Fall 2010 Ta x Watch

Costly Countdown: Will the Bush Tax Cuts Expire? Message from The Bush-era tax cuts provided online calculator this summer at the President Americans with billions in tax relief. www.MyTaxBurden.org, which shows 2 But as their expiration looms, families families how much the expiring cuts are bracing for what may be the big- would cost them. Estate Tax May gest peacetime tax hike of all time—if Using the calculator, taxpayers can type Rise from the Grave 3 Congress fails to preserve the cuts. in basic information such as filing status, “Many taxpayers are unaware of the huge income and number of dependents, and Congress Targets Oil number of tax increases that may be on see how their 2011 income taxes would Companies for Tax Hikes the way next year,” said Scott A. Hodge, change under three scenarios: if all the 4 President of the Bush tax cuts expire, Tax Foundation. “If if they’re all made Dividend Tax Rates Congress fails to act, permanent, or if May Soar to 68 Percent 5 most federal income President Obama’s tax rates will rise, proposed budget the estate tax and is adopted, which Thanks to would include a mix Our Sponsors 6 will return, capital of both tax hikes and gains taxes will rise, tax-cut extensions. Media Impact Report; and more.” For example, if State Policy Report To help educate Congress fails to 7 Americans about extend the Bush-era the expiring cuts, Learn how the expiring Bush-era tax cuts would affect your tax cuts, a married Leave a Legacy to the Tax Foundation taxes at www.MyTaxBurden.org. couple filing jointly the Tax Foundation 8 has produced a flurry making $80,000 of analysis this summer, highlighting with two children would pay $2,137 which taxes may be on the rise, who will more in federal income taxes next year pay, and how those extra tax burdens than if all the cuts were extended. would affect the struggling U.S. economy. “Since the calculator was launched MyTaxBurden.Org in July, it has been greeted with rave reviews,” said Hodge. The website “The most important question facing most www.MyTaxBurden.org was prominently families is, how much will our taxes rise if featured in a Fox News story on the the Bush-era tax cuts expire?” said Hodge. Bush-era tax cuts, and has been visited To help answer that question, the by over 138,000 taxpayers so far. Tax Foundation launched a free continued on page 6 Message from the President: Gearing Up for D-Day on Taxes By the time you read this we will have about 90 days before the expiration of the Bush tax cuts. Never in history have we seen anything quite like this, where such a major por- tion of the tax code is set to expire on a single date and affect so many Americans all at once. It means a return to Clinton-era tax policies: a top federal tax rate on wages, interest and dividends of 40 percent, and a “death tax” rate of 55 percent. And that’s before the health reform taxes take effect in 2013, bringing the top tax rate on wages, interest, dividends, rents and royalties to 43.4 percent. The typical middle-income family will see a tax hike of $1,540. On a state-by- state basis, that same family would see a tax increase of $1,959 in Alaska, which has the highest median incomes in the nation, and a $1,316 tax increase in West Virginia, which has one of the lowest. But since all politics is local, we also calculated how the median family would be impacted in all 535 congressional districts. I’ve been told by the staff director of a member of the Ways and Means Committee that our list has been circulating all over Ta x Capitol Hill since every member wants to know how their constituents will be affected. Watch And to really personalize the issue, we built an online calculator at Tax Watch (ISSN 1552-924X) is published www.MyTaxBurden.org where people can see for themselves how much four times per year by the Tax Foundation in their taxes will go up automatically next year. Washington, D.C., a nonprofit, non-partisan But I worry that the secret goal of many in Congress is to allow the Bush tax cuts to research organization that has monitored expire without lifting a finger. Why? Because now that spending is where they want tax policy at the federal, state and local it at European-levels, they need to trick Americans into higher taxes to pay for it. levels since 1937. You remember Ronald Reagan’s strategy of “.” Well, the folks in Washington have created a new strategy called “feed the beast.” The problem with “feed the beast” is that it takes ruinously high taxes to pay for that new spending. In order to raise enough money to close this year’s $1.5 trillion The Tax Foundation is a 501(c)(3) nonprofit deficit, Washington would have to either: enact a 25 percent VAT; take 130 percent organization that relies on tax-deductible contribu- of the profits earned by U.S. companies this year; raise the top income tax rates to tions for support. Please send correspondence to: 100 percent; or take 100 percent of business income earned by individual taxpayers. Tax Watch These examples make it clear that the deficit is being caused by reckless National Press Building 529 14th Street, N.W., Suite 420 spending, not a shortfall of taxes. Cutting spending is the only way to get the Washington, D.C. 20045 nation’s finances under control. Visit us on the web at www.taxfoundation.org When the ball drops in Times Square at midnight on December 31, Americans or call (202) 464-6200. may face a massive tax increase. We are explaining the issue to the public, but need your help to reach more people with our message. Please consider making a © 2010 Tax Foundation major gift today to support our efforts.

