Federal Tax and Spending Patterns Benefit Some States, Leave Others Footing the Bill

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1 TAX FEATURES www.taxfoundation.org Summer 2002 Volume 46, Number 3 Federal Tax and Spending Patterns Benefit Some States, Leave Others Footing the Bill

Some states feast at the expense of others, full report on line at: according to the Tax Foundation’s annual www.TaxFoundation.org/taxingspending.html analysis of federal fiscal operations. By comparing the federal tax burden in each state with an adjusted set of the Census Bureau’s most recent data (2001) on Federal Spending by State for Each Tax Dollar Sent to Washington federal spending in each state, Tax Foundation senior economist FY 2001 Scott Moody has ranked states Ten highest ratios of spending to tax in order of which got the Ten lowest ratios of spending to tax best deal in 2001 from WA Uncle Sam’s tax and 84¢ NH VT 71¢ ME spending policies. MT ND $1.12 $1.31 $1.67 $1.95 OR MN Federally Favored $1.00 81¢ MA ID WI 84¢ $1.24 SD 89¢ NY States $1.50 83¢ RI WY MI $1.11 In No. 116 of the $1.14 86¢ PA CT IA 67¢ Tax Foundation’s Spe- NE $1.17 $1.07 NV NJ cial Report series, $1.17 IL OH 76¢ IN $1.01 DE 67¢ UT 78¢ 99¢ 86¢ titled “Federal Tax $1.11 WV CA CO $1.73 VA MD 82¢ 82¢ KS MO $1.45 $1.26 Burdens and Expendi- $1.14 $1.29 KY $1.38 DC tures by State,” Moody NC $5.73 TN $1.06 points out that during AZ OK $1.20 fiscal 2001, taxpayers in $1.12 NM $1.48 AR SC $2.08 $1.45 $1.30 New Mexico benefited the most MS AL GA $1.78 $1.53 $1.01 from the give-and-take with Uncle LA TX $1.42 Sam. 92¢ New Mexico received $2.08 in AK $1.63 federal outlays for every $1.00 the FL $1.05 state’s taxpayers sent to Uncle Sam.

HI $1.54 Taxes vs. Spending continued on page 2 In this issue: FRONT & CENTER Federal Taxes and Spending by State 1 Report on “Jock Taxes” 4 Jefferson on Estate Taxes 6 Permanently Repeal a Tax Detrimental New Study on State Budgetary Institutions 8 to Minority Wealth: The Estate Tax State Tax Compliance Cost 9 European Tax Conference 10 Hodge on Inversions 11 William Jefferson (D-LA), Member, Committee on Ways and Means, U.S. House of Representatives TF History 12 6-7 2

Taxes vs. Spending from page 1 fisc99) more than 25 years ago. In re- Federal Tax Collections by cent years, however, other states have Type of Tax No other state got a 2-1 ratio, but Uncle eclipsed New York for the “blessing” of Sam spent $1.95 in North Dakota for being the state that gives far more than Fiscal Year 2001e each tax dollar, $1.78 in Mississippi, and it receives. ($Billions) $1.73 in West Virginia. Combining the second highest tax Though not comparable as a state, burden per capita with low federal the District of Columbia is by far the spending (33rd highest), New Jersey 1.4% 0.9% 0.0%* biggest beneficiary of federal spending: had the lowest federal spending-to-tax Estate & Gift Customs Duties Other Taxes ($18.7) ($0.1) In 2001 it received $5.73 in federal ratio (0.67). The 0.67 ratio means that ($27.5) outlays for every dollar its taxpayers New Jersey only receives 67¢ in federal sent to the U.S. Treasury. spending for every dollar its taxpayers send to Washington and is therefore the 3.4% Excise States That Help Others nation’s biggest loser from federal fiscal Taxes If some states are beneficiaries, then operations. Other states that had low ($66.9) 48.1% naturally some states must be benefac- federal spending-to-tax ratios in FY Individual tors — those states where so much is 2001 are Connecticut (67¢), New Income Taxes 10.2% ($949.2) collected in federal taxes that any federal Hampshire (71¢), Nevada (76¢) and Corporate largesse they receive is overwhelmed. Illinois (78¢). Income Taxes New York has often been the big- ($201.4) gest loser in the Tax Foundation’s an- Changing Ranks nual comparison of taxes to spending, The state that raised its ratio the 35.9% which inspired Daniel Patrick most between 1991 to 2001 is Alaska Social Insurance Moynihan and the Kennedy School of where federal spending rose from Taxes Government to launch their annual $1.19 to $1.63 for each dollar in taxes. ($708.0) reference book comparing state taxes This 44¢ increase beats out Hawaii, with spending (www.ksg.harvard.edu/ where federal spending increased 42¢ * Less than 0.5 percent.

