‘Bush-ama’ tax cuts: The $2.2 trillion decision

May 4, 2010: 12:10

NEW YORK (CNNMoney.com) — They’re often called the “Bush” tax cuts. But at this point they might as well be called the Bush-ama tax cuts.

That’s because President Obama has embraced the tax relief measures introduced in 2001 and 2003, proposing they be extended indefinitely for most Americans. If lawmakers do nothing, the measures expire Dec. 31.

The tax cuts lowered income and investment tax rates, boosted the child credit, reduced the estate tax, and narrowed inequalities affecting married taxpayers.

Another reason for the new Bush-ama moniker: Like President Bush, President Obama has not called on Congress to pay for the cost of the tax cuts. In fact, the extension of the cuts is exempt from the new “pay-go” rules that Obama signed into law recently.

Extending the tax cuts for most Americans will increase the federal deficit by an estimated $2.2 trillion over 10 years.

Deficit hawks are uber-frustrated.

“Why do you spend over $2 trillion in your budget — the most you spend on any single policy item — on your predecessor’s tax policy, which you repeatedly explain is to blame for the deterioration and unsustainability of our nation’s fiscal outlook?” Diane Rogers, chief economist for the Concord Coalition, wrote in her blog Economistmom.com.

In a nod to deficit reduction, Obama did propose that lawmakers let the tax cuts expire for high-income households, couples making more than $250,000. Doing so would reduce the deficit by $678 billion from where it would be if the cuts were extended for everyone.

But recently, while he didn’t say so explicitly, Obama seemed open to rethinking his campaign promise not to raise taxes on the middle-class. In an interview last month, he said he would weigh recommendations from the bipartisan fiscal commission he created to suggest ways to put the U.S. fiscal house in order.

“We should be able to solve this problem without putting a burden on middle class families,” he told CNBC. “Having said that, I’m also going to wait for the fiscal commission to provide me [with] their best recommendations. … At a certain point, what we’ve got to do is match up money going out and money coming in.”

The next 7 months

The commission won’t report its recommendations until Dec. 1. In the meantime, it’s not clear when Congress will take up the issue of the 2001/2003 tax cuts. One theory is that they’ll vote to extend them before their August recess to score political points before the midterm elections in November.

“It would look ugly to go home and campaign for five weeks without having done something for the middle class,” said Clint Stretch, managing principal of tax policy at Deloitte Tax LLC.

On the other hand, the legislative agenda is already fairly packed.

Anne Mathias, director of research at Concept Capital’s Washington Research Group, is in the camp that believes Congress may not address the issue until December.

It’s also not clear yet how long lawmakers might opt to extend the tax cuts. There had been a push by both parties to make them permanent. But some believe extending them for a year or two may be the smartest move given current political and economic constraints.

IOUSA Solutions’: Deficit explosion

Maya MacGuineas, president of the Committee for a Responsible Federal Budget, proposes that lawmakers extend the tax cuts to the end of 2012, and then use the prospect of making them permanent as a “sweetener” to draw votes for a serious deficit-reduction deal. No deal, no tax cuts.

“This would turn the expiration of the tax cuts at the end of 2012 into a realistic action-forcing hammer … . Otherwise, the task of stabilizing the debt goes from really hard to nearly impossible,” MacGuineas wrote in a blog post.

No matter how long the tax cuts are extended, no one should bank on low rates forever, Stretch cautioned. The country’s long-term fiscal condition is too precarious for that.

“No matter what happens, Americans’ taxes are going up one way or another. The middle class is going to have to be called on to help reduce the deficit. There’s not enough fiscal capacity if we just tax the top 3%,” Stretch said.

Health Care Reform Reshapes Tax Code

By ALISTAIR M. NEVIUS, J.D.

April 1, 2010

In March, Congress passed two pieces of legislation designed to reform the U.S. health care system. The Patient Protection and Affordable Care Act (PL 111-148) was enacted on March 23, and was quickly followed by the Health Care and Education Reconciliation Act of 2010 (PL 111-152), which amended several portions of the first act, as well as adding new provisions of its own. While the legislation generally deals with the health care system, it contains many revisions to the Internal Revenue Code. Individuals and businesses are affected and are likely to look to their accountants and financial advisers for guidance and compliance help.

Among other things, the legislation provides a credit to help individuals afford insurance; it also imposes a penalty on individuals who do not obtain health insurance. Small businesses that provide health coverage for their employees are also eligible for a credit; large businesses that provide inadequate health coverage are subject to an excise tax. The medical deduction threshold is increased to 10% of adjusted gross income. And, in a provision not related to health care, Forms 1099 will now be required for payments of $600 or more to corporations (see sidebar, “Provisions Unrelated to Health Care,” at bottom of page).

This article describes many of the tax items in the two acts applicable to individuals and businesses. Note that most of these items do not take effect until future years.

