The Zuckerberg Charitable Pledge and Giving from One’s Wealth

Mark Zuckerberg and his wife, Priscilla Chan, recently pledged to donate 99 percent of their Facebook shares to charitable purposes over their lifetimes. They are doing it through the Chan Zuckerberg Initiative, which uses a limited liability corporate structure.

Why not give to an IRS-approved charity, or a foundation created by Zuckerberg and Chan, instead? Two reasons leap to my mind, both shaped by nonprofit law. The first, which I fail to see in most commentary to date, is that generous lifetime giving by the wealthy can’t get much of a charitable deduction no matter how structured. Second, the Zuckerberg-Chan pledge falls into a class of efforts sometimes labeled “fourth sector” initiatives, which give much greater flexibility for how the money is used, including combining charitable and business purposes and lobbying for a favored cause—essentially what private individuals can but pure charities cannot do.

Economic Income, Realized Income, and the Charitable Deduction

In studies examining the behavior of those with significant wealth, other researchers and I show how little income they tend to realize, often 3 percent or less of the value of that wealth. That doesn’t mean the investors have earned such low rates of return. In fact, many like Mark Zuckerberg became millionaires or billionaires because they got very high returns. Most of their money, however, tends to be in stock or a closely-held business and, especially for those with only a few million dollars in total wealth, residences and vacation homes. As long as the wealthy don’t sell those assets, they won’t “realize” for tax or other accounting purposes the true economic returns or gains they achieve. And those gains can be substantially more than 3 percent: from 1926 to 2014, including during the Great Depression and Great Recession, stocks produced an average annual return of about 10 percent before inflation.

Related research examining the charitable activities of such wealthy individuals shows that most delay a huge portion of their giving until death. That is, they give from the wealth of their estates, not the income of their lifetimes. Why? Because tax law provides very little incentive to give huge donations to charity during a lifetime. Let’s suppose that Mark Zuckerberg and Priscilla Chan normally realize as income 2 percent of their estimated $45 billion wealth, or $900 million, this year. The charitable deduction is limited to 50 percent of yearly income, which in Zuckerberg and Chan’s case is $450 million; it’s only 30 percent ($270 million) if they want to give to foundation. Thus, if Zuckerberg and Chan give away more than 1 percent of their wealth each year, they run out of allowable charitable deductions. If in an average year they earn 10 percent on their wealth and give away only 1 percent, they are still accumulating much faster than they are giving it away, unless they consume billions annually.

Running out of charitable deductions doesn’t mean that the wealthy gain nothing from giving away money directly to charities earlier in life. Once assets are transferred to a charity, the donors don’t have to pay taxes on the income earned from those assets. But donors such as Zuckerberg and Chan would achieve only modest tax savings from early gifts to charity as long as their taxable income from the alternative remains a small percentage of their wealth. What also might be in play here, and I don’t fully know, is that the charitable side of the Chan Zuckerberg initiative will yield enough losses, transfers, and sales to needy individuals at below-market cost to offset any taxable income otherwise earned on the business side, so it can effectively avoid income tax just as well as an outright charity.

For Benefit Corporations and the Fourth Sector

So limits on the advantages of a charitable deduction provide a significant impetus for wealthy individuals to pledge money for charitable purposes without necessarily giving it to a charity. Donors may also think the flexibility they gain is substantial relative to any potentially modest tax costs. Giving to charity later is always an option, thus avoiding estate tax; meanwhile, other options haven’t been foreclosed.

Among the additional options at play is combining nonprofit and business activity. Among the many efforts of this type that get complicated in a pure charity setting are raising private equity; sharing real estate investment returns with low-income residents; running a business centered around training its workers and building up their equity rather than making profits for investors; investing in new drug research and pledging that the public, not investors, will garner any potential monopoly returns from some successful patent; or investing in green energy by granting some risk protection to private capital partners; and garnering research and development tax credits.

Some states have tried to create special rules applicable to certain “for-benefit corporations” that allow shareholders and charities to share returns. But, for the most part, the walls surrounding charitable money can’t be torn down. Federal and state tax and other nonprofit laws protect money that now essentially belongs to the public (with the charity as fiduciary), not to the donors.