Federal Tax Burden Per Capita in Current and Constant Dollars Fiscal Years 1992 – 2002

Current Constant Dollars 2002 Dollars

Federal Taxe Per Person in the U.S. Federal Taxe

Fiscal Year 3 per dollar of tax, North Dakota high spending levels in Virginia, Mary- states with higher incomes per capita (40¢ more spending per dollar), land and the District of Columbia are — Connecticut stands out — pay and West Virginia (31¢ more explained by the predominance of much higher federal taxes per capita spending per dollar). federal employees. because of the income tax’s progres- States where the ratio dropped On the tax side of the equation, sive structure. most dramatically are Colorado and Massachusetts. Colorado has seen its federal spending-to-tax ratio fall 33¢ Federal Spending by State Per Dollar of Federal Tax from $1.15 in FY 1991 to 82¢ in FY 2001. Massachusetts’s has dropped 23¢. FY 1991 and 2001

Change How Can States React? Expenditures in Spending Change Federal spending on defense and Per Dollar of Taxes Per Dollar Ranking in other procurement dollars are often FY 1991 FY 2001 of Tax FY 1991 FY 2001 Rank funneled to the states of powerful con- Total $ 1.00 $ 1.00 – – – – gressmen, and state governments can Alabama $ 1.37 $ 1.53 + 15¢ 7 8 – 1 Alaska 1.19 1.63 + 44 20 6 + 14 grab more federal grant money by skill- Arizona 1.20 1.12 – 8 19 25 – 6 fully — some would say slavishly — Arkansas 1.29 1.45 + 16 11 11 0 manipulating their spending to comply California 0.89 0.82 – 8 39 44 – 5 with federal regulations. Colorado $ 1.15 $ 0.82 – 33¢ 22 43 – 21 However, demography is at least as Connecticut 0.79 0.67 – 12 45 49 – 4 Delaware 0.74 0.86 + 12 48 39 + 9 influential as politics. States with more Florida 1.07 1.05 – 2 26 31 – 5 residents on Social Security, Medicare Georgia 0.92 1.01 + 9 37 33 + 4 and other large federal entitlements are Hawaii $ 1.11 $ 1.54 + 42¢ 23 7 + 16 bound to rank fairly high. Similarly, the Idaho 1.28 1.24 – 4 14 19 – 5 Illinois 0.73 0.78 + 5 49 46 + 3 Indiana 0.88 0.99 + 11 40 35 + 5 Iowa 1.02 1.17 + 15 29 21 + 8 Publication Summary Kansas $ 1.07 $ 1.14 + 7¢ 27 24 + 3 Kentucky 1.29 1.38 + 9 12 14 – 2 General: Special Report No. 116; ISSN Louisiana 1.22 1.42 + 20 17 13 + 4 1068-0306; 12pp.; $10 or $50/yr. for 6 Maine 1.32 1.31 – 2 10 15 – 5 issues on varied fiscal topics Maryland 1.22 1.26 + 4 16 18 – 2 Title: Federal Tax Burdens and Expendi- Massachusetts $ 1.06 $ 0.84 – 23¢ 28 41 – 13 tures by State Michigan 0.80 0.86 + 7 44 38 + 6 Minnesota 0.85 0.81 – 5 41 45 – 4 Author: J. Scott Moody Mississippi 1.67 1.78 + 12 2 3 – 1 Date: July 2002 Missouri 1.37 1.29 – 8 8 17 – 9 Subject: Calculation of how much each Montana $ 1.46 $ 1.67 + 21¢ 4 5 – 1 Nebraska 1.08 1.17 + 9 24 22 + 2 state’s citizens pay in federal taxes, Nevada 0.78 0.76 – 2 46 47 – 1 including adjustments for federal taxes New Hampshire 0.75 0.71 – 4 47 48 – 1 collected in other states. The tax burden New Jersey 0.66 0.67 0 50 50 0 in each state is then compared to fed- New Mexico $ 2.00 $ 2.08 + 7¢ 1 1 0 eral funds that are spent in each state. New York 0.84 0.83 – 1 42 42 0 Tables: Federal Tax Burden, Total and North Carolina 0.95 1.06 + 10 33 30 3 North Dakota 1.55 1.95 + 40 3 2 1 Per Capita, FY1934–2002; Federal Tax Ohio 0.98 1.01 + 3 31 32 – 1 Burden by State and Rank, Selected Oklahoma $ 1.24 $ 1.48 + 24¢ 15 10 + 5 Fiscal Years, 1970–2002; Federal Tax Oregon 0.93 1.00 + 6 36 34 + 2 Burden by State, Per Capita and Rank, Pennsylvania 0.98 1.07 + 9 32 29 + 3 Selected Fiscal Years, 1970–2002; Rhode Island 1.08 1.11 + 4 25 27 – 2 Federal Tax Burden by State, Type of South Carolina 1.29 1.30 + 2 13 16 – 3 Tax and Rank, FY2001; Federal Tax South Dakota $ 1.36 $ 1.50 + 14¢ 9 9 0 Burden by State and Type of Tax, Per Tennessee 1.16 1.20 + 4 21 20 + 1 Capita and Rank, FY2001; Federal Ex- Texas 0.94 0.92 – 2 35 36 – 1 penditures by State, Type of Expenditure Utah 1.21 1.11 – 10 18 28 – 10 and Rank, FY2001; Federal Expendi- Vermont 0.94 1.12 + 18 34 26 + 8 tures by State and Type of Expenditure, Virginia $ 1.42 $ 1.45 + 4¢ 6 12 – 6 Per Capita and Rank, FY2001; Federal Washington 0.90 0.84 – 6 38 40 – 2 West Virginia 1.43 1.73 + 31 5 4 + 1 Tax Burdens and Expenditures Per Wisconsin 0.83 0.89 + 6 43 37 + 6 Capita as a Percentage of the U.S. Wyoming 1.00 1.14 + 14 30 23 + 7 Average, FY1991 and FY2001; Adjusted District of Columbia $ 5.83 $ 5.73 – 10¢ – – – Federal Expenditures Per Dollar of Taxes by State, FY1991 and FY2001 Sources: Census Bureau; Tax Foundation’s “State–by–State Tax Burden Allocation Model.” 4 Employees of Professional Sports Franchises Paying Income Taxes in Up to 20 States as State Governments Compete for Funds

