TaxWatchSummer 2004

Making Sense of the Presidential Plans

When voters head to the ballot box make it clear to the taxpayer who and what this November, one factor infl uencing is being taxed, and for how much. their decisions will be the tax packages 3. Stability and non-retroactivity: proposed by candidates. should not change continually. Good eco- That is, if they are able to comprehend them. nomic decisions require stable “rules of the Presidential tax plans are notoriously game,” and that includes predictable . complex, with political sound Taxpayers should be able to rely on the law bites and tax jargon obscur- as it exists when they enter into Message from ing their impact. Given their transactions, and not be penal- the President 2 complexity and vagueness, ized by subsequent tax changes. how should the average voter 4. Neutrality: The purpose Jock Taxes evaluate candidates’ plans? of taxes is to raise revenue, One way is to start with a few not “socially engineer” the Keep Spreading 3 simple rules of “sound taxa- economy with subsidies and tion,” and then compare plans penalties. Taxes should aim to minimize economic distor- Wacky Taxes; to these criteria. While this alone won’t tell whether a tax tion, favor broad tax bases Tax Bills to Watch; 4 plan is good or bad, it offers a and low rates, and should simple, objective way to com- not attempt to micromanage economic outcomes. in the Media pare plans across candidates. Over the years, economists 5. Growth-promotion: Taxes from Adam Smith to Milton should promote economic Putting a Face on Friedman have offered their growth, and not interfere with America’s Tax Returns 5 own lists of principles that or capital fl ows within should guide good . the U.S. or across borders. At the Tax Foundation, our Taxes should consume as small Making Taxes economists have narrowed them down a portion of national income as possible Simple 7 to fi ve simple rules, which are applicable to fund legitimate government programs. to a wide range of tax proposals. They With these rules in mind, let’s have a are as follows: look at the candidates’ tax plans. Support the Tax Foundation 1. Simplicity: The tax system should be The Bush Plan 8 as simple as possible. Complexity makes The Bush administration’s main tax tax compliance needlessly expensive proposal in their 2005-2009 budgets is a and punitive. Taxes should be easy to call for Congress to make the 2001 and understand and comply with. 2003 temporary Bush tax cuts perma- 2. Transparency: A good tax system re- nent, rather than expiring between quires informed taxpayers. Tax plans should continued on page 6 Message from the President: Welcome to Tax Watch I’m thrilled to introduce you to the fi rst issue of the Tax Foundation’s newest publication, Tax Watch. Since 1937 our mission has been to inform Americans about the true cost of government. The aim of Tax Watch is to present our research in a simpler, less technical way. Look forward to Tax Watch continuing our tradition of telling the truth about taxes. This year, our economists are working on several new projects. I’m sure you’ve heard repeatedly that the Bush tax cuts benefi ted the rich at the expense of low-income taxpayers. But did you know that the cuts knocked more than 7 million low- Tax income families off the tax rolls? Three years ago, we launched a program to provide facts like these to Watch counter “class warfare” arguments against tax cuts. We call the program Tax Watch is published four times per year Putting a Face on America’s Tax Returns, and you can read this issue’s install- by the Tax Foundation in Washington, D.C., ment on page 5. Through it, our economists are helping paint a picture of the a nonprofi t, nonpartisan research organiza- actual taxpayers behind the political slogans. tion that has monitored tax policy at the A second project is our State Business Tax Climate Index, which provides an federal, state and local levels since 1937. objective measure of how business-friendly each state’s tax system is. The aim Joseph O. Luby, Jr. Chairman, is to show state legislators that complex and punitively high taxes can have Program Committee severe long-term effects on their state’s business climate. Michael P. Boyle Vice Chairman, Program Committee Last year we released our fi rst annual Index, and it had an immediate impact Scott A. Hodge President on tax debates, especially in America’s most populous state of California, where Arnold Schwarzenegger publicized our results during his run for governor. William Ahern Communications Director During the past 67 years, the Tax Foundation has earned the respect of the J. Scott Moody Senior Economist media, policymakers and taxpayers because we have stayed true to our mis- Andrew Chamberlain Staff Economist sion to tell the truth about taxes. Thank you for your support, and I hope you Sumeet Sagoo Staff Economist enjoy the fi rst issue of Tax Watch. Alicia Hansen Staff Writer and Circulation Manager Sincerely,