PROVISIONS FOR INDIVIDUALS

Premium assistance credit. The Patient Protection Act provides for a refundable tax credit that eligible taxpayers can use to help cover the cost of premiums for health insurance purchased through a state health benefit exchange (which each state is required to establish under the act). Under new IRC § 36B, an eligible individual will enroll in a plan offered through an exchange and report his or her income to the exchange. Based on the information provided to the exchange and his or her income, the individual will receive a premium assistance credit. The Treasury Department will pay the premium assistance credit amount directly to the insurance plan in which the individual is enrolled. The individual will then pay to the plan in which he or she is enrolled the dollar difference between the premium tax credit amount and the total premium charged for the plan. Alternatively, eligible individuals can pay for the insurance out of pocket and then claim the credit on their tax returns.

Eligibility for the premium assistance credit is based on the individual’s income for the tax year ending two years prior to the enrollment period. The premium assistance credit is available for individuals (single or joint filers) with household incomes between 100% and 400% of the federal poverty level (for the family size involved) who do not received health insurance through an employer or a spouse’s employer. The credit amount is determined by the secretary of Health and Human Services, based on the amount by which premiums exceed a threshold amount. The threshold rises from 2% of income for those at 100% of the federal poverty level for the family size involved to 9.5% of income for those at 400% of the federal poverty level for the family size involved.

The Reconciliation Act provides for an inflation adjustment in the starting and ending percentages for years after 2014. The adjustment will be based on the rate of premium growth for the preceding calendar year over that year’s rate of income growth.

After 2018, the inflation adjustment will be based on the rate of premium growth for the preceding calendar year over that year’s consumer price index growth, but only if the aggregate amount of premium assistance tax credits and cost-sharing reductions (under section 1402 of the Patient Protection Act) for the preceding calendar year exceeds an amount equal to 0.504% of the gross domestic product for the preceding calendar year.

The premium assistance credit will be available for years ending after Dec. 31, 2013.

Excise tax on uninsured individuals. The Patient Protection Act creates new IRC § 5000A, which requires U.S. citizens and legal residents to maintain minimum amounts of health insurance coverage. Minimum essential coverage includes various government-sponsored programs, eligible employer-sponsored plans, plans in the individual market, grandfathered group health plans, and other coverage as recognized by the secretary of Health and Human Services in coordination with the Treasury secretary. The coverage requirement would not apply to individuals who are incarcerated, are not legally present in the United States, or qualify for a religious exemption.

Individuals who fail to maintain minimum essential coverage will be subject to a penalty equal to the greater of (1) 2.5% of the amount by which the taxpayer’s household income for the tax year exceeds the threshold amount of income required for income tax return filing under section 6012(a)(1); or (2) $695 per uninsured adult in the household. The penalty will be phased in from 2014–2016. For 2014, the penalty will be the greater of 1% of household income over the filing threshold or $95; for 2015, it will be the greater of 2% of household income over the filing threshold or $325; and for 2016 it will be the full 2.5% or $695.

The act specifies that liens and seizures are not authorized to enforce this penalty, and noncompliance will not be subject to criminal penalties. The excise tax on uninsured individuals has been criticized as unconstitutional, and it has been challenged in a lawsuit brought by several state attorneys general (Florida v. Dept. of Health and Human Services, docket no. 3:10-cv-00091-RV-EMT (N.D. Fla., filed 3/23/10)).

This provision is effective for tax years beginning after Dec. 31, 2013.

Adult dependent. The Reconciliation Act raises the age up to which parents can carry their children on their health insurance policy. It does this by changing the definition of “dependent” for purposes of IRC § 105(b) (excluding from income amounts received under a health insurance plan) to include amounts expended for the medical care of any child of the taxpayer who has not yet reached age 27. The same change is made in section 162(l)(1) for purposes of the self-employed health insurance deduction, section 501(c)(9) for purposes of benefits provided to members of a VEBA, and in section 401(h) for benefits for retirees. These changes were effective upon enactment.

Medical care itemized deduction threshold. The threshold for the itemized deduction for unreimbursed medical expenses is increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for tax years beginning after Dec. 31, 2012, except that in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Additional hospital insurance tax on high-income taxpayers. Under the Patient Protection Act, the employee portion of the hospital insurance tax part of FICA, currently 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.

The provision applies to remuneration received and tax years beginning after Dec. 31, 2012.

Medicare tax on investment income. The Reconciliation Act added a new IRC § 1411 that imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or adjusted gross income over the dollar amount at which the highest trust and estate tax bracket begins.

For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income is defined as income from interest, dividends, annuities, royalties and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business (however, income from passive activities and from a trade or business of trading in financial instruments or commodities is included in the definition of net investment income).

This provision applies to tax years beginning after Dec. 31, 2012.

Return information disclosure. The Patient Protection Act allows the IRS, upon written request of the secretary of Health and Human Services, to disclose certain taxpayer return information if the taxpayer’s income is relevant in determining the amount of the tax credit or cost-sharing reduction or eligibility for participation in the specified state health subsidy programs.