A new report from the Tax Foundation daily basis whenever they were in full report on line at: on the so-called jock tax reveals how town. Illinois responded with the www.TaxFoundation.org/jocktax.html state governments are extending their “Michael Jordan’s Revenge” tax on Cali- income taxes to more and more non- fornia athletes, and 11 years later, what an income tax return in each state they residents who just work for a few days started as a pernicious California tax visit. The tax is due whether a player in their states. has spread to every other state that has actually plays in the games or not. In Tax Foundation Special Report an income tax and hosts a professional As taxes often do, the jock tax has No. 115, economist David Hoffman sports franchise in the National Football spread. Coaches and support staff were explains that the so-called jock tax League (NFL), National Basketball Asso- the first non-athletes to be hit, and now began with California trying to get back ciation (NBA), the National Hockey thousands of people are forced to file at Michael Jordan for beating the Lakers League (NHL) or Major League Baseball income tax returns in dozens of states, in 1991. (See Publication Summary.) (see map). many of whom earn typical middle- After the championship series that Even though the visiting players are class salaries. year, California extended its state in- just like any other people whose work The report was released to coin- come tax to the Chicago Bulls on a brings them out of state, they must file cide with Major League Baseball’s All-

States That Levy Income Taxes on Visiting Employees of Sports Franchises (Top Income Tax Rate Shown for Each State)

Pro Team and Jock Tax

Pro Team but No Jock Tax WA None No Pro Teams Currently MT ND Subject to Jock Tax ME

OR MN VT 9% 7.85% NH MA ID 5.6% SD WI NY 6.85% WY 6.75% CT MI RI 4.2%* PA IA NJ 2.8% NV NE 6.37% I N OH UT I L 7.5% DE 3.4%* MD 7% CO 3%* WV CA 4.85% 4.63%** KS VA 9.3% MO 6% KY DC NC 9.3% TN 8.75% AZ OK None 5.04% NM AR SC GA MS AL 6% TX LA AK None 6%

FL None HI

* Tax base is federal AGI with modifications. ** Tax base is federal taxable income. See Table 2 for more details. 5

Star Game in Milwaukee, where every athletes can be taxed by states without lower incomes. player, coach, trainer or announcer fear of political pressure. And profes- See table below for examples of racked up taxes owed to Wisconsin sional athletes cannot take their how the jock tax applies to three pro- (even though neither side won). business elsewhere: each professional fessional athletes. Surveys of key personnel in the sports league is a government-backed industry indicate that members of the monopoly that decides when and Professional Golf Association, the where its employees will work. Publication Summary Women’s National Basketball Associa- General: Special Report No. 115; ISSN tion, the Arena Football League, and A Case Study of Poor Tax Policy 1068-0306; 12pp.; $10 or $50/yr. for 6 many others are currently spared. That Since 1991, the jock tax has issues on varied fiscal topics may change, since the tax is not limited masqueraded as a tax that only affects Title: State Income Taxation of Nonresi- to the four biggest leagues by statute, multi-millionaire superstars. In fact, all dent Professional Athletes and it is already being collected by players, coaches, and support staff of Author: David K. Hoffman many states from “rock stars” and the sports teams in four professional Date: July 2002 people who travel with them. leagues have to pay it. Subject: Discussion of the recent trend The total take for Wisconsin on July Second, the jock tax is arbitrary for state governments to extend their 9 was estimated to be over $136,000 because it targets a specific occupation. income taxes to selected nonresidents, from the players alone. Alex Rodriguez, Many doctors and lawyers have compa- a trend that started with professional who carries the highest salary, will rable lifetime earnings, and some busi- athletes. pay $8,864 himself for the privilege ness executives have far more, but they Tables: Salaries and Jock Taxes of of playing a couple innings in the do not have to pay state income taxes Major League Baseball All-Star Game Participants, 2002; Individual Income annual exhibition. in every state where they work for a Tax Rates in States with NFL, NBA, NHL While most states enacted the few days. or Major League Baseball Franchises; tax as retaliation against other states, Third, those affected by the jock The Complex State Income Tax Obliga- professional athletes are a tempting tax have to file numerous state income tions of Three Professional Athletes; target for state lawmakers because they tax forms. This complexity adds to the Salary Ranges of Non-Athletic Members represent a highly concentrated pool overall compliance costs borne by tax- of Professional Athletic Teams; Statisti- cal Comparison of the Incomes and of wealth that can be taxed with little payers, a burden that is proportionately Taxation of Athletes and Doctors enforcement. Like other nonresidents, much greater on the employees with The Complex State Income Tax Obligations of Three Professional Athletes 2001–2002

Steve Francis David Bell Reggie Miller (home state: Texas) (home state: Washington) (home state: Indiana) (salary: $3,441,000) (salary: $2,140,000) (salary: $12,000,000) Number of Number of Number of Amount Games Played Games Played Games Played that Indiana States Imposing a in Jock Additional in Jock Additional in Jock Jock Would Have Additional Jock Tax Tax States Taxes Paid Tax States Taxes Paid Tax States Taxes Paid Collected Taxes Paid

