Revenue Goes Up In Smoke

And the news about cigarette taxes keeps on rolling. This is from a news article in the Denver Post:

Since Colorado's 64-cent cigarette-tax increase took effect in January, sales have declined so much that many cities and counties are experiencing double-digit drops in cigarette-tax revenue.

As I pointed out in my last post, cigarette taxes are a bad source of long-term revenue for programs with increasing costs (such as health care). There's an additional lesson to learn from this case in Colorado - declining revenue source.

One of the theories as to why cigarette sales and hence cigarette tax revenues are dropping is that people are now buying them online - which allows them to evade sales taxes. Another theory is that the tax increase simply pushed people into quitting or smoking less. Each theory would lead to a decline in cigarette tax revenue.

The overall lesson to be learned - cigarette taxes don't make for good, long-term revenue policy. It's a slow growth tax, and as with the case in Colorado, it could also be a declining revenue source.

Cigarette Taxes as a Revenue Stream

Lawmakers in Oklahoma are learning a painful but valuable lesson - cigarette taxes cannot be counted on as a long-term, reliable revenue source. As reported by the BNA:

Last fall, Oklahoma voters approved an 80-cent-per-pack increase in the cigarette tax, raising the rate from 23 cents to $1.03. The increase was projected to raise an additional $200 million annually but a shortfall has been running for seven consecutive months, according to Rep. Kris Steele (R),chairman of the House Health and Human Services Committee.

Not only are cigarette taxes regressive, they provide a slow-growth revenue source, as an excerpt from ITEP's Policy Brief, "Cigarette Taxes: Issues and Options" explains:

Over time, cigarette tax revenues grow more slowly than do most other taxes. This is partially because these taxes are usually calculated on a per-pack basis: a 25-cent-per-pack tax will always yield the same amount of tax revenue for each pack. (By contrast, general sales taxes are calculated as a percentage of the sales price of a taxableitem. This means that when inflation drives prices up, sales tax revenues will automatically increase, but cigarette tax revenues will not.)

Given that cigarette taxes in Oklahoma are earmarked to fund public health initiatives (which increase in cost over time), this funding scheme was doomed to failure at its conception. You simply can't fund a program that increases in cost each year (such as public health) with a revenue source that doesn't match the program's cost growth (such as cigarette taxes).

Gas Prices, The Energy Bill and the Credit Card Nation

Reading this article in today's NYT, I couldn't help but think about the recently passed Energy Bill, which rewards energy companies for doing exactly what they've been doing. Not only did the Congress and President not take due action, they probably made our current problems worse.

From the article:

"We spend much less," said Hollie Tubbs, a 32-year-old teacher's assistant in Brooklyn. Instead of going to the movies, watching plays or dining out, she now takes walks in the park with her husband and son and checks the newspaper to see when a nearby Barnes & Noble will be holding a free story hour. "Everything is related to gas prices. The more you drive, the more you spend. In order to bring the budget down, we stopped driving."
If consumers are feeling hard-pressed by higher gasoline prices, matters could become worse this winter when heating oil bills arrive. Some commodity analysts say that is when the full impact of the higher energy costs will be felt.
Forecasters still expect economic growth to remain healthy for the rest of the year, as companies invest in new factories and the housing boom continues. But the high cost of oil already appears to be curbing growth, translating into unusually modest gains in employment and pay.
If history is any guide, higher prices will hurt consumption, curb the nation's output and shift spending patterns. The risks of a domino effect on the economy are real, economists say.
"We can't lose sight of the fact that energy restricts growth," said Anthony Chan, a senior economist at J. P. Morgan Asset Management. "It is doing so."

Non-Recurring Revenue

The Congressional Budget Office just came out with its new budget numbers - some good news and some bad news.

The good news, revenues are up. The bad news, these new revenues are temporary, or non-recurring, and don't change the overall, long-term federal deficit picture. So really, there's no good news.

The Director of the CBO, Douglas J. Holtz-Eakin states to the New York Times:

... corporate income tax payments were growing more than would have been indicated by the growth of corporate profits, and that he did not know why. The agency assumes that three-fourths of this year's increase in corporate tax payments is temporary.

The Center on Budget and Policy Priorities concurs, stating that:

The unanticipated increase in revenues this year is largely the result of temporary factors, such as an increase in corporate book profits relative to the size of the economy, and revenues over the next 10 years are not expected to be significantly higher than CBO estimated last March

Those touting that the President's tax cuts are "working" because of this higher than expected revenue gain are wrong. These new unexpected revenues are nothing more than a one shot non-recurring revenue gain and don't reflect an overall positive shift in the economy.

