March 25, 2008

Gas Taxes: When Is An 'Increase' Not An 'Increase'?

Facing the clashing realities of rising transportation costs and widespread opposition to tax increases, state governments are turning to tolls, fees, and less visible local sales taxes wherever possible. But though increasing the gas tax has been perceived as political suicide by many politicians, tinkering with this traditional centerpiece of transportation funding is worth a second look. Gas taxes are intended to charge drivers for their use of public roads, and when gas tax revenues consistently fall short of the amounts needed to maintain those roadways, increasing that tax makes great intuitive sense.

Aside from all this, in most cases raising the per-gallon gas tax can boost revenues without actually “increasing” taxes in the traditional sense. This paradox, where a “tax increase” may not actually be a “tax increase” at all, arises primarily from the odd structure of the gasoline tax. Unlike traditional percentage-based sales taxes where the tax you pay is a fixed amount of every dollar you spend (typically 5-7 cents per dollar), gas taxes are levied as a fixed amount per gallon (typically 15-35 cents per gallon at the state level).

Under a traditional sales tax, as the price of goods increase, tax revenues increase accordingly. With a 5% sales tax rate, for example, the tax owed on a $3 gallon of milk is 15 cents. If after a few years milk has increased in price to $4 as a result of inflation, the tax per gallon will rise to 20 cents. This increase in taxes paid is in essence identical to what occurs when the legislature decides to increase the per-gallon tax on gasoline, but it receives none of the negative publicity. Additionally, given that inflation increases the cost of providing public services, such tax increases are in fact a necessary component of any sustainable method of financing government.

Though this problem plagues every government relying on per-gallons gas taxes, taking a look specifically at Minnesota’s recent gas tax increase is particularly illuminating. Legislators in Minnesota who were involved in the tax increase are currently taking a lot of criticism for being “tax-first liberals” unconcerned with perceived out-of-control government spending.

Using data released by the U.S. Energy Information Administration, the 2 cent gasoline tax enacted in Minnesota in 1925 was at the time equivalent to a 9% tax (when gasoline cost 22 cents per gallon). Where does Minnesota stand today now that their tax was recently increased from 20 to 28.5 cents? This may come as a shock to some, but today’s 28.5 cent tax is still the same as a 9% rate (assuming, conservatively, that gas costs $3.07 per gallon). Without the 8.5 cent hike, the effective gas tax rate would have been only 6.5%. For some perspective, Minnesota gas taxes have been levied at effective rates of 20% or more for 13 of the past 83 years, most recently in 1988 and 1989.

A similar result can be shown by examining the effects of inflation over this time period, using data from the Consumer Price Index (CPI). Adjusted for inflation, the 2 cents collected on each gallon of gas in 1925 was the equivalent of what would be a 24.4 cent tax today. By setting the rate at 28.5 cents, what the legislature has done is little different from what inflation does to percentage-based sales taxes, though inflation of course does not have to face any of the harsh criticisms currently directed at Minnesota legislators.

Data released by the U.S. Census Bureau also suggests that Minnesota’s 8.5 cent hike may not really be a tax increase by yet another measure: as a share of consumer income. While many meaningful measures exist for measuring tax changes, what has the most meaning for consumers is tax as a percentage of personal income. Data on this measure do not extend as far back, but what is clear is that a smaller portion of Minnesotans’ budgets is going to paying the gas tax than at almost any time in the last 30 years. In 1977, 0.7% of income earned by Minnesotans went to paying the gas tax. The trend since then has been steadily downward, reaching a low of 0.3% of income in 2005. The 8.5 cent hike will certainly change this figure, though not by enough to negate the overall trend. This trend can be observed in nearly every state, and it demonstrates plainly that despite numerous per-gallon tax increases across the nation over the past few decades, gas taxes have become a less important component of taxpayers’ daily budgets and daily lives. If transportation is to continue to be adequately funded, the portion of taxpayers’ budgets devoted to its funding it will have to rise.

Summing up, it should be clear that states are justified in regularly increasing their per-gallon gas tax rates. Doing so is necessary for maintaining transportation infrastructure, and doing so should, in reality, be relatively painless since inflation is always hard at work minimizing and eventually negating the impact of such increases.