Total 28 $ 66,948 72 $ 60,667 35 $ 205,540 $ 97,043 $ 108,497 Arizona 2 $ 2,951 – – 1 $ 5,177 $ 3,462 $ 1,716 California 8 26,598 26 $ 28,237 4 45,432 13,846 31,586 Colorado 2 3,540 6 3,456 1 5,724 3,462 2,262 Georgia 1 2,104 – – 2 14,968 8,589 6,378 Illinois (a) – – – – 3 7,418 6,702 715 Indiana 1 $ 1,300 – – – – – – Louisiana – – – – – – – – Maryland – – 8 $ 4,682 – – – – Massachusetts 1 2,237 6 4,367 2 $ 14,003 $ 6,702 $ 7,301 Michigan 1 1,606 5 2,613 2 10,053 6,702 3,351 Minnesota 2 $ 5,219 6 $ 5,076 2 $ 5,034 $ 3,462 $ 1,572 Missouri – – 3 2,015 – – – – New Jersey 1 761 – – 5 13,729 6,702 7,027 New York 1 1,842 6 7,060 1 24,611 10,385 14,227 North Carolina 1 2,549 – – 3 16,163 6,702 9,460 Ohio 1 $ 1,258 6 $ 3,162 2 $ 6,236 $ 3,462 $ 2,775 Oregon 2 6,711 – – 1 10,955 3,462 7,494 Pennsylvania 1 1,071 – – 2 – – – Utah 2 5,232 – – 2 17,187 6,702 10,485 Wisconsin 1 1,970 – – 2 8,851 6,702 2,149 (a) Illinois only taxes nonresidents whose home states tax residents of Illinois. Sources: www.bskball.com, USA Today Baseball Salaries. Computations by Tax Foundation. 6

can–owned daily newspaper in Permanently the United States, is a good example FRONT & CENTER of the unique problem presented for Repeal a Tax minority families. It was forced into bankruptcy due to financial burdens imposed by the estate tax. But, beyond and excise taxes, which fall more Detrimental to that, the question was – were the heavily on low-income groups relative Chicago Defender family forced to to their income. They also argue that Minority Wealth: sell, could a minority owner be found to increasing the unified credit to $4 or $5 purchase it, or would it become a white- million would remove small and minor- The Estate Tax owned asset, reducing the overall wealth of the African American community? by U.S. Rep. William Jefferson (D-LA) On a smaller scale, another potential victim, a storeowner named Leonard L. The insignificant amount Harris who is a first generation owner of Chatham Food Center on the South Side of money the estate tax The freedom to attain prosperity of Chicago is frightened that all the work and accumulate wealth is the basis of and value he has put into his business raises for the federal the “American Dream.” We are taught will be for naught because it will be government cannot justify that through hard work we can achieve stripped from his two sons. According to that dream and, God willing, pass it on Mr. Harris, “My focus has been putting my the harmful effects it has to our children. Unfortunately, for many earnings back into growing the business. on business owners who the estate tax turns that dream into a For this reason, cash resources to pay nightmare. federal estate taxes, based on the way spend more to avoid the The current tax treatment of a valuation is made, would force my family tax than the federal tax person’s life accumulations is so oner- to sell the store in order to pay the IRS ous that when one dies, the children within 9 months of my death. Our yearly revenue raised. are often forced to turn over half of earnings would not cover the payment of their inheritance to the federal govern- such a high tax. I should know. I started ity-owned businesses and farms from ment. The estate tax, which is imposed my career as a CPA.” the harsh impact of the estate tax. at an alarming 37 to 55 percent rate, is These two stories are not isolated. I share my colleagues concerns higher than in any other industrialized According to the Life Insurance Market- about protecting the tax base and en- nation in the world except Japan. Thus, suring that our Tax Code remains progressive. However, I find these arguments in support of the estate tax un- I share my colleagues’ concerns about protecting the convincing in the face of substantial evidence otherwise. First, there is no tax base and ensuring that our tax code remains clear evidence that the estate tax is progressive. However, I find these arguments in progressive or that larger estates are paying a greater portion of the tax. support of the estate tax unconvincing. Wealthier members of our society are able to reduce and or eliminate the impact of the estate tax by stuffing many families must watch their loved ing Research Association, less than half money away here and there at the sug- one’s legacy being snatched away by of all family-owned businesses survive gestion of high-priced attorneys and the federal government at an agonizing the death of a founder, and only about accountants. Similarly, tax planning time. This is tragically wrong and nulli- five percent survive to the third genera- techniques such as gift tax exclusions fies the hard work of those who have tion. or valuation discounts reduce the size passed on. Many of my colleagues who are of the gross estate but do not appear in In the minority community there proponents of the estate tax contend the IRS data causing effective tax rates are numerous examples of the injurious that the tax adds progressivity to the to be overstated for many larger estates. effects of the estate tax. The Chicago Tax Code and provides needed tax The Institute for Policy Innovation re- Daily Defender, the oldest African Ameri- revenue. They argue that the estate tax cently revealed evidence of this fact in falls on wealthier and higher income a study showing that the effective tax individuals and increases the total tax rate on the most valuable estates was William Jefferson, Democrat of paid by this segment of the population actually lower than that on medium- Louisiana, serves on the House relative to their income. This helps sized estates. Committee on Ways and Means. offset the regressivity of payroll taxes Second, the insignificant amount of 7 money the estate tax raises for the federal government cannot justify the harmful effects it has on business owners who spend more to avoid the tax than the federal tax revenue raised. According to the President’s FY 2003 Budget, the estate and gift tax brought in $28.4 billion in revenues to the federal government in 2001. This repre- sents less than 1.5 percent of the total revenues out of a nearly $2 trillion federal budget and less than the amount of money spent complying with, or trying to circumvent, the death tax. In 2000, Congress’s Joint Economic Committee reported that the death tax brought in $23 billion in annual revenue, but cost the private sector another $23 billion in compliance costs. Therefore, the total impact on the economy was a staggering $46 billion. And, when one calculates the amount of money spent on complying with the would remove small family-owned busi- ciation has condemned raising the ex- tax, the number of lost jobs resulting nesses and farms from the threat of the emption as an approach and has instead from businesses being sold, or the re- estate tax. The Small Business urged estate tax repeal. sources directed away from business Administration’s definition of a small Repeal is the right approach for the expansion and into estate planning, it business is based on industry size stan- American people and the American is clear why this punitive tax must be dards. For example, a construction economy. Permanent repeal of the eliminated. company or grocery store with less estate tax will provide American fami- It is also important to note that than $27.5 million in annual receipts is lies with fairness in our tax system and many economists believe that overall considered a small business. Thus, fami- remove the perverse incentive that tax revenues would increase if the es- lies who build their businesses past the makes it cheaper for an individual to tate tax were repealed. According to a exemption amount will continue to sell the business prior to death and pay the individual capital gains rate than pass it on to heirs. But for minorities, it provides an additional benefit. It will The Chicago Daily Defender — the oldest African allow wealth created in one generation American-owned daily newspaper in the U.S. — was of an African–American or Hispanic family, for example, to be passed on to forced into bankruptcy due to financial burdens the next, with assets representing that imposed by the estate tax. wealth remaining minority-owned. Generations of African American or other minority-owned wealth will cre- study of estate tax repeal proposals, face estate taxes that range from the ate economically powerful minority which was prepared by Dr. Allen Sinai aforementioned, alarming rate of 37 to communities with the capacity to cre- for the American Council for Capital 55 percent. The exemption threshold ate jobs and minority employment. Formation and Center for Policy Re- would not help these small businesses. search, federal tax receipts would rise A similar exemption established in in response to a stronger economy, 1997 and expiring in 2004, which feeding back 20 cents of every dollar of shields $1.3 million in assets for farms estate tax reduction. In fact, over the and businesses from the tax, has report- years 2001 to 2008, estate tax repeal edly not been successful. According to would increase real Gross Domestic reports, less than 3 percent of family Product by $90 billion to $150 billion, businesses qualify for relief under this The Tax Foundation invites a national and U.S. employment by 80,000 to provision; hence, the exemption fails to leader to provide a “Front and Center” 165,000. help many of those that need it. Ac- column each month in Tax Features. Finally, it is not clear that increasing cordingly, the Real Property and Pro- The views expressed are not necessarily the unified credit to $4 or $5 million bate Division of the American Bar Asso- those of the Tax Foundation. 8 Tax Foundation Center for International Tax Policy Promotes Understanding of Key Issues WTO Rejection of U.S.’s ETI Requires Prompt Action by Congress