Long Term Financing! No Down Payment on Your Government Until The Year 20__!

If only.

The estimable Max Sawicky explains (and here he further explains) the way that over the last 4 years, the White House and Congress have committed the compounded mistake of shifting the tax burden from the rich to the poor, even as they hold it off until the future. Harry Reid calls this the "birth tax." And we've described here how increasing our debt every year makes the government even more expensive to run, with less bang for our taxpayer bucks, each year down the line.

It's a familiar story, but it's falling on deaf ears. Max goes in depth and provides some good specific examples. Check it out.

CTJ has been on this beat for years. Here's our 2003 analysis. Look closely at the per-family costs of the debt versus the per-family "tax cut." This is raw deal economics at its worst, courtesy of President Bush.

Energy Bill Final Votes

For those keeping score, here's how Congress voted on the egregious conference committee energy bill:
The House approved it 275 to 156.
The Senate approved it by a big 74 to 26 vote.

This vote was driven more by pork than by partisanship, as the lopsided numbers indicate.

Fun facts:

-More Senate Democrats voted for this bill than voted against it. Dems split 25-20 in favor, usually driven by nice fat subsidies to their favorite home-state industry. In West Virginia, home of Rockefeller and Byrd, that meant subsidies for clean coal technology. In half a dozen other states, generous new ethanol subsidies were the story. In Illinois, Dick Durbin and Barack Obama were presumably swayed by both of these angles. In Michigan, the story has to be the absence of any action to change fuel efficiency standards.

-Six Senate Republicans voted against the bill. Here's the list:
Chafee (R-RI)
Gregg (R-NH)
Kyl (R-AZ)
Martinez (R-FL)
McCain (R-AZ)
Sununu (R-NH)

-Out of 32 Texans in Congress, just two voted against the bill: Lloyd Doggett and Ron Paul.

-The only states in which House members rejected the bill unanimously: Delaware (0 for 1), Massachusetts (0 for 10), Maine (0 for 2), Rhode Island (0 for 2), Vermont (0 for 1).

Albatross!

Further evidence that night must follow day: yesterday Casey drew attention to a numbers-laden New York Times editorial on estate tax repeal. Today, well, we get this from the Augusta (Georgia) Chronicle:

Without congressional action the death tax - a.k.a. the estate tax, which is currently being phased out - will be resurrected in its entirety after 2010 - at a whopping 60 percent confiscatory rate.

It's always refreshing to see editorial boards making data-free assertions about the estate tax, using the "death tax" rhetoric to try to carry the day. But the Chronicle boldly takes this approach one step further, using data that is simply misleading to assert that the tax they call "a moral and economic albatross" must be repealed.

It's true that before 2001 the estate tax did have a top marginal rate of 60 percent. Your estate had to have a taxable value (that is, the leftover value after subtracting the basic exemption from the estate tax, deductions for charitable bequests, and any other deductions that cut the portion of the estate that is subject to tax) of over $10 million, which means that pretty much nobody paid it.

It's also true that the 60 percent figure is a marginal rate, which means that most of the value of these high-dollar estates is being taxed at lower rates. Only taxable estate value above $10 million gets the top rate.

So, with that in mind, here are two numbers that are a bit more relevant: 37 and 18. 37 percent is what you get when you look at the estate tax paid by the very wealthiest estates (over $20 million gross value in 2001) and take that as a percentage of the taxable estate. And 18 percent is what you get what you divide this group's tax by the total value of the estate, including the exempt parts. (The raw data is on the IRS website, here.)

In other words, the real impact of the estate tax on even the very wealthiest estates is a lot less than the "confiscatory" top rate would suggest.

The estate tax does have one very real problem, I think, that absolutely must be addressed-- much of the public has been scared into thinking (inaccurately) that they will someday end up paying it. With editorials like the Chronicle's, it's a bit easier to see how the public could end up so badly misinformed.

Estate Tax Demise

In today's New York Times, there's an excellent, straight to the point op-ed on the current status of the estate tax; specifically its proposed demise.

Realizing that full-out repeal of the estate tax is no longer a viable option, estate tax opponents are touting a "reform" proposal by Senator Jon Kyl:

Under Mr. Kyl's approach, the estate tax would not kick in until the value of one's assets at death exceeded at least $3.5 million. That's overly generous; a $2 million exemption would be ample to protect the hard-working families, entrepreneurs and farmers that estate tax foes claim to care about most. Still, it's in the ballpark. With an exemption of $3.5 million, only the top 0.3 percent of estates would be subject to the tax. Huge estates are precisely those that should be taxed most heavily, because the larger the estate, the more likely it is to be made up of investment gains that were never taxed during the owner's lifetime.

