Taxable Talk

Yet another bond proposal. This one would raise $980 million in bonds to help children’s hospitals. The downside is that it would cost taxpayers $2 billion per year over $30 years to repay the bonds.

The bonds would be used at msot of the children’s hospitals in the state. Proponents argue that children’s hospitals could use the money to expand and help more children. Opponents argue that the state is in debt, and that hundreds of millions from an earlier version of this proposition (Proposition 61) remain unspent.

Remember to vote on November 4th.

Proposition 2 would change animal agriculture, a major industry in California. It would impact not only cattle and chickens but eggs and some other industries.

Proposition 2 would require more “humane” handling of animals. This sounds innocuous, but it’s not. I worked in agriculture (citrus, not animals) for many years. Should this measure pass it would increase prices for eggs, would likely increase prices for beef, chicken, and veal, and would eliminate any expansion of those industries in California. In fact, the most likely result would be a movement of jobs from California to nearby states (and perhaps to Baja California).

Proponents of the measure state that this would be more humane to the animals, improve safety, and help family farmers. Opponents believe that this measure could negatively impact public health, would increase costs, and would decrease jobs.

It’s time to begin our study of the ballot measures on California’s ballot in two weeks. I will be continuing my series on the presidential candidates—my article on John McCain will be up later this week. For now, let’s look at Proposition 1A, the Safe Reliable High-Speed Passenger Train Bond Act.

If this measure passes $9.95 billion of bonds would be sold by the state, costing about $19.4 billion over thirty years (or around $667 million a year). The bonds would be used to construct a high speed train from Los Angeles to San Francisco.

Proponents argue that passage would lead to a safe, high-speed train system to link the state. Opponents argue that this would be a huge cost to the state, and would run in red ink. The Legislative Analyst estimates that annual operating costs would exceed $1 billion, so that too must be figured in.

After the arguments were written the financial credit crisis occurred. That’s not mentioned by either the proponents or opponents, but you need to consider it. The ability of any government to issue bonds has been reduced; it’s likely that borrowing costs would be higher—potentially much higher—than estimated. I am very unconvinced about ridership claims; train service in the United States has to be supported by the government in order to continue.

No matter what you think, do make sure to vote on November 4th.

Note: Proposition 1 (listed in the original Voter’s Guide) was removed from the ballot and replaced by Proposition 1A (listed in the supplemental Voter’s Guide).

This is the first of a three part series looking at what taxes might be under our new President. This series starts by looking at what might happen under a President Obama. Next week I’ll examine John McCain’s plans. In the final part I’ll compare and contrast the two plans.

Let’s start with what the Obama campaign says they’ll do. This is taken from the Barack Obama website:

• Cut taxes for 95 percent of workers and their families with a tax cut of $500 for workers or $1,000 for working couples.
• Provide generous tax cuts for low- and middle-income seniors, homeowners, the uninsured, and families sending a child to college or looking to save and accumulate wealth.
• Eliminate capital gains taxes for small businesses, cut corporate taxes for firms that invest and create jobs in the United States, and provide tax credits to reduce the cost of healthcare and to reward investments in innovation.
• Dramatically simplify taxes by consolidating existing tax credits, eliminating the need for millions of senior citizens to file tax forms, and enabling as many as 40 million middle-class Americans to do their own taxes in less than five minutes without an accountant.

These seem like great goals, and a wonderful plan. Let’s check this out to see if it’s borne out by facts.

