The Center's work on 'Federal Tax' Issues

The Center analyzes major tax proposals, examining their likely effects on the economy and on the government’s ability to address critical national needs, especially over the long term. We place particular emphasis on the effects of tax proposals on households at different income levels. In addition, we analyze trends in the level of federal revenues, income distribution, and tax burdens.


Plug the Inversion Loophole Now

July 22, 2014 at 2:53 pm

The New York Times’ latest “Room for Debate” feature asks how the United States can stop corporations from moving their headquarters overseas — known as corporate “inversions” — to avoid taxes.  In my contribution, I explain that inversions are a high-profile part of the problem that multinationals’ profits aren’t taxed anywhere, because tax rules let companies claim they earned the profits in in zero- or low-tax havens.

I point out that Pfizer — whose inversion plans made recent headlines — could keep billions in profits permanently untaxed by inverting.  Ed Kleinbard, USC law professor and former staff director for Congress’ Joint Committee on Taxation, explains in detail in a new Wall Street Journal piece how companies can lower their tax bills through an inversion.

In the Times, I recommend swift, targeted anti-inversion legislation:

Slashing U.S. corporate taxes won’t solve an inversions problem created by profits that already aren’t taxed. Instead, U.S. policymakers should first swiftly enact targeted anti-inversion legislation to protect the U.S. tax base.

That’s why Senate Finance Committee Chair Ron Wyden should be applauded for his pledge today (during a Senate Finance Committee hearing on inversions and international tax reform) to immediately try to stop U.S. firms from incorporating overseas for tax purposes.  “Let’s work together to immediately cool down the inversion fever … The inversion loophole needs to be plugged now,” Wyden said.

Then, any eventual corporate tax reform could raise revenue by eliminating inefficient business tax breaks for both domestic and foreign profits and reducing opportunities and incentives for corporations to engage in international tax avoidance, and level the playing field between domestic and multinational companies, as we’ve previously explained.

Click here to read the full “Room for Debate” piece.

Understanding Marginal Tax Rates and Government Benefits

July 22, 2014 at 12:58 pm

Some Washington policymakers are increasingly focused on whether government benefits for low- and moderate-income people create disincentives to work — in particular, when these benefits phase down as the earnings of beneficiaries rise, our new commentary notes.  That phase-down rate is often called the “marginal tax rate” because it resembles a tax — benefits fall as earnings rise.  As we explain:

[P]olicymakers across the ideological spectrum share concerns about marginal tax rates and agree that, all else being equal, lower marginal tax rates are preferable to higher ones.  Unfortunately, all else is not equal, and lowering marginal tax rates entails significant and very challenging policy trade-offs. . . .

[M]arginal tax rates are the product not of bad policy design but rather of competing policy goals:  providing needed assistance to financially struggling individuals and families and limiting costs by not providing help to those with more adequate income.  Any serious discussion of the marginal tax rate issue must grapple with the fundamental tension between limiting assistance, controlling costs, and reducing marginal tax rates.

No such serious discussion is likely to result, however, from exaggeration of the marginal tax rates that most low-income families face, overstatement of the impact those marginal rates have on actual work behavior by low-income households, or glossing over the tough policy trade-offs that policymakers must face when seeking to reduce marginal rates.

Click here for the full commentary.

Congress Shouldn’t Renew Internet Tax Freedom Act Unless It’s Paired With the Marketplace Fairness Act

July 21, 2014 at 2:54 pm

The Internet Tax Freedom Act’s (ITFA) ban on state and local sales taxation of monthly Internet access fees costs state and local governments about $6.5 billion annually in forgone revenue, and the states and localities currently taxing access under ITFA’s “grandfather” provision would lose at least $500 million on top of that each year if the provision expired, as I’ve recently explained.  Despite these costs, the House last week approved making ITFA permanent while letting the grandfather clause expire.  A new bipartisan Senate bill, however, would help state and local governments make up for the lost revenue.