Where Mr. Kyl's plan really implodes is in its drive to cut the tax rate on big estates by some two-thirds, to 15 percent. A $3.5 million exemption, together with a top rate of 15 percent, would cut the taxes of America's wealthiest families by some $550 billion during its first 10 years. That would be nearly as bad as repeal itself.

The estate tax is one the most progressive features of the federal income tax structure and deserves to be left intact. Eliminating the estate tax, either through full-out repeal or "reform" would be nothing more than an undeserved tax break for the wealthiest of the wealthy at the expense of America's wage-earning families.

Following Through in Louisiana

Today's Times Picayune has this cautionary tale on the implementation of Louisiana tax reform.

A couple of years ago, lawmakers passed (and voters ratified) a tax swap that eliminated the state sales tax on groceries and utilities and hiked the personal income tax on upper-income Louisianans. This was a great move from a tax fairness perspective, and helped put some teeth into what had been one of the lowest and least-fair personal income taxes in the nation.

But it turns out that passing laws to achieve tax fairness is only half the battle. You've also got to make sure that retailers actually comply with the laws. The Times-Picayune article finds that some retailers have basically ignored the new grocery tax exemption and are continuing to charge tax on items that ought to be exempt.

This is a big deal because sales taxes on groceries hit low-income families harder than just about any other tax the state levies. Louisiana lawmakers thought (correctly) that they'd come up with a good approach to tax fairness when they passed this thing three years ago. But if up to a third of the retailers selling food aren't passing on these tax savings to consumers, as the article suggests, then low-income families are still feeling the squeeze from the food tax-- just in a more unpredictable and less uniform way.

The article focuses not on grocery stores but on convenience stores, and the primary research appears to have been done by a private citizen on his own rather than by the Department of Revenue. But the point is a good one: every tax (and every tax break) is only as good as its enforcement mechanisms allow it to be. Just as the lack of IRS auditing ability has hamstrung the feds' ability to prevent tax avoidance over the past five years, the inability of Louisiana tax administrators to enforce a new tax break has meant that many Louisiana consumers are paying more than they should.

This seems like a good opportunity for Louisiana policymakers to push for a stronger general enforcement capacity at the Department of Revenue. Let DOR make sure everyone gets the tax breaks they are entitled to-- and then let them ensure that no one gets tax breaks they're not entitled to.

The Chicago Tribune on Illinois Tax Reform

The Chicago Tribune is shocked, shocked to find that the persistent inadequacy of Illinois state tax revenue is making school funding more inequitable. An August 1 article uses data from the State Board of Education to show that:

The difference between the highest- and lowest-spending districts was $19,361 per pupil in 2003-04, about $4,000 higher than the year before and the biggest school-spending gap in a decade...

This staggering gap exists, of course, because of disparities in property wealth between rich and poor school districts. The poorest districts have to apply much higher tax rates, and still get less revenue per pupil to spend on schools. Wealthier districts can levy low tax rates and get a lot more money per pupil. The result is that the quality of your kid's K-12 education varies dramatically depending on where in Illinois you happen to live.

The best way to counteract this basic inequity on local property tax bases is to use a different tax base-- for example, the state income tax-- to fund schools. But oops, the property-tax-for-income-tax swap that occupied lawmakers for much of the 2005 legislative session never got enacted, partially because of a very negative Tribune article a few months back on how the bill would affect Illinoisans.

As one observer characterizes it, the Tribune article "discovered, after massive research, that a plan to increase taxes to raise more money for the public schools would increase taxes."

So I guess that makes two Trib articles on tax and education policy within three months that ought to be subtitled "Duh."

Thanks to Dan Johnson-Weinberger for noting all this.

South Carolina: Mark Sanford Asks the Hard Questions

Well, who knew? Turns out that before South Carolina lawmakers start cutting property taxes, they should probably think about the impact this would have on school funding. SC lawmakers have been meeting informally this summer to discuss options for relieving property taxes in fast-growing areas when they convene next year. Speaking to a local Kiwanis club this week, Governor Mark Sanford had this to say:

"If you want relief ... then how are we going to do it in a way that still provides adequate funding for the education process?"

To which one Senate leader had this response:

"We are not going to ignore education, but I'm just not going to put the property owners on the back seat," said Sen. Glenn McConnell, R-Charleston. "People's homes are at stake, it's time to act."

One shouldn't have to congratulate elected officials for asking the sort of basic questions Sanford is bringing up, but in the current climate that's the way it is. Good job, governor.