Anticipating that international tax is- mostly defensive (filings in which the cern over the Bush Administration’s pro- sues and reform of the corporate in- EU is defending its trade policies) to posals to prevent corporate inversions, come tax code would dominate the offensive (filings in which the EU is which, if enacted, would treat non-U.S. congressional calendar in the second petitioning against the trade policies of firms active in the United States more half of this year, the Tax Foundation led another country, primarily the United harshly than U.S.-based firms in regard a delegation of senior congressional States). Abbot said that EU officials to the way they can allocate debt among staff and corporate executives to were very concerned about the subsidiary companies. Copenhagen, Brussels, and Paris this recently enacted steel tariffs and vari- Finally, the delegation met with past May. The trip was the Foundation’s ous agricultural subsidies contained senior officials from the Organization twelfth International Tax Policy Seminar in the 2002 farm bill. These concerns for Economic Cooperation and Devel- to be held in European capitals. are in addition to the EU’s ongoing opment (OECD), including U.S. Ambas- As in previous years, the Tax consideration of the “proper” response sador Jeanne Phillips and Jeffrey Foundation was joined in sponsoring to the WTO’s ruling that the ETI is Owens, the Head of the Organization’s the Seminar by the Organization for anti-competitive. Centre for Tax Policy and Administra- International Investment and the Euro- The congressional delegation re- tion. The meetings, held at OECD pean-American Business Council. The sponded that Congress was moving headquarters, provided the congres- seminar is the cornerstone of the Tax toward elimination of the ETI to com- sional staff and business executives Foundation’s Center for International ply with the WTO’s ruling and that any with an opportunity to learn more Tax Policy, giving senior congressional retaliation against the steel tariffs or about the manner in which OECD staff the opportunity to immerse them- research is determined, conducted, selves in international tax policy and and disseminated. meet with their European counterparts Although arcane at times, and al- to discuss tax policy. ways confusing, international tax policy The Tax Foundation-led delegation has come to dominate the tax debate in met with U.S. Embassy staff and Danish Washington, DC. Public outrage over officials in Copenhagen to discuss the corporate inversions such as that at- Danish government’s agenda for their tempted by Stanley Works and the need six-month tenure as President of the to reform the corporate income tax European Union. code in light of the World Trade In Brussels, the delegation re- Tax Foundation Executive Director Organization’s ruling against the U.S. in ceived a briefing on current U.S.-EU Scott A. Hodge (r.) talks with Jeffrey a recent dispute have placed these tax issues from Joann Weiner, former Owens, leader of the OECD’s Centre issues at the forefront of discussion. Treasury official and now a senior for Tax Policy and Administration. The Tax Foundation’s 12th annual writer for Tax Notes International, International Tax Policy Seminar in Jack Anderson, a Director of Ernst and Europe was a valuable opportunity for Young’s European tax practice, and agricultural subsidies would make senior congressional staff and key Dina Shapiro of Citibank, London. Top- reform (and passage of Trade Promo- corporate executives to examine ics of discussion included the World tion Authority or TPA) more difficult. these issues in greater detail and con- Trade Organization’s recent ruling that Also while in Brussels, the delega- tinue a dialogue with their European U.S. Extra-Territorial Income Exclusion tion met with the Union of Industrial counterparts. (ETI) provisions violate anti-subsidy and Employers’ Confederation of Eu- The Tax Foundation’s Center for rules, the EU’s recent electronic VAT rope (UNICE), an association of busi- International Tax Policy plans to con- directive, and recent American steel nesses located throughout Europe. The tinue these successful seminars. The tariffs and agricultural subsidies. meeting focused on two major issues: next one is planned for early Decem- The briefing served as background American concern over the EU’s elec- ber and will take participants to Asia to to the delegation’s meeting with Rod tronic VAT initiative, which treats elec- discuss similarly timely and important Abbott, Deputy Director General of tronic delivery of goods by non EU- issues. Trade for the EU. Abbott noted that based firms less advantageously than since 2000, the balance in EU filings electronic delivery of goods by EU- before the WTO has shifted from based firms; and second, European con- 9 Moody Testifies on the Impact of State Income Tax Complexity at ALEC Conference

