

Perhaps the most interesting portion of the article is Avi-Yonah's discussion of the normative basis for the two international norms (single tax principle and benefits principle). Underlying the single tax principle is the accepted international norm of both personal and corporate income taxes.  As a result, to maintain equity--especially on domestic labor income--it is important to avoid both double taxation and zero taxation of cross-border income.  Double taxation would lead to too-high tax rates and stifle international investment, while zero-taxation would create opportunities for avoiding domestic taxation by investing abroad and eroding the national tax base (and harming less mobile wage earners).  "In a world in which international trade and investment are important, but taxes (unlike tariffs) cannot be reduced to zero, the Single Tax Principle is the best option."  at 20

Similarly, Avi-Yonah founds the active-source/passive-residence "benefits" principle on the notion that individuals primarily earn investment income and corporations primarily earn busienss income.  Residence-based taxation makes the most sense for individuals--it is easy to define, residence overlaps political allegiance, and distributive principles can be most easily addressed by country of residence.  Source-based taxation makes the most sense for corporations--residence is meaningless or formalistic, multinationals have no allegiance to a particular society, and multinationals exert significant political influence in various jurisdictions so taxing "foreign" multinationals is appropriate.  And source-based taxation is consistent with the benefits theory of tax justification.  It also would be hard to prevent source taxation of businesses.

The paper deals with three threats to the international regime--zero taxation of passive income due to tax haven activity; tax competition for active investment; and tax arbitrage.  Regarding the first, Avi-Yonah notes that the US enactment of the portfolio interest exemption led to a trend not to tax passive income (interest, rents, royalties, capital gains and even dividends) at source.  That, combined with the existence of tax havens made it hard for residence countries to tax passive income as well, leading to zero taxation in violation of the Single Tax Principle.  Recent steps to encourage better information reporting may be making a difference, but Avi-Yonah proposes instead a coordinated withholding tax that is refundable upon a showing that the income has been declared in the residence country. 

As to tax competition, Avi-Yonah is more optimistic than Julie Roin, Robert Peroni and Craig Boise at the January meeting of the AALS. (There, the concern was whether an income tax could survive globalization, but the problems caused by tax havens and tax arbitrage were a looming part of the problem.) The OECD countries have been reducing the threshold for finding a permanent establishment, making it hard for multinationals to avoid being subject to tax.  And the OECD is putting pressure on members and non-members to abolish tax havents and abandon tax sparing rules that foster double-non-taxation.  Avi-Yonah suggests that the "trend will continue until effective residence-based taxation by OECD members stops developing countries from engaging in harmful tax competition."

Finally, as for tax arbitrage, Avi-Yonah considers anti-conduit developments since 1984--when the US terminated its treaty with the Netherlands-Antilles because it did not tax on a residence basis--to show a consensus that rejects it.  Other US developments--the dual consolidated loss rule, the reverse hybrid rule in section 894(c), and recent regulations on tax arbitrage transactions involving foreign tax credits--show a growing desire to stifle arbitrage as inappropriate.

Senate Budget Committee Hearings

The Senate Budget Committee hearings were held today --one of  a series of hearings on budget outlooks and related issues--on the so-called "tax gap".  That's the difference between the tax revenues collected and the amount that should be collected with full compliance.  One of the speakers was Robert McIntyre from Citizens for Tax justice, whose testimony is available at this link.

McIntyre set the stage with three key facts about the budget outlook:

1. for the last five years (FY 2002 through FY 2006), 25% of non Social Security outlays have been financed with borrowed money (counting money borrowed from Social Security for spending on other programs)
2. along with this increase in borrowing, there has been a "remarkable" decline in personal income tax revenues--from more than 10% of GDP in FY 2000 to only 7.3% of GDP in FY 2002--
3. while much of the decline is due to the huge revenue reduction bills passed over the last five years, some significant part of the shortfall in tax revenues is due to tax cheating--as much as 300 billion annually and probably even more--"led by the accounting firms, banks and lawyers that now make billions of dollars a year facilitating tax evasion and avoidance."