The classic bait-and-switch anti-tax lawmakers tend to pull with property tax reform is telling the public and the media that it's all about saving elderly homeowners who are in danger of losing their homes-- and then enacting big-time property tax cuts that benefit even the wealthiest homeowners. You can see the beginnings of this in McConnell's quote above. It's very likely true that "people's homes are at stake," as he claims, because property taxes are going up fast in certain areas of the state and some low-income homeowners will have real trouble paying these growing bills.

But with that kind of rhetoric, you would think that the proposed remedy would specifically target the folks whose homes really are "at stake." Right now, it's not looking that way. The most frequently-mentioned proposal would completely repeal local property taxes for education and replace them with sales taxes. In the understatement of the week, an AP article notes that "It would be tough to eliminate property taxes because, on average, they provide 84 percent of local funding to the state's school districts."

Even the less costly reforms being discussed would have their bad side. If, as some have suggested, the state simply caps the growth of taxes on homes in fast-growing areas, this just means that the cost of funding services will be shifted away from people whose property values are high and growing, and toward people living in low-valued, low-growth homes.

Once again, Gov. Sanford is right on the money:

"You've got an equity lawsuit about some counties in some of the rural parts saying 'Wait, we don't have enough,' " Sanford said. "You want to be careful to make sure any of these proposals that they're trying to limit property tax for the big homes on Sullivans Island ... that you're not therefore loading up more tax on some guy living in a trailer in Hampton County."

Amen to that.

Letting the IRS Do Their Job

Earlier this year, Citizens for Tax Justice put out a report called "Tax Cheats and Their Enablers." The argument of the "Tax Cheats" publication was that the federal government is being way too lax in going after high-income individuals and corporations who are coming up with clever tax avoidance schemes, and that the IRS has been effectively stripped of its powers to adequately enforce the tax laws.

Last week I got an email from an irate reader who took issue with the report:

I noticed your article does not even mention the Earned Income Credit as a source of Tax Cheats. The EIC is probably the largest source of tax fraud there is. Apparently, your organization is not interested in EIC fraud because it is not perpetrated by wealthy people.

This guy (who will remain nameless unless anyone really wants to know) saw this as evidence that CTJ is hopelessly "biased."

Now, there's a good literature out there making it clear that EITC noncompliance is a pretty unimportant part of the tax avoidance picture in dollar terms. This literature also makes it clear that Congress has actually shown an odd fixation with EITC "fraud" in recent years, and as a result has spent a disproportionate amount of IRS enforcement time and money trying to ferret out this source of noncompliance. See here and here to learn more.

And it seems likely that if EITC noncompliance is a problem, it's not because single moms are trying to bilk Uncle Sam, but because the forms are simply incomprehensible and they're making mistakes. If this is "tax avoidance," it's a whole different kind from companies shifting their income offshore to avoid having to pay US tax at all. And the remedy for this sort of accidental tax avoidance is to simplify the EITC, something Max Sawicky at the Economic Policy Institute has a lot of good ideas about. (See here for more.)

I pointed all this out to my friendly emailer, who (as is typical of folks who accuse us of being systematically biased) never responded.

So a couple of days later, the Wall Street Journal had this on the IRS' newfound ability to enforce federal tax laws. Turns out the IRS is managing to conduct a lot more audits these days, and is targeting proportionally more of them at the high-end tax evaders discussed in the "Tax Cheats"' report. So that's good. Of course, the IRS data cited in the WSJ report also makes it clear that the glass is still half empty: in 2004, the total number of audits was about half the number the IRS managed to complete in 1996. That's better than 2000, when they were at about a quarter of the 1996 level, but still not that good.

An even more sober take on this data comes from the Lansing State Journal, which noted that high-end taxpayers still face pretty low odds of being audited. The Lansing paper also printed this quote from IRS Commissioner Mark Everson which didn't make it into the WSJ coverage:

"If you look at overall audit rates, they're still too low."

We've said it before, but it's worth saying again: Congress' self-serving demonization of the IRS in the late 1990s has set back the cause of effective tax administration a long way. Describing IRS enforcement folks as a bunch of jack-booted thugs is a sleazy way of shifting the blame for the pathologies of our tax system away from the folks who designed it (yes, Congress!) and toward the people whose job is simply to enforce the laws. So if filling out your tax forms makes you mad, don't get P.O.'ed at the IRS. Take your gripes straight to the source: the tax writers in the US Congress.

We know that there are a lot of bad people out there creating and exploiting tax avoidance schemes. Every dollar these guys don't pay is a dollar the rest of us have to pony up. But looking past this reality and focusing on bogeymen such as an out-of-control IRS and a gang of EITC tax cheats is the surest way to ensure that high-income tax avoiders will continue to get away with it.

