Chained CPI: A Stealth Tax Increase

Posted by Chris Edwards

As we close in on congressional votes to increase the federal debt limit, negotiators are coming up with all kinds of ideas to hike taxes. (Suspiciously, they haven’t revealed very many spending cut ideas so far).

One idea being discussed is to raise revenue by reducing the indexing of parameters in the income tax code. Currently, tax brackets and other features of the tax code are indexed to the Consumer Price Index (CPI). It is widely recognized that the CPI overestimates inflation for various reasons, as discussed here.

The Bureau of Labor Statistics has developed a more accurate (and lower) measure of inflation, called chained CPI. If the tax code was indexed to chained CPI instead of CPI, the government would receive an automatic tax increase relative to current law every year until the end of time.

Switching to chained CPI is a very bad idea for two reasons:

  • It would create a large tax increase over the long run. And it would be an invisible annual tax increase on families and voters because there would be no obvious changes in their tax forms.
  • It would be an anti-growth tax increase because it would push families into higher tax brackets more quickly over time, subjecting them to higher marginal tax rates. The chained CPI proposal is essentially a proposal to increase marginal tax rates slowly and steadily over time.

Some economists may argue that the chained CPI proposal is a good idea because the tax code would more accurately reflect inflation, and it would. However, the tax code already contains a bias that pushes families into higher tax brackets over time, which is called “real bracket creep.” Real growth in the economy steadily moves taxpayers into higher rate brackets since the tax code is indexed for inflation but not real growth. The discussion in the Congressional Budget Office’s new long-range budget outlook implies that this will be an important force in raising federal revenues as a share of GDP in coming decades.

So I’ve got a better idea than indexing the tax code to chained CPI: indexing the tax code to nominal GDP growth. That would adjust for the effects of both inflation and real economic growth on tax code parameters, and it would prevent stealth tax rate increases under our graduated income tax system.

Tuesday Links

Posted by George Scoville

Tuesday Links

Posted by George Scoville

  • Republicans have a big opportunity to undo Obamacare and reform Medicaid and Medicare all at once.
  • It’s a good thing, too, because we’re facing a big debt crisis and if we don’t change course, federal spending will crest 42% of GDP by 2050.
  • There’s also a big elephant in the room in an excessively complicated tax code.
  • One has to wonder if the Republicans intend to put the big sacred cow of defense spending on the table.
  • Unrelated to the budget, education choice proponents scored a big victory in the U.S. Supreme Court yesterday in ACSTO v. Winn, a decision that upheld education tax credits:

The Bogus Charge of ‘Shipping Jobs Overseas’

Posted by Daniel Griswold

In the final push before Election Day, President Obama has been traveling the country criticizing Republicans for favoring tax breaks for U.S. companies that supposedly ship U.S. jobs overseas. It’s a bogus charge that I dismantle in an op-ed in this morning’s New York Post:

The charge sounds logical: Under the US corporate tax code, US-based companies aren’t taxed on profits that their affiliates abroad earn until those profits are returned here. Supposedly, this “tax break” gives firms an incentive to create jobs overseas rather than at home, so any candidate who doesn’t want to impose higher taxes on those foreign operations is guilty of “shipping jobs overseas.”

In fact, American companies have quite valid reasons beyond any tax advantage to establish overseas affiliates: That’s how they reach foreign customers with US-branded goods and services.

Those affiliates allow US companies to sell services that can only be delivered where the customer lives (such as fast food and retail) or to customize their products, such as automobiles, to better reflect the taste of customers in foreign markets.

I go on to point out that close to 90 percent of what U.S.-owned affiliates produce abroad is sold abroad; that those foreign affiliates are now the primary way U.S. companies reach global consumers with U.S.-branded goods and services; and that the more jobs they create in their affiliates abroad, the more they create in their parent operations in the United States. If Congress raises taxes on those foreign operations, it will only force U.S. companies to cede market share to their German and Japanese (and French and Korean) competitors.