The Tax Foundation is a 501(c)(3) nonprofi t organization that relies on tax-deductible Scott A. Hodge contributions for support. Annual subscriptions are $15. Please send all correspondence to: Tax Watch, 1900 M Street N.W., Suite 550, Washington, DC 20036. Visit us on the web at www.taxfounda- tion.org or call (202) 464-6200. © 2004 Tax Foundation

2 • TaxWatch “Jock Taxes” If state tax collectors have their way, we ment for a couple of months are subject may all be “jocks” soon. to the tax as well.” That’s the finding of a new report from Jock taxes are advertised as “soak-the- Continue the Tax Foundation that explores the rich” taxes. But in reality, the jock tax growth of “jock taxes”—taxes requiring nails everyone traveling with teams, visiting athletes and other team em- including middle- and low-income Spreading to ployees to file tax returns in every state trainers, coaches, and staffers with sala- where games are played. ries ranging from $18,000 for scouts to Non-Jock “The jock tax began with California trying $112,000 for team doctors. to get back at Michael Jordan and the Chi- The report was released July 9th to cago Bulls for beating the Lakers in 1991,” coincide with Major League Baseball’s Professions said David Hoffman, adjunct scholar with All-Star Game in Houston, Texas. the Tax Foundation and co-author of the Texas is one of the few states with a new report. “Illinois fought back with a professional sports team that does not retaliatory tax the next year. Since then, have a jock tax—along with Washing- many other states have joined in.” ton, Tennessee, and Florida—resulting Today, of the 24 states in thousands of dollars of savings and with pro teams, 20 have reduced tax-paying complexity for play- enacted jock taxes, along ers from around the country. with a half dozen cities. The study gives three major reasons the The study finds that rev- jock tax is ill-conceived: enue-hungry state trea- • The tax is poorly targeted. Originally suries are extending their aimed at athletes, it has spread to income taxes to more people with moderate incomes, such and more nonresidents as trainers and scouts, and other pro- who just work a few days fessions. a year in their states. • The tax is arbitrary. Professionals in Jock taxes were first other occupations with comparable aimed at a tiny number incomes over their working lives, of wealthy athletes, but such as doctors and corporate execu- the study shows they are tives, are not penalized by a “doc tax” now beginning to spread to salespeople, or “exec tax.” newspaper reporters, lawyers and others, “Jock taxes were forcing non-jocks to pay as well. • The tax imposes an administrative burden on people who have to file more first aimed at New Jersey has begun taxing visiting than a dozen state returns. attorneys, Cincinnati has levied a tax wealthy athletes, on touring skateboarders, and several “Texas is one of the few states without jurisdictions have begun taxing travel- a jock tax, so that’s good for players,” but they’re now ing entertainers. said Scott Hodge, president of the Tax Foundation, “but those tuning in to this “First, it was just Michael Jordan and spreading to year’s All-Star Game from the road on the Chicago Bulls, then all professional business better watch out. To state tax athletes, and now trainers, scouts, law- collectors, they may be ‘jocks’ too.” other traveling yers, and even amateur skateboarders are being taxed when they leave their The full “jock tax” report is available at professions— www.taxfoundation.org or by calling home state,” said Hoffman. (202) 464-6200. salespeople, Last year Patrick Hill, spokesman for the California Franchise Tax Board made the home builders, goal of the jock tax clear: “The tax isn’t just on professional athletes. Even people reporters with more-pedestrian lifestyles…are sub- ject to this tax. A tradesman coming to and more.” build a building, or a reporter on assign-