Upon written request from the commissioner of Social Security, the IRS may disclose certain limited return information of a taxpayer whose Medicare Part D premium subsidy, according to the records of the Treasury secretary, may be subject to adjustment.

Flexible spending arrangement. The Patient Protection Act mandates that the maximum amount available for reimbursement of incurred medical expenses of an employee, the employee’s dependents, and any other eligible beneficiaries with respect to the employee, under a health flexible spending arrangement for a plan year (or other 12-month coverage period) must not exceed $2,500. The provision is effective for tax years beginning after Dec. 31, 2012.

Restrictions on use of HSA and FSA funds. Under the Patient Protection Act, amounts paid for over-the-counter medications will no longer be reimbursable from health savings accounts (HSAs), Archer medical savings accounts (MSAs), health FSAs, or health reimbursement arrangements. Amounts paid for a drug will only meet the definition of “qualified medical expenses” in sections 106, 220 and 223 if the drug is a prescribed drug (or is insulin). This provision is effective for amounts paid or expenses incurred after Dec. 31, 2010.

Tax on HSA distributions. The additional tax on distributions from an HSA or an Archer MSA that are not used for qualified medical expenses is increased to 20% of the disbursed amount, effective for disbursements made during tax years starting after Dec. 31, 2010. (Under prior law, the tax was 10% of the disbursed amount for HSAs and 15% for Archer MSAs.)

Cafeteria plans. The Patient Protection Act makes premiums for coverage under a qualified health plan offered through an exchange a qualified benefit under a cafeteria plan. This provision applies only to cafeteria plans established by a small employer that elects to make all its full-time employees eligible for one or more qualified plans offered in the small group market through an exchange.

This provision is effective for tax years beginning after Dec. 31, 2013.

PROVISIONS FOR BUSINESSES

Small business tax credit. The Patient Protection Act provides tax credits for small businesses and individuals designed to increase levels of health insurance coverage, as part of the IRC § 38 general business credit. Small businesses—defined as businesses with 25 or fewer employees and average annual wages of less than $50,000—are eligible for a credit of up to 50% of nonelective contributions the business makes on behalf of its employees for insurance premiums (new IRC § 45R). Tax-exempt organizations would get a 35% credit against payroll taxes.

Employers with 10 or fewer employees and average wages of less than $25,000 will get 100% of the credit; for other eligible employers, the credit will be reduced based on the number of employees over 10 and the excess of the employees’ average wages over $25,000. The $25,000 average annual wages figure will be indexed for inflation after 2013. 

This credit is available for tax years beginning after Dec. 31, 2009, and is phased in from 2010 through 2013. During the phase-in years, the maximum credit is 35% of the employer’s eligible premium expense (25% for tax-exempt employers).

Employer responsibility. Under new IRC § 4980H, an “applicable large employer” that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or offers minimum essential coverage that consists of a plan under which the plan’s share of the total allowed cost of benefits is less than 60%, is required to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee.

An employer is an applicable large employer with respect to any calendar year if it employed an average of at least 50 full-time employees during the preceding calendar year.

The penalty for any month is an excise tax equal to the number of full-time employees over a 30-employee threshold during the applicable month (regardless of how many employees are receiving a premium tax credit or cost-sharing reduction) multiplied by $166.67 (one-twelfth of $2,000).

This provision is effective for months beginning after Dec. 31, 2013.

Prescription drug coverage deduction. The Patient Protection Act eliminates the IRC § 139A deduction for employers who subsidize prescription drug coverage for their employees who are eligible for Medicare Part D. This provision is effective for tax years beginning after Dec. 31, 2010.

Reporting requirements. The Patient Protection Act requires insurers (including employers who self-insure) that provide minimum essential coverage to any individual during a calendar year to report certain health insurance coverage information to both the covered individual and to the IRS (new IRC § 6055).
The information required to be reported includes: (1) the name, address and taxpayer identification number of the primary insured, and the name and taxpayer identification number of each other individual obtaining coverage under the policy; (2) the dates during which the individual was covered under the policy during the calendar year; (3) whether the coverage is a qualified health plan offered through an exchange; (4) the amount of any premium tax credit or cost-sharing reduction received by the individual with respect to such coverage; and (5) such other information as the Treasury secretary may require.

This requirement is effective for calendar years beginning after 2013.

Information reporting. The Patient Protection Act requires employers to disclose on each employee’s annual Form W-2 the value of the employee’s health insurance coverage sponsored by the employer, effective for tax years beginning after Dec. 31, 2010.

Tax-exempt health insurers. The Patient Protection Act provides for a program administered by the Department of Health and Human Services to encourage the creation of qualified nonprofit health insurance issuers to offer health insurance. Insurers receiving federal grants or loans under the program would be exempt from federal tax (under IRC § 501(a)) for periods when the insurer complies with the terms of the program.