I unpack the issue at greater length in a Free Trade Bulletin published last year, and on pages 99-104 of my recent Cato book, Mad about Trade: Why Main Street America Should Embrace Globalization.

Costly IRS Mandate Slipped into Health Bill

Posted by Chris Edwards

Most people know about the individual mandate in the new health care bill, but the bill contained another mandate that could be far more costly.

A few wording changes to the tax code’s section 6041 regarding 1099 reporting were slipped into the 2000-page health legislation. The changes will force millions of businesses to issue hundreds of millions, perhaps billions, of additional IRS Form 1099s every year. It appears to be a costly, anti-business nightmare.

Under current law, businesses are required to issue 1099s in a limited set of situations, such as when paying outside consultants. The health care bill includes a vast expansion in this information reporting requirement in an attempt to raise revenue for an increasingly rapacious Congress.

In a recent summary, tax information firm RIA notes the types of transactions covered by the new 1099 rules:

The 2010 Health Care Act adds “amounts in consideration for property” (Code Sec. 6041(a) as amended by 2010 Health Care Act §9006(b)(1)) and “gross proceeds” (Code Sec. 6041(a) as amended by 2010 Health Care Act §9006(b)(2)) to the pre-2010 Health Care Act categories of payments for which an information return to IRS will be required if the $600 aggregate payment threshold is met in a tax year for any one payee. Thus, Congress says that for payments made after 2011, the term “payments” includes gross proceeds paid in consideration for property or services.

Basically, businesses will have to issue 1099s whenever they do more than $600 of business with another entity in a year. For the $14 trillion U.S. economy, that’s a hell of a lot of 1099s. When a business buys a $1,000 used car, it will have to gather information on the seller and mail 1099s to the seller and the IRS. When a small shop owner pays her rent, she will have to send a 1099 to the landlord and IRS. Recipients of the vast flood of these forms will have to match them with existing accounting records. There will be huge numbers of errors and mismatches, which will probably generate many costly battles with the IRS.

Tax CPA Chris Hesse of LeMaster Daniels tells me:

Under the health legislation, the IRS could be receiving billions of more documents. Under current law, businesses send Forms 1099 for payments of rent, interest, dividends, and non-employee services when such payments are to entities other than corporations. Under the new law, businesses will be required to send a 1099 to other businesses for virtually all purchases. And for the first time, 1099s are to be sent to corporations. This is a huge new imposition on American business, costing the private economy much more than any additional tax that the IRS might collect as a result.

There appears to have been little discussion before this damaging mandate was slipped into the health bill and rammed through Congress, but a few business groups did raise concerns. Here’s what the Air Conditioner Contractors of America said:

The House bill would extend the Form 1099 filing requirement to ALL vendors (including corporate) to which they pay more than $600 annually for services or property. Consider all the payments a small business makes in the course of business, paying for things such as computers, software, office supplies, and fuel to services, including janitorial services, coffee services, and package delivery services.

In order to file all these 1099s, you’ll need to collect the necessary information from all your service providers. In order to comply with the law, you would have to get a Taxpayer Information Number or TIN from the business. If the vendor does not supply you with a TIN, you are obligated to withhold on your payments.

Private transactions are the core of a market economy, and the source of America’s growth and prosperity. Now the federal government is imposing a vast new web of red tape on perhaps billions of these growth-generating private exchanges.

For what purpose? So the spendthrift Congress can shake a few extra bucks out of private industry? The business sector is the generator of America’s high living standards, but most federal legislators just see it as a kitty to be raided or a cow to be milked dry.

I’m stunned that there wasn’t a broader debate before such a costly mandate was enacted. If it goes into effect, it will waste vast quantities of human effort in filling out forms, reworking computer systems, collecting and organizing data, and fighting the IRS. The struggling American economy can’t afford anymore suffocating tax regulations. This mandate is a giant deadweight loss. It should be repealed.

