Topic: Tax and Budget Policy

Bush’s Standard Health Insurance Deduction: Tax Hike or No?

National Review’s Ramesh Ponnuru takes the Bush administration’s economist Kate Baicker and spokesman Tony Snow to task for what he suggests is a misleading representation of the President’s proposed “standard health insurance deduction.”

Briefly, under that proposal, most people who purchase health insurance would receive a substantial tax cut.  However, some workers would no longer be able to exempt from taxation the full amount of their health benefits.  Individuals who now receive more than $7,500 in health benefits, and families that receive more than $15,000 worth, would have to pay taxes on the difference. 

Ponnuru writes:

Snow and Baicker are right to say that if the proposal becomes law, compensation packages will adjust, with expensive plans being scaled back and the savings passed on in higher wages. But those higher wages will be taxed. No matter how the compensation package is rearranged, the percentage of compensation that is taxed will go up for these people.

My Cato colleague Arnold Kling concurs.  I disagree.

I think there are ways to avoid a tax increase, though I agree with Ramesh that this New York Times article didn’t do enough to explain how. 

In today’s New York Sun, I discuss the prospect of tax increases on workers with expensive health benefits:

Though that’s troubling, it is by no means certain. In fact, those workers may not face a net tax increase at all, because the President’s proposal would reduce other costs on those same workers. One such “tax” is the higher health care costs that result from the current employer-sponsored system. The President’s proposal would reduce that tax. Another is the current penalty imposed on workers who do not buy coverage through an employer. The President’s proposal would eliminate that tax.

Finally, when premiums exceed the proposed deductions, employers could reduce health benefits and shift the difference to other untaxed compensation, such as contributions to health savings accounts, life insurance, or 401(k)s. That would leave those workers with zero additional taxes. Or they could shift that difference to wages, in which case the workers would pay taxes on it, but their take-home pay would rise.

Of course, it would become more difficult to avoid a tax increase over time.  The deduction amounts would rise with overall inflation, while health insurance premiums traditionally have risen much faster.

I’ll be discussing these issues with Kate Baicker and the Urban Institute’s Len Burman at a Capitol Hill briefing tomorrow.

Hurray for Profits

Good news from the oil industry: ExxonMobil announced a record after-tax profit of $39.5 billion for 2006.

http://news.yahoo.com/s/ap/20070201/ap_on_bi_ge/earns_exxon_mobil

That is great news because it means the company will have more funds to reinvest in exploration, refinery expansion, drilling platforms, chemical plants, and all those other brilliant machines that American families benefit from every day.

The firm invested $20 billion in exploration, structures, and equipment in 2006 and $18 billion in 2005. See here and here.

High profits are a signal to ExxonMobil management, other energy companies, and Wall Street to feed this industry more capital and to continue increasing energy production. That’s good news for U.S. energy security and U.S. consumers.

The bad news with high corporate profits is that governments confiscate so much of them. In 2005, the firm paid current income taxes of $23 billion on pre-tax profits of $59 billion, for an effective income tax rate of 39%. (The firm also paid $31 billion in excise taxes to governments). Of course, Exxon simply collects these taxes on behalf of governments–the ultimate burden falls on individuals.

(In 2006, income taxes were $28 billion on pre-tax earnings of $67 billion, but I couldn’t find the breakdown of current vs. deferred tax)

Anyway, kudos to Exxon for their fine performance!

