Mississippi: More Tobacco Tax Talk

The main tax topic on last year's agenda for Mississippi lawmakers was the cigarette tax. And just as in early 2006, legislative leaders are now talking about hiking the state's relatively-low cig tax (currently 18 cents per pack) and using some of the money to cut the sales tax on groceries. As we noted earlier this year, this idea has some flaws, not least of which is that it would use a no-growth revenue source to pay for a growing tax cut.

Of course, Gov. Haley Barbour doesn't even need to work this hard to find a reason to oppose such a move: he's against tax hikes, and a cigarette tax increase is definitely a tax hike.

Mississippi editorial boards are not without entertaining opinions on this one. The Hattiesburg American argues that if Barbour were really a no-new-taxer, he would support the cigarette tax hike. Here's the logic:

If he were really against "raising anybody's taxes," he would support a tobacco tax increase that would reduce smoking and thereby reduce the growth in taxes necessary to support public health care needs.

It's an interesting argument, and one that shows a good understanding of what the cig tax ought to be used for, but doesn't really give Barbour an exemption from his no-taxes pledge, for a couple of reasons. First, it doesn't work unless Mississippians respond to the tax hike by quitting smoking. For every Mississippi resident who ponies up the extra tax and keeps on puffing, the state will enjoy (horror of horrors!) a little extra tax revenue, and the extra health care costs associated with smokers will still be a burden on the state. And second, any reductions in health care costs due to smoking cessation are gonna take a few years to emerge. The idea that the state's health care costs will go down in fiscal year 2007 (or even fiscal year 2008 or 2009) due to a tax hike enacted in '07 is fanciful at best.

Having said that, the folks at the American are thinking about the uses of a cigarette tax hike in exactly the right way. If a cig tax is working right, it's discouraging a socially bad (and socially costly) behavior, and is saving the state money. That (rather than finding revenue to cut other taxes) is the right reason to advocate a cigarette tax hike.

The Lame Duck Tax Bill: Digging in The Dirt

The tax-cutting legislation rushed through a lame-duck session of Congress earlier this month has already drawn some attention for the sneaky way in which some pretty important (and bad) tax provisions were stuck in at the last minute. But yesterday's Washington Post casts a less critical eye on one newly-extended temporary tax break: a $5,000 federal income tax credit for "first-time homebuyers" in the District of Columbia. This tax break has been around since the beginning of 1997, although it expired at the beginning of 2005. This year's legislation, the "Tax Relief and Health Care Act of 2006," extends the tax credit for two years, from the beginning of 2006 to the end of 2007.

Has the $5,000 credit been effective? The Post thinks so:

Economists and real estate professionals have called the exemption a key factor in the housing boom in the District over the past several years. Del. Eleanor Holmes Norton (D-D.C.), who pushed the measure in Congress, said: "Even in today's cooling housing market, home prices are out of reach for many D.C. residents. The $5,000 home buyer credit is desperately necessary in this town today."

Of course, one could argue that the home buyer credit has had exactly the opposite effect. If home sellers are factoring the availability of the credit into their pricing, the real beneficiaries will be individuals (or developers) who are selling homes-- making house prices higher for first-time homeowners than they otherwise would be. Under this scenario, the $5,000 credit will make it marginally more difficult for low- and middle-income first-time homebuyers to break into the DC housing market-- hardly the outcome Norton (or any other DC policymaker) wants.

Of course, the real answer is almost certainly between these two poles-- sellers and buyers are getting something out of this. And it's hard to contest the idea that, for those who are lucky enough to own a home in DC, this tax break makes these homes more valuable. But the real question is whether this is the best approach to making DC a more affordable place for first-time homebuyers-- and the Post article has no insights on this question.

Louisiana: Adventures in Property Tax Deform

In at least one Louisiana parish, some folks are pushing to change the way property taxes are administered by putting a cap on the amount by which a home's taxable value can grow from one year to the next. As the Times Picayune explains, this idea is being championed by the assessors themselves in St. John the Baptist Parish.

Whitney Joseph Jr., the St. John assessor who is leading the effort to amend property tax rules, has not determined the exact limit he wants for the annual property tax increases. But he admires the 2 percent cap that California passed in 1978 with Proposition 13... "Hurricane Katrina not only devastated people's lives as far as destroying their properties, but it also increased the market value on things," Joseph said. "Everything went up. Insurance is going up on homes because of Katrina and now we are going to have to double or triple your taxes. Something has to be done."

