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”.

Obama agenda: Taxes, not just health care

The president’s next 200 days will be as full, if not fuller, than the first. And tax questions will underlie a lot of key debates ahead.

By Jeanne Sahadi, CNNMoney.com senior writer

Obama’s Money Moves

200 days in, the President is going for broke. Click for analysis of where he’s succeeding – and where he’s not. View interactiveObama: 200 days in office

When he became the 44th president on Jan. 20, Barack Obama inherited the worst economic crisis since the Great Depression. After 200 days, here’s a look at the progress he’s made toward a recovery.
View photos
NEW YORK (CNNMoney.com) — President Obama’s fall agenda has grown larger as some of the biggest decisions — and fights — over health care reform have been punted to September … at the earliest.

But health reform is not the only major initiative he wants to get done. Far from it. There’s climate change. There’s reforming Wall Street. And, of course, there’s passing a budget for 2010 at a time of huge deficits.

Running in the background to all of this will be one of the biggest issues the Obama administration must address: taxes.

“As soon as they can clear health care off the plate, it will be taxes, taxes, taxes,” said Anne Mathias, director of research at Concept Capital’s Washington Research Group.

Health reform taxes: Before health care can be cleared off the plate, Obama will have to answer some key tax questions.

For starters, he will need to be more explicit about what he will accept in terms of increasing taxes to pay for health reform and indicate exactly which of the revenue raisers on the table in Congress he considers deal-breakers.

The president originally proposed limiting the itemized deductions that high-income tax filers could take, an idea that fell flat with lawmakers. He doesn’t like what had been a leading idea in the Senate to help fund reform — taxing what are currently tax-free health benefits that workers receive from their employers. But at various times he has indicated indirectly he might be open to it in some limited form.

Now the idea gaining currency in the Senate is to tax insurers who offer very expensive plans. Critics say such a tax could either be passed on to workers through higher premiums or reduced benefits. In the House, meanwhile, the leading idea is to impose a surtax — or additional tax — on the highest-income households.

“The problem here is there are no good ideas,” said Clint Stretch, managing principal for tax policy at Deloitte Tax.

Translation: Only proposals to cut taxes typically generate support. Winning the debate over a tax hike is guaranteed hard slogging.

Estate taxes: Regardless of what happens with health reform, lawmakers and the administration will have to make a decision about what to do about the estate tax. Otherwise, it will be repealed for one year, starting on Jan. 1, 2010.

Since that’s revenue the country can’t afford to lose, what’s most likely to happen is that Congress will extend the estate tax for one year at the 2009 exemption levels, Mathias and Stretch said. In that case, the first $3.5 million of an individual’s estate would be exempt from the federal estate tax. And the taxable portions of the estate would then be taxed at rates up to 45%.

Then in 2010, lawmakers are likely to address what to do with the estate tax on a more permanent basis. Obama has proposed making the estate tax permanent at the 2009 exemption levels.

But doing so will look like a revenue loser over 10 years. That’s because it would raise less tax money than what’s set to happen under current law. If nothing is done by 2011, the first $1 million of an estate would be exempt from the tax and the top rate would be 55%.

Climate change taxes: Whether or not lawmakers succeed in getting a climate change bill ready for the president’s signature before the year is out, there is likely to be discussion over several revenue issues. For example, what to do with revenue generated from a cap-and-trade program in which carbon-emission permits are bought and sold?

Corporate taxes: Obama has said he wants to close what he calls corporate tax loopholes.

The administration laid out a few proposals to that effect earlier in the year, particularly with regard to U.S. companies doing business overseas. And Obama created a tax reform panel and asked it to make suggestions by Dec. 4 about how to raise more revenue. Corporate tax breaks are a focus for the group.

But it’s not clear how Obama’s corporate tax proposals will fly given that tax writers on Capitol Hill have already crafted many of their own proposals. Some lawmakers only want to curb corporate breaks and simplify the corporate tax code if rates are lowered, a step Obama has not yet proposed.

“The Hill knows where it wants to go on tax reform generally. They want to close the tax gap and they want to do international tax reform,” Stretch said. But he doesn’t envision the changes as big revenue raisers per se. Rather, he said, the overarching goal would be to make U.S. businesses operating abroad more competitive.

“It won’t be about raising revenue, but about lowering rates. The point of doing it is to generate more business,” Stretch said.

Although discussions will be had, he only thinks there’s a 50/50 chance that international corporate tax reform will be completed in the next year.

Kitchen sink taxes: There are a host of tax provisions that, barring lawmaker action, will expire in 2009 and 2010. Many are tax breaks that companies and individuals have come to expect and which lawmakers typically extend every year. Among these are the research and development credit for businesses, relief from the Alternative Minimum Tax for middle- and upper-middle-income families and various renewable energy tax credits.

What’s very possible is that extensions for most such expiring provisions will be bundled into one bill at some point next year. “There’s no way they can get through 2010 without a tax bill,” Mathias said.

The midterm elections provide added incentive, she noted. “Democrats will want to campaign on extending popular provisions.”

First Published: August 5, 2009: 2:54 PM ET