BBC Story Highlights Moral Bankruptcy of Europe’s High-Tax Politicians

As noted previously, high-tax European governments are upset that taxpayers are fleeing to Switzerland. The economic aspects of this issue are important, but a BBC story raises two interesting philosophical questions. First, the socialist candidate for the French presidency accuses Switzerland of “looting” its neighbor. But this implies that individuals belong to the government and that they do not have the individual freedom and sovereignty to choose where they want to live. Second, the European Union’s Ambassador to Switzerland argues that low tax rates are a subsidy. This argument implies that income belongs to government and it creates a moral equivalence between an interest group that seeks to seize other people’s wealth through the political process and taxpayers who merely want to keep more of their own money. Sounds absurd, but read the BBC report:

Switzerland’s decentralised taxation system is causing irritation among its European Union neighbours. The row was triggered by the decision, late last year, of the French rock star Johnny Hallyday to leave France and take up residence in the Swiss Alpine resort of Gstaad. …In France, where Hallyday is a national icon, there is anger. Advisers to the French presidential candidate Segolene Royal have accused Switzerland of “looting” its neighbours. …Swiss cantons are allowed to set their own taxes and many are now engaging in an internal corporate tax-cutting competition. Canton Obwalden, in central Switzerland, slashed its corporate tax rate to just 6.6% at the start of 2006; it attracted 376 new companies in just 11 months. The European Commission has warned that this may constitute an unfair subsidy under the European Free Trade Agreement. “Talk to any tax expert,” said Michael Reiterer, the commission’s new ambassador to Switzerland. “This is recognised as a subsidy. And there we think Switzerland should think a bit whether behaviour which is clearly outlawed in the EU is the best policy to follow in such a close relationship between two partners.” …Stefan Kux, head of economic development for Zurich, is not the least bit worried by the complaints from Brussels, in fact he sees them as quite positive. “We are profiting from the mistakes of our neighbours,” he explained. “They are making economic promotion for us for free, everyone now knows that Switzerland has an excellent tax system, so I’m very grateful.” …within the Swiss government there is little patience with Europe’s objections over tax. “The Swiss position is on very safe ground,” insisted Adrian Sollberger, spokesman for Switzerland’s office of European policy. “We do not have an agreement to harmonise taxes, none whatsoever, so by definition there cannot be any infringement of any agreement between Switzerland and the EU.” …the Swiss government will not budge; ministers say they view an attack on the tax system as an attack on Swiss sovereignty. The row is sure to simmer on. Meanwhile the businesses and the celebrities just keep on coming.

New Tax Proposal Combines Social Engineering and Class Warfare

Congressional Democrats want to use the tax code to penalize large corporate severance packages. But this should be a matter for stockholders to decide, not headline-seeking politicians. The Wall Street Journal, meanwhile, explains that the middle class often feels the brunt of tax schemes designed to punish the so-called rich:

One of the ways the Senate bill does this is to place a cap on the amount of “deferred compensation” that a company can award its top executives in a given year. The cap is equal to $1 million or the executive’s average salary for the previous five years, whichever is lower. But rather than simply tax any deferred compensation above that threshold as income, it imposes an additional 20% penalty tax on deferred comp above the limit. The Joint Committee on Taxation predicts this provision will bring in $800 million over the next decade. We’ll go out on a limb and predict it brings in an amount closer to $0.

Senate leaders describe this cap on deferred compensation as closing a loophole in the 1993 law that barred companies from deducting from their taxes more than $1 million of salary paid to their CEO and other top execs. Never mind that employee salaries have always been a deductible business expense. This was the last time Democrats ran Congress, and thus the last time they could sock it to the successful.

That 1993 law has itself become a classic example of unintended consequences. The biggest “loophole” in that law was an exemption carved out for performance-based compensation, which was meant to alleviate concerns about Congress setting pay rates in the private sector. Back then, even tub-thumping Senator Carl Levin said “I don’t support the government setting CEO pay in the tax code.” Which he and his mates proceeded to do anyway. And businesses promptly responded by shifting CEO pay away from salary and toward stock options and bonuses to circumvent the cap.

[…]

[T]his time, a much larger pool of people than CEOs could be hit by the new deferred comp cap. People who make a lot less than $1 million have occasion to defer some of their salary, and at many companies even middle managers can do so. If this bill becomes law, those non-millionaires potentially face a 55% tax rate on the income they might otherwise have tried to defer. The tax code is riddled with provisions, such as the Alternative Minimum Tax, the estate tax and any number of phaseouts and caps, that were sold politically as targeting only the “super-rich” but now capture taxpayers of far more modest means.