Sincerely,

Scott A. Hodge President

2 • TaxWatch Estate Tax For the first time in a century, the federal Penalizing Wealth Creation Message from the President: estate tax is repealed this year. But with By penalizing entrepreneurship, the the unpopular tax scheduled to return estate tax may actually reduce turnover Gearing Up for D-Day on Taxes May Rise from next year, a new Tax Foundation study among wealthy families. Previous Tax offers a variety of reasons Congress should Foundation studies have found the estate put the “death tax” to permanent rest. tax acts as a sharp disincentive toward the Grave “Many experts view this year’s repeal of the entrepreneurship. A 1994 study found estate tax as a great improvement in tax that the estate tax’s 55 percent rate at the policy that should be made permanent,” time had roughly the same disincentive said William Ahern, Director of Policy and effect as doubling an entrepreneur’s top Communications at the Tax Foundation. effective marginal income tax rate. “In their view, the tax is unfair, preposter- “Because the estate tax penalizes saving ously complex and far more economically and capital formation, it can discour- damaging per dollar of tax age the creation of new wealth among collected than any other America’s most innovative, productive individual tax.” entrepreneurs,” said Ahern. Over the years, many While estate tax repeal has been contro- Tax Foundation studies versial in Congress, the study shows it has have analyzed the federal never been an important federal revenue estate tax. The new report source. The tax has typically accounted condenses decades worth for just 1 to 2 percent of federal collec- of research into an 8-page tions in recent years. brief on what the recent estate tax repeal means While it raises little revenue, economists for taxpayers. argue the tax leads to very large compli- ance costs, both for taxpayers and the IRS. A common argument in favor of estate taxation is By allowing the estate tax to be perma- Gerald Prante discusses the expiration that it helps redistribute nently repealed, the report notes that of the Bush-era tax cuts on C-SPAN’s wealth from rich to poor. But recent Congress could save Americans billions ‘Washington Journal.’ economic data show this argument in estate planning costs, as well as lighten is outdated. the administrative cost to taxpayers of IRS operations. “The traditional rationale for estate taxa- tion—preventing excessive concentration “Over the years, myriad studies have of wealth—is obsolete,” said Ahern. “The found the estate tax penalizes hard U.S. economy has become so dynamic work and investment while raising little “The estate tax that a constant turnover occurs among revenue in the process,” said Scott A. the nation’s wealthiest people.” Hodge, President of the Tax Foundation. “It’s time for Congress to retire the ‘death discourages According to the report, studies show tax’ once and for all.” the same few families do not stay at the top of the nation’s income distribution Read the full report, “The Federal Estate wealth creation Tax: Will It Rise From the Grave in 2011 or for generations, as is commonly assumed. Sooner?” at taxfoundation.org/publications/ among Instead, new entrepreneurs routinely show/26360.html. emerge and overtake older fortunes. America’s most IRS data show that only seven of the top 400 taxpayers stayed in the nation’s productive top income tier between 1992 and 2007. Meanwhile, more than 2,500 taxpayers entrepreneurs.” made just one appearance in that top Tax Fact: group, demonstrating the tremendous Tax increase for a typical middle- turnover that exists among the nation’s income family if the Bush-era tax wealthiest families. cuts expire: $1,540.