The Flat Tax: Good for America, Bad for Washington

Posted by Daniel J. Mitchell

America’s biggest fiscal challenge is excessive government spending. The public sector is far too large today and it is projected to get much bigger in coming decades. But the corrupt and punitive internal revenue code is second on the list of fiscal problems. This new video, narrated by yours truly, explains how a flat tax would work and why it would promote growth and fairness. Something to keep in mind with tax day in just a couple of weeks.

There are two big hurdles that must be overcome to achieve tax reform. The first obstacle is that the class-warfare crowd wants the tax code to penalize success with high tax rates. That issue is addressed in the video in a couple of ways. I explain that fairness should be defined as treating all people equally, and I also point out that upper-income taxpayers are far more likely to benefit from all the deductions, credits, exemptions, preferences, and other loopholes in the tax code. The second obstacle, which is more of an inside-the-beltway issue, is that the current tax system is very rewarding for the iron triangle of lobbyists, politicians, and bureaucrats (or maybe iron rectangle if we include the tax preparation industry). There are tens of thousands of people who make very generous salaries precisely because the tax code is a playground for corrupt deal making. A flat tax for these folks would be like kryptonite for Superman. But more than two dozen nations around the world have implemented a flat tax, so hope springs eternal.

A 10-Point, Libertarian, SOTU Address

Posted by Jeffrey A. Miron

1. Abandon Obamacare

2. Forget Cap and Trade

3. Reject the Card Check Bill

4. Withdraw from Iraq and Afghanistan

5. Legalize Drugs

6. Scrap the tax code and replace with a flat tax

7. Expand free trade and immigration

8. Stop the bailouts

9. Cut spending

10. Cut spending

BONUS -  Cut spending

Reforming the Insane Tax Code

Posted by Chris Edwards

We’ve got an IRS Commissioner who doesn’t even do his own taxes, and is not embarrassed about it. We’ve got complex deductions that nobody understands, including the government, as the Maryland nurse with the MBA found out. We’ve got a Treasury Secretary and other high appointees who apparently cheated on their taxes. And we’ve got the Democrats hell-bent on greatly increasing the power and responsibilities of the overwhelmed IRS with their health care bill.

Now, more than ever, it’s time to scrap the current income tax and put in a flat tax. Or at least we could take a big jump in that direction with a “Simplified Tax,” as discussed in a new National Academies report. Get rid of all almost all deductions, exemptions, and credits and drop individual rates to 10 and 25 percent. While we’re at it, let’s drop the federal corporate rate to 25 percent or less.

For more on the two-rate tax idea, see my Options for Tax Reform and Rep. Paul Ryan’s American Roadmap.

‘Tax Cuts’ and Welfare Spending

Posted by Chris Edwards

A story in the Washington Post today is headlined: “Obama Would Keep $85 Billion in Tax Breaks for Working Poor.”

The “tax breaks” in question are expansions in the earned income tax credit and the child tax credit. The Post story repeatedly calls the expansions “tax breaks” and “tax cuts.” The budget expert quoted in the story calls them “tax cuts,” and so does a House staffer and a spokesperson for the president.

But these are not tax cuts. They are expansions in the refundability of provisions in the tax code. That means that households that pay no federal income tax will receive larger welfare checks from the government under these Obama proposals.

Obama has proposed a slew of “tax cuts” that are partly welfare payments. The chart below shows the share of the 2010-2019 dollar values of these proposals that are actually increased federal spending, and not reductions in taxes. (Calculated from OMB’s May summary tables).

200909_edwards_blog

The Post reporter and the budget analyst quoted in the story are both fiscal experts, and they know that these “tax cuts” are not really tax cuts. But there is a growing problem in fiscal discussions that words are getting flipped upside down to mean the opposite of what a layman would understand them to mean. A classic example is how the dollar value of true tax cuts is nearly always referred to in news articles as a “cost” rather than a “saving.”

Steny Hoyer’s use of the phrase “paid for” in the health debate is another example of how Washington-speak is confusing the heck out of people.