March 07, 2008

Social Security Reform, KBR-Style

In case you thought the dearth of Halliburton-related scandals in the news lately meant that the company's leaders were regaining their moral compass-- fear not. Yesterday's Boston Globe breaks the story of how Kellogg Brown & Root (KBR), until last year a subsidiary of Halliburton, is avoiding hundreds of millions of dollars in federal Social Security and Medicare taxes by pretending its Iraq-based employees are working for a Cayman-Islands based "shell company."

According to the Globe, KBR has made a special arrangement to avoid paying taxes on about 10,500 of its American employees who are working in Iraq on various reconstruction programs. The way it works: KBR recruits people to work on reconstruction-related projects. But when the workers get their first paycheck, they see that it's not coming from KBR, but from a KBR subsidiary, Service Employers International Inc. (SEI). The Globe's Farah Stockman quotes several KBR hires who had no idea they were working for SEI until they landed on the ground in Iraq.

Why such deception? Because unlike KBR, SEI is not based in the United States. SEI's corporate home is the Grand Cayman Islands. (Legally, anyway--- SEI has no actual offices in the Caymans, just a mailing address.) And while KBR employees working in Iraq would be subject to the 15.3 percent payroll tax for Social Security and Medicare (half of which is paid by the employer, the other half of which is paid by employees), SEI employees don't incur federal payroll tax liability, because they're not working for a US-based company.

While KBR isn't releasing information on SEI employees' pay, the Globe's Stockman estimates a ballpark average pay of $63,000 for their 10,500 Cayman-based workers. At 15.3 percent, this would mean SEI is avoiding about $101 million in payroll taxes every year. And if this has been going on throughout SEI's 5-year stint in Iraq, that's more than $500 million in revenue that won't be shoring up the Social Security system.

The good news, according to Stockman, is that virtually none of KBR's competitor companies for Iraq reconstruction contracts have been pulling the same shenanigans:
Other top Iraq war contractors - including Bechtel, Parsons, Washington Group International, L-3 Communications, Perini, and Fluor - told the Globe that they pay Social Security and Medicare taxes for their American workers.
"It has been Fluor Corporation's policy to compensate our employees who are US citizens the same as if they worked in the geographic United States," said Keith Stephens, Fluor's director of global media relations.
The bad news is that the US Defense Department apparently knew about KBR's malfeasance four years ago, in 2004-- and didn't do anything about it. Pentagon auditors told the Globe they were OK with KBR's offshore shenanigans because the tax savings "are passed on" to the US military.

You'd have to know a lot more about the bidding process for reconstruction contracts to know whether this is true. Since labor is a big cost for these contractors, the ability to reduce these costs by 15 percent would clearly make it easier for KBR to underbid its competitors. But would they underbid by the full 15.3 percent, or by just enough to make sure they get the bid? Take a wild guess.

Now, if KBR is shortchanging Social Security and Medicare trust funds by $500 million, we should be upset about this, right? The Globe says KBR representatives breezily dismiss this argument by pointing out that "the loss to Social Security could eventually be offset by the fact that the workers will receive less money when they retire, since benefits are generally based on how much workers and their companies have paid into the system."

So, for those looking for a more creative way of subverting Social Security than John McCain's privatization plans, here it is: reduce future Social Security benefits by pretending your employees aren't entitled to them!

One glitch in this clever plan, as the Globe alertly points out, is that Medicare benefits are not reduced for those who don't contribute. So the Medicare portion of the foregone 15.3 percent tax is money that is going to have to be raised through taxes on the rest of us.

But as long as these employees figure out some other infallible way to put aside an adequate nest egg for retirement on their own, the rest is gravy, right? Well, no. As it turns out, Texas-based KBR is also avoiding unemployment taxes on these workers, when means that they'll be ineligible for unemployment benefits later on.

There's a simple solution to the whole problem, which is for Congress to pass legislation requiring companies receiving defense contracts to refrain from artificially offshoring its employees. In the Senate, John Kerry has a bill that would do just that.