If donors aren’t worried about getting a charitable deduction up front anyway, as is likely the case for Zuckerberg and Chan, the easiest route is to create a potentially profit-making limited-liability business. Meanwhile, donors can engage in all sorts of ventures without having their lawyers shouting “Stop” to each new creative idea because it might violate some charitable law. At the same time, Zuckerberg and Chan need a new entity since they can’t pursue their charitable pursuits directly through Facebook without soon running into problems meeting that corporation’s obligations to other shareholders.

If Zuckerberg and Chan decide that they want to lobby government, they also can avoid any limitation imposed on foundations or other charities.

These types of private initiatives, sometimes labeled as a Fourth Sector, push society in new, exciting, and yet-to-be-determined directions. As I’ve discovered when I raise money for charity, people will often consider giving away much more when asked to think about giving out of their wealth, not just their realized income. Fundraisers, take note: I don’t think we’ve even begun to tap this way of encouraging giving. Also, people often see new possibilities for enhancing charitable purposes when not confining themselves within the walls surrounding a typical charity, with entrepreneurs and venture capitalists often especially excited by the new adventure. Zuckerberg and Chan are merely two of the richer faces giving new attention to these broader movements.


My Christmas Wish List: I Want to Be a Drug Company

When I was a kid, I asked Santa to bring me a bike or a baseball glove. As an adult, I mainly wished for good health and good cheer for myself and my loved ones. This year, I have a particular request that I hope the man in the red suit can grant: I want to be a drug company.

I want the government to give me a monopoly over what I produce. I want to be able to set almost any price for my products.

I want the government to pay for whatever tens of millions of government-subsidized customers buy from me. I also want the government to pay those who sell my product or spend their time advising and prescribing my product for others.

I want to be paid for years and decades for producing the same thing to meet some chronic need, even if it would be better to produce things that heal or cure. I want to be paid for things that sometimes turn out to be worthless, and to avoid the possibility of my customers haggling over prices or suing me because they don’t pay for those things directly.

I want Congress to give me the power to appropriate money to myself and give up some of the power reserved in the Constitution for itself.

But I’m not done.

I want the government to let me avoid paying tax on the income I earn from the money it pays me. I want to be able to live in the United States and claim citizenship for tax purposes abroad in some low–tax rate country. I want to defer taxes on my income, then have the government forgive that tax debt. And I want congressional representatives who for years—even decades—have been more interested in fighting among themselves than in doing anything about this type of arrangement.

Why not? A recent news flurry surrounds Pfizer’s announcement that it will now become a foreign company so it can avoid US corporate tax and grab money set aside abroad for US tax liabilities. But that’s only the tail on a long list of favors granted it and other drug companies.

I write a lot. Imagine if I put my work under copyright, then lobbied to have a law passed that creates millions of subsidized customers who can have my work for free because I’m billing the government. Of course, I should be allowed to set almost any price for what the government pays on behalf of those customers. And the government could promise to book and magazine sellers that their profits would rise automatically with sales of my writings. Meanwhile, I’ve been around long enough that I’ve got a good share of my income deferred from tax until I draw down my 401(k) accounts, so I should be allowed to rent a shack somewhere abroad, claim a foreign residence, and avoid ever paying tax on that income, even while I live in the States.

Now, don’t blame me if I respond naturally to all those incentives. Or lobby Congress to maintain them. And don’t blame me if I end up producing things less worthwhile than what I could produce. Hey, it’s a free country.

How about you? Maybe together we can invent a company for workers and could be granted power to charge anything we want for providing that work to a large set of government-subsidized customers. We shouldn’t have to pay tax, given all we are doing for the economy. We could get some deep-thinking consulting firms to prove that this would probably solve any future unemployment problem.

What do you say, Santa? For goodness sake, you know I’ve been good, and I’m not pouting. With this wish, I’m just asking for what your competitor, Congress, gave the drug company next door.