Fees on health plans. Under new IRC § 4375, a fee is imposed on each specified health insurance policy. The fee is equal to $2 ($1 in policy years ending during fiscal year 2013) multiplied by the average number of lives covered under the policy. The issuer of the policy is liable for payment of the fee.

New IRC § 4376 imposes a similar fee on self-insured health plans, equal to $2 ($1 in policy years ending during fiscal year 2013) multiplied by the average number of lives covered under the plan.

For any policy year beginning after Sept. 30, 2014, under both IRC §§ 4375 and 4376, the dollar amount is equal to the sum of the dollar amount for policy years ending in the preceding fiscal year plus an amount equal to the product of (1) the dollar amount for policy years ending in the preceding fiscal year, multiplied by (2) the percentage increase in the most recent projected per capita amount of national health expenditures.

The fee is effective with respect to policies and plans for portions of policy or plan years beginning on or after Oct. 1, 2012.

Charitable hospitals. The Patient Protection Act establishes new requirements applicable to section 501(c)(3) hospitals, regarding conducting a community health needs assessment, adopting a written financial assistance policy, limitations on charges, and collection activities.

Excise tax on high-cost employer plans. New IRC § 4980I imposes an excise tax on insurers if the aggregate value of employer-sponsored health insurance coverage for an employee (including, for purposes of the provision, any former employee, surviving spouse and any other primary insured individual) exceeds a threshold amount. The tax is equal to 40% of the aggregate value that exceeds the threshold amount. For 2018, the threshold amount is $10,200 for individual coverage and $27,500 for family coverage, multiplied by the health cost adjustment percentage (as defined in the act) and increased by the age and gender adjusted excess premium amount (as defined in the act).

Retirees and employees in certain high-risk professions or who repair or install electrical or telecommunications lines have a higher limit. After 2018, the annual limitation is adjusted for inflation.

The provision is effective for tax years beginning after Dec. 31, 2017.

Medical device excise tax. The Reconciliation Act added new IRC § 4191, which imposes a 2.3% excise tax on sales of certain medical devices. The tax applies to sales of any medical device intended for humans (as defined in section 201(h) of the Federal Food, Drug, and Cosmetic Act (21 U.S.C. § 321(h))), except eyeglasses, contact lenses, hearing aids, and medical devices generally sold at retail to the public for individual use. This provision is effective for sales after Dec. 31, 2012.

SIMPLE cafeteria plans for small businesses. The Patient Protection Act establishes a SIMPLE cafeteria plan for small businesses. Under the provision, an eligible small employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan, including group term life insurance, benefits under a self-insured medical expense reimbursement plan, and benefits under a dependent care assistance program. Under the safe harbor, a cafeteria plan and the specified qualified benefits are treated as meeting the specified nondiscrimination rules if the cafeteria plan satisfies minimum eligibility and participation requirements and minimum contribution requirements.

The provision is effective for tax years beginning after Dec. 31, 2010.

The health care legislation contains several tax provisions unrelated to health care. These include:

Information reporting. The Patient Protection Act requires businesses to file an information return (for example, a Form 1099) for all payments aggregating $600 or more in a calendar year to a single payee, including corporations (other than a payee that is a tax-exempt corporation). The provision is effective for payments made after Dec. 31, 2011.

Expansion of adoption credit, adoption-assistance programs. For 2010, the maximum adoption credit is increased to $13,170 per eligible child (a $1,000 increase). This increase applies to both non-special-needs adoptions and special-needs adoptions. Also, the adoption credit is made refundable. The new dollar limit and phase out of the adoption credit are adjusted for inflation in tax years beginning after Dec. 31, 2010. The scheduled sunset of Economic Growth and Tax Relief Reconciliation Act (EGTRRA) provisions relating to the adoption credit is delayed for one year (that is, the sunset becomes effective for tax years beginning after Dec. 31, 2011).

For adoption-assistance programs, the maximum exclusion is increased to $13,170 per eligible child (a $1,000 increase). The new dollar limit and income limitations of the employer-provided adoption-assistance exclusion are adjusted for inflation in tax years beginning after Dec. 31, 2010. The EGTRRA sunset of provisions relating to adoption-assistance programs is also delayed for one year (that is, the sunset becomes effective for tax years beginning after Dec. 31, 2011). Under the sunset, after 2011, the adoption credit will revert to its pre-EGTRRA provisions (that is, a $6,000 credit for special-needs children only), and the income exclusion will disappear.

Economic substance doctrine. The Reconciliation Act codifies the economic substance doctrine in new IRC § 7701(o). The provision says that a transaction will be treated as having economic substance only if the transaction changes the taxpayer’s position in a meaningful way (apart from the tax benefits) and the taxpayer has a substantial purpose (apart from the tax benefits) for entering into the transaction.