March 05, 2008

McCain Backs Away From "No New Taxes"

We noted a couple of weeks ago that presidential candidate John McCain appeared to be following in the footsteps of the first President Bush by making a pledge that he would almost certainly not be able to keep as President: "no new taxes." But in a recent interview with the Wall Street Journal, McCain laudably retreats from this position:
WSJ: On ABC's "This Week" on Feb. 17, in response to a question, "Are you a 'read my lips' candidate, no new taxes?" you replied, "No new taxes." Did you mean that literally?
McCain: I'm not making a "read my lips" statement in that I will not raise taxes. But I'm not saying I can envision a scenario where I would, OK? But I'm not making it a centerpiece in my campaign.
I want lower taxes. I want the family to keep more of their money.
McCain clearly wants to enact more tax cuts, of course. In the same interview, here's his prescription for getting the economy going again:
I would go very public in advocating that the tax cuts be made permanent, otherwise Americans are looking forward to a tax increase at a vulnerable time in our economy. I would call for the elimination of the AMT [alternative minimum tax]. And we absolutely need to reduce corporate tax rates, which are the second highest in the world.
But the good news is that he's not taking a blood oath that this is the only acceptable outcome. In today's political climate, that (sadly) counts as a victory for fiscal sanity.

NYT on McCain's Tax Flops

Now that John McCain is semi-officially the Republican nominee for president in 2008, more attention is being paid to the important question of how he'd restructure the US tax system. As we pointed out recently, McCain's current position on extending the Bush tax cuts (he wants to) is sharply at odds with his speeches (and, more importantly, his votes) during the Bush administration's tax-cutting spree between 2001 and 2005. In short, he not only voted (sensibly, in our view) against various editions of the Bush tax cuts-- he also explained quite clearly that he thought these cuts were too tilted to the wealthiest Americans and would bust the budget. And he now claims not to be troubled by either of these concerns, despite the fact that both of these concerns remain quite accurate.

In yesterday's New York Times, Elizabeth Bumiller surveys the inconsistencies in McCain's policy positions across a number of issues, and finds that "[H]is most striking turnaround has been on the Bush tax cuts, which he voted against twice but now wants to make permanent." Here's Bumiller's take on McCain's shift:
In May 2001, Mr. McCain was one of only two vote against President Bush’s $1.35 trillion 10-year tax cut. On the Senate floor, Mr. McCain said, “I cannot in good conscience support a tax cut in which so many of the benefits go to the most fortunate among us, at the expense of middle-class Americans who most need tax relief.”
Two years later, Mr. McCain was one of three Republicans to vote against additional Bush tax cuts... because, he said then, the costs of the Iraq war were not yet known. Specifically, he said he was open to the idea of tax cuts in the future, “but not until Congress and the administration have a better understanding of the costs of war and peace.”
Later, he said he also opposed the 2003 tax cut because it, too, disproportionately benefited the rich. “I just thought it was too tilted to the wealthy, and I still do,” Mr. McCain told Stephen Moore, a member of The Wall Street Journal editorial board, in an interview published on Nov. 26, 2005.
These days, Mr. McCain says at almost every campaign stop that he wants to make those tax cuts permanent rather than have them expire, as the law stipulates, because getting rid of them would have the effect of a tax hike. He rarely mentions that he originally opposed them or that he did so in large part because he thought they were too tilted to the rich — an objection that
conservatives consider heresy.
When pressed, Mr. McCain now says he voted against the tax cuts because they were not accompanied by sufficient spending cuts, an explanation somewhat more palatable to the right. Asked last week on his campaign plane if he thought the tax cuts were too tilted to the rich, Mr. McCain sidestepped the question and replied that he preferred his own tax proposal at the time, which he said was “more tilted towards the middle class.”
We've argued before that the "flip-flop" epithet is often just silly. Consistency is often a foolish standard to impose on lawmakers in an ever-changing world, as our recent foreign policy exploits remind us-- in 2003 it was not all that hard for lawmakers to make what turned out to be the wrong choice on invading Iraq, and by 2005 it was pretty clear that those initial decisions were based on bad information stoked by a trigger-happy administration and a compliant media.

But when McCain was voting against the Bush tax cuts, we didn't need the CIA to help us evaluate them. McCain's earlier criticisms of the Bush tax cuts' fairness were based on the complete (and entirely accurate) information that was available then-- and remains available now-- about who would benefit from Bush's proposed cuts.

Even on an issue as cut-and-dried as this, however, you could make a case for why McCain's contradictory positions on the Bush tax cuts are sensible. McCain could, if he wanted to, explain that he just doesn't value fairness or balanced budgets as much as he used to, and that he now thinks we ought to pare down the size of government by any means necessary. If and when he does this, we can stop calling this a "flip-flop" and start calling it a lightning-quick, politically-aware evolution in his policy positions.

Until he does so, however, this seems like a case in which the "flip-flopper" label might fairly be applied.