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Posts Tagged ‘Loophole’

Every so often, I share very weird stories about government regulations, from both America and around the world. And when I say weird, I’m not exaggerating.

But we also have some strange examples of tax loopholes.

I’m not talking about corporate jets, which should be characterized as a business expense.

Instead, I’m referring to bizarre examples of income that is arbitrarily exempt from tax.

The weirdest example in the United States is from Nevada (probably because politicians have a conflict of interest).

Today I want to write about a new tax loophole in Poland.

Polish lawmakers have approved a measure that would exonerate most workers under the age of 26 from income taxes… The bill would exonerate workers under the age of 26 from Poland’s 18 percent personal income tax for those whose gross earnings don’t surpass 85,500 zlotys (20,000 euros, $22,500) per year. That level is higher than Poland’s average income… Some two million people could benefit from the measure.

So what’s motivating this example of age-based tax discrimination?

Poland has long been haemorrhaging skilled workers to other EU states where they can find better paying jobs, posing both a long-term demographic risk and short-term problem finding enough labourers to continue the country’s streak of economic growth since the fall of communism in 1989.

I certainly agree that Poland faces a demographic challenge (along with other nations in Eastern Europe), both because of emigration and low birth rates.

And I also agree that Poland’s economy has been relatively successful since escaping the evil of communism.

But I’m not very confident that this policy is the right recipe for continued prosperity.

  • First, I don’t like discrimination in the tax code, whether based on the source of income, the use of income, the level of income, or – in this case – the age at which income is earned.
  • Second, this policy doesn’t affect social insurance taxes and value-added taxes, which are actually the biggest burden for ordinary workers in many Eastern European nations.
  • Third, unless Poland’s government imposes some spending discipline, a tax preference for young people may lead to higher taxes on other groups, thus offsetting any economic benefit.

To be sure, I’m glad Poland is addressing the issue by lowering taxes rather than by creating new programs and subsidies, as we’ve seen in some other European nations.

I’m simply not expecting big results.

P.S. You can click here to peruse other oddball examples of international tax policy.

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Politicians who preach class warfare repeatedly assert that we need higher taxes on “the rich.”

Indeed, that’s been the biggest political issue (and oftentimes biggest economic issue) in every recent tax fight (the Trump tax reform and Obama’s fiscal cliff), as well as the issue that generates the most controversy when discussing tax reform.

So it seems almost inconceivable that the class-warfare crowd would support a change to the tax code that would only benefit the top-10 percent, right?

Yet that’s exactly what’s happening in the fight over the deduction for state and local taxes.

Democrats want to restore an unlimited deduction, thereby enabling people to shield more of their income from tax. But, as the Tax Foundation notes, that change only produces benefits for upper-income taxpayers.

Itemized deductions such as the SALT deduction are mostly utilized by higher-income individuals. As such, any change to the SALT deduction will chiefly impact them. In addition, the value of a deduction increases as a taxpayer’s statutory tax rate increases. A deduction against the top rate of 37 percent is more valuable than a deduction against the 32 percent tax rate. We estimate that eliminating the SALT deduction cap would have no impact on taxpayers in the bottom two income quintiles and a negligible impact on taxpayers in the third and fourth quintiles. …However, taxpayers in the top 5 and 1 percent of income earners would see an increase in after-tax income of 1.6 percent and 3.7 percent respectively.

And if restoring the deduction is “paid for” by raising the corporate tax rate, the net effect is to raise taxes on the bottom-90 percent in order to give a tax to top-10 percent.

Or, to be more precise, to give a tax cut to the top-1 percent.

Some of you may be thinking that the Tax Foundation leans right and therefore can’t be trusted.

So let’s look at some research from the Tax Policy Center, which is a joint project of the left-leaning Urban Institute and left-leaning Brookings Institution.

Only about 9 percent of households would benefit from repeal of the Tax Cuts and Jobs Act’s (TCJA) $10,000 cap on the state and local property tax (SALT) deduction, and more than 96 percent of the tax cut would go to the highest-income 20 percent of households… For all middle-income taxpayers, the average tax cut would be $10. Those in the top 1 percent would pay an average of $31,000, or 2 percent of after-tax income, less.

And here’s the TPC chart showing how almost all the tax relief goes to upper-income taxpayers.

So what’s going on? Why are Democrats fighting for an idea that would give the rich a $31,000 tax cut while only providing $10 of relief for middle-class taxpayers?!?

The simple answer is that they think the loophole is a very valuable way of facilitating higher taxes and bigger government at the state and local level. And they’re right, so I don’t blame them.

But it’s nonetheless very revealing that they are willing to jettison their tax-the-rich rhetoric when it interferes with their make-government-bigger agenda.

P.S. This “SALT” debate strikes me as being similar to the Laffer-Curve debate, which requires folks on the left to choose whether it’s more important to punish rich people or to get more revenue to spend.

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I’m not a fan of loopholes in the tax code.