Fall 2010 • 3 Lawmakers looking to raise revenue “Why has the administration decided Congress have aimed their crosshairs at the oil that companies that produce t-shirts, and gas industry. But according to a hamburgers, toys, software, or rap music new Tax Foundation study, repealing are qualified to receive a tax credit, but Targets Oil corporate tax deductions for a single oil companies are not?” said Hodge. “It industry is a costly and unfair way to appears that it comes down to environ- Companies for raise federal revenue. mental politics, not sound tax policy or “Instead of unfairly punishing one good economics.” industry by repealing a manufacturing The Obama administration argues the Tax Hikes deduction just for oil companies, the Section 199 deduction distorts markets Obama administration should instead by lowering taxes for oil companies, thus lower the U.S. federal corporate tax rate, encouraging “too much” investment which would benefit all American com- and overproduction of oil and gas. But panies,” said Scott A. Hodge, President of according to the study, by that reasoning the Tax Foundation. the deduction should be repealed for all The Obama adminis- industries, not just oil and gas. tration has proposed The deduction was originally enacted as repealing a corporate part of the American Jobs Creation Act tax provision called the of 2004 in response to an earlier World Domestic Manufacturing Trade Organization ruling that the Activities Deduction or U.S.’s “extraterritorial income exclusion” the “Section 199 deduc- violated trade laws. To mitigate the tion.” It allows companies harm from repealing these provisions, to deduct up to 9 percent Congress enacted a new tax deduction of their income from available to domestic manufacturers. domestic manufactur- However, a better policy may have been ing activities. Studies an across-the-board rate cut in the show the deduction cuts federal corporate income tax rather than corporate tax burdens on a special new deduction. Scott A. Hodge discusses capital gains these activities from 35 taxes on CNBC’s ‘Street Signs.’ According to the study, the main reason percent—which is today’s top corporate American companies were disadvantaged income tax rate—to 32 percent. before the Section 199 deduction is the “While the tax deduction is by no means same reason they are struggling today: perfect, it’s available to a broad swath a U.S. corporate tax rate of 35 percent of industries, not just oil and gas,” said that is sharply higher than most other “Tax laws Hodge. “Tax laws shouldn’t be used to wealthy nations. punish one industry over another. Using “Rather than creating a new tax deduc- shouldn’t be the tax code in this way is arbitrary and tion, lawmakers should have responded has led to the byzantine tax system we by slashing the U.S. corporate tax rate used to punish suffer from today.” to a competitive level,” said Hodge. “It Picking Winners and Losers would be wrong and punitive to carve up the existing deduction simply to one industry Under current law, a wide range of score political points against the oil industries qualify for the deduction, and gas industry.” over another.” including clothing, food and software manufacturers; music recordings and Read the full study, “The Administration’s film; producers of electricity, natural gas Assault on the Manufacturing Deduction for Oil Companies,” at www.taxfoundation.org/ and water; residential and commercial publications/show/26579.html. building construction; construction of roads and power lines; and even some engineering and architectural services.