The Post and Times Push for Cap and Trade

Posted by Patrick J. Michaels

Since the June House vote on the Waxman-Markey “cap-and-trade” bill, lawmakers from both chambers have backed significantly away from the legislation. The first raucous “town hall” meetings occurred during the July 4 recess, before health care. Voters in swing districts were mad as heck then, and they’re even more angry now. Had the energy bill not all but disappeared from the Democrats’ fall agenda, imagine the decibel level if members were called to defend it and Obamacare.

But none of this has dissuaded the editorial boards of the The New York Times and Washington Post. Both newspapers featured uncharacteristically shrill editorials today demanding climate change legislation at any cost.

The Post, at least, notes the political realities facing cap-and-trade and resignedly confesses its favored approach to the warming menace: “Yes, we’re talking about a carbon tax.” The paper—motto: “If you don’t get it, you don’t get it”—argues that in contrast to the Boolean ball of twine that is cap-and-trade, a straight carbon tax will be less complicated to enforce, and that the cost to individuals and businesses “could be rebated…in a number of ways.”

Get it? While ostensibly tackling the all-encompassing peril of global warming, bureaucrats could rig the tax code in other ways to achieve a zero net loss in economic productivity or jobs. Right. Anyone who makes more than 50K, or any family at 100K who thinks they will get all their money back, please raise you hands.

The prescription offered by the Times, meanwhile, is chilling in its cynicism and extremity. It embraces the fringe—and heavily discredited—idea of “warning that global warming poses a serious threat to national security.” It bullies lawmakers with the threat that warming could induce resource shortages that would “unleash regional conflicts and draw in America’s armed forces.”

(Note to the Gray Lady: This is why we have markets. Not everyone produces everything, especially agriculturally. For example, it’s too cold in Canada to produce corn, so they buy it from us. They export their wheat to other places with different climates. Prices, supply, and demand change with weather, and will change with climate, too. Markets are always more efficient than Marines, and will doubtless work with or without climate change.)

Appallingly, the piece admits that “[t]his line of argument could also be pretty good politics — especially on Capitol Hill, where many politicians will do anything for the Pentagon. … One can only hope that these arguments turn the tide in the Senate.” In other words: the set of circumstances posited by the national-security strategy are not an object reality, but merely a winning political gambit.

There’s no way that people who see through cap-and-trade are going to buy the military card, but one must admire the Times’ stratagem for durability. Militarization of domestic issues is often the last refuge of the desperate. How many lives has this cost throughout history?

Nevertheless, one must wonder at the sudden and inexplicable urgency that underpins the positions of both these esteemed newspapers. Global surface temperatures haven’t budged significantly for 12 years, and it’s becoming obvious that the vaunted gloom-and-doom climate models are simply predicting too much warming.

Still, one must admire the Post and Times for their altruism. The economic distress caused by a carbon tax, militarization, or any other radical climatic policy certainly won’t be good for their already shaky finances, unless, of course, the price of their support is a bailout by the Obama Administration.

Now that’s cynical.

For Financial Stability, Fix the Tax Code

Posted by Mark A. Calabria

There seems to be near universal agreement that the excessive use of debt among both corporations, particularly banks, and households contributed to the severity of the financial crisis.  However, other than the occasional refrain that banks should hold more capital, there has been little discussion over why corporations choose to be so highly leveraged in the first place.  But then such a discussion might lead us to the all too obvious answer — the federal government, via the tax code, encourages, even heavily subsidizes corporate leverage.

Cato scholar and banking analyst Bert Ely has estimated that the subsides for debt have historically resulted in an after tax cost of debt of 3 to 5 percent, compared to an after tax cost of equity of 12 to 15 percent.  With differences of this magnitude, it should not be surprising that financial companies and corporations in general become highly leveraged.

For corporations, this massive difference in cost between debt and equity financing results primary from the ability to deduct interest expenses on debt, while punishing equity due to the double-taxation of dividends along with taxing capital gains. 