But market value is supposed to be the basis for measuring a homeowner's ability to pay taxes. What's so wrong with that? Here's Joseph's take on this:

"This is not normal growth, people were coming in and desperate to buy homes," Joseph said. "They lived cramped in homes with their family and in hotel rooms, and when they received the insurance money they wanted to buy homes. They came in and started buying. I don't think they cared about how much they cost."

The "let's cap assessed value" approach is wrong in general because it makes property taxes more unfair, as we've discussed elsewhere. The first step in making property taxes fair should be ensuring that they're based on what a home is actually worth-- and assessed value caps basically abandon this fairness goal. Caps basically say that the (typically poorer) people who live in undesirable neighborhoods should have to pay a higher property tax rate than otherwise identical people who live in popular neighborhoods. (This is because poor people will be paying tax on 100% of their home's value, while wealthier people will be paying on less than 100% of their value due to the assessed value cap.)

But there's a new twist here. Whitney is basically arguing that the yardstick Louisiana is using for measuring a homeowner's ability to pay taxes-- market value-- is simply a flawed measure in Louisiana right now. He's arguing (implicitly, at least) that post-hurricane real estate speculation has created a temporary bubble in real estate values that shouldn't be reflected in the property taxes people pay. A house that sold for $50,000 six months before Katrina is selling for twice that in Katrina's wake, and that (he argues) is a bubble that won't last.

At the heart of Whitney's criticism is a basic truth about the property tax: for a lot of homeowners, a lot of the time, the "market value" of a home is pretty irrelevant to your short-term well-being. In the property tax world, a booming real estate tax market can make you "rich" pretty fast by jacking up your home's value, but if you have no plans to sell anytime soon, this doesn't make you "rich" in a way you can appreciate at all. The only real impact is that your property taxes go up.

In the long run, of course, the use of market value as a yardstick is defensible because when you sell your house, you will absolutely enjoy the benefits of your home's growing value-- unless it turns out to be a temporary bubble. And Whitney is basically saying that's exactly what is going on with Louisiana.We've argued in the past that assessed value caps are just a bad idea because they create a gap between a home's assessed value and its actual worth. But if there's ever a time when these caps are appropriate, it's probably when a home's "actual worth" is being temporarily inflated due to a real estate bubble. At first glance, it's a compelling argument.

And yet. For every home that has rapidly appreciated due to the recent wave of speculation, there's another home in a lousy neighborhood that isn't appreciating. And property tax caps, even in Whitney's "bubble" scenario, inevitably result in a tax shift away from the rapidly appreciating home toward the lousy-neighborhood home. That sort of tax shift is unfair in a way that assessed value caps can never justify: seeking to fix one perceived source of tax unfairness by making taxes even more unfair in a different way.

There's a lot more to discuss here. From a practical perspective, there's the whole question of, if you're gonna have a tax cap, what that cap should be. The 2% cap implicitly suggested by Whitney's comments about California would be dangerously low, for reasons we'll discuss another day. But for the moment, the thing to remember is that Whitney's attempt at making the property tax less unfair would create a whole new kind of unfairness-- and one that would make affected homeowners just as mad as the current bubble is doing.

Georgia Governor's Capital Gains Hijinks

From the "Too Incomprehensible to Ever Become a Real Scandal" Department:

Georgia Governor Sonny Perdue is facing criticism over allegations that he avoided paying over $300,000 in federal income taxes by engaging in a shady land deal. On its face, the deal seems legit-- but the Atlanta Journal Constitution is asking questions about whether there's more to the story.

Here's the story, in brief. Governor Perdue inherited a Georgia property from his father. He sold it for about $2 million-- a sale that would have resulted in about $300,000 in federal income taxes under the special low 15 percent capital gains tax rate. But federal income tax laws say that you don't have to pay capital gains taxes on property sales if you reinvest your gains in another property of equal or greater value within 180 days of the sale.

And this is exactly what Perdue did, at least on the surface. He waited 179 days to reinvest the $2 million (that is, one day before the 180-day deadline), but ended up spending a bit over $2 million on a property in Florida. This swap absolutely conforms, on the surface, to the letter of the law.