Combined Tax Rates and Creating a 21st Century Social Welfare Budget

In testimony yesterday before a joint hearing of two House subcommittees, I urged Congress to modernize the nation’s social welfare programs to focus on early childhood, quality teachers, more effective work subsidies, and improved neighborhoods. One way lawmakers can shift their gaze is by considering the effects of combined marginal tax rates that often rise steeply as people increase their income and lose their eligibility for benefits.

While some talk about how we live  in an age of austerity, we are in fact  in a period of extraordinary opportunity. On a per-household basis, our income is higher than before the Great Recession and 60 percent higher than when Ronald Reagan was elected President in 1980.

A forward-looking social welfare budget should not   be defined by the needs of a society from decades past.  Two examples of how our priorities have shifted:   Republicans and Democrats didn’t always agree on the merits of Aid to Families with Dependent Children (AFDC) or the Earned Income Tax Credit, yet they agreed on the need to shift from welfare to wage subsidies.  Ditto for moving from public housing toward housing vouchers.

I sense that both the American public and its elected representatives are united in wanting to create a 21st century social welfare budget.  That budget, I believe, should and will place greater focus on opportunity, mobility, work, and investment in human, real, and financial capital.

However, for the most part, our focus has been elsewhere.  As I show in my recent book Dead Men Ruling, we live at a time when our elected officials are trapped by the promises of their predecessors.  New agendas mean reneging on past promises.  Even modest economic growth provides new opportunities, but the nation operates on  a budget constrained by choices made by dead and retired elected officials who continue to rule.

For instance, the  Congressional Budget Office and others project  government will  increase spending and tax subsidies by more than  $1 trillion annually by 2025, yet they already absorb more than all future additional revenues—the traditional source of flexibility in budget making.

I am concerned about the potential negative effects of these programs on work, wealth accumulation, and marriage of combined marginal tax rate imposed mainly on lower-income households.  To see how multiple programs combine to reduce the reward to work and marriage, look at this graph.

taxandtransfer

For households with children, combined marginal tax rates from direct taxes and the phasing out of benefits from universally available programs like EITC, SNAP, and government-subsidized health insurance average about 60 percent as they move from about $15,000 to $55,000 of income.  This is what happens when a head of household moves toward full-time work, takes a second job, or marries another worker.

Beneficiaries of additional housing and welfare support face marginal rates that average closer to 75 percent. Add out of pocket costs for transportation, consumption taxes, and child care, and the gains from work fall even more. Sometimes there are no gains at all.

While there is widespread disagreement on the size of these disincentive effects on work and marriage, there is little doubt that they exist. One solution: Focus future resources on increasing opportunity for young households. Make combined tax rates more explicit and make work a stronger requirement for receiving some benefits.

This post originally appeared on TaxVox.


How to Pay Zero Taxes on Income of Millions of Dollars

Remember when people complained that hedge fund managers and private equity firm owners paid a lower tax rate than many workers? Or when Warren Buffett said he shouldn’t pay a lower rate than his secretary?  In those cases, investors were benefiting from low capital gains rates, but at least they paid some tax.

Now, thanks to Roth accounts, a special form of retirement savings, investors and even their children pay close to zero tax on huge sums of income. While this scheme can create significant future government budget shortfalls, my attention here is on how our tax code favors those who understand how to play this Roth-account game.

You got a hint of what might be possible when Governor Romney disclosed that he had over $100 million in his individual retirement account. However, this money was in a traditional IRA, taxable upon distribution, not a Roth IRA, where once a modest tax is paid up front, then all future income from the account escapes tax. Thus, Romney missed out on some of the tax benefits available to Roth holders.

The Taxpayer Relief Act of 1997 first made such accounts possible. At about that time, I warned in Tax Notes Magazine about how some investors could use Roths to avoid almost all tax on significant amounts of income. But I didn’t have a smoking gun, since I was anticipating future accruals on this then-new option. Tax professionals who put high-return hedge fund or private equity return assets into a Roth for wealthy clients have no incentive to disclose the details of these deals.

But a recent article by Richard Rubin and Margaret Collins for Bloomberg  describes a redesigned retirement plan of Renaissance Technologies that allows employees to put retirement monies into Medallion, a hedge fund that historically has produced extraordinary high returns. My colleague, Steven Rosenthal, examines the tax implications and questions the future role of the Labor and Treasury Departments in these developments.