If we are going to use the tax code to subsidize debt and tax equity, we shouldn’t act surprised when firms load up on the debt and reduce their use of equity — making financial crises all too frequent and severe.

Kennedy’s Health Bill: A First Look

Posted by Michael D. Tanner

A draft of Sen. Ted Kennedy’s health care reform bill is finally available, and it is difficult to overstate how far he would move us to a government-run health care system. An initial read-through reveals among the key provisions:

  • An individual mandate, requiring that every American purchase a “qualified” insurance plan. (Sec. 161(a)) The mandate will be enforced through the tax code with Americans required to pay a penalty if they fail to comply.  In an extraordinary delegation of congressional authority, the Kennedy bill would give the Secretaries of Treasury and Health and Human Services the power to determine what this penalty should be. Individuals would be required to submit information on their insurance status over the previous year to the Secretary of HHS, along with “any such other information as the Secretary may require.” (Sec. 6055(b)(2) and (3)). Individuals who already have insurance could keep it. However, if they changed plans (or presumably changed jobs), their new insurance would have to meet the definition of “qualified.”
  • A “pay or play” employer mandate requiring employers to provide all workers with health insurance and pay a minimum amount of the premium, or pay a tax (Sec 162). Again, the amount of the new tax is left to the discretion of the Secretaries of HHS and Treasury. Some small employers would be exempt from the mandate, but the size of those firms remains TBA. (Sec. 3113(g)) Companies with fewer than 250 workers would be forbidden to self-ensure. (Sec. 2720)
  • A new federal bureaucracy, the Medical Advisory Council, which would determine what benefits will be required to be part of your “qualified” insurance plan. (Sec. 3103(h) and (i)). Lest anyone think Congress won’t get involved. The Council’s decisions can be disapproved by Congress if, say, they don’t mandate inclusion by a favored provider group or disease constituency. (Sec 3103(g)).
  • Massive new federal subsidies. Medicaid would be expanded to individuals earning 150 percent of the poverty level, and the federal government would pay all incremental costs of the increased enrollment. (Sec 152.) Single, childless adults would become eligible for Medicaid. Even more egregious, individuals and families with incomes between 150-500 percent of the poverty level ($110,250 for a family of four) would be eligible for subsidies on a sliding scale-basis.(Sec. 3111(b)(1)(A-G)).
  • Insurers would be required to accept all applicants regardless of their health (guaranteed issue) and forbid insurers from basing insurance premiums on risk factors (Community rating). There does not appear to be any exception for lifestyle factors, such as smoking, alcohol or drug use, diet, exercise, etc. Thus, not only will the young and healthy be forced to pay higher premiums to subsidize the old and unhealthy, but the responsible will be forced to pay more to subsidize the irresponsible.
  • A “public option” operating in competition with private insurance (Section 31__). How this plan would be funded, the level of premiums, etc. is left mostly TBA. In response to criticism, the Kennedy bill does require that the public plan pay providers 10 percent above Medicare reimbursement rates. (Sec 31__(B)). That would still allow for a considerable degree of cost-shifting to private insurance. And, we should recall that such promises are ephemeral. When Medicare began, proponents promised it would reimburse at the same rate as insurance. That promise didn’t last long.
  • States would be prodded to set up “gateways,” similar to Massachusetts’ “connector.” (Sec 3104(a)) If a state fails to do so, the federal government will set one up for them. (Sec. 3104(d)) The federal government would provide grants to states to help them set up these gateways. The amount of the grants is, you guessed it, left to the discretion of the Secretary of HHS. Gateways may also fund their operations by assessing a surcharge on insurers. Sec. 3101(b)(5)(A)/
  • A new federal long-term care program (Sec 171).

Kennedy does not include any estimate of how much his plan would cost, nor any proposal for how to pay for it.

More details will undoubtedly emerge, but it is very clear that the Kennedy plan would put one-sixth of the US economy and some of our most important, personal, and private decisions firmly under the thumb of the federal government.