The Senate bill would pair a 10-year ITFA extension with the Marketplace Fairness Act (MFA).  The MFA would enable states and localities to receive a substantial share of the sales tax that is legally due on purchases of goods and services from Internet and catalog merchants like Amazon and L.L. Bean but that they can’t collect from the companies.

Due to 1967 and 1992 Supreme Court decisions, a state can require out-of-state companies to charge its sales tax only if they have a physical presence in the state like a store, warehouse, or sales force.  The tax is still legally due, and consumers are supposed to pay it directly to their state, but few people do.  Those lost revenues could help pay for schools, roads, police, and other critical state and local services, and they keep sales and income tax rates higher than they’d otherwise need to be.

MFA would authorize states to require out-of-state sellers with more than $1 million in nationwide interstate sales to charge the applicable taxes — provided that states simplify their sales taxes and give merchants free software that calculates the correct tax.

This change would allow state and local governments to collect as much as $23 billion in annual revenues that they are owed under current law.  That would help them maintain and possibly reinvest in public services they cut during the recent recession.  It would also help offset states’ and localities’ ITFA-related $7 billion revenue loss — lost dollars that will grow as more people subscribe to Internet service; others trade-up to faster, and therefore more expensive, service; and others cancel their taxable landline telephones and cable TV in favor of Internet-based alternatives like Skype and Netflix.

MFA’s long-overdue enactment would also:

  • Create a more level playing field for local store-based retailers.  Because combined state and local sales tax rates typically range between 5 and 10 percent, Internet retailers that don’t collect sales taxes outside their home states start out with a price advantage over their local competitors.  This makes it harder for Main Street merchants to create local jobs.  It also has a ripple effect on local economies, as depressed sales at the neighborhood book or musical instrument shop lead to fewer purchases by their owners and employees at the farmers’ market and dry cleaner. 
  • End the unfair sales tax treatment of consumers who don’t shop online.  Low-income people who lack the computers, Internet access, or credit cards needed to shop online pay more than their fair share of sales taxes because online shoppers can avoid these taxes. 

These are worthy goals, and Congress should have passed the MFA long ago to achieve them.  But if lawmakers decide to extend ITFA, it’s even more urgent that they also enact MFA.  Congress should not extend the moratorium without also enacting MFA.

Busting Three Myths About the Internet Tax Freedom Act’s “Grandfather Clause”

July 18, 2014 at 4:08 pm

The Senate next week will likely consider its version of a bill to renew the Internet Tax Freedom Act (ITFA), a federal law prohibiting state and local governments from taxing the monthly Internet access subscription fee that households and businesses pay.  The House voted earlier this week to make ITFA, which is due to expire on November 1, permanent.

ITFA was enacted in 1998 with strong bipartisan support, and it has always included a “grandfather clause” that allowed states and localities that were taxing Internet access to keep doing so.  Despite its long history, there’s widespread misunderstanding about the grandfather clause in the current debate about renewing ITFA.  Here are the facts behind three widespread myths about that clause:

Myth:  The House and Senate bills that would make ITFA permanent preserve the grandfather clause.

Fact:  The House-approved bill and its Senate analog both effectively eliminate the grandfather clause.  There has been confusion about this because both bills strike ITFA’s November 1, 2014 expiration date with no mention of the grandfather clause.  But the current law terminates the grandfather clause as of November 1, 2014, meaning that it expires as of that date unless policymakers explicitly extend it.  Neither the House nor Senate bill does so.

Myth:  Eliminating the grandfather clause would affect the revenues of only seven states that directly tax Internet access service. 

Fact: Virtually every state, and thousands of local governments, would be at risk of losing revenue if the grandfather clause expires — dollars they use to pay teachers and police, provide financial aid to state university students, repair roads, and provide many other critical services.  That’s because the clause not only preserves the pre-1998 direct taxes on Internet access service of Hawaii, New Mexico, North Dakota, Ohio, South Dakota, Texas, and Wisconsin, it also preserves all pre-1998 taxes that could be considered indirect taxes on Internet access.  That would include, for example, state and local taxes that Internet access providers pay on the things they buy in order to provide Internet service, such as computer servers, fiber-optic cable, or even gasoline for their vehicles.  Almost all of these taxes existed before 1998, so the grandfather clause protects them from legal challenge.  But if Congress eliminates the clause, Internet access providers could challenge these taxes in court as indirect taxes on Internet access service and therefore voided by ITFA.  (For more on this issue, see pages 8-10 of my recent analysis.)