But you don’t need to work for a private equity firm or hedge fund to benefit.  Let’s start with the tax sheltering opportunity available to almost anyone willing to invest far into the future and who earns no more than the normal long-term rate of return on stocks.

Suppose a 25 year-old taxpayer puts $10,000 in Roth accounts, perhaps helped out by parents. Once he pays a small upfront tax on the contributions, the tax on these accounts is now totally prepaid. He will never owe another dime. If stocks provide a traditional historic return of, say, 9 percent per year, the portfolio would grow to $483,000 by age 70, the age at which people must withdraw from traditional retirement accounts but not Roths.  Make a few such deposits, and soon millions of dollars of income can escape tax.

But 9 percent represents an average return, chicken feed compared to the successful private equity investor, inventor, entrepreneur, or small business person. If they are insiders or somehow know, they might well know that they are likely to generate 15 percent per year over time. Others might also generate this higher return because of invention, luck, or simply leveraging up their returns. If the investment returns 15 percent annually, a $10,000 deposit held for 45 years grows to $5.4 million by age 70.

Perhaps you think the example of a 25-year old depositing money until age 70 is exaggerated. But it understates the more extreme cases. A Roth IRA can be held much longer than 45 years, e.g., a 35 year old living to 90 can leave the money to his kids who must withdraw the money only gradually after the parent’s death, so in this case complete tax exemption would last 55 years, and partial exemption would extend outward toward a century.

Think what this does for the fairness of a tax system. People who turn out to make millions of dollars of income on their investments will often pay no more tax (up front or down the road) than people who make little or nothing on their saving. To be clear, I’m saying dollars of tax, not rate of tax, would often be the same. The unsuccessful will be taxed the same as the successful, violating the whole notion of proportionality, much less progressivity, in taxation. I can think of almost no other tax provision, whether in an income or consumption tax, that goes so far in violating the notion that those who either make more money or consume more can afford to pay more tax.

This post originally appeared on TaxVox.


A Better Alternative to Taxing Those Without Health Insurance

Although the public debate on health insurance coverage centers on a thumbs-up, thumbs-down fight over the Accountable Care Act (ACA, also called Obamacare), our national system needs a lot of smaller fixes. Many items on this long list of fixes make sense under either a Republican alternative to Obamacare (like the one recently but only partially laid out by Representative Paul Ryan) or Democratic amendments to the existing plan. One example: rethinking the tax penalty on people who do not buy insurance, an issue receiving increased attention as the IRS assesses its first penalties. We can achieve the same end much more effectively by requiring households to purchase health insurance if they want to receive the other government benefits to which they are entitled. No separate tax is required.

The history of the tax penalty

A system of near-universal insurance—where most people of the same age, regardless of their health conditions, can buy insurance at approximately the same price—needs a backup. This need became clear when health reform proposals were first introduced in 2009. Without a backup, individuals have a strong incentive to avoid buying insurance until they are sick, thus effectively getting someone else to pay for their health care. This incentive exists regardless of income level: even a wealthy person who buys health insurance only after becoming sick could hoist his bills on those with lesser incomes who pay for insurance year-round and every year.

The ACA’s partial response to this incentive is to tax those who fail to buy health insurance. The tax for failure in 2014 was either 1 percent of income or $95 per person; it rises to 2.5 percent of income or $695 (adjusted for inflation) after 2015. At the beginning of 2015, millions of people discovered that they owed this tax as they started filing their federal tax returns for 2014.

Practical considerations have always led toward some individual requirement to buy insurance, simply because there are limits on how much government can spend on subsidizing everyone. Our very expensive health care system now entails average health costs per household of about $24,000. The federal government would have to spend just about all its revenues trying to cover all those costs. A mandate to purchase insurance is a partial alternative to ever-more subsidies—as Governor Romney knew when he implemented a related mandate in Massachusetts. At one point, the mandate idea was favored by conservatives even more than liberals as a way to avoid an even more expensive government-controlled system, such as Medicare for all.