California's LWOM Act

California residents may get to vote on a ballot initiative entitled the California Live Within Our Means Act (LWOM). In essence, LWOM proposes to add on an new state spending limit and grant the Governor unprecedented line item veto power; making the Legislature almost completely unnecessary in the budgetary process during times of "emergency".

According to California’s Legislative Analyst’s Office:

This measure retains the existing appropriations limits, but adds a new limit on the annual growth in state expenditures. Specifically, annual state expenditures (General Fund and special funds) in a given fiscal year — beginning in 2006-07 —
would be limited to the prior-year expenditure level plus the average growth rates in combined General Funds and special funds revenues over the prior three years.

This method of limiting state spending carelessly assumes that what happened three years ago will hold true for the future. The additional spending limit proposed under LWOM could actually run counter to reality. If California had three boom years but is currently in a rough year, the state could spend as if it were still in the boom years - running a possible deficit. And of course this example can be reversed - three poor previous years with a current boom year.

The other major policy provision of LWOM deals with Gubernatorial power:

Following the enactment of a budget, the measure permits the Governor to issue a proclamation declaring a fiscal emergency at the end of the quarter — and call the Legislature into special session to deal with the emergency — when the administration determines either of the following conditions:

General Fund revenues have fallen by at least 1.5 percent below the Department of Finance estimate.

The balance of the BSA* will decline by more than one-half between the beginning and then end of the fiscal year.

So far, not too bad. Allowing for adjustments throughout the year could be a good thing. However, here comes the power play:

Once the emergency is declared by the Governor, the Legislature would have 45 days to enact legislation which addresses the shortfall. Absent such legislation, the Governor would be permitted to reduce most items in the budget (with the exception of items discussed below), either proportionally or disproportionately, to eliminate the shortfall. Language in the measure suggests that gubernatorial reductions could also occur at the beginning of the fiscal year in the event of a late budget — 30 days after the issuance of an emergency proclamation and absent the enactment of legislation addressing the shortfall.

The exceptions to the "gubernatorial reductions" are spending required by federal laws and regulations, appropriations where the result of a reduction would be in violation of contracts to which the state is a party and debt service. So in essence, the Governor can cut whatever he/she wants with very few exceptions. During an "emergency" the Governor gets to act as both the state’s chief administrator and Legislature.

Working in state tax policy, you see haphazard spending limit measures being brought before voters all the time. However, the LWOM act is just absurd. Never before have I seen a spending limits measure that grants the Governor pretty much complete legislative control with a veto pen. LWOM doesn’t seem to be much about controlling state spending as much as it’s about pure political power.

For a more in-depth analysis of LWOM, I suggest you check out this report by the California Budget Project.

*BSA stands for Budget Stabilization Fund - a reserve fund.

More on the Energy Bill

The Philly Daily News gets it just about right in their editorial this morning. This Energy Bill does nothing to fundamentally change the way that America fuels itself. Instead, it gives tax breaks and direct subsidies to an industry that is already doing better than ever. I can't imagine how a Senator could explain spending tax dollars this way, but luckily for the oil industry lobbyists, 74 US Senators found a way.

Back home, a lot of these folks get to deal with a happily pliant press. For example, in Jim Talent's case:

U.S. Senator Jim Talent said, a pro-growth, pro-jobs energy bill is long overdue. That's why he's particularly excited about what has recently happened on the Senate floor.
....

Senator Jim Talent, a member of the Senate Energy Committee who helped craft the bill, said it will provide a blueprint for
the supply, delivery and efficient use of energy resources of all kinds including renewable resources such as ethanol and
biodiesel.
....

Talent calls it a real victory for Missouri. He says it will help lower energy prices for consumers.
Talent says the bill is also important because we'll keep the money we spend on energy in the United States.

That's what passes for reporting on this issue. How this bill will lower energy prices or "keep the money we spend on energy in the United States" is anybody's guess. Despite the fact that the bill is described as "pro-growth" (my personal favorite amorphous buzz-phrase), Talent apparently couldn't be bothered to actually explain any of the Bill's details with the reporter, writing for his local ABC affiliate. Fortunately, Taxpayers For Common Sense put together a Bill tracking website. There you can find out the full potential cost of the Bill, which they think will be way above the $14 billion ballpark that most papers are reporting. That's because, beyond the corporate tax breaks, the Energy Bill is bogged down with direct subsidies that are yet to be appropriated. Watch for the cost to rise dramatically, perhaps to $80 billion.

I mean, people, this bill is so bad it got the CATO Institute and Sierra Club to not only sit at the same table, but pen an Op-Ed together denouncing it.