Summer 2004 • 3 Key Tax Bills to Watch Wacky Taxes H.R. 3184—“Streamlined Sales and Use Tax Act” Taxes may be a fact of Sponsor: Ernest Istook (R-OK) life—but they don’t always What it does: Forces Internet and catalog com- have to make sense. Some panies to collect state sales taxes from customers of history’s more bizarre in other states. tax-law oddities: S. 2281—“VoIP Regulatory Freedom Act” From Russia with Love Sponsor: John Sununu (R-NH) Russian czar Peter the What it does: Bans all states from taxing and Great returned from regulating Internet phone calls. Europe in 1690 convinced that Russian men needed H.R. 1308—“Tax Relief, Simplification, to “modernize”—includ- and Equity Act of 2003” ing shaving their beards. Sponsor: Bill Thomas (R-CA) He passed the famous What it does: Range of targeted tax breaks, “beard tax” as an incen- from bow-hunting and tackle boxes to families tive. The result? Beards of the space shuttle crew. May also extend four became a status sym- expiring 2001 Bush tax cuts. bol. Other taxes Peter launched include taxes on burials, windows, and even “human souls.” Tax Foundation in the Media Men Without Women Spreading the message of low taxes and growth is part of our mission. Here’s Using the tax code to a sample of recent media appearances by Tax Foundation economists: promote marriage is noth- News Stories ing new. In 1695, the Los Angeles Times, “High-Salaried Visitors Feel the Bite of the ‘Jock Tax’” British passed the first tax on bachelors. More than New York Times, “The State-Tax Tug of War” a century later, Missouri Boston Globe, “A Contest between Big Spenders” followed suit in 1820—a Philadelphia Inquirer, “Pay to Play” $1 tax on men between Christian Science Monitor, “Don’t Mind Paying Taxes? the ages of 21 and 50 You’d Love New England” without wives. Atlanta-Journal Constitution, “Ideological Offspring Follow Reagan’s Ideals” Orange County Register, “FTB: F Stands for ‘Fanatic’” Ancient Taxes Sacramento Bee, “Basic Taxation Issue Lingers, Even in Schwarzenegger Era” Salt was famously taxed by the ancients, but it San-Diego Union Tribune, “Welfare Programs Targeted For Cuts” wasn’t the only commod- Op-Eds ity. As early as 2500 B.C. Barron’s, “Rating Unemployment Rates” by John A. Tatom ancient Sumerians were taxed on cattle, fishing, Houston Chronicle, “The Jock Tax: A foe not even Clemens can fan” and funerals. By 2000 by Scott Hodge B.C., Egyptians were Contra Costa Times, “Don’t Let Cigarette Tax Hurt the Poor” by Justine Lam taxing cooking oil. And Television & Radio around 1 A.D. Romans WIXL-Radio Orlando, Scott Hodge on the child passed a tax on—of all things—urine. WTAQ-Radio Green Bay, Scott Hodge on Wisconsin state tax burden KTSA-Radio San Antonio, William Ahern on John Kerry’s tax return Not surprisingly, Rome ESPN SportCenter, David Hoffman on “jock taxes” was also the first to im- prison tax evaders—first KHOU-TV Houston, William Ahern on “jock taxes” ordered by Emperor Con- KSEV-Radio Houston, Andrew Chamberlain on “jock taxes” stantine in 306 A.D. Visit our new “Press Room” at www.taxfoundation.org/pressroom.html.