So what's the government to do (if it won't take the responsible action and raise taxes to satisfy legitimate government needs)?  IRS Commissioner Everson thinks there's an easy $50-100 billion a year that could be collected from tax cheats if the IRS only had the resources.  Avi-Yonah and Guttentag suggest another $50 billion of the tax gap related to evasion in the international area could be "eliminatated overnight" with certain policy changes.

Citizens for Tax Justice thinks there are already some good ideas floating around, including ones suggested at hearings held by Carl Levin and Norm Coleman last year.  Here's some of the easy ones.

1. presumption of US control for offshore trusts and shell corporations
2. disclosure by publicly traded companies and company insiders of any offshore holdings of their stock by company directors, officers or large shareholders
3. "independent" offshore entities related to a company director, officer or large shareholder treated as an affiliate
4. sanctions on uncooperative offshore tax havens
5. repeal deferal/exemption of taxes on profits earned by US-owned foreign corporations (and end the tax incentive to move US jobs to low-tax foreign countries)
6. replace transfer pricing system with formula allocation
7. require information reporting on capital gains
8. clarify economic substance--but, as McIntyre says, with a strong enough rule that disallows any scheme for which tax avoidance is the primary purpose of the transaction
9. clarify that S corporation owners cannot avoid self-pemployment taxes on their earnings
10. increase penalties for facilitators of tax evasion
11. increase IRS funding--the budget has been slashed by "more than a fifth" since 1994, and enforcement staff have declined by 36 percent and audit rates have declined while the number of returns have jumped

Why is more enforcement staff needed at the IRS?  It's worth quoting a full paragraph from McIntyre's testimony on that issue.

[T]he New York Times reported on January 17, 2007 that a survey of 50 IRS corporate auditors found that every one felt that "large companies were being allowed to pay far less than they owed" in taxes due to insufficient IRS resources to fully pursue cases.  "It's catch and release," one auditor told the Times, about how little tax-cheating corporations were forced to pay when their illegal activities are detected.  "They are giving away the store," another auditor complained.

This is important, and Congress should listen.  It's time to turn the tide that has permitted aggressive reporting positions by increasing enforcement staff and significantly increasing real audits.  Congress can even do just three of the items suggested by McIntyre--fund IRS enforcement activities, eliminate the "deferral" provisions in the international tax area, and require reporting of capital gains--and make a substantial dent in the tax gap.  So let's see if this "new" majority Democratic Congress has the spine to take these needed steps, or will they cave to the highly influential, well-monied business lobby yet again.....

(Thanks to my colleague Mike McIntyre for bringing the hearings to my attention.)

Lokken's Assessment of Justification for Reforming international Taxation to a Territorial System

Lawrence Lokken has a new article, Territorial Taxation: Why Some U.S. Multinationals May Be Less Than Enthusiastic About the Idea (and Some Ideas They Really Dislike) in 59 SMU L. Rev 751 (2006).   He notes that various commentators have proposed a territorial tax system to replace the current system where multinationals incorporated in the United States are taxed on their worldwide income with a tax credit for foreign taxes, limited by the amount of foreign source income.  Among those proposing a territorial system is the President's Advisory Panel on Federal Tax Reform.  It's reasons are primarily two-fold: first, deferral of foreign earnings for active businesses outside the US results in economic distortions as US multinationals are essentially encouraged to invest outside the US to gain the tax benefit; and second, the current system may allow US multinationals to achieve better tax results than they could under a territorial system. often allows U.S. multinational enterprises to achieve U.S. tax results more favorable than they could obtain under a territorial system.

Lokken's paper doesn't deal with the first rationale for territoriality, though he notes that many have responded that the distortions caused by a deferral regime are best fixed by ending deferral rather than by creating a tax system that just exempts the income. 

The paper deals with the second argument--that territoriality might be better because it wouldn't allow some of the favorable tax schemes permitted under our current system.  The paper goes shows how the current system could be reformed to prevent the problems, without the need to scrap the current system in favor of a territorial system. Lokken also points out that similar problems would exist in the territorial system without similar corrections.

Perhaps the most important point that Lokken makes is stated up front in the abstract.