I’ve complained about the number of pages in the tax code, the number of provisions in the tax code, and I’ve even groused about the rising number of pages in the instruction manual for the 1040 tax form.

And I’ve specifically come out against tax preferences for ethanol, housing, municipal bonds, charity, and state and local taxes.

But just as you don’t necessarily know whether someone is tall or short without knowing the average height of a population, you can’t automatically identify loopholes without first defining an ideal tax system. In other words, you need a benchmark (referred to as “the tax base” or “taxable income”) in order to measure what’s a loophole.

Unfortunately, that’s not an easy task because there are two competing visions of the ideal benchmark. I’ve addressed this issue previously, in this post on the “tax expenditure con job,” but let’s dig into the weeds a bit.

  1. Those on the left, including the Joint Committee on Taxation, use what is sometimes called the “Haig-Simons” definition of a tax base. Also known as the “comprehensive income tax base,” this system assumes that there should be double taxation of income that is saved and invested (as shown by this startling chart). Another way of saying this is that the Haig-Simons approach assumes the government should tax income plus changes in the value of assets. Moreover, the Haig-Simons system assumes “worldwide taxation” and that businesses can’t deduct investment costs as they occur.
  2. Those on the right, by contrast, support what is generally called “consumption-based” taxation. This doesn’t mean a tax collected at the cash register (though a national sales tax is an example of a tax with a “consumption base”). Instead, it simply refers to a system where income is taxed only one time. So, for example, a flat tax is a consumption-base tax since income is taxed only one time as it is earned, just as a national sales tax is a consumption-base tax since income is taxed only one time as it is spent. Moreover, a consumption-base system assumes “territorial taxation” and that business expenses should be deductible in the year the money changes hands.

While some features of the tax code – such as the healthcare exclusion – are loopholes according to both the Haig-Simons system and the consumption-base system, you get a divergence of opinion in key areas.

a) In a consumption-base world, there’s no double taxation and the capital gains tax therefore doesn’t exist. But from the perspective of the Haig-Simons tax base, the fact that capital gains are taxed at 23.8 percent instead of 39.6 percent is characterized as a loophole.

b) In a consumption-base world, there’s no double taxation and all savings gets the equivalent of IRA or 401(k) treatment. But from the perspective of Haig-Simons tax base, IRAs and 401(k)s are loopholes.

c) In a consumption-base world, there’s territorial taxation and no attempt to impose tax on income earned (and subject to tax) in other countries. But the Haig-Simons tax base assumes “worldwide taxation,” which means that “deferral” is a loophole rather than a way of mitigating a discriminatory penalty.

So why am I getting into boring details on this wonky issue? In part, because it helps people understand that tax reform is not just a matter of having a low tax rate. It’s also very important to define income correctly.

But I also think some background knowledge is necessary to explain why the White House is blowing smoke when they relentlessly demagogue against “corporate jets” as part of their never-ending campaign for class-warfare tax policy.

Let’s examine some excerpts from an ABC News report.

Listening to the White House, you’d think the key to averting the across-the-board spending cuts (the dreaded “sequester”) set to in place on March 1 is closing the tax break for owners of private jets. …Carney has brought up the corporate jet tax break at every single briefing this week. Listening to the White House, you might think that the “balanced” Democratic plan to avert the spending cuts would close that loophole for private jets. But you would be wrong. The Senate Democratic plan – which has been endorsed by the White House and is, in fact, the only Democratic plan actively under consideration right now – doesn’t touch corporate jets. …The tax break…allows the owners of private jets to depreciate their airplanes over five years instead of the standard seven years for commercial airplanes.

I don’t want you to focus on the demagoguery or the potential hypocrisy. Instead, consider the final sentence of the excerpt.

It turns out that the supposed “loophole” is really a penalty from a consumption-base perspective. If a company purchases a jet for $20 million, they should be able to deduct – or expense – that $20 million when calculating that year’s taxable income (after all, what is profit other than total revenue minus total costs?).

A sensible tax system defines profit as total revenue minus total costs – including purchases of private jets

But today’s screwy tax code forces them to wait five years before fully deducting the cost of the jet (a process known as depreciation). Given that money today has more value than money in the future, this is a penalty that creates a tax bias against investment (the tax code also requires depreciation for purchases of machines, structures, and other forms of investment).

Anyhow, because the tax bias imposes a five-year wait rather than a seven-year wait, the Obama White House would like us to believe that companies are getting some sort of egregious loophole.

Nonsense. In a good tax regime, companies should be able to deduct expenses in the year they are incurred. The fact that they have to wait five years is a penalty. But the White House wants us to perceive this penalty as a loophole or subsidy because it could be even more onerous.

By the way, if we’re worried about actual subsidies that benefit corporate jets, Tim Carney’s already explained that we should focus on the cronyists at the Export-Import Bank. And I heartily agree.

P.S. Defining the right “tax base” doesn’t imply anything about tax rates. You can have a so-called progressive rate structure or a single rate with either the Haig-Simons system or a consumption-base system.

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