Here are the nuts and bolts of the plan:
1. A $500 (single)/$1000 (MFJ) refundable tax credit for those who work.
2. A $4,000 refundable tax credit for college education.
3. A 10% refundable tax credit to offset mortgage interest payments. It’s unclear from the fact sheet whether this credit would be available to those who itemize or is limited to those who do not itemize.
4. No income tax for senior citizens who make less than $50,000.
5. An automatic pension account will be created.
6. The Savers Credit will be expanded so that it will match 50% of the first $1000 for families earning under $75,000.
7. Health care tax credits will be increased.
8. Expand the Earned Income Tax Credit to more working parents.
9. The child care credit would be refundable and allow low-income families to receive up to 50% of $6,000 of child care expenses.
10. Add a $7,000 tax credit for purchase of “advanced technology vehicles.”
11. Simplify the system; some taxpayers would receive pre-printed forms with numbers already filled-in.
12. Eliminate capital gains taxes on investments in small and start-up firms.
13. Increase corporate tax on companies that “retain their earnings overseas.” Use that money to lower corporate tax rates for companies that expand operations within the U.S.
14. Add a refundable corporate tax credit for small businesses that offer healthcare.
15. Make the Research and Development tax credit permanent.
16. Increase the top tax bracket to 39.6% on families making $250,000 or more.
17. Estate tax begins at $7 million per couple ($3.5 million/person).

How would all of these be paid for? Obama wants to reform international tax loopholes, close domestic tax loopholes, eliminate tax breaks for oil and gas companies, and close other loopholes.

But there’s more on other areas of the website that impact taxes. Obama wants to “…ask those making over $250,000 to pay in the range of 2 to 4 percent more in total (combined employer and employee).” Originally, Obama wanted to completely uncap the social security tax above $250,000. What’s not said here is would this kick in based on individuals at $125,000 or families at $250,000?

Let’s assume that Obama is elected President. Let’s also assume that Congress continues to be controlled by Democrats. What would the tax impact be for you and I?

1. The wealthy already pay most of the taxes in the U.S. Under a President Obama they’d pay even more. In high tax states such as California the marginal tax rate would end up at 58.8% for those making above $125,000 if employed and 68.7% for those who are self-employed. That’s if Obama gets his way. Given the leanings among the Democrats in Congress, that’s likely the best we could hope for under Obama.

2. Obama’s tax plan would result in the redistribution of income away from entrepreneurs. Though Obama wants his plan to help entrepreneurs (through elimination of capital gains on investments in small companies), his income tax plan says the opposite. Additionally, there’s nothing in Obama’s plan about the AMT. Assuming the AMT lives on, those capital gains tax cuts would be imaginary; entrepreneurs wouldn’t pay capital gains taxes but they’d pay the same amount as AMT.

3. Obama has proposed a wealth of new programs. Those new programs would have to be funded with money from somewhere. Obama mentions health care, but that’s not the only program he proposes. Obama’s reliance on “closing loopholes” is misplaced (see #4 below).

4. Obama’s primary funding for his tax plan comes from closing various loopholes. Good luck. The IRS has been trying to close various loopholes for years, and increase enforcement activities. Congress writes the Tax Code to benefit lobbyists and others–in the bailout legislation that just passed numerous loopholes were added. As far as international loopholes the IRS has been successful in closing some. The reality is that only incremental progress will occur no matter who is President. There is no way that Obama will be able to fund his programs and tax cuts solely from closing loopholes.

5. A much more realistic scenario is that under a President Obama only a couple of his programs would be implemented but the tax increases and redistribution plan would occur. This would likely lead have a major negative economic impact (see #6 below).

6. Many large companies are organized as S-Corporations and are taxed on individuals tax returns rather than at the corporate level. (As a reminder, corporate taxes are always passed on to individuals.) When taxes increase to S-Corporation owners they will likely cut their hiring.

7. It is possible that Congress would go much further with social security taxes than the Obama campaign currently wants. There is sentiment among Democrats in Congress to tax high-income self-employed individuals fully at 15.3% (that is, uncapped social security). If this were to occur many high-income individuals would stop working when their income reached a certain level as the tax would be confiscatory. This occurred in the 1940s and 1950s when marginal tax rates reached 90%. This would have a negative impact on the economy in the United States.

8. The current economic climate is uncertain. Increasing taxes when the economy is not doing well would cause major economic problems. Obama has mentioned this in an interview with Bill O’Reilly.

9. Obama has publicly said he’s for the elimination of the Bush Tax Cuts. All of them. The elimination of a tax cut is a tax increase–forget the semantics.

10. The goal of Obama’s that makes the most sense–simplification of the tax system–is impossible under President Obama. His programs would tremendously increase the complexity of the Tax Code.