"The Panel and the Joint Committee staff fell into a common error in tax policy discussions: comparing current law, in its highly-corrupted state, with an idealized alternative and reaching the obvious conclusion that the latter is preferable. In fairness, the proposed system must be compared with the best feasible version of a worldwide/credit system."

Congress should not be mislead by these unbalanced comparisons.  The problems with the current system should be fixed, and ending deferral is probably the best step to take.  But comparing the current system, with all its defects, to an "ideal" replacement system is not a sound way to think about reform.  You'd think the Panel and Joint Committee Staff would not have made this basic error, unless there was a hidden agenda in favor of a territorial tax system.

FIN 48: not to be delayed

In spite of a slew of letters lobbying for a delay (mostly short form letters following a template proposed by the Tax Executives Institute), the financial accounting standards board (FASB) voted on January 17th not to defer implementation of the new guidelines for reporting tax uncertainty set forth in FIN 48.   The new guidance will be effective for fiscal years beginning after December 15, 2006, and is expected to result in an increase in financial reports of tax-related liabilities.  According to the BNA Corporate Accountability Report at 64 (vol. 5, No.3, Jan 19, 2007), FASB chair Robert Herz noted the importance of beginning implementation because  "Taxes are a very important part of reported earnings,...  an important part of the balance sheet, and there was a lot of concern that this was, for a large area, one that has been extremely opaque and a little mystical."

FASB did agree to try to provide some clarification.  Tax positions reported are to be measured by the benefit that is more likely than not to be realized on "ultimate settlement," a term for which tax executives have sought explanation.

The first year of implementation of the new guidance will be especially interesting for the IRS, as it receives some clues to aggressive tax positions undertaken by corporations but not easily tracked in the financial statements and perhaps not reported previously to the IRS.  Robert Willens, a prominent tax commentator, has noted that  "There is a lot of fear the IRS will use this disclosure to tailor and fine-tune their audits," said Willens. See this article about the upcoming FASB meeting  by Helen Shaw, FASB Weighs One-Year Delay (CFO.com). 

The podcast of the FASB meeting is available at this link.

AMT: repeal or reform: January 19, 2007 Tax Policy Center Report

As Congress finally tries to cope with the AMT with other than short-term fixes and in the context of the existing Bush revenue reductions (sunsetting after 2010), it is necessary to consider what kind of reform should be undertaken.  Either the cost of reform will be allowed to add further to the deficit, the borrowing, and the future tax increase to pay it back, or Congress must make some tough choices now about the proper relationship between the AMT and the regular tax and the taxpayers who should be protected from the tax increases necessary to make changes to the AMT.  The Tax Policy Center has just released a new report that provides a model-based estimate of the various options available to Congress, both for reform and repeal, and the existing ways to finance that reform with reasonable fiscal discipline.  See Len Burman, William Gale, Greg Leiserson and Jeff Rohaly, Options to Fix the AMT (Jan 19, 2007).

Whether the decision is ultimately reform (probably a more pragmatic course) or repeal, Congress will likely need to revisit the excessive tax break given to capital gains and dividends in the course of the Bush revenue reduction bills.  The report makes this point quite clearly in a separately "box", quoted in full, below.

Box 3. Scaling Back Capital Gains and Dividends Tax Preferences as Anti-Tax Shelter Measure

Currently, long-term capital gains and most dividends are taxed at rates of 15 percent or less under the regular income and under the AMT. The rationale for the lower rates is that corporate stock is already taxed under the corporate income tax and thus a second level of tax under the individual income tax constitutes “double taxation.” This creates significant complexity under both the regular income tax and the AMT as taxpayers must effectively calculate tax on these two preferred forms of income under an alternative tax rate schedule. Moreover, the lower tax rates create opportunities for tax sheltering. The lower capital gains tax rates do not require that the appreciated asset actually be a corporation subject to the entity-level tax and … dividends [qualify for the] tax break even if the company paying dividends never paid any corporate income tax.