4 • TaxWatch Hold onto your wallets, investors. of taxation but don’t have the benefit of Dividend According to a new Tax Foundation limited liability found in the corporate study, America’s top tax rate on dividends structure,” said Carroll. Tax Rate could soar to 68 percent next year—the Double taxation also encourages highest rate in the industrialized world. companies to carry higher debt loads. “A U.S. integrated dividend tax rate of According to the study, higher taxes on May Soar to 68 percent is substantially higher than dividends lead to an over-reliance on in other nations,” said economist Robert debt finance for corporate investment. Carroll, author of the new report. “The In turn, these higher debt burdens 68 Percent average rate among OECD member increase a company’s risk of bankruptcy nations is about 44 percent and the during economy-wide downturns. average among the larger G-7 economies The study notes another problem with is about 47 percent.” high dividend taxes: they encourage Economists have long criticized America’s companies not to issue dividends to double tax on corpo- shareholders, potentially leading to rate profits, which are poorer investor oversight of corporations. taxed once by corporate “The payment of dividends may improve income taxes and again corporate governance by providing an by dividend taxes when important signal to investors of a com- distributed to shareholders. pany’s underlying financial health and In 2003, Congress partially profitability,” said Carroll. “To the extent addressed the double-tax that dividend payments are more heavily problem. The Bush-era taxed than capital gains, U.S. companies tax cuts lowered the top are discouraged from distributing earnings tax rate on dividends to investors through dividend payments.” from 39.6 percent to 15 These tax-related changes in companies’ percent, and cut the tax dividend policies can have a big impact rate on capital gains from on families. According to the study, even 20 percent to 15 percent. Mark Robyn discusses sales tax if the higher dividend tax rate resulting holidays on Fox Business Network’s However, those tax cuts expire at the from the expiring Bush-era tax cuts is ‘The Willis Report.’ end of this year. Along with other new limited to families earning over $250,000, taxes on investment passed as part of the all households that hold dividend-paying recent health care reform, double taxa- stocks—regardless of their income— tion of dividends may soar next year. would be affected. In 2007, one-fifth of More Double Taxation all income tax returns reported earning dividend income. “Double “The double tax on corporate profits discourages productive capital formation, “High dividend and corporate tax rates taxation lowers which ultimately hurts U.S. wages and raise serious concerns about the interna- living standards,” said Carroll. tional competitiveness of the U.S.,” said Carroll. “By injecting tax considerations One way high dividend taxes hurt growth productivity into investment decisions, double taxa- is by biasing investment away from its tion lowers productivity and ultimately best use in the economy. By pushing and reduces reduces living standards for U.S. citizens.” investment dollars into less-valuable uses living standards for tax reasons, the economy’s capital is Read the full study, “The Economic Effects being used poorly, leading to lower GDP of the Lower Tax Rate on Dividends,” at than would otherwise be possible. www.taxfoundation.org/publications/ for all U.S. show/26384.html. “The greater tax burden citizens.” on corporations encour- ages business owners to choose partnerships and Tax Fact: other pass-through entities Federal estate tax rate in 2010: 0 percent. that enjoy a single level Federal estate tax rate in 2011: 55 percent.

Fall 2010 • 5 (continued from Which Areas Pay Most? The Tax Foundation has also posted a page 1) While nearly all Americans would pay “frequently asked questions” list on their higher taxes if the Bush-era tax cuts website at www.taxfoundation.org expire, the burden would not be shared to answer common questions about equally. Differences in incomes and the Bush-era cuts. According to the “If Congress lifestyles throughout the nation mean the list, families are facing a long list of tax tax increases would take a bigger bite out increases if Congress fails to act: fails to act, of some areas than others. • The estate tax returns with an According to Tax Foundation research, exemption level of $1 million and income tax the nationwide typical middle-income a top tax rate of 55 percent; family with a median income of $63,366 • The “marriage penalty” for rates will rise, would see its federal income tax burden joint filers returns; increase by $1,540 if the tax cuts expire. • The child tax credit will be cut However, middle-income families in Alaska the estate tax from $1,000 to $500 per child; would face a much higher tax increase of will return, and $1,959—the highest in the nation—fol- • Long-term capital gains taxes rise lowed by families in Connecticut ($1,903), from 15 percent to 20 percent, and capital gains New Jersey ($1,860), Massachusetts dividend taxes rise from 15 percent ($1,831), and Utah ($1,779). to ordinary income tax rates; taxes will jump Among congressional districts, the biggest • The 10 percent tax bracket expires, tax increases would hit middle-income reverting to 15 percent, and the top sharply.” families in California’s 14th district near tax rate rises from 35 percent to the San Francisco, who would pay $3,194 more Clinton-era rate of 39.6 percent. in taxes. They are followed by families in “Experts have been warning for years Virginia’s 11th district near Fairfax ($3,180), that if the Bush-era tax cuts expire, families in New York’s 14th district near Americans will face tremendous tax Manhattan ($3,066), New Jersey’s 11th increases,” said Hodge. “This year the district near Dover ($2,987), and Virginia’s Tax Foundation has greatly expanded 8th district near Arlington ($2,895). our research on this issue, highlighting These facts could affect the politics of the serious risks to taxpayers if Congress tax debates. According to the study, fails to act.” eight of the ten congressional districts To learn more about how the expiring facing the biggest tax hikes are repre- Bush-era tax cuts could affect your family, sented by Democrats, while just two visit www.MyTaxBurden.org. are represented by Republicans.