But the folks at the Journal Constitution did a little poking around and found that in fact, the Florida land Perdue had bought was worth a lot less than the $2 million he paid for it. The property was most recently assessed at $187,000, and is largely swamp land right next to a toll road.

This doesn't make Perdue's transaction seem illegal-- it just makes it seem crazy. Why would he spend $2 million on a property that was worth just a fraction of that?

The county assessor in Osceola County, Florida, where Perdue's new swampland retreat is located, has a theory:

Based on the purchase price, Atlee Mercer, the county tax appraiser for Osceola County, Fla., where Perdue's property is located, said he believes the sale was probably not an arm's-length transaction, meaning that other considerations were part of the deal.
"This was a transaction in preparation for some future transaction," said Mercer, who based his opinion on his experience assessing land values. He was not privy to negotiations between Perdue and Thomas.
In fast-growing central Florida, Mercer noted, land deals for development sometimes involve seemingly unrelated transactions among the parties, where assets are swapped or side-deals are negotiated so that "everyone ends up whole at the back
end."
"I think that's why there is some kind of quid pro quo going on here, to either repair an old harm or establish a future benefit," said Mercer, a former Republican commissioner for Osceola County who was appointed county tax appraiser by Gov. Jeb Bush. "He paid too much money for the land."

In other words, Mercer thinks that Perdue took a $2 million bath on this property either because he expects to get the money back at some point, or because he was repaying a previously incurred debt of some kind. If either explanation it's true, it's a tax dodge, plain and simple.

This is, of course, the uninformed speculation of a guy who has no idea what's in Perdue's head. It's totally conceivable that Perdue is simply gambling that this land will be a good investment in the long run, or that he has purely personal reasons for wanting the land that he doesn't feel like he has to defend publicly. But it doesn't sound good. And, as the AJC notes, if it turns out he intentionally overpaid for a property he knew was less than $2 million, that's illegal.

If this story ever develops beyond mere speculation, you'll read about it right here.

AMT failure: Congress abdicates responsibility once again

In 1997, California increased the AMT threshold from $40,000 to $80,000, indexed the threshold for inflation, and eliminated the child credit from AMT calculations. Anti-tax Republican legislators asked me why my organization, usually a staunch opponent of tax relief for the well-off, supported this change (which came packaged with a major increase in the child credit). The obvious answer: it was about the credibility of the income tax —having middle-class taxpayers hammered by the AMT despite ordinary tax circumstances will damage the standing of the income tax in the public mind.

Since then, I have watched in amazement that, despite trillions in federal tax reductions since 2001, the AMT has not been fixed—and the recent tax extender bill continues the abdication of responsibility. There was plenty of room for all kinds of goodies, from improving the tax-sheltering opportunity offered by HSA’s to accelerated depreciation for restaurant owners to drilling incentives to independent oil producers (as if they need them at these oil prices!). But, of course, Congressional scoring now assumes the exponential growth of the AMT, $40 billion for next year, which makes it harder than ever to fix.

From my left coast vantage point, the failure to fix the AMT was an intentional effort by the Republican Congress to do what we in California explicitly avoided, that is, damage the credibility of the tax system. Inside the beltway, it was also a way to pretend to pay for the Bush tax cuts—even though everyone knew it had to be fixed. Outgoing Ways and Means Chair Bill Thomas finally made a comment that confirmed that the Republicans wanted to let the system fester and damage its standing with taxpayers, so presumably we would be forced to scrap it.

The price tag in California in 1997 was $82 million, grown now to a modest $110 million—affordable for a personal income tax which pulls in $50 billion in revenue yearly. But the scoring at the federal level has assumed that the AMT would work its wrath with middle-income taxpayers, so as to hide the real net cost of the other tax cuts. Even our hometown paper, the Sacramento Bee, has excoriated the Congress for its phony accounting and failure to fix the AMT.

Fixing it is easy substantively, difficult politically. The Tax Policy Center has described the fixes which raise the threshold, index it, eliminate dependent credits and other middle-class credits, and pay for it by rolling back some of the Bush tax cuts, so that the AMT will affect only those high-income, tax-avoiding taxpayers it was designed for.

Politically, of course, the Democrats have to fact the fact that an unfortunate part of their job is going to be cleaning up the mess that the Republicans have made of fiscal policy. Facing a Presidential veto of any tax raisers, fixing the AMT is likely to be put aside. And the on-going costs and frustrations of taxpayers will continue to mount.