Thus, some tax experts fear that non-taxpaying corporations could be used as a way to channel income tax-free through to owners in the form of lightly-taxed dividends and/or capital gains. Other business entities (such as sole proprietorships or partnerships) have also been used in the past as a way to convert ordinary income into capital gains. If the purpose of the AMT is to restrain tax shelters, capital gains and dividends should be taxed like other income. Indeed, before the Tax Reform Act of 1986 temporarily eliminated a capital gains preference under the regular income tax, capital gains were the single largest preference item under the AMT. If the AMT is eliminated, making the capital gains tax rate as close to the ordinary income tax rate as possible would reduce the ability to create tax shelters.

If the purpose of the AMT is to restrain tax shelters, capital gains and dividends should be taxed like other income. Indeed, before the Tax Reform Act of 1986 temporarily eliminated a capital gains preference under the regular income tax, capital gains were the single largest preference item under the AMT. mIf the AMT is eliminated, making the capital gains tax rate as close to the ordinary mincome tax rate as possible would reduce the ability to create tax shelters.

The following provides a brief summary of some of the options for repeal and reform, and the suggested ways to finance such options the authors have tested using the Tax Policy Center's microsimulation model.  The report provides extensive information on the budgetary impact of the options (including some very useful graphs showing distributive impact).

Repeal Options

The options for repeal are broadranging.  The selection below begins with the worst possible result (repeal, with increases in regular tax rates across the board, resulting in a less progressive tax system overall), which it is hoped the Congress will reject.  Other possibilities follow.

Option 1 Repeal the AMT and increase rates across the board by 6% (not percentage points):

"The 10-percent bracket would become 10.6 percent and the 35-percent bracket would become 37.0 percent. In 2011, when the Bush tax cuts expire, the rates would range from 15.9 percent to 41.9 percent.  This would make the tax system less progressive overall…. In general, it would raise taxes on those least likely to owe AMT under current law—those in the bottom 90 percent of the income distribution—and cut taxes substantially on those with incomes between $100,000 and $500,000—roughly the 90th to the 99th percentiles."

Option 2 Repeal the AMT and increase top three rates 15%

"This option would …raise the top rate from 35 percent to 40.4 percent in 2007 and from 39.6 percent to 45.7 percent after 2010 when the Bush tax cuts expire. … As in option 1, this option cuts taxes in the first five years and increases them in the second five after the Bush tax cuts expire. Most of the net tax increases are within the top 5 percent. The top 1 percent face the largest tax increases—averaging over 3 percent of income after 2010. They are most affected by the rate increases and benefit relatively less from repeal of the AMT since many taxpayers in this group do not owe AMT."

Option 3 Repeal the AMT and increase top three rates 24% but no changes after 2011

"The option would have very small effects on the distribution of tax burdens by income quintile—less than 1 percent of after-tax income in any year. But it would raise taxes significantly on high-income taxpayers, especially those in the top 1 percent. The tax increases for that group amount to almost 4 percent of income before 2011 and average about 2 percent after 2010."

Option 4 Repeal the AMT, repeal the state and local tax deduction, and decrease tax rates

"[V]ery few individuals in the bottom sixty percent of the income distribution will benefit from the [state and local tax] deduction since most of those tax units do not itemize deductions. In addition, since the deduction is not allowed for AMT purposes, the primary beneficiaries are those at the very top of the income scale who escape the AMT. ] More than 70 percent of those in the top one percent benefit from the deduction, with an average tax savings of almost $11,965 or 1.3 percent of income. This option raises more than enough money to pay for repeal of the AMT (although it would not if the Bush tax cuts were extended). As a result, under this option, income tax rates can be reduced by 2 percent across the board."

Option 7 Repeal of the AMT, roll-back of the Bush capital gains and dividends rate cuts, increases in top income tax rates until 2011, and then no further increases after the sunset of the Bush tax cuts (or, Option 8, to prevent large revenue losses, increase the top rates by 13%)

"The benefits [of the capital gains and dividends rate cuts] are heavily concentrated at the top of the income scale. More than a quarter of the tax units in the top quintile receive a tax savings; the average savings for this group is $2,798 or 1.9 percent of income. Close to 60 percent of the top one percent of income earners benefit from the preferential rates; the average tax savings among this group is more than $48,000, representing 5.4 percent of income."

