|Overlooking Tax Policy: A Decade in Review
The first decade of the 21st century was not a good one for tax policy.
January 14, 2010
The decade 2000 to 2009, started with the decline of the dot.com boom when the NASDAQ peaked in March 2000 and ended with discussions of additional stimulus measures to address a nagging recession. Despite efforts to name this decade — the "aughts" or the "double ohs," nothing stuck. At the end of the decade, economist Paul Krugman suggested calling it the "Big Zero" because economically, "nothing good happened" ("The Big Zero," The New York Times, December 28, 2009). That label also suffices to describe tax policy in this past decade. This article evaluates selected federal and state tax actions (and inactions) to support the proposition that the first decade of the 21st century was not a positive one for good tax policy.
Rationale for the Bleak Label
From a tax policy perspective, the period 2000 to 2009 saw little activity that improved tax systems to better reflect principles of good tax policy. At least three problem areas support this conclusion:
Despite time, as well as having lots of data and studies, problem areas in the federal tax systems have mostly been ignored. Temporary tax cuts were enacted in 2001 and 2003 that mostly expire after 2010, except for the estate tax that expired just for 2010. Despite talk of not letting the estate tax expire, Congress adjourned in December 2009 with the expiration untouched while two competing healthcare bills were passed that include a variety of new, complex tax provisions. Failure to address the one-year expiration despite having many years to act, does not bode well for thinking that Congress will be ready to thoughtfully address other tax cuts before they expire at the end of 2010.
Also, despite years of knowing that the alternative minimum tax (AMT) is out of control — reaching millions of individuals for which it was not intended to affect, only one-year "patches" are offered and we start 2010 without a patch.
In 1998, former Senator William Roth, then chair of the Senate Finance Committee, noted the need to "fundamentally rethink the tax code with a view to enhancing American competitiveness in the new global economy and helping the American workforce" (Tax Déjà Vu, AICPA Tax Insider, October 9, 2008). Numerous studies on international taxation and reform have been prepared by the Joint Committee on Taxation (JCT) in the past 15 years and hearings on the topic have been held by the tax-writing committees (JCT, Impact On International Competitiveness Of Replacing The Federal Income Tax (PDF), JCS-5-96, July 1996; Nellen, Groundwork for Modernizing International Tax Rules in the U.S., AICPA Corporate Taxation Insider, November 13, 2008). Yet, no actions have been taken to modernize international tax rules.
Also in 1998, the IRS Restructuring and Reform Act (P.L. 105-206; 7/22/98; §4002) called upon the Joint Committee on Taxation to study the Internal Revenue Code and make proposals for simplification. A three-volume report (over 1,200 pages) was issued in April 2001 (JCS-3-01). Proposals included repeal of the AMT and most phase-outs, elimination of the two percent of adjusted gross income (AGI) limitation on miscellaneous itemized deductions, replacing the multiple rate structure for capital gains with a deduction and changes to simplify the numerous provisions for higher education expenses. Almost all recommendations have not been acted upon other than most notably, the recommendation for a uniform definition of a "qualifying child" (Working Families Tax Relief Act of 2004, P.L. 108-311 (October 2004)).
Federal revenue and spending problems continue to grow. The Congressional Budget Office (CBO) estimates a $1.4 trillion deficit for fiscal year 2009, almost $1 trillion larger than for the prior year. The Government Accountability Office (GAO) notes "the federal government faces even larger fiscal challenges that will persist long after the return of financial stability and economic growth" (GAO-10-137SP, October 15, 2009). In several years, revenues will not be sufficient to cover growth in mandatory spending (such as Social Security and Medicare). The Tax Foundation estimates that addressing the 2010 deficit would take an unrealistic tripling of individual tax rates (Can Income Tax Hikes Close the Deficit?, October 22, 2009).
The current recession challenged almost all state governments due to declining tax revenues and balanced budget requirements. Tax changes made in desperate times are likely to produce less than ideal tax changes, such as rate increases and suspension of carryovers, rather than addressing structural problems that require more thought and time.
For example, some states, including California and North Carolina, increased sales-tax rates in 2009 to help close budget shortfalls. Without the fiscal crisis, additional time could perhaps have been spent on reviewing the overall state tax system to identify changes that would be more equitable (sales taxes are regressive) and efficient (generally, tax systems with broad bases and low rates better meet principles of good tax policy).
Some states have also faced a crisis due to frustration of their inability to address certain issues, such as collection of sales tax by remote vendors. In 1992, the U.S. Supreme Court ruled in Quill, 504 US 298, that a physical presence was required in order for a state to require a vendor to collect sales tax from customers. The Court noted that Congress could exercise its commerce clause powers to create a different treatment. Despite legislative proposals, Congress has taken no final action on this matter. States have explored and pursued solutions on their own, including development of uniform sales and use tax law (Streamlined Sales and Use Tax Agreement) and new laws that broaden the possibility that a vendor has a physical presence in the state (Nellen, Grabbing Remote Vendors, AICPA Corporate Taxation Insider, July 31, 2008).
Legislation enacted in Rhode Island and North Carolina in 2009 to follow the lead of New York to create a rebuttable presumption that certain vendors have sales tax nexus due to relationships with associates in the state, will not reach the states' desired result. In these states, Amazon (and perhaps other vendors) cancelled their contractual relationships with in-state associates thus causing the vendor to not be subject to the new law ("Amazon Cuts Its R.I. Ties Over Sales Tax," The Providence Journal, June 30, 2009; and "Amazon Cuts North Carolina Affiliates to Avoid Tax," The Wall Street Journal, June 27, 2009). Effective legislation would not be this easy to legitimately avoid. The ultimate result of such legislation, partly brought about by crisis and desperation, is certainly not helpful to state coffers, the associates' income producing capabilities and tax system policy and design.
At the federal level, many new deductions and credits were added from 2000 to 2009, including many temporary ones, leading to increased complexity. Also, the fiscal downturn caused more individuals and businesses to have to deal with cancellation of debt and foreclosures which require more taxpayers to deal with complex tax rules. The 2008 National Taxpayer Advocate report to Congress notes the complexity of tax provisions on these topics and the high likelihood of errors due to "extremely challenging tax reporting requirements." Simplification suggestions were also made in the report (2008 Report (PDF), p. 391).
The problems noted above do not bode well for strong tax policies in federal and state tax systems. For example, continued delay in modernizing international tax rules and evaluating the corporate rate structure can lead to economic inefficiencies. Delays in engaging in thoughtful analysis of how to address the impending expiration of numerous changes enacted in 2001 and 2003 and the out-of-control AMT, lead to inequities, complexity, non-transparency and inefficiencies.
Lawmakers at the federal and state levels have big jobs in front of them. Avoidance of effectively identifying and addressing tax system weaknesses, increasing complexity, ignoring simplification proposals and operating in crisis mode rather taking time to consider what is best for long-term fiscal health of tax systems cannot continue. Principles of good tax policy need to become a focal point as we close the door on the first decade of the 21st century.
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Annette Nellen, CPA/Esq., is a tax professor and director of the MST Program at San Josť State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel and chairs the California Bar Tax Section’s Tax Policy Committee. She has several reports on tax reform and a blog.