LennyG

Virginia: Kaine Proposes Hiking Income Tax Threshold

Virginia Governor Tim Kaine is getting positive reviews for his proposal to increase the state's income tax "threshold" (that is, the amount of income you can earn before you start owing income tax). Under Kaine's plan, the amount single Virginians (and unmarried parents) could earn before owing income tax would increase from $7,000 to $12,000. And the threshold for married couples would increase from $14,000 to $24,000.

Without a doubt, this move would provide low-income singles with a tax break. Under current law, a single person earning just under $12,000 would pay about $100 in state income taxes in Virginia in 2006. The Kaine plan would zero out this person's income tax liability completely.

But there are a couple of flies in the ointment.

First, working families with children would actually get remarkably little from the Kaine proposal. In 2006, a married couple with 2 children, with $24,000 in wages, already doesn't owe Virginia income tax-- so they can't benefit from the Kaine proposal. The same is true for married couples with more than 2 children. Similarly, a single parent with one child would see their income tax threshold increase from $7,000 to $12,000 under the Kaine plan-- but a single mom can already earn $16,000 in wages in 2006 without owing any income tax at all. So this plan basically offers nothing to single parents whose income is all wages.

Second, if tax fairness is a problem in Virginia (and it certainly is), increasing the income tax threshold is nowhere near the most effective solution. The Virginia taxes that hit low-income working families the hardest are sales, excise and property taxes. Cutting these taxes for fixed-income families would provide much more meaningful relief, and would go a lot further toward making the Virginia tax system less unfair.

Third, the biggest beneficiaries from the Kaine plan might well be... middle-income seniors. The rules of Virginia's income tax threshold right now say that if your Virginia Adjusted Gross Income (AGI) is less than $14,000 for a married couple, you don't have to file a tax return. But Virginia already provides special tax breaks for seniors by completely exempting Social Security benefits, and allows an additional $12,000 tax exemption for each senior. So under current law, an elderly married couple with $57,999 of income (including, say, $20,000 of Social Security benefits), won't owe any Virginia income tax at all. ($20,000 of Social Security is excluded from Virginia AGI, as is $12,000 for each spouse, for a total of $44,000 exempt from AGI, which leaves this couple with a total AGI of $13,999-- just below the current $14,000 threshold.) The impact of the Kaine plan for seniors is basically to increase the no-tax threshold for this senior couple from $58,000 to $68,000-- hardly the low-end tax break that Kaine presumably has in mind.

This shouldn't be interpreted as a mean-spirited rant against Kaine's plan. The Governor's attention to the plight of low-income Virginians is admirable. And some of the objections we've raised here are technical, and can be fixed quite easily. But if Virginia lawmakers agree with the Governor, in the upcoming legislative session, that improving the fairness of Virginia's tax system is a priority, there are better ways of doing it.

President Brownback's Tax Agenda

Kansas Senator Sam Brownback has formed an exploratory committee for a potential run for President in 2008. From a tax policy perspective, Brownback is most notable for his support for a flat tax. Here's an excerpt from a speech earlier this year:

And I also believe we need an alternative flat tax to keep the economy growing and creating jobs. Not a removal of the current tax code, which I would support, but we've tried that for a long period of time. I think it's time for us to build into the tax code an alternative flat tax. If you want to file under the old tax code system, God bless you, here it is, go ahead. We're going to create an alternative flat tax, 19 percent, no deductions, no credits, no nothing, here's the rate, period. If you want to do it, this is it. You pick which way you want to go. You can't jump back and forth, but you pick which way to go, as a way of growing the economy.

This is hardly an inspiring rallying cry for federal tax reform-- we can't fix the existing tax system, so let's just slap another one on top of it-- but you can see why he would uncork this one in front of an audience. It seems simple, and it sounds like it gives you a choice. Simplicity and choice are both good things, right?

But on a moment's reflection, it should be clear that this idea would clearly be a lot more complicated than he's letting on-- and that it would give people less choice, not more, in the long run.

First, forget about the idea that this plan would leave the current tax system unchanged and just add one new optional feature. As a practical matter, you'd have to repeal the Alternative Minimum Tax to make this choice work-- after all, a tax that says you have to pay at least 26 percent of your income in tax is hard to reconcile with a tax that says you can pay as little as 19 percent of your income--which would mean close to a billion-dollar hit on federal tax collections over the next decade.