Reform Options

The report notes that reforming the AMT to retarget it more at the higher income taxpayers who are likely to be engaged in tax sheltering activity provides additional options.  "To the extent that the AMT deters tax shelters, it could continue to serve that purpose. And some changes, such as taxing capital gains and dividends the same as other income under the AMT (see box 3), could make it more effective as an anti-tax shelter tool. In addition, preserving the AMT lowers somewhat the revenue hurdle needed to finance reform."

Set out below are just a few of the options that the report explores through modeling to ensure as revenue neutral as possible.  As with reform, the options generally assume that the Bush revenue reductions will end when they sunset at the end of 2010.  If the Congress were to extend the Bush revenue reductions, the cost of AMT reform or repeal would be significantly greater.

Option 9 Extend and Index 2006 Law, and increase top regular tax rates by about 12% to finance (or, Option 10, increase AMT rates by 20%) (or, Option 11, disallow capital gains preference and increase regular tax rates by about 2%):

Option 14 Extend and Index 2006 Law, add Family Relief (allow personal and dependent exemptions under the AMT), and increase top regular tax rates 12% (or, Option 15, increase AMT rates by 22%)

Option 18 Extend and Index 2006 Law, add Family Relief and Broader Reforms (state and local taxes, medical and miscellaneous itemized deductions or standard deduction) and increase top regular tax rates 14% (or, Option 19, increase AMT rates by 38%--from 26% and 28% to 36% and 38.7%)

Option 22  Extend and Index 2006 Law, add Family Relief and Broader Reforms and convert to a flat tax (by disallowing capital gains and dividend preference in AMT, and increasing top regular tax rates by 8%)

Small Business and Work Opportunity Act of 2007

Regretably, the Senate Finance Committee seems to think that there is some reason for passing even further revenue reduction bills this year, in order to get recalcitrant Republicans to finally raise the minimum wage after years of stagnation.  The Small Business and Work Opportunity Act of 2007,  summary and revenue effects of which are available at the Joint Committee on Taxation and report and text at the Senate Finance Committee, would provide a potpourri of further tax breaks for small business taxpayers, including (to name a few of the more egregious provisions):

• further super-accelerated cost recovery provisions
• expanding availability of the cash method of accounting for businesses to those that have $10 million rather than $5 million average annual gross receipts
• permitting banks to transition from the reserve method (and then elect S corp status) without the double-rate of tax expected for such transitions, and
• changes in S Corporation requirements and rules that eliminate taxes in various ways (including letting nonresident aliens own small business trusts that hold S corporation stock and eliminating the treatment of capital gains as passive investment income).

There is little justification for any of these provisions.   Continued acceleration of expensing--already much faster than economic depreciation and operating as a pure tax subsidy for these taxpayers--cannot be justified especially in an era of runaway deficits that are being made up for, in part, by the surplus from taxes borne only by lower and middle-income wageearners.   Congress should be eliminating business use of the cash method of accounting, not expanding it to an even broader category of businesses!

Here's what Citizens for Tax Justice had to say on in its January 5 report about the proposal to link tax breaks for small businesses to a minimum wage increase.

"Polls indicate that at least 80 percent of Americans — including majorities of Democrats, Republicans and Independents — want to see the minimum wage increased. One poll even shows that three out of four small business owners think a minimum wage increase will have no effect on them. Yet President Bush and his Republican allies in Congress have come to the strange conclusion that in order to pass both chambers of Congress, any bill increasing the minimum wage must include new tax breaks for business in order to compensate companies for the alleged damage it will cause them. As Jared Bernstein and Lawrence Mishel explain in the American Prospect, the idea that business needs to be compensated because Congress is raising the minimum wage from its lowest inflation-adjusted level in 50 years is nonsensical."

The offset provisions, on the other hand, are generally reasonable ones that should be passed--such as denying a deduction for punitive damages, and other fines and penalties, granting Treasury authority to address foreign tax credit transactions that allow taxpayers to strip the credit from the related income, and making somewhat stricter the corporate inversion provision (though still not enacting the reasonable "headquarters" rule that other countries use).