Thanks to Our Sponsors: 2010 National Taxpayers Conference Each year since the 1940s, presidents of state budget trends, panelists discussing new research on taxpayers’ associations have gathered to discuss state pension problems, presentations on how states current trends in fiscal policy. The Tax Foundation are improving budget transparency, and, of course, the was honored to host the annual gathering this year, latest research from the Tax Foundation. September 26th to 29th in Washington D.C. The 2010 National Taxpayers Conference meeting Over a dozen expert speakers and panelists shared was graciously supported by DCI Group, Expedia, their insights about tax developments in the states. Altria, Verizon, the Council on State Taxation, and Noteworthy events included a roundtable on state Corporate Press.

6 • TaxWatch Media Impact Report With the looming to discuss sales tax holidays. Robyn expiration of the Bush-era was also interviewed by CBS News tax cuts, Tax Foundation Radio, Illinois Public Radio and stations experts were cited in Richmond, VA, Austin, TX and throughout the media Charlotte, NC. this summer. Newspapers Television and Radio Manager of Media Relations Natasha President Scott Hodge Altamirano published an op-ed on appeared on several Fox CNN.com about the new excise tax on News Channel programs indoor tanning. Intern Aaron Merchak to discuss the expiration authored an op-ed on “jock taxes” and of the Bush-era tax cuts LeBron James for CNBC’s Sports Biz Joseph Henchman testifies before and the Tax Foundation’s blog, the Sacramento Bee and the Arizona the U.S. House Committee on the Judiciary on how state taxes affect the web calculator at www.MyTaxBurden.org. Republic. Intern Ryan Forster published nation’s economy. Hodge was also interviewed on Fox an op-ed on cell phone taxes in the San Business Network, CNBC’s “Street D i ego Un i o n-Tr ib un e. Signs,” CNN’s “CNN Sunday Morning,” Tax Foundation research on the CNN’s “American Morning,” and Radio expiring Bush-era tax cuts was featured America’s “Dateline DC.” by , the Hill Senior Economist Gerald Prante, Ph.D., and the Los Angeles Times, and other was a guest on C-SPAN’s “Washington studies appeared in Reuters, Bloomberg, Journal” to discuss the expiring Bush- Associated Press, USA Tod ay, Stateline. era tax cuts. Economist Mark Robyn org and others. appeared on Fox Business Network’s Learn more about the Tax Foundation’s media “The Willis Report” and “Fox Business” impact at www.taxfoundation.org/press/.

Bringing Sound Tax Policy to the States Tax Foundation experts have been busy Ohio/Florida: Tax Foundation intern throughout the states this summer: Aaron Merchak received wide media California: The San Diego Union-Tribune attention for his op-ed on the tax impli- in July ran an op-ed by summer intern cations of basketball star LeBron James’ Ryan Forster on a wave of new local cell decision to play for Miami instead of phone taxes being adopted in the state. Cleveland. Kentucky: Tax Foundation experts Rhode Island: We hosted Gov. Don met with state legislators from across Carcieri on our podcast program to dis- the country attending the National cuss the Ocean State’s dramatic income Conference of State Legislatures (NCSL) tax reduction, and how Tax Foundation annual conference in July. research played a major part in it. Nevada: As a state commission considers Nationally: Our updated report on sales ideas for new business taxes, we released tax holidays, which explains how they fail a report debunking claims that gross to promote economic growth or reduce receipts taxes are not distortive and that taxes, received wide coverage as 16 states corporate income taxes are less volatile held “back-to-school” tax holidays. than other taxes. Learn more about the Tax Foundation’s state policy work at www.taxfoundation.org/ research/topic/9.html.

Fall 2010 • 7 National Press Building 529 14th Street, N.W., Suite 420 Washington, D.C. 20045

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