The economic substance doctrine was created by the courts, and while they agree about the general definition and purpose, they have applied various tests in determining whether a transaction has economic substance. The act codifies a two-part test and requires transactions to meet both prongs of the test.

The Reconciliation Act puts failure to meet the economic substance test within the list of transactions that are subject to penalty under IRC § 6662 and imposes an increased penalty amount for nondisclosed transactions that lack economic substance. The act also removes transactions that lack economic substance from the reasonable cause exception in IRC § 6664.

Tax on indoor tanning services. The Patient Protection Act imposes a 10% tax on amounts paid for indoor tanning services (new IRC § 5000B). Like a sales tax, the tax will be collected from the person tanning when payment for the tanning services is made. The provision applies to services performed on or after July 1, 2010.

Federal Income Taxes on Middle-Income Families at Historically Low Levels

By Chuck Marr and Gillian Brunet

Middle-income Americans are now paying federal taxes at or near historically low levels, according to the latest available data. That’s true whether it comes to their federal income taxes or their total federal taxes.

■Income taxes: A family of four in the exact middle of the income spectrum will pay only 4.6 percent of its income in federal income taxes this year, according to a new analysis by the Urban Institute-Brookings Institution Tax Policy Center. This is the second-lowest percentage in the past 50 years.

■ Overall federal taxes: Middle-income households are paying overall federal taxes — which include income as well as payroll and excise taxes — at or near their lowest levels in decades, according to the latest data from the Congressional Budget Office (CBO).

Federal Income Taxes Have Declined Significantly in Recent Decades

Federal income taxes on middle-income families have declined significantly in recent decades (see Figure 1).

In 2000, the year before the 2001 tax cut that President Bush and Congress enacted, the median-income family of four paid 8.0 percent of its income in individual income taxes, according to Tax Policy Center estimates — a smaller share than in any year since 1967 (except for 1998 and 1999). [1] The Bush tax cuts further reduced middle-income tax obligations.

This year, the Making Work Pay tax credit, which President Obama and Congress enacted as part of the 2009 American Recovery and Reinvestment Act, is providing a credit of $800 to married joint filers ($400 to single filers). A median-income family with two children thus will receive an $800 tax cut in the return it files this year.

With the new tax cut, the median family’s federal income taxes will equal just 4.6 percent of its income in 2009. That is lower than in any year since 1955 (the first year for which these data are available) except for 2008, when another stimulus-related tax cut was in effect.

The 4.6 percent effective tax rate — the percentage of its income that a family pays in taxes — is well below the 15 percent marginal tax rate that a family of four in the exact middle of the income spectrum faces. Typically, such a family reduces its effective tax rate by taking the standard deduction (or, in some cases, itemized deductions), personal exemptions, and tax credits such as the child tax credit. The Making Work Pay tax credit further reduces that family’s effective tax rate.

Overall Federal Taxes Also at Low Levels

The decline in income taxes on middle-class households in recent years has driven a decline in these households’ overall federal taxes.

Households in the middle fifth of the income spectrum paid an average of 14.2 percent of their income in overall federal taxes in 2006, the latest year for which data are available, according to CBO.[2] This is just slightly above this group’s effective tax rate of 13.8 percent in 2003, which was the lowest level since at least 1979.

Most Americans pay more in payroll taxes, which support Social Security and Medicare, than they do in income taxes. Thus, the 14.2 percent figure reflects the impact of payroll taxes far more than income taxes.

Due to the impact of the recession and the temporary tax cuts in the Recovery Act, particularly the Making Work Pay tax credit, CBO data for 2009 (when they become available) will likely show that middle-income families faced significantly lower effective overall federal tax rates than in 2006.

End Notes:

[1] Tax Policy Center, “Historical Federal Income Tax Rates for a Family of Four,” April 12, 2010. The Tax Policy Center’s estimates were derived by updating (using Treasury’s methodology) a 1998 Treasury Department analysis that examined changes since 1955 in the percentage of income that the median-income family of four pays in federal income taxes.

[2] The CBO study covers the 1979-2006 period and includes federal income, payroll, and excise taxes. Congressional Budget Office, “Historical Effective Federal Tax Rates, 1979-2006,” April 2009.

Business Tax Tip of the Day Apil 9 2010

The amount of investment interest expense deduction is limited to the amount of the taxpayer’s net investment income. The excess is carried forward and treated as an amount of investment interest expense incurred in the next year.

How $1 trillion hides in plain sight

By Jeanne Sahadi, senior writerMarch 5, 2010: 7:30 AM ET

Stuart Rohatiner, CPA, JD

NEW YORK (CNNMoney.com) — The government does without roughly a trillion dollars a year because of a slew of tax breaks — everything from the mortgage-interest deduction, to education and child credits, to low rates on investments.

The irony is that all those breaks can translate into higher tax rates and a federal budget that is much bigger than advertised, according to tax experts Len Burman, a professor at Syracuse University, and Edward Kleinbard, a professor at University of Southern California.