The problem is that the Senate Finance Committee is putting another revenue reduction bill through as the "price" for passing minimum wage reform. It looks like the Senate Finance Committee can't imagine passing any single measure that would benefit ordinary--and especially low-income--Americans  without yet another huge dose of tax breaks for the well-to-do.  That likely makes the business lobby happy, but it is a lamentable development in a democratic institution that should be thinking a good deal more these days about ordinary Americans.

The House has it right--pass a minimum wage bill, and quit linking wage rules to inappropriate tax subsidies for businesses.

Revised 2/1/07 to provide updated links

Taxes as a rationale for multinational enterprise location decisions

Multinational enterprises (MNEs) based in the United States have been lobbying vigorously over the past few years to convince Congress to change our international tax regime.  They'd like zero taxation on their foreign source income--a "territorial" system rather than a "worldwide" income taxation system.  The tax panel at the AALS meeting considered whether a income tax system can survive at all with the globalization pressures and the claims that a corporate income tax puts US MNEs at an economic disadvantage in comparison to their global competitors.

Of course, one response to claims from MNEs that the US tax system should be loosened up to help them be globally competitive is to ask--for what purpose?  MNEs treat aid for their competitiveness as an unquestioned good.  Yet that is clearly not the way Congress should address the issue.  If we relax tax on a US MNE and thereby permit it to open a manufacturing plant in a country where it pays inferior wages to workers, pollutes the world's air and water at a rate higher than that permitted in the US, all to manufacture products that it charges its US affiliate dearly to import into this country, we have done little of benefit to the US or, in fact, to anyone other than the owners (sometimes US based and sometimes not) of the US MNE.  Aiding MNEs in their game of pulling tax rates across the world down to the bottom so that their owners (and top executives) can reap even higher profits and control even more of the world's wealth is not an inherent good.  In that situation, US workers lose out because their jobs are outsourced, aided by tax provisions undertaken to aid MNEs' economic competitiveness.

Even if there are some situations in which the US should be deeply concerned about the global competitiveness of its home-based MNEs, the next question is whether the precipitous race to the bottom in corporate tax rates is necessary to lure corporations into a particular country (or keep them where they are already located).  There has been considerable commentary of late that assumes that taxation is a major factor in MNE location decisions.  So it is interesting to see some new empirical research based on OECD data about the relative importance of taxation and other policies (openness to foreign firms, labor rules, etc.).  A new OCED Economics Department working paper by Hajkova, Nicoletti, Vartia and Yoo, Taxation, Business Environment, and FDI Location in OECD Countries,  examines just these areas, to determine how important is the impact of tax regimes on multinational corporations' location decisions.

They conclude that taxation matters, of course, but perhaps not as much as everyone has assumed. 

The results indicate that omission of other policies that shape the business environment of host countries may lead to serious upward bias in tax elasticity estimates. Moving from a simple model specification including only tax policies to a wider one covering also other factors and policies affecting rates of return on FDI significantly lowers the estimated tax elasticities. As a result, the elasticity estimates are on the low side of the range covered by recent surveys of the empirical literature. Moreover, the impact of tax regimes on bilateral FDI appears to be quantitatively limited. On the whole, taxation would seem to be a relatively minor factor affecting the location choices of MNE as compared to policies affecting the ease of entry for foreign firms, their labour costs and the functioning of product markets in the host country. These results appear to be robust to changes in model specification and estimation methods as well as to accounting for the possibility of FDI diversion from third countries. (emphasis added)

Don Tobin on Churches and Politics

I have written several times here about the problem of churches' intervention in political campaigns and the resulting pressure on democratic political processes when religious organizations are able to use their often formidable organizational discipline in favor of a partisan issue or candidate.  See, e.g., here, here and here.   For an example of the way some churches blatantly intervene in politics, see The IRS and Church Tax Exemptions in Religion Ethics Newsweekly (online) about the pastor of Fairfield Christian Church in Lancaster Ohio.  For the perspective from Americans for Separation of Church and State, see this link.