4 • TaxWatch al Tax Model and Matched IRS/Census Database to calculate how many Ameri- cans in the top income are small business owners and employers. A significant finding is that as taxpay- ers’ incomes rise, so does the likelihood High tax rates may be aimed at soaking that they have some form of business Are Business the rich, but if those so-called “rich” are income. That means cuts in top mar- small business entrepreneurs, the taxes ginal tax rates can have a direct impact Owners may end up soaking the poor. on job creation by small business. That’s one of the findings of the forth- Critics argue that top brackets only coming Tax Foundation report “Wealthy affect a small percentage of businesses. the ‘Rich’? Americans and Business Income,” by But individually owned businesses pay Scott A. Hodge and J. Scott Moody. the lion’s share of all individual income Today, more and more businesses are tax collections. organized as sole proprietorships, part- The report shows that business owners nerships and S-corporations. will pay an estimated 54 percent of all “These companies don’t file regular cor- individual income taxes in 2004. Of the porate income tax returns,” said Hodge. total amount of income taxes paid by “Instead, they file business owners, 70 percent comes from individual 1040s, with high-income taxpayers—or “the rich.” business profits taxed as That means soaking wealthy taxpayers personal income.” will end up penalizing small businesses As more business in- and their employees. come is taxed through “Since taxpayers with business income are the individual tax code, shouldering such a disproportionate share changes in rates—like of the tax burden, it’s only logical that tax the recent cut from 39.6 cuts will disproportionately benefit them,” percent to 35 percent— said Hodge. “Tax cuts can only aid those become more important who pay taxes in the first place.” to the economy. In 1980, Some critics argue that high-income there were 13.3 million taxpayers with business income are merely businesses filing through “gentlemen investors” who have little the individual income impact on jobs and economic growth. If tax code. By 2002, there were more than that were the case, one would expect to see 25.5 million—a 92 percent increase. clustering in one or a few occupations. But “Soaking Small businesses employ more than 30 U.S. Census data show nearly the opposite. million Americans. With so many small “Overall the data show that high-income wealthy tax- business owners falling into the highest business owners are involved in nearly all income tax brackets, cuts in top mar- occupations and industries in the U.S. payers may ginal rates may have a dramatic impact economy,” said Moody. “Such evidence on small business job creation. does not support the notion that these end up penal- “Since the 2001 cuts in top marginal tax taxpayers are somehow passive investors.” rates, there’s been an ongoing debate over “The conclusion from these findings,” izing small how much those cuts will affect businesses he added, “is that lowering the top who file taxes individually,” said Moody. marginal income tax rates in 2001 did businesses Some scholars have argued that the 2001 indeed benefit many highly taxed busi- Bush top marginal cuts did little ness owners—and the U.S. economy.” and their for individual business owners and didn’t Advance copies of the forthcoming report impact job creation, while others argue (“Wealthy Americans and Business Income”) employees.” that rate cuts are important for business. are available by calling (202) 464-6200. The new report helps settle the debate, by using the Tax Foundation’s Individu- Summer 2004 • 5 Tax Plans 2005-2011. The cuts Bush promises to • A tax credit for telecommunications (continued from make permanent include: companies that deploy broadband In- page 1) • The $1,000 child tax credit; ternet connections to rural areas; and • The reduction in the “marriage penalty”; • A tax credit to firms with employ- ees who’ve been called up to active • The expanded 10 percent tax bracket; reserve . • The increased ability of small busi- nesses to expense investments; Comparing the Plans How do the plans measure up to our • Cuts in the tax rates on dividends principles? and capital gains; and Simplicity • The phasing-out of the estate By the first criterion of simplicity, neither tax by 2011. plan looks especially attractive. Both The Bush plan also con- the Bush and Kerry plans fail to notice- tains several proposals ably streamline the