On August 8, 2002, in testimony before are of a more difficult and speculative hardest. They pay a compliance cost of the American Legislative Exchange nature, so no opportunity costs are over 4.53 percent of their AGI. Because Council’s Task Force on Fiscal Policy, Tax included in Tax Foundation estimates. compliance costs are essentially a fixed Foundation Senior Economist Scott As an example of a quantifiable tax cost, their compliance cost falls as AGI Moody praised the model bill under opportunity cost, Moody cited the re- increases. For taxpayers with $40,000– consideration by the task force and dis- quirement that taxes be withheld from $75,000 in AGI, their compliance cost cussed new Tax Foundation research on workers’ paychecks. By pre-paying consumes a much lower 1.32 percent of the complexity of state income taxes. their tax bills, taxpayers lose any inter- their AGI. The compliance cost drops to Moody defined the general eco- est, profit, or dividends they might have 0.29 percent for taxpayers with an AGI nomic costs of tax complexity, report- generated between the time of with- of over $200,000. ing the most recent results from the Tax holding and the time when the taxes Foundation’s longstanding research are actually due. How States Could Mitigate project to quantify the economic im- In 2001, state governments col- Compliance Burdens pact of federal income tax complexity lected an estimated $218.7 billion in States could save their taxpayers a (see article in March/April Tax Features great deal of trouble by keeping basic about Tax Foundation Special Report attributes of their codes in common No. 114, “The Cost of Complying with with other states or the federal govern- the Federal Income Tax”). The 43 states with income ment, according to Moody. In fact, most taxes have added roughly states do use some part of the federal Overhead and Opportunity individual income tax as their own Costs $25 billion to taxpayers’ starting point in order to calculate state The complexity generated by the compliance costs. income tax liability — such as federal growth and constant change of tax adjusted gross income, taxable income codes creates two general types of or even tax liability. This “piggy-back- economic cost, overhead costs and individual income taxes. In the absence ing” on the federal income tax system opportunity costs. of withholding, taxpayers could have reduces tax compliance costs for tax- Overhead costs can be divided into conservatively invested this money in payers. three principal activities: the economi- U.S. Treasury Bonds (T-Bills), pocketing Piggy-backing is unfortunately de- cally sterile exercises of tax planning, $5.5 billion in interest payments. clining on the business side. Nearly all compliance, and litigation, all of which As an example of an unquantifiable the states used the federal definition of act like surcharges on taxpayers. tax opportunity cost, Moody cited the taxable business income, but since the Excluding tax planning and litiga- lost creativity and productivity that recent federal tax cut, 28 states have tion, Moody recently estimated the results when talented people put aside “decoupled” from the federal code, federal income tax compliance burden what they’re good at to spend consider- mostly because of the new tax deduc- at $194 billion in 2002. This amounts to able time wrestling with the tax code. tion for “bonus depreciation.” imposing a 20.4-cent tax compliance Less obvious is the growing multi- surcharge for every dollar the income The Uneven Economic Impact of state tax compliance cost issue for indi- tax system collects. Tax Compliance Costs viduals. For example, the interest In addition to the federal income Moody presented evidence that the earned on in-state municipal bonds is tax system, the 43 states with an income Federal income tax compliance cost on typically exempt from state income tax have layered additional levels of tax individuals is quite regressive. In other taxes, leaving individuals with multi- compliance costs onto taxpayers. Pre- words, the compliance cost hits lower state municipal bond holdings the ad- liminary research indicates that taxpay- income individuals harder than higher ministrative nightmare of subtracting ers bear another $25 billion in compli- income individuals. In fact, taxpayers the usually small amount of exempt ance costs at the state level, amounting with less than $50,000 of adjusted gross interest from the non-exempt interest, to roughly an 11-cent compliance sur- income (AGI) pay almost 54 percent of which may not even be worth the tax charge for every dollar collected. the total compliance cost borne by all savings. The second general type of eco- individuals — $46.8 billion of the total In addition, the traditional link nomic cost, opportunity cost, is in- $86.1 billion compliance cost imposed between residency and income as a curred when a less efficient economic on individuals. basis for state income taxation has activity displaces a more efficient one. As a percentage of AGI, taxpayers begun to fray (see article on non- Some can be quantified while others with AGI of less than $20,000 are hit the resident taxation on page 4). 10 New Study Explores Impact of State Budgetary Institutions on Tax and Spending Levels Balanced Budget Requirements, Line-Item Vetoes, and other Techniques Prove Less Effective than Generally Thought