What might work better

The problem with the Obamacare tax penalty isn’t the idea; it’s the design. This problem, in various forms, occupied the federal courts needlessly. The central dilemma that pre-occupied an earlier Supreme Court decision was whether government could mandate that we had to buy some particular product (maybe not, it said, but, at least in Chief Justice Roberts’ opinion, it could impose a tax).

Another type of requirement avoids many past and current issues surrounding the Obamacare tax penalty. Simply deny to taxpayers other government benefits if they do not obtain insurance for themselves and their families. There has been no debate over whether government can—indeed,  at some level administratively must—set conditions for determining who receives benefits.

This type of requirement could be implemented in various ways. The personal exemption or the child credit or home mortgage subsidies could be limited; some portion of low interest rates for student loans could be denied. This approach entails no new “tax” for not buying insurance; it simply adds to the conditions for receipt of other government benefits.

Designed well, the denial of any tax benefit could easily be reflected in withholding, so there are fewer end-of-year surprises. Employers, for instance, could adjust withholding for months in which employees did not declare insurance for themselves. As for the many poor receiving benefits like SNAP, most tend to be eligible for Medicaid, so the requirement than they sign up could be handled better by the related administrative offices that deal with them than by the IRS imposing some surprise penalty at the end of the year.

For both administrative and political reasons, this type of requirement can also be made stricter than the current extra tax. The IRS has always had trouble collecting money at the end of the year, and people react more negatively to an additional tax than to a requirement that they shouldn’t shift health costs onto others if they want to receive some other government benefit.

The road ahead

I doubt that any future government, Democratic or Republican, is going to deny people the ability to buy health insurance at a common community rate, even if they are sick or have failed to purchase health insurance previously. The world has already changed too much. Insurance companies have adapted, and so have hospitals. Before health reform, uninsured people could generate partial benefits or coverage by receiving treatment in emergency rooms (where such care is often required by law), and then not paying their bills. With some major exceptions, that practice has declined since the ACA was implemented. No one wants to go back to the old ways.

In a partisan world, of course, a fix of almost any type becomes difficult. Republicans are afraid to fix almost any aspect of Obamacare for fear it would involve a buy-in to the plan’s success; Democrats dread amending Obamacare because it might hint at some degree of failure. Watching the current Supreme Court battle, you sense that many enjoy the fight more than anything else. Still, this simple fix should be added to the list of reforms for consideration when and if we decide we want something better.


Addressing income inequality first requires knowing what we’re measuring

Politicians, researchers, and the media have given a good deal of attention recently to widening income inequality. Yet very few have paid attention to how—and how well—we measure income. Different measures of income show very different results on whether and how much inequality has risen. Without clarity, even honest and non-ideological public and private efforts to address inequality will fall short of their mark—and, in some cases, exacerbate inequality further.

How we typically measure income

Income measures tell different stories about opportunity and can be useful for different purposes. Some studies on income inequality measure income before government transfers and taxes—for instance, studies that compare workers’ earnings over time. Studies of the distribution of wealth or capital income, too, typically exclude any entitlement to government benefits. These “market” measures capture how much individuals have gained or lost in their returns from work and saving.

More comprehensive measures examine income after transfers and taxes. Transfers include Social Security, SNAP (formerly food stamps), cash welfare, and the earned income tax credit. Taxes include income and Social Security taxes. These measures best capture individuals’ net income and what living standards they can maintain, but not their financial independence or how much they are sharing directly in the rewards of the market.

Within both sets of measures (pre-tax, pre-transfer and post-tax, post-transfer), most studies still exclude a great deal. Health care often fails to be counted, even though increases in real health costs and benefits now take up about one-third of all per-capita income growth. Most of these health benefits come from government health plans (like Medicare and Medicaid) or employer-provided health insurance. Households pay directly for only a minor share of health costs, so they often don’t think about improved health care as a source of income growth.