tax code, and neither that would expand the attempts any real tax simplification or use of tax-favored savings reform of the Alternative Minimum Tax accounts, like 401(k)s. (AMT), which desperately needs restruc- turing. Although the Kerry plan introduc- The Kerry Plan es somewhat more complexity, both plans In various speeches, further complicate the existing tax code. press releases, and on his campaign website, Transparency Sen. Kerry has laid out Transparent taxes are visible to taxpayers an extensive tax plan and easy to measure. Although there are over the last several some murky elements in the Bush plan, months. Though the overall it relies on simple across-the-board complete details are unclear, to date his rate cuts, which are highly transparent. proposals include: In contrast, the Kerry plan features an avalanche of targeted tax credits and rule “Both the • A repeal of the Bush tax cuts on indi- changes, making it mostly inconsistent viduals with incomes over $200,000 by with the transparency rule. Bush and raising top marginal tax rates; Stability and non-retroactivity Kerry plans • Reversing the Bush plan to phase-out Permanent tax cuts are good for stabil- the death tax, raising the exemption ity; temporary ones aren’t. The cen- are equally level to $2 million in 2005; terpiece of the Bush plan would make • A refundable tax credit for higher the 2001 and 2003 tax cuts permanent, clear— education expenses; which is consistent with the stability or murky, • A two-year “new jobs” tax credit to principle. The Kerry plan—by promis- cover employer’s payroll taxes on new ing to revive the death tax, let the Bush manufacturing jobs; tax cuts expire, repeal Bush’s cuts in depending top rates, and introduce new temporary on the inter- • A 1.75 percentage point reduction in tax credits—is not consistent with the the rate; stability principle. The Kerry plan is pretation— • An end to tax liability deferral for packed with temporary tax changes, foreign subsidiaries of multinational which make it impossible for taxpayers about who companies in an effort to curb “out- to plan for the future and can affect the sourcing” by U.S. companies; long-term performance of the economy. will benefit • A refundable tax credit for small busi- Neutrality from tax nesses who purchase health insurance The centerpiece of the Kerry plan is a for employees; mixture of carrot-and-stick tax credits breaks or • A tax credit to fund health insurance aimed at changing taxpayer behavior—a for laid-off workers and early retirees; clear violation of the neutrality principle. rate changes.” Though the Bush plan also violates the • A tax credit for 20 percent of the cost of neutrality rule with targeted tax cuts like new energy-efficient building equipment; 6 • TaxWatch Tax Plans the child tax credit, it does so in far fewer income taxpayers are also job-creating (continued from places than the Kerry plan. Also, the business owners who pay taxes through page 6) Bush plan would totally eliminate some the individual income tax code. taxes, like the death tax. The Bush plan The Bush plan, on the other hand, is would reduce discrimination in the tax aimed mainly at promoting economic code by making top tax rate cuts perma- growth through permanent across-the- nent, along with a flat 15 percent rate on board tax reductions and improved capital gains and dividend income. expensing for small business. Although Growth-promotion some parts of Bush’s plan aren’t growth- The Kerry plan has several tax reforms oriented—like the child tax credit, intended to promote economic growth. which is good for families but has Kerry’s plan to cut the corporate tax little impact on growth—overall the rate would make the U.S. more compet- Bush plan is more consistent with the itive globally. However, the plan’s tax growth-promoting principle. credits to manufacturers are less growth- As you can see, the above principles promoting, as they help some industries help highlight important differences at the expense of others. The Kerry plan between the Kerry and Bush tax plans. would also penalize U.S. companies Unfortunately, like most election-year who compete in global markets over- tax plans they have much in common. seas, harming domestic workers in those industries. Additionally, the Kerry plan The bottom line is that both the Kerry would boost taxes on taxpayers earn- and Bush plans fall far short of the ing $200,000 or more, which may cause fundamental America slower job growth since many high- needs today.