The Tax Foundation’s new Center for institutions to constrain government now a general acceptance among State Fiscal Policy has published a study spending. For instance, the acceptance economists that institutions do matter. on state budgetary institutions by J. of performance-based budgeting is The states pioneered much of the Brian O’Roark, Assistant Professor of predicated on the notion that such a development and fine-tuning of institu- Economics at James Madison University. tool will hold agencies within a govern- tions, and there is reliable data going back a number of years for each state. Thus, the states proved a natural testing grounds for the success or failure of Difficult decisions to raise taxes, increase other budgetary institutions. Unlike previous studies that collections, or reduce spending are affected by focused on spending, O’Roark empha- budgetary institutions that vary substantially sizes the effect that each institution has on state-level tax collections including from state to state. user fees, license charges and other sources of funds. Number 41 in the Tax Foundation ment accountable for meeting predeter- He finds that budgetary institutions Background Paper series, and titled, mined goals. Therefore, if the perfor- are less effective than generally thought “The Effect of Budgetary Institutions mance of a specific program justifies at controlling state-level spending, on Spending and Taxation by State the spending, the budget is increased. taxation, or total collections. Evidence Governments,” the new study is the first in a series of papers that will investigate the nature and effectiveness of budgetary institutions at the state Budgetary institutions have been less effective than level (see Publication Summary). generally thought at controlling state-level spending, This report on state budgetary institutions is timely because the tight- taxation, or total collections, especially over the past ening economy has created a difficult fiscal environment in many states for seven years, a period of strong economic growth. the first time in nearly a decade. Politi- cally difficult decisions — to raise taxes, Similarly, tax and expenditure limitations shows this to be especially true over increase other collections, or reduce were adopted during the tax revolt of the past seven years, a period of strong spending — are often necessitated or at the 1970s to limit the growth of a state’s economic growth. least affected by budgetary institutions taxes and spending after a long period that vary from state to state, creating of state government expansion. substantial differences in the way fiscal Interestingly, it was not until the policy is carried out. anti-tax furor began to die down that Publication Summary In O’Roark’s first report, he defines economists and political scientists General: Background Paper No. 41; and analyzes the seven most common delved into the empirical evidence on ISSN 1527-0408; 16pp.; $25 or $60/yr. and important budgetary institutions: the role of institutions in the fiscal pro- for 4 issues on varied fiscal topics • the line-item veto cess. A multitude of studies were under- Title: The Effect of Budgetary Institu- • biennial budgeting taken looking at whether certain insti- tions on Spending and Taxation by State • balanced budget restrictions tutions “worked,” focusing on state bud- Governments (the deficit carry-over rule) gets. The results have been mixed. Author: J. Brian O’Roark • the supermajority legislative vote Basically, the success or failure Date: August 2002 • tax or expenditure limitations of an institution in lowering fiscal out- Subject: Examination of state budget- • term limits comes depends on the economic situa- ary institutions, with discussion of how • performance-based budgeting tion in which a state finds itself. How- effectively they control spending and States have typically adopted these ever, there is empirical evidence and taxation. 11