Second, a truly optional flat tax wouldn't require you to make a choice and stick with it. Brownback says "you can't jump back and forth, but you pick which way to go." If you plan on being rich enough to take advantage of the flat rate forever, this seems fine. But what happens if you lose your job or become disabled? Paying 19 percent of your entire income in tax is going to seem much more oppressive than the current income tax, for sure.

Forced to confront these details, Brownback would certainly agree (in the first example) that his plan would involve more complication than he lets on, and would also have to agree that forcing a taxpayer to make this choice and stick with it doesn't make much sense.

But he clearly hasn't thought much about these basic implementation issues at all-- and I guess his staff hasn't either, or else they'd have thought of these issues immediately. This apparent unwillingness to think through the basic implications of tax reform ideas is especially worrisome given that he didn't just think this up yesterday. As noted previously in this blog, Brownback tried to impose an optional flat tax on the District of Columbia last year.

Nothing wrong with shaking things up with bold ideas-- but Brownback has been actively pushing this one for over a year and still doesn't seem to have thought critically about whether it could ever actually be implemented. And that doesn't say much for his potential ability to run the nation.

A small victory for ordinary taxpayers

California’s Franchise Tax Board recently approved a permanent Ready Return program, which provides fully filled-out tax returns for taxpayers with simple returns. Although the program was wildly popular with taxpayers who used it, Intuit, makers of Turbotax and chief lobbying force against free on-line filing, had lobbied the legislature to end the program.

Intuit took a well-deserved hit on this issue after it poured $1 million into a campaign against John Chiang (D), recently elected Controller and a current member of the FTB, who supports Ready Return and free on-line filing. Intuit has also spent hundreds of thousands of dollars in a lobbying effort (hiring the same firm that represents big tobacco) to eliminate the CalFile program, which allows taxpayers to go on-line and file their state income taxes without going through private sector filers like Intuit and HR Block. They even promoted a bill which said that any on-line filing system would not be allowed to perform arithmetic and tax-table look-up functions!

Fortunately, and unlike at the federal level, California and many other states continue to have free on-line filing, in which taxpayers can fill out their information, the program calculates the tax or refund, and the return is sent electronically. Ready Return takes that a step further: it says to the taxpayer, here’s the information we have, is it correct? If so, send it back, either electronically or through the mail, and your taxes are done. 96% of taxpayers who used the system were highly positive about it.

Meanwhile, as previous blogs and Taxpayer Advocate Nina Olson have noted, the federal “Free File Alliance” program continues to be a mess. It’s not free if your income is over a certain unspecified level, it charges to file state taxes as well, and often charges for “upgrades”—that is usable programs rather than the minimal, unusable programs offered for free.

A small step by the new Democratic Congress could require the IRS to move to direct on-line filing, as many states already provide. (Estonia, much admired by Bush for its flat tax, apparently also provides on-line filing). At minimum, truth-in-advertising requires removal of the word “free” from the IRS website.

Lenny G

Missouri Legislation Threatens Checks and Balances

Anyone who has taken a civics class learned about the importance of checks and balances. They ensure that any one branch of government doesn’t overstep its bounds.

One Missouri legislative leader, Rep. Jane Cunningham, has prefiled legislation that turns the concept of checks and balances on its head. HRJ1 is a constitutional amendment that limits the jurisdiction of any court in the state to mandate that revenues are increased or levied. Here’s a portion of the legislation:

Neither the supreme court nor any inferior court of the state shall have the power to instruct or order the state or any county, city, or political subdivision thereof, or an official of the state or of any county, city, or political subdivision thereof, to levy or increase taxes.

The bill also makes it illegal for the courts to instruct the state or localities about how revenues should be spent. A portion of the judicial branch’s ability to check and balance the legislative and executive branches is clearly eliminated if this legislation passes.

Not only should this legislation turn the stomachs of anyone who cares about the balance of power, but those concerned with school funding should be moved to action. It seems likely that next year a court will rule that Missouri’s school funding formula provides Missouri children with neither an adequate or fair education. If Rep. Cunningham’s constitutional amendment becomes law this would make it illegal for the courts to rule that Missouri needs to increase funding for education.

Checks and balances and school funding are obviously complex issues. This legislation doesn’t offer a real solution to the school funding issue and does a disservice to the concept of checks and balances.