Making Taxes Simple: the Laffer Curve Econ 101 teaches that when a business economic effect is that lower taxes cuts prices, revenue may go up or down. induce people to work more, expanding They’ll earn less money per sale, but the the tax base. price cut also leads to more sales. Wheth- The name “Laffer curve” was coined er total revenue grows or shrinks depends in 1978 after economist Arthur Laffer. on which factor outweighs the other. However, the idea behind it is ancient. Governments face a similar problem 14th century Muslim philosopher Ibn with tax policy. Like price cuts, tax cuts Khaldun recognized that kings who im- can either shrink or expand revenue posed high taxes often caused revenues depending on how taxpayers react. to fall. 19th century economist Frédéric The Laffer curve shows the tradeoff Bastiat also beat Laffer to the idea. between tax rates and . The In the 1980s, the Laffer curve helped argument is simple: tax rates of zero per- give birth to “supply side” econom- The Laffer Curve cent and 100 percent will both gener- ics and the 1981 Reagan . The ate no revenue. That means the clearest demonstration of the Laffer “right” tax rate lies somewhere effect came after the 1981 cut in capital in between. gains tax rates, when revenues jumped T* Tax cuts have two effects on 50 percent after rates were cut from 28

Tax Revenue Tax total revenue—“arithmetic” percent to 20 percent. and “economic”. The arith- The Laffer curve is less popular in the me- metic effect is that lower dia today, but it continues as a warning to rates bring in less revenue governments that if taxes get out of hand, per dollar of tax base. The there may be nothing left to tax. Tax Rate (%)

Summer 2004 • 7 Providing for An important part of the Tax Founda- Justine Lam graduated from Univer- tion’s mission is reaching out to young sity of California at Berkeley in 2001, leaders and introducing them to sound and spent the last two years at a re- the Future principles of tax policy. search firm in California. Justine plans As part of our internship program, the to pursue a career in public policy in Tax Foundation invites college students Washington. “This summer I chose to of Sound from around the country to participate in intern at the Tax Foundation because research internships at our Washington, of my desire to learn more about public Tax Policy D.C. headquarters. Tax Foundation interns finance,” said Justine. “I also believe in work side-by-side with staff economists— the Tax Foundation’s principles that the writing, researching, and learning to apply tax code needs to be simple and pro- the Tax Foundation’s pro-growth, free-mar- mote economic growth.” ket approach to tax policy. Justin Slaughter is from Kennesaw, Geor- This summer, the Tax gia, where he attends Berry College and is Foundation welcomes double majoring in economics and math. three interns: Justin is hoping to pursue a career in public policy in Washington after gradu- Nicole Akar is a student at ate school in economics. “I knew that Rice University in Hous- an internship with the Tax Foundation ton, Texas, where she’s would provide invaluable research experi- studying economics. After ence,” said Justin. “I was elated to work graduating, she’s hoping to alongside Tax Foundation economists.” pursue a career in either banking and finance or in- As a Tax Foundation sponsor, your con- ternational affairs. “When I tributions help us train young leaders started my internship at the like Nicole, Justine and Justin, and help “Tax Foundation: reaching young leaders.” Tax Foundation, my knowl- provide for the future of good tax policy. edge of tax policy was very minimal,” said To learn how to make a special gift to Nicole. “I’m excited to be at a place with fund a visiting student, please contact Julie Burden at (202) 464-5102. Join us for the such a long-standing reputation.” Tax Foundation’s Annual Dinner

Mark your calendars— Thursday, November 18, Sixty Years Ago 2004 in Washington, at the Tax Foundation D.C., the Tax Foundation will host its Annual Din- From our archives: A 1947 article “The Tax Foundation After Ten ner at the Four Seasons Years,” by Prof. Raymond Moley of Columbia University. Hotel. Join us for the “At the Tax Foundation’s founding in 1937 … a bitter fight was presentation of our going on. On one side were believers in economy. On the other were advocates of a novel economic theory which anticipated Distinguished Service the death of private enterprise. Addressing the tax problem was Awards for major con- an essential step toward saving ancient freedoms…. tributions to tax policy. “The word ‘liberal,’ however it may have been abused in these Space is limited— years, may still be used to describe the spirit of the Tax Founda- reserve your seat now tion. Governments have a way of growing too large, and when by calling Julie Burden they do, taxpayers strike back. It is the duty of the Tax Foundation at (202) 464-5102. to remind people of the cost of their governments.”

8 • TaxWatch