Several commentators have lately suggested that the ban on partisan politics in churches should simply be lifted, either because it is an impractical prohibition on important activity in a democracy or an infringement on religious freedom or free speech.  See, e.g , Richard W. Garnett, A Quiet Faith? Taxes, Politics, and the Privatization of Religion, 42 B.C. L. REV. 771, 800 (2001) ( an article that engages in considerable polemics, calling section 501(c)(3)  "the tip of a monstrous iceberg of tax law that affects churches" and providing cites to a number of other articles questioning the constitutionality of the prohibition based on religious freedom and free speech rationales).   Others acknowledge practical enforcement difficulties, claim literal enforcement is "unpalatable", and suggest at least some limitation on the scope of the ban on campaign intervention. See Rendering Unto Caesar by Alan Feld.

In that context, we should welcome Don Tobin's recent contribution, available through SSRN. It is an interesting piece supporting the current ban (based in large part on the destructive impact on democratic processes of powerful, taxpayer subsidized religious views) and suggesting ways to enforce the ban that would make the government's actions more transparent while taking the IRS out of the political hotseat in this regard.  See Political Campaigning by Churches and Charities:  Hazardous for 501(c)(3)s; Dangerous for Democracies (Nov. 2006).

The AMT

Senators Baucus and Grassley are proposing repeal of the AMT.    As I've written before, this doesn't really make sense.  AMT repeal is very costly, and it will benefit primarily taxpayers in the top quintile of the income distribution.   Fixing the AMT so that it doesn't impact ordinary taxpayers--those making $100,000 or less--could be done relatively cheaply.  That's the problem that should be addressed.  There is not much reason to worry about the AMT effect on taxpayers making $300,000 or $500,000--it is, in fact, operating as it should to disallow too big a benefit from aggregations of deductions. 

The cost of AMT repeal is not small--the Tax Policy Center estimates it will cost considrably more than one trillion dollars over ten years (if the Bush tax cuts are not repealed).  See this January 5, 2007 release (posted earlier on Tax Prof).   

Furthermore, the AMT serves a useful function, once the exemption amount is raised to a reasonable level (permanently) so that the AMT's effect does not reach down in the lower half of the distribution curve.  Rather than having individual phase outs and caps on each individual tax expenditure item, the AMT can be used to ensure that individuals with considerable economic income do not aggregate so many deductions that they end up paying little or no tax.  Every person should pay an effective tax of at least 15% (perhaps more) on their overall income.  The AMT helps us come closer to that target than we would without the AMT.

The concern about complexity is overstated.  It would be relatively easy to prevent the AMT from affecting the people most unable to deal with tax code complexity by instituting a reasonably high AMT exemption (around $100,000, as noted earlier).  Although the AMT calculations remain for higher income individuals, those individuals are simply not as sympathetic as people in the lower half of the distribution  curve.  Simplicity is a much weightier topic in talking about provisions that affect the poor than in discussing provisions that affect the wealthy. 

Moreover, retaining the AMT in combination with a few other changes could create a much more progressive tax system that protects those at the bottom from the complexity of AMT calculations while ensuring that those at the top pay their fair share.  Back in 2004, I proposed adding the preferential treatment of capital gains to the list of AMT preferences. (See my summary of the 2004 article's proposals, posted on A Taxing Matter, here.  For readers who prefer a more detailed exposition of these ideas, see Congress Fiddles While Middle America Burns:  Amending the AMT (and Regular Tax), published in 6 Fla. Tax Rev. 811 (2004), available on the SSRN network at http://ssrn.com/author=83521. )  CTJ has proposed a similar remedy for the AMT as well.  See this link.

So why is it that the Democrats now taking over Congressional committees think that another tax cut is what is needed--especially a tax cut that will primarily benefit America's upper crust while doing little for ordinary Americans?  Congress needs to shelve AMT repeal, and consider AMT reform--create a higher exemption amount ($100,000, adjusted for inflation) and add the capital gains preferential rate as an AMT preference.  That's real reform, without bankrupting the Treasury.