Anyway you slice it, a cool trill is not chump change. In fact, it’s equal to nearly a third of the federal budget.

But you won’t actually see that highlighted in the federal budget process every year. That’s because lawmakers focus on the money the government will spend and how much it will raise in taxes. But “total revenue passed up” doesn’t really come up.

Burman and Kleinbard think tax breaks should be treated as a form of spending.

“Like direct spending programs, tax expenditures crowd out other spending and require higher tax rates than otherwise needed,” Burman wrote in a paper co-authored with Eric Toder and Christopher Geissler.

Even though tax breaks lower the tax bite for eligible individuals and corporations, they end up raising taxes on others.

“Targeted tax relief is just another name for government spending, in which taxes extracted from those of us who are not targeted fund hidden spending on those who are,” said Kleinbard, who used to run the Joint Committee on Taxation, in a speech last fall.

If lawmakers did treat tax breaks as spending, the size of the federal budget — defined by how much the government will spend in a year — would be more like $4.6 trillion, not $3.6 trillion.

Tax breaks on auto pilot

The number of tax breaks has quadrupled since 1972. No one advocates that all tax breaks be abolished. But Burman has suggested lawmakers cap how much they spend on them.

Done right, such breaks can advance government-favored activities such as giving to charities, boosting retirement savings or purchasing health insurance.

But even when the mission is clear, lawmakers’ aim isn’t always dead-on. For example, a tax break might encourage behavior that would have happened without a government subsidy.

Done wrong, tax breaks can squander resources that could be put to better use.

“These revenues could be used to lower marginal tax rates, fund more social programs, improve infrastructure, eliminate budget deficits, or promote various other purposes,” Burman and his colleagues wrote.

The problem, Kleinbard and Burman say, is that most tax breaks don’t get much scrutiny once they become law. By contrast, Congress each year must review discretionary spending, such as that on defense, education and infrastructure.

Some tax breaks, of course, have expiration dates. But even then they’re often lumped together with other expiring tax breaks and renewed en masse.

“If we can force tax expenditures into the sunlight, by subjecting them to the full rigor of the budget process, we can make better choices,” Kleinbard said.

Aiming for fiscal stability

In view of the country’s looming fiscal shortfalls, the discussion about tax breaks isn’t just academic.

Tax experts have been saying for years that streamlining tax breaks and simplifying their rules is key to reforming the tax code. And let’s face it, you’d have to pay someone an obscene amount of money to say without laughing that the code, with its mind-bending complexity, is just fine.

As it is, tax breaks can increase the sense that the tax code is unfair and make people feel better about cheating. It’s always the other guy it seems who’s getting more breaks and the wealthiest corporations getting the sweetest deals.

Among the benefits of rethinking tax breaks: it could lead to a broader base of people paying into the federal income tax system.

Today, because of the multitude of tax breaks, nearly half of all tax filers will end up owing no federal income tax, according to Roberton Williams, a senior fellow at the Tax Policy Center.

With fewer tax breaks, more people will end up with some federal income tax liability. But with more people paying in, that could also mean tax rates wouldn’t need to be as high as they otherwise might be.

To learn about more tax breaks, and how to do this year’s taxes, visit my website, StuartRohatiner.com.

Will the beginning of a new decade bring an end to the Great Stagnation?:

from Economist’s View by Mark Thoma

The Big Zero, by Paul Krugman, Commentary, NY Times: Maybe we knew, at some unconscious, instinctive level, that it would be an era best forgotten. Whatever the reason, we got through the first decade of the new millennium without ever agreeing on what to call it. The aughts? The naughties? Whatever. …

But from an economic point of view, I’d suggest that we call the decade past the Big Zero. It was a decade in which nothing good happened, and none of the optimistic things we were supposed to believe turned out to be true.

It was a decade with basically zero job creation…, private-sector employment has actually declined — the first decade on record in which that happened.

It was a decade with zero economic gains for the typical family. Actually, even at the height of the alleged “Bush boom,” in 2007, median household income adjusted for inflation was lower than it had been in 1999. And you know what happened next.

It was a decade of zero gains for homeowners…: right now housing prices, adjusted for inflation, are roughly back to where they were at the beginning of the decade. … Almost a quarter of all mortgages … are underwater, with owners owing more than their houses are worth.

Last and least for most Americans — but a big deal for retirement accounts, not to mention the talking heads on financial TV — it was a decade of zero gains for stocks, even without taking inflation into account. Remember the excitement when the Dow first topped 10,000…? Well, that was back in 1999. Last week the market closed at 10,520.

So there was a whole lot of nothing going on in measures of economic progress or success. Funny how that happened.