Obama likes to talk in broad terms and doesn’t like to be forced to mention specifics. That’s true of his stance on taxes. I’ll be very specific: If Obama is elected President you will pay more. This may be in taxes, or in the increased cost of goods and services as tax increases on some are passed on. There is no free lunch.

Next weekend I’ll report on what taxes might be like under a President McCain. It should be clear that I’m not a fan of Obama’s tax plans. For very different reasons I have concerns over McCain’s tax plans.

The bailout bill passed Congress today and was signed into law by President Bush this afternoon. I’m of mixed opinion on the bailout portion of the bill. But I’m thrilled about one part of the bill—this year’s AMT (Alternative Minimum Tax) patch was included in the bailout legislation.

Every year Congress goes through the effort to raise the AMT exemption so that millions more individuals don’t get impacted by AMT. Last year Congress waited until December to pass an AMT patch and it impacted the filing season.

Also included in the bill were “extenders.” The extenders extended popular deductions that would have been eliminated.

Here is a list of some of the major tax items in the bill:

– AMT exemption increased to $46,200 for single and $69,950 for married filing jointly;
– Sales tax deduction extended through 2009;
– The Tuition and Fees deduction extended through 2009;
– Educator expense deduction of up to $250 extended through 2009;
– The real estate taxes deduction (for those taking the standard deduction) of $500 single/$1000 married filing jointly was extended through 2009; and
– Major tax benefits for those who live and/or work in major disaster areas.

There’s probably a lot more in the legislation (it runs 300 pages) but let me add a caveat: California will not be in compliance with any of these changes for 2008.

Joe Kristan has an excellent post noting what some of the root causes of the financial mess are. He quotes and links from the Tax Policy Blog; bluntly, a lot of the blame falls on political schemes done in the past. Something I remember from physics: “For every action there is an equal and opposite reaction.” All the money and funding that were pushed into housing so that everyone could own a home (which really accelerated during the Clinton Administration) is now seeing the obvious reaction: Not everyone should be a homeowner.

I’ll have more next week when I return from Connecticut.

With a very competitive election race between Democrat Barack Obama and Republican John McCain, the innuendo, charges, and rhetoric have flown back and forth. Senators McCain and Obama hold different views on many issues. Since I write a tax blog I’m going to examine the differences on tax issues between the two Senators. I hope that this series will enlighten you on the candidates and this important issue as we head towards November and Election Day.

First, though, I’m going to give a general overview on taxes, the economy, and how legislation is (and isn’t) enacted.

Taxes

A man condemning the income tax because of the annoyance it gives him or the expense it puts him to is merely a dog baring its teeth, and he forfeits the privileges of civilized discourse. But it is permissible to criticize it on other and impersonal grounds. A government, like an individual, spends money for any or all of three reasons: because it needs to, because it wants to, or simply because it has it to spend. The last is much the shabbiest. It is arguable, if not manifest, that a substantial proportion of this great spring flood of billions pouring into the Treasury will in effect get spent for that last shabby reason. — Rex Stout (And Be A Villain, 1948)

Rex Stout’s words, penned sixty years ago, match my views on taxation. (If you’d like to read an excellent overview on taxes, I strongly recommend Charles Adams’ For Good and Evil.) There has been a lot of discussion on earmarks and taxes during the current election cycle. Let’s first examine what taxes exist, and how they are enacted into law.

The primary tax in the United States is the income tax, authorized by the 16th Amendment. But it is not the only tax that the federal government collects. There are excise taxes (primarily on fuel, trucks, and wagering), payroll taxes, and an estate tax. There are taxes on individuals and on businesses.

All taxes add a cost to the price of a good. If the cost of a good increases, and the supply of the good remains constant, fewer of the good is sold—that’s the law of supply and demand. Taxes always decrease overall economic performance.