How improving our definition of income—and using alternative measures—sharpens our view of income inequality

Starting with a more comprehensive measure of income, and then breaking out components, can improve our understanding of income inequality and its sources. As an example, let’s use some recent Congressional Budget Office (CBO) estimates, which provide perhaps the most comprehensive measure of household market incomes (consisting of labor, business, capital, and retirement income), then add the value of government transfers and subtract the value of federal taxes.

Between 1979 and 2011, the average market incomes—that is, incomes before taxes and transfers—of the richest 20 percent of the population (or the top income quintile) grew from 20 times to 30 times the incomes of the poorest 20 percent (the bottom income quintile).

income1

When examining income after taxes and transfers, however, the relationship between the top and bottom income quintiles is more stable. It starts at a ratio of about 5.5:1 in 1979 and increases very slightly to 6:1 by 2011.

income2

We find somewhat similar trends when comparing the fourth quintile with the second quintile. After taxes and transfers, income ratios don’t change much over this period, though the market-based measures of income show increased inequality. Of course, the very top 1 percent still has gained significantly; in 2011 it had nearly 33 times the income of the bottom 20 percent, compared with about 19 times in 1979.

What’s still missing

Even the CBO measures, however, are far from comprehensive. They exclude many benefits that are harder to measure or distribute, such as the returns from homeownership and the value of public goods like highways, parks, and fire protection. As Steve Rose points out, even more elusive are the broadly shared gains in living standards brought by improved technology and new inventions.

Why getting it right matters

Though defining income may seem like merely a technical exercise, it has huge consequences. Inequality has always been a political football: all sides tend to quote statistics that support their policy stances while ignoring the statistics refuting them. Yet if we want good policy, we’ve got to be open to how well any particular policy might improve income equality by one measure or make it worse by another, often at the same time. This is not a new story: bad or misleading information almost inevitably leads to bad policy.

This column first appeared on MetroTrends.


The President’s Capital Gains Proposals: An Opening for Business Tax Reform?

In his budget proposal, President Obama would raise capital gains taxes as a way to finance middle class tax relief. Along with many Republicans, he also supports tax rate cuts for business and efforts to prevent multinational corporations from avoiding U. S. taxation.

This raises an intriguing possibility. Why not pay for at least some corporate tax cuts with higher taxes on individuals on their receipts of capital gains or similar returns? In effect, as it becomes increasingly difficult to find a workable way to tax profits of the largest businesses, largely multinational companies, why not tax shareholders directly?

Most proposals to deal with the complexities of international taxation wrestle with how to tax corporations based on their geographical location. But as Martin Sullivan of Tax Notes said years ago, what does it mean to base taxes on a company’s easily-reassigned mailing address when its products are produced, consumed, researched, and administered in many places?

By contrast, individuals usually do maintain residence primarily in one country. Thus, reducing corporate taxes while increasing shareholder taxes on U.S. residents largely avoids this residence problem. Indeed, many proposals, such as a recent one by Eric Toder and Alan Viard, move in this direction. While such a tradeoff is not a perfect solution, it makes the taxation of the wealthy easier to administer and less prone to today’s corporate shelter games.

Many have made the case for why cutting corporate rates is sound policy. On what policy grounds can Obama’s plan for raising taxes on capital gains fit into this story?

Much of the publicity about taxing the rich focuses on their individual tax rate. But many very wealthy people avoid paying individual taxes on their capital income simply by never selling stock, real estate, or other assets on which they have accrued gains. That’s because, at death, the law forgives all capital gains taxes on unsold assets.

The very wealthy, moreover, tend to realize a fairly small share of their accrued gains and an even smaller share than those who are merely wealthy. It makes sense: the nouveaux riche seldom become wealthy unless they continually reinvest their earnings. And when they want to consume more, they can do so through means other than selling assets, such as borrowing.

Warren Buffett was famous for claiming that he paid lower tax rates than his secretary, alluding in part to his capital gains rate versus her ordinary tax rate on salary. But Buffett doesn’t just pay a modest capital gains tax rate (it was 15 percent when he made his claim and about 25 percent now). On his total economic income, including unrealized gains, it’s doubtful that his personal taxes add up to more than 5 percent.