For as the decade began, there was an overwhelming sense of economic triumphalism in America’s business and political establishments, a belief that we — more than anyone else in the world — knew what we were doing. …

Let me quote from a speech that Lawrence Summers, then deputy Treasury secretary…, gave in 1999. … [quote] … Mr. Summers — and … just about everyone in a policy-making position at the time — believed … America has honest corporate accounting; this lets investors make good decisions, and also forces management to behave responsibly; and the result is a stable, well-functioning financial system.

What percentage of all this turned out to be true? Zero.

What was truly impressive about the decade past, however, was our unwillingness, as a nation, to learn from our mistakes.

Even as the dot-com bubble deflated, credulous bankers and investors began inflating a new bubble in housing. Even after famous, admired companies like Enron and WorldCom were revealed to have been Potemkin corporations with facades built out of creative accounting, analysts and investors believed banks’ claims about their own financial strength and bought into the hype about investments they didn’t understand. Even after triggering a global economic collapse, and having to be rescued at taxpayers’ expense, bankers wasted no time going right back to the culture of giant bonuses and excessive leverage.

Then there are the politicians. Even now, it’s hard to get Democrats, President Obama included, to deliver a full-throated critique of the practices that got us into the mess we’re in. And as for the Republicans: now that their policies of tax cuts and deregulation have led us into an economic quagmire, their prescription for recovery is — tax cuts and deregulation.

So let’s bid a not at all fond farewell to the Big Zero — the decade in which we achieved nothing and learned nothing. Will the next decade be better? Stay tuned. Oh, and happy New Year.

What is a Tax?

by Eric Toder on Wed 30 Sep 2009 04:05 PM EDT |

What is a tax? You would think a senior economist at the Tax Policy Center would have no trouble answering that question. But it is not so simple.

This question has come up in the debate over the proposal to require all Americans to have medical insurance—a provision in all of the major congressional health reform bills. If you must buy insurance, is the payment you make a tax or just a premium for insurance coverage? Is the penalty imposed on those who don’t buy insurance a tax or a fine for failing to comply with the law?

Of course, we know taxes are what we pay to fund the general activities of the government. And for most taxes, including the individual income tax, what we pay bears little relationship to how much we benefit from government services. But not all payments to governments are for broad public services and some levies, such as airline ticket taxes, are associated with direct consumption of a service by the payer.

Payments to governments that are analogous to commercial transactions are counted as user fees, not taxes, and reduce measured spending on the public activity. Examples include the fees I pay when I visit a National Park or for getting my car emissions tested. Getting the emission test gives me a lot less pleasure than hiking in Shenandoah Park, but it is a requirement I must meet for the privilege of driving. And since I am the potential polluter, the state requires me to bear the cost.

So when is a payment to government by users of a service a tax and when is it a fee? A 1993 CBO report cited Malcolm Baldrige, a Commerce Secretary during the Reagan Administration. “I think it is simple,” Baldrige commented. “If it is a Democratic proposal, it is a tax; if it is Republican, it is a user fee.” Of course, Baldrige was joking, but nonetheless user-related taxes are often hard to distinguish from user fees. If my local community funds trash collection out of property tax revenues, total tax collections look higher than if they charge me a separate fee for trash collection (even if the fee is collected when I pay my property tax). Using federal gasoline taxes to finance interstate highways makes the tax burden look higher than if those roads, like some older state highways, were paid for by tolls.

The 1993 CBO report cites four categories of user-related charges: user fees, regulatory fees, beneficiary-based taxes, and liability-based taxes. In general, fees are distinguished from taxes by the degree of connection between the payment and the service received or social cost imposed by the payer. Thus, payments to the black lung fund are considered a liability-based tax because, although payments to miners result from past activities of the coal industry, they are not closely linked to the current actions of any firm on which the impost is based. In contrast, charges for food safety inspections are a regulatory fee, because (assuming the cost is passed forward) food consumers who are the beneficiaries of the inspection activities are paying for it. Often, however, a particular levy can be classified on either side of the tax/fee line.

So what are payments for mandatory health insurance? They are involuntary and not based on something the person chooses to do, which makes them look like a tax. However, the individual gets a benefit –insurance coverage – in exchange for the payment, which sounds like a fee. Because of subsidies, some individuals will pay more than others for the same coverage (tax). And if the individual fails to buy insurance, she must make a payment to the IRS, for which she will get nothing directly in exchange (tax). But the payment can be viewed as a regulatory fine for failing to meet a public responsibility (fee). Finally, because the IRS is administering these payments, it looks very much like (and will likely be scored as) a tax.

As a tax economist, parsing these questions is fascinating. But I’m not sure it is very important to the health debate. Instead, we’d be better off asking a different set of questions: Who would bear the net costs of this mandate by paying more than the value of insurance they receive? Who would benefit by receiving insurance in excess of the amount they pay? Is this income redistribution desirable? Is it the best way to pay for (near) universal coverage? And is that goal worth the cost? If we like the answers, we should support reform and if we don’t we should oppose it, regardless of whether we label the payments “tax” or “fee”.