Public Choice in Action

The Washington Post ran a story today that could be a case study in a Public Choice textbook, “Maverick Costco CEO Joins Push to Raise Minimum Wage.”

The chief executive of Costco Wholesale, the nation’s largest wholesale club, yesterday became the most prominent member of a new organization of business owners and executives pressing Congress to approve an increase in the federal minimum wage.

Wow, Costco’s Jim Sinegal must be a really moral and public-spirited CEO. Sinegal “said he signed onto the effort because he thinks a higher minimum wage would be good for the nation’s economy as well as its workers.” The CEO explained: “The more people make, the better lives they’re going to have and the better consumers they’re going to be… It’s going to provide better jobs and better wages.”

Who does Sinegal think he is fooling? His real aim is to use the government to squash any low-end competition. 

Costco, of Issaquah, Wash., would suffer no direct impact from a higher minimum wage because its lowest-paid employees now make about $11 an hour, Sinegal said, adding that the average worker in the company’s 504 stores in the United States makes $17 an hour.

Tax Reform Is the Right Way to Lower the So-Called Tax Gap

Many politicians in Washington think they could get a lot more money to redistribute if Americans could be compelled into being fully compliant with the internal revenue code. Yet the world’s leading expert on the underground economy estimates that the United States has less evasion than any other nation [.pdf]. Moreover, the Wall Street Journal notes that the vast majority of noncompliance is the result of tax code complexity, which is why the only pro-growth way to generate more revenue is lower tax rates and simplification:

The “tax gap” is the difference between what the Internal Revenue Service thinks taxpayers should be paying and what it collects. The IRS currently estimates this at about $290 billion a year. Ask any Congressional chairman how he intends to close the deficit, expand the Medicare drug benefit, reform the Alternative Minimum Tax or subsidize college education, and the answer is invariably “close the tax gap.” Last year the Senate held some half-dozen hearings in search of this pot of gold. …We suppose politicians are allowed to dream. But it’s worth recalling that Washington has searched for this revenue Atlantis for decades without success. …Nina Olson, the IRS’s taxpayer advocate, told Congress last year that IRS auditors have found that an estimated 94% of noncompliance is the result of honest mistakes by tax filers who simply don’t understand the 17,000-page beast of a tax code. One obvious answer would be to simplify the code (more on that later). But this requires political will, so Congress naturally prefers the easier route of ratcheting up taxpayer regulation and enforcement. …Our personal favorite would require that Americans withhold taxes from any cash payments they make to such individual contractors as babysitters, gardeners or plumbers. They’ll love that one in the suburbs. Implicit in all these new plans is a much bigger IRS staff to monitor and chase tax miscreants. Here’s another bad idea: Many doctors and lawyers who are incorporated under subchapter S will often pay themselves lower wages but higher dividends, in order to reduce self-employment taxes. The law is vague on the limits of this practice, and it is undoubtedly abused. But the Joint Tax Committee’s preferred solution is to make all professional income – even dividend payments – subject to self-employment taxes; this is nothing more than a backdoor tax hike. …There is a better way. The more complicated a tax system, the more likely taxpayers won’t understand, or will try to dodge, the rules. Simple tax regimes, such as a single flat rate, encourage compliance and efficiency, not to mention economic growth. This has been the experience of many Eastern European countries after they imposed a flat tax, and the U.S. had similar jumps in reported tax income from “the rich” following the 1986 tax reform that cut rates and closed loopholes.

Capitol Hill Briefing Re: Standard Health Insurance Deduction

At noon this Friday, the Cato Institute will host a Capitol Hill briefing on President Bush’s proposal to replace the tax exclusion for employer-sponsored coverage with a standard health insurance deduction.

Discussing the proposal will be: Katherine Baicker of the president’s Council of Economic Advisers, Leonard Burman, director of the Urban-Brookings Tax Policy Center, and me.

The room number and video of the event can be found where you preregister, here.