At the same time, many of the wealthy do pay significant tax in other ways. If they own stock, they effectively bear some share of the burden of the corporate tax. Real estate taxes can also be significant and not merely reflect services received by local governments. Decades ago I found that more tax was collected on capital income through the corporate tax than the personal tax. Today, the story is more complicated, since many domestic businesses have converted to partnerships and Subchapter S corporations, where partners and shareholders pay individual income tax on profits.

The President would raise the capital gains rate and tax accrued gains at death. This would encourage taxpayers to recognize gains earlier, since waiting until death would no longer eliminate taxation on gains unrealized until then. The proposal would effectively capture hundreds of billions of dollars of untaxed gains that forever escape taxation under current law.

Trading a lower corporate tax rate for higher taxes on capital gains could also result in a more progressive tax system since many corporate shares sit in retirement plans and charitable endowments. It would reduce to hold onto assets—in tax parlance, lock-in—and the incentive to engage in tax sheltering. There’s also a potential one-time gain in productivity, to the extent that the proposal taxes some past gains earned but untaxed, as such taxes would have less effect on future behavior than the taxation of current and future returns from business.

Tough issues would remain. Real reform almost always means winners and losers. For instance, how would a proposal deal with higher capital gains taxes for non-corporate partners and owners of real estate? Toder and Viard, for instance, would apply higher individual taxes only on owners of publicly-traded companies.

Still, some increase in capital gains taxes could help finance corporate tax reform without reducing the net taxes on the wealthy. It is exactly the type of real world trade-off that both Democrats and Republicans must consider if they are serious about corporate tax reform.

This column originally appeared on TaxVox.


President Obama’s Middle-Class Tax Message in the State of the Union

President Obama’s tax proposals for the middle class were a key element of his State of the Union address. But they represent only relatively modest efforts to create subsidies through the tax code rather than through other departments of government. Looked at broadly, many only tinker around the edges of tax policy and count on an overloaded and troubled agency, the IRS, to administer them.

Will $320 billion of tax increases finance very much?

The President proposes $320 billion in tax increases on the wealthy. It sounds like a lot. But how much would it finance in expenditures and additional tax breaks, assuming it is all spent rather than used to reduce the deficit?   Well, there are approximately 320 million Americans, so the proposal would garner about $1,000 per person. But, then again, the $320 billion would be raised over ten years, so that’s about $100 per person per year that could be financed.

Now compare the $100 per year with what we already spend. Add together federal, state, and local spending plus tax subsidies (and the President would “spend” a good deal of his additional revenue on new tax subsidies), and the figure comes out to more than $20,000 per person.  And that spending is scheduled to rise by an average of several thousand dollars per year over the same ten year period, due more to (hoped for) economic growth than anything else.

None of these observations speaks for or against the proposals. I like some of them, don’t like others. But if you want to have a significant impact on the budget and on the well-being of citizens, concentrate on where the money is.

Should we throw even more subsidies into the tax code?

Like almost all his recent predecessors, the President talks in his State of the Union address about tax simplification, but in almost the same breath he proposes a range of new tax subsidies. It’s an old story. Tax cuts show up as “smaller” government to those who simply count up net government revenue as a measure of government size. According to that theory, we could achieve dramatically limited government or no government at all if we put all expenditures into the tax code, thereby collecting negative taxes on people, at least as long as we run deficits.

Huge jurisdictional problems also lead to more and more being put into the tax code. Discretionary spending is capped; tax subsidies are not. Congressional tax committees can use increased revenues to pay for increased tax subsidies, but they do not have the jurisdictional authority to spend additional tax revenues on higher levels of spending, or, on the flip side, to reduce many items of direct spending to pay for lower tax rates.

Now I’m not suggesting that a new tax subsidy is necessarily more complex than a new expenditure. But it does raise the issue of whether the IRS is the right agency to administer the subsidy. All of this is coming at a time when the IRS has lost significant resources, the Taxpayer Advocate suggests we should be ready for a horrible filing season in which taxpayers will have difficulty getting ahold of someone in IRS to advise them, and many in the IRS remain disheartened and have been pushed into a bunker mentality that fears bad publicity more than bad administration.

This column originally appeared on TaxVox.