Wall Street stumbles into September

After a bleak 2008, equities are looking up. But whatever the market, our trademark long-term portfolio can help you build a nest egg for a secure future.
NEW YORK (CNNMoney.com) — Markets tumbled Tuesday afternoon, as investors took a big step back at the start of what is typically a rough month, betting that stocks have risen too far too fast without any underlying support.
“I think we’ve had a nice run and it’s time for a bit of a pullback,” said Tom Schrader, managing director at Stifel Nicolaus. “I wouldn’t be surprised if we moved back to the 880 level (on the S&P 500) before moving back up.”
A drop to the 880 level would constitute a slide of about 12% from the current levels.
Investors nitpicked through the morning’s better-than-expected reports on housing and manufacturing but found little reason to jump back into the fray.
With around 40 minutes left in Tuesday’s session , the Dow Jones industrial average (INDU) had lost 160 points, or 1.7%. The S&P 500 (SPX) index fell 18 points, or 1.8%. The Nasdaq composite (COMP) fell 33 points, or 1.7%.
“I think the ‘whisper number’ for [the manufacturing report] was higher and once people digested that, the market swung in the other direction,” said Schrader.
Schrader said that investors were also reacting to the “calendar influence,” amid a variety of reports about the tendency for September to be a weak month on Wall Street. September is typically the biggest percentage loser of the month for the Dow, S&P 500 and Nasdaq composite, according to the Stock Trader’s Almanac.
“The reports this morning were positive, but investors are basically saying that stocks have had a good run up and now it’s time to take some profits,” chimed in Phil Orlando, chief equity market strategist at Federated Investors.
Stocks have essentially been on the rise since March, as investors have welcomed extraordinary fiscal and monetary stimulus and signs that corporate profits and the economy have stabilized. The major gauges ended last week at the highest levels in 9 to 10 months. Financial shares took a beating Tuesday after enjoying a nice ride through the late summer, fueled largely by speculation and momentum.
But with the S&P up 52% from the March 9 lows, market participants are now looking for concrete evidence that the economy is recovering. The morning’s reports were positive, but perhaps not as positive as the most optimistic forecasts.
Manufacturing: The Institute for Supply Management’s manufacturing index for August showed growth in the sector for the first time since January 2008. The index rose to 52.9 from 48.9 previously. Economists surveyed by Briefing.com thought it would rise to 50.5.
Pending home sales rose for the sixth straight month, jumping 3.2% in July, to the highest point in nearly two years, according to a report from the National Association of Realtors released Tuesday morning. The index rose 3.6% in June. Economists surveyed by Briefing.com thought sales would rise 1.5% in July.
Construction spending fell 0.2% in July versus forecasts for an unchanged reading. Spending rose a revised 0.1% in June.
Financials: Many of the summer’s big bank sector winners led the declines Tuesday.
Dow component Bank of America (BAC, Fortune 500) slipped 5% in active NYSE trading. BofA was the biggest Dow gainer in the June through August period, rising 56%.
Dow component American Express (AXP, Fortune 500) lost 4% Tuesday. Over the last three months, AmEx has gained 36% and was the second-best Dow performer.
Dow component JPMorgan Chase (JPM, Fortune 500) lost 3% after rising 17% this summer.
Among other movers, Citigroup (C, Fortune 500) lost 6% after rising 34% in the summer. Regional bank Fifth Third Bancorp (FITB, Fortune 500) lost 5% after rising 59% this summer.
The KBW Bank (BKX) index fell 4.6% after rising 20% over the summer.
Oil prices and stocks: U.S. light crude oil for October delivery fell $1.91 to settle at $68.05 a barrel on the New York Mercantile Exchange. Oil prices have been slipping since hitting a ten-month high just below $75 a barrel late last month.
The decline in oil prices dragged on heavily-weighted energy stocks including Dow components Chevron (CVX, Fortune 500) and Exxon Mobil (XOM, Fortune 500).
Auto sales: The government’s popular Cash for Clunkers program gave a boost to sales in August, major automakers said. Although a plunge in sales in the last week of the month, following the program’s end, suggests the impact will not be far reaching.
Company news: Online auctioneer eBay (EBAY, Fortune 500) said it will sell a large stake in its Skype Internet phone business to a group of investors for $2.75 billion.
World markets: European markets tumbled, while Asian markets ended higher.
Bonds: Treasury prices rose, lowering the yield on the benchmark 10-year note to 3.37% from 3.40% late Monday. Treasury prices and yields move in opposite directions.
Other markets: COMEX gold for December delivery rose $3.50 to settle at $957 an ounce.
In currency trading, the dollar gained versus the euro and the Japanese yen.
Market breadth was negative. On the New York Stock Exchange, losers beat winners by over four to one on volume of 1.09 billion shares. On the Nasdaq, decliners topped advancers by over three to one on volume of 2.19 billion shares.