Myth:  The grandfather clause was intended to give states time to phase out Internet access taxes, which they’ve had ample time to do.

Fact:  The original 1998 committee reports on ITFA don’t back up this claim.  Such a rationale wouldn’t have made sense anyway, because ITFA itself was supposed to be temporary.  As the 1998 Senate Commerce Committee report said, ITFA was intended to be “a temporary moratorium on Internet-specific taxes [that] is necessary to facilitate the development of a fair and uniform taxing scheme.”  Lawmakers included the grandfather clause to protect the interests of states and localities that had already come to rely on Internet access tax revenues to fund services.  If Congress had wanted to push the states taxing Internet access to phase out those taxes, it could have had the grandfather clause expire sooner than the overall moratorium in the original 1998 legislation or in any of the three subsequent renewals, but it didn’t.

The facts make the case:  if Congress extends ITFA, no matter for how long, the law must continue to include the grandfather clause.

House Should Reject Backwards Child Tax Credit Bill

July 18, 2014 at 2:11 pm

The full House next week will consider the Ways and Means Committee’s recently passed Child Tax Credit (CTC) bill.  A recent Tax Policy Center (TPC) analysis confirms our previous critical assessments of the proposal, finding that it would make many relatively affluent people better off while making low-income working families poorer.

As we explained, the bill makes three main policy decisions that, taken together, constitute poor policy:

  1. It extends the Child Tax Credit higher up the income scale — on a permanent basis — so more families with six-figure incomes will benefit.  The bill raises the income levels at which the CTC begins to phase out.  (It also indexes those thresholds to inflation.)  Couples with two children making between $150,000 and $205,000 would become newly eligible for the credit; a family making $150,000 a year would receive a new tax cut of $2,200 in 2018. 
  2. It fails to make permanent a key CTC provision for working-poor families that will expire in 2017 unless Congress acts.  The provision, which was enacted in 2009, made more working-poor families eligible for the CTC and enlarged it for other working-poor families who had been receiving only a partial credit, by phasing in the credit as a family’s earnings rose above $3,000.  If this low-income provision expires on schedule — as the Ways and Means bill allows — a single mother with two children who works full time throughout the year at the minimum wage and earns $14,500 would lose $1,725 in 2018, as her CTC would be eliminated. 
  3. It indexes the current maximum credit of $1,000 per child to inflation.  This provision benefits only those with incomes high enough to receive the maximum credit.  If the low-income provision is allowed to expire in 2017, millions of working-poor families would either lose their CTC altogether or have their CTC cut and no longer receive the maximum credit, which would make the inflation adjustment meaningless for them.  Under the bill, indexing wouldn’t benefit a family with two children in 2018 until it has earnings of at least $28,050 — nearly double what full-time minimum-wage work pays an individual, as we have explained. 

TPC’s analysis illustrates how the combined effects of these policy decisions harm low-income families while benefiting many with higher incomes.  As the first chart below shows, families with children that have incomes between $100,000 and $200,000 would gain, on average, nearly $550 apiece in 2018, while families with incomes below $40,000 would lose, on average.

The Ways and Means bill’s effects on households’ after-tax incomes are also striking.  As the next chart below shows, households earning less than $20,000 in 2018 would face, on average, a drop in their after-tax income of more than 3 percent while those with incomes between $100,000 and $200,000 would get a boost in their after-tax earnings.

TPC’s analysis underscores the downsides of the Ways and Means bill for low-income working families.  These are parents who work for low or modest wages as cashiers, waitresses, home health aides, and day laborers; they clean office buildings or perform other low-paid work.  Policymakers should reverse course and put these families’ needs first, rather than last, when the full House considers the bill.