FOUNDATION MESSAGE

tax rules that are forcing companies Defending the “Indefensible” to look for relief in offshore tax havens. To his credit, House Ways and It has never been easy or popular to to learn that Means Committee Chairman Bill defend lower taxes for businesses. As I lesson. Earlier Thomas has introduced H.R. 5095, the learned recently by appearing on this year, law- American Competitiveness and Corpo- MSNBC’s Hardball, it is even more makers there rate Accountability Act, which includes challenging in today’s highly charged enacted a $1.3 Scott A. Hodge 19 overdue improvements to the tax political climate over corporate gover- billion tax Executive Director laws governing the foreign operations nance and financial irregularities. hike. Among Tax Foundation of U.S. companies and would curb the I was asked to come on the pro- the provisions flight of companies to tax havens. gram to defend, or at least explain, why was a change While these fixes to our interna- some U.S. companies have taken the in the state’s corporate income tax that tional tax laws will clearly allow many dramatic step of re-incorporating in is intended to double corporate income firms to compete more effectively over- low-tax countries such as Bermuda. As tax collections. seas, it is still an open question whether Mike Barnicle, the show’s substitute The effect on the state’s business these changes are enough to prevent host said to me: “Scott, you seem like a climate was immediate. As reported in some firms from seeking additional tax nice guy, you’ve just got an impossible the NorthJersey Record, Federated De- relief on their own. Instead of relocating position to defend.” partment Stores (the parent company to Bermuda, some may re-incorporate in Most politicians — including my of Macy’s and Bloomingdale’s), an- Ireland, which has a favorable tax treaty opponent on the program, Rep. Bernie nounced that the new tax hike would with the U.S. and will have a 12.5 Sanders (I-VT) — are calling such re- more than double the company’s state percent corporate tax rate next year. incorporations “unpatriotic” and are tax payments from $4.4 million to The tax fix missing from the seeking to outlaw them in the future. $10.1 million next year. In a letter to Thomas bill is a cut in America’s high Setting aside the political rhetoric Gov. James McGreevey, the company’s corporate tax rate. (in some cases demagoguery), what chairman wrote, “[Federated] cannot With the increased mobility of these companies are doing is little dif- and will not absorb a $5.7 million New capital in the global marketplace, the ferent from what millions of Americans Jersey tax increase without taking com- investment decisions of U.S. multina- do every day — reside in one jurisdic- mensurate measures to reduce expendi- tional firms are much more sensitive tion and work in another. Here in the ture there.” The bottom line: Federated to the tax rates of host countries. If nation’s capital, thousands of us live in plans to lay off 50 to 60 employees at a taxes are a major determinant to where the Virginia and Maryland suburbs but distribution center and expects future firms invest abroad, doesn’t it make work in Washington, DC. Why? Lower closings of stores or facilities. sense that they would be similarly taxes are one of the main reasons. Ironically, business and political sensitive to taxes at home? Of course. In other cities, such as Philadelphia, leaders in New York (which has tradi- At 35 percent, our corporate tax most workers prefer to live in the low- tionally been a high-tax state but has rate ranks as the fourth highest among tax suburbs than pay the city’s 4.5 per- cut business taxes in recent years), are the 24 leading industrial countries in cent wage tax. Snowbirds flock to now encouraging New Jersey firms to the world. Countries with lower corpo- Florida for 51 percent of the year to consider moving to the Empire State. rate rates include: France (33.3 per- take advantage of the Sunshine state’s But imagine what would happen if cent); Great Britain (30 percent); and, warm climate, of course, but the ab- New Jersey had the legal authority to Japan (30 percent). Even socialist coun- sence of a state income tax probably prevent firms from escaping to low-tax tries like Denmark (30 percent), Finland plays a major role. New York. Trapped New Jersey firms (29 percent), and incredibly, even Economist Charles Tiebout once would become less competitive and Sweden (28 percent) have lower rates. described this behavior as “voting with continue to cut jobs or lose market The U.S. started the global tax com- your feet.” The ability of people and share, while New York firms would be- petition race in 1986 when we lowered firms to relocate to lower-taxed jurisdic- come relatively more competitive, add- our 45 percent corporate tax rate to 34 tions is often credited with promoting ing jobs and growing the local economy. percent. Sixteen years later the world tax competition among cities, states, and In a similar vein, politicians in has passed us by, and our rate has even countries. At a minimum, the fear Washington should not react to the bounced up to 35 percent. of losing residents or businesses can recent wave of re-incorporations by Cutting corporate tax rates may not prevent politicians from raising taxes building a legal wall around the coun- be the most popular thing for lawmak- too high compared to their neighbors. try. They should instead fix the sys- ers to do in today’s political climate, but Politicians in New Jersey are about temic problems in the U.S. international it’s the right thing. 12

Tax Features© (ISSN 1069- using this page during 2002 to remind our 711X) is published bi- readers of Tax Foundation highlights from years monthly by the Tax past. One constant has been our reference book, Foundation, an independent 501(c)(3) organization Facts and Figures on Government Finance. chartered in the District of Columbia. Annual subscriptions to the newsletter are $15. Joseph O. Luby, Jr. Despite the turmoil over public finances today, Chairman, Program Facts and Figures on Government Finance has Committee been through worse. On the back end of the Great Depression and the front end of WWII, Michael P. Boyle the first edition of the book — titled Tax Facts Vice Chairman, Program & Figures — was published in 1941. For the Committee first time, widely scattered facts on tax Scott A. Hodge collections, government spending, and public Executive Director debt were assembled in one convenient and concise handbook. Bill Ahern Editor & Communications Now the newest edition is out, with over 200 Director tables of rates and collections data. John S. Barry Chief Economist Alicia Hansen Facts and Figures on Staff Writer Government Finance 36th Edition, July 2002 J. Scott Moody Senior Economist ISSN 0071-3678 David Hoffman 343 pp., 7 x 10 Staff Economist Hardback: $65.00 ISBN 1-884096-14-X Tax Foundation Paperback: $45.00 (202) 783-2760 ISBN 1-884096-15-8 (202) 783-6868 Fax www.TaxFoundation.org “Facts and Figures on Government Finance is the [email protected] most detailed and useful statistical portrait of where the spending goes and how it is financed.”

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