Yet the government must have revenue in order to operate; some amount of taxation must occur. Well, why don’t we just tax businesses? Assume that the only tax was an income tax on businesses. We would still be paying the tax. Again, this is a result of basic economics. If a business is taxed, it will raise its prices in order for it to continue to make a normal profit. All taxes on businesses are passed on to customers. When laws have been passed “banning” businesses from passing on taxes most businesses respond by cutting production, which hurts consumers because not enough of a good is produced.

Consider, also, regulations. Economics teaches that businesses pass on their costs to their customers. The cost of complying with regulations is passed on to consumers. Of course, many regulations are necessary but it is important to remember who ultimately pays for regulations—you and I.

Tax Legislation

The Constitution requires that tax legislation be first introduced in the House of Representatives. Tax legislation normally is first heard by the Ways and Means Committee. Once legislation passes out of committee it is then heard by the full House. The Speaker of the House has tremendous control over what legislation is heard by the entire body. With the Democrats in control of the House, this means that Nancy Pelosi (D-CA) can in most circumstances determine what is and isn’t considered.

Once legislation passes the House, it is then heard by the Senate. Tax legislation is usually first reviewed by the Senate Finance Committee and is then considered by the full Senate. Before legislation is considered by the Senate, cloture must be achieved; it takes 60 votes for cloture. (A bill needs a majority, 51, to pass. If the vote is tied the Vice President, who serves as president of the Senate, can cast a tie-breaking vote.) If a measure is amended in the Senate a Conference Committee is appointed to mesh out the differences. Then the legislation must again pass the House and Senate. Then the bill is sent to the President who can sign the bill or veto it. If a measure is vetoed, Congress can override the veto by getting a two-thirds vote in both the House and Senate in favor of the measure.

Why did I bring up how the legislative process works for taxes? Because it is of vital importance when considering the impact of a President. When Congress is controlled by one party and the President is a member of the other party usually few measures will actually be enacted into law. That’s certainly been the case with the 110th Congress. But this isn’t just President Bush using his veto power. This particular Congress just hasn’t been able to agree on much of anything. Whether that’s good or bad I’ll leave for you to decide.

Part 1 Conclusion

It is important to understand how the legislative process works in order to evaluate what a President can and cannot do. Of course, if voters demand that a piece of legislation be passed Congress usually responds. However, America is divided, and there have been few times in recent years where the public has demanded a certain piece of tax legislation be passed. One example of legislation that is passed because of what the public would do is the annual AMT patch. The public would yell bloody murder if an AMT patch were not passed; Congress knows this and, thus, passes the patch annually.

In Part 2 I will examine the proposals of Senator Obama (D-Illinois). I will look at the totality of the legislation he proposes—not only tax legislation but spending legislation because if a new program is passed the money to fund it must come from somewhere. I’ll also look at earmarks and how this does or does not impact Senator Obama’s proposals.

While I was away on vacation Congress passed a Housing Bill. There are a number of tax impacts of the legislation:

A first-time homebuyer’s credit of up to $7,500. This credit can be taken if you are a first-time homebuyer who purchases a home between April 1, 2008 and July 31, 2009 who meets the income qualifications (phase out of the credit begins with at an AGI of $75,000 if single or $150,000 if married-filing-jointly (MFJ)). This credit must be paid back over 15 years beginning two years following the purchase. Additionally, the credit can be taken in 2008 if a qualified home is purchased in 2009.

There is a one-time property tax deduction for taxpayers who don’t itemize for 2008. It’s $500 if single or $1,000 if MFJ.

New credit card reporting requirements are one of the offsets of the cost of this legislation. The new requirements, effective January 1, 2011, require credit card processors to report the total dollar amount of transactions to the IRS and the merchant if the total is at least $20,000.

There are a number of other tax impacts of this legislation. CCH has published an excellent summary that’s available here.

Hat tip: Tax Guru-Ker$tetter Letter

Last week the House of Representatives passed an AMT patch for 2008. That patch contained offsets (tax increases) which doom it in the Senate. Further, President Bush promises a veto if it somehow manages to make it out of Congress.

Eventually, Congress will pass a patch which doesn’t contain offsets. Will it be in September or November? I think we’re looking at a replay of 2007 and November is optimistic.