Official Tax Guide

Please tell me it isn’t true: Washington is buzzing with talk of Homebuyer Tax Credit III.  Like the killers in those really bad slasher movies, this tax subsidy wreaks havoc wherever it goes, appears to meet its demise in the last reel, yet returns to create more misery. 

The latest round started on Sunday, when HUD Secretary Shaun Donovan said it was “too early to say” whether the White House would support another round of credits.  Donovan and the Obama Administration have been backtracking ever since. But the damage is done.

Members of Congress and congressional hopefuls have leapt on the bandwagon. There is even a facebook page called “Extend the $8000 Federal Tax Credit until 2011 for 1st Time Homebuyers.”

Congress has run the homebuyer credit experiment twice in the past two years. And the dismal results were exactly what economists predicted: In the months before the credit expired, buyers scrambled to get a deal from Uncle Sam. The frenzy boosted demand and drove up prices. Until the day the credit expired. Then demand collapsed and so did those prices.

We know what’s happened to home sales since the credit ended on April 30—they plunged to their lowest levels in four decades. While we don’t have good price data yet, there is growing anecdotal evidence that in some markets, house prices fell by more than the value of the $8,000 credit. Thus, buyers would have been better off waiting until it expired. Of course those sellers who rushed to take advantage by putting their homes on the market got hammered if they couldn’t find a buyer in time. Such is the madness caused by an on-again-off -again tax subsidy.   

As Steve Cook, author of the blog realestateeconomywatch.com, notes, even talk of a credit has perverse effects on the housing market. That’s perhaps one reason why Cook says the real estate industry is divided over whether to bring it back. The problem: The Siren song of a new tax deal on the way may well drive potential buyers back to the sidelines while they await its return. Thus, administration-fueled rumors of a new credit could further slow sales in the coming months, the last thing either real estate agents or Democrats need right now.

The ever-popular solution to this problem is to make the credit retroactive so that those who bought after the expiration of Homebuyer Credit II will get the tax break. It is only fair, supporters of this terrible idea say. But such a step is a pure windfall for those who have already bought, and while it surely will increase the national debt it will do absolutely nothing to encourage new sales or new jobs.

The other day a reporter asked if, for all its flaws, the credit was better than nothing. No, it isn’t. 

There may be good ways to reduce the supply of unsold houses, which after all is the real problem. But those solutions lie far beyond the realm of tax policy, which aims to boost demand by heavily subsidizing home ownership.  

Steuerle discusses a Bush administration proposal for a lifetime savings account (LSA) and the opportunities for tax shelters and tax arbitrage that it would create.

Senior Fellow Eugene Steuerle suggests that there are three major features of the U.S. multi-tiered tax structure that together reveal a fundamental distrust of “bigness:” (1) the graduated rate structure in the individual income tax; (2) the corporate income tax; and (3) the estate and gift tax.

Senior Fellow Eugene Steuerle comments on the apparent demise of the Clinton Administrations USA proposal, and examines its pros and cons.

You buy what you think will be a state-of-the-art GPS device to give you driving directions. The gizmo was designed by a committee of the nation’s smartest highway engineers. But instead of telling you to turn right now, the e-voice says something like this: “You could turn right now. It would be better than going straight, which is a really bad choice but, on the other hand, the road might be a little bumpier and besides, you could also get where you want to go by turning left three blocks from here. So I’m not actually recommending what to do.”

That’s the feeling I got reading the long-delayed Report on Tax Reform Options from the President’s Economic Recovery Advisory Board (PERAB in Washington-ese). The paper, approved by the panel this afternoon, is filled with lots of useful information about our flawed tax system but leads nowhere. There are no recommendations. No revenue estimates. And no ownership by President Obama, even though he picked the panel’s members and staffed it with White House aides.

As a result, this report is a huge missed opportunity. Obama might have used this exercise to jump-start a debate over fundamental tax reform. Instead, the report does nothing to fill the policy vacuum that is being filled by an argument over what to do about the decade-old Bush tax cuts.

Imagine if Obama used this group to start the process of doing what President Reagan did, develop a broad-based reform plan. Or even if he had allowed the panel to design full-blown alternative tax structures—a step George W. Bush took in 2005 (although, it must be noted that Bush ultimately ignored the suggestions of his own commission).

This panel might have had some clout. Former Fed chairman Paul Volcker headed the group, which included economic heavyweights such as Marty Feldstein and Laura Tyson, as well as business executives such as John Doerr and Jeff Immelt. But Obama hamstrung them from the beginning by prohibiting the committee from considering any changes that would raise taxes on those making less than $250,000-a-year. He also limited its charge to simplification, compliance, and corporate taxes—the first two, at least, relatively low-hanging fruit.

There is nothing wrong with the report’s focus: These are important issues, though obviously not the whole story. But per White House instructions, the committee makes no recommendations at all, instead merely describing general options for change and outlining both the benefits and disadvantages to each.

As if that was not enough, the report comes with not one but two disclaimers:

First: “It is important to emphasize at the outset that the PERAB is an outside advisory panel and is not part of the Obama Administration. Our report is meant to provide helpful advice to the Administration as it considers options for tax reform in the future.”

And if you didn’t get it, there is also this: “The report does not represent Administration policy.” 

Thus, the study was thrown under the bus.

While there is almost nothing in this paper that has not been hashed over by prior studies, including the Bush commission, the PERAB report does a nice job describing what is wrong with the current tax code. And it includes some valuable hints, at least, about possible future policy choices. But, in the end, it does little to advance a debate the nation desperately needs to have.  

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This Congressional testimony by Leonard Burman examines how the plans put forth by the President’s Advisory Panel on Federal Tax Reform would affect small businesses, focusing particularly on the effect of: adopting a national retail sales tax on small business and the viability of federal and state tax systems; the effect on small business health insurance and retirement coverage; the effect of disallowing state and local tax deductions for businesses; and the effect of certain simplification proposals.

The story goes that when Lyndon Johnson was losing his first congressional election he put out the word that his opponent was having sex with barnyard animals. An aide innocently warned Johnson that this wasn’t true. “Make the SOB deny it,” LBJ was said to have replied.   

If you go to the Website of House Ways & Means Republicans, you will see this:

Meanwhile, Fox Business is running a graphic that includes another one of these ominous digital clocks, this time counting down to what it calls “the largest tax hike ever.”

All this drama is about the coming expiration of the Bush tax cuts, of course. But what else do these two allegations have in common? They are both utterly untrue.

To start, not a single important Democrat favors letting all the Bush tax cuts expire at the end of the year, as the Ways & Means Republicans allege. Ever since his campaign for president, Barack Obama has vowed not to raise taxes for anyone making $200,000 or less—a pledge I wish he had never made, but one he has nonetheless kept. His 2011 budget explicitly calls for extending nearly all of those tax cuts (except for the highest-earning 3 percent of taxpayers). Finance Committee chairman Max Baucus (D-MT), Senate Democratic leader Harry Reid (D-NV), House Speaker Nancy Pelosi (D-CA) and Ways & Means Committee chairman Sandy Levin (D-MI) all favor continuing the tax cuts, at least for the middle-class. Relative to current law, this would cut taxes by $3 trillion over 10 years. So to say that “on January 1, 2011, Democrats will drop a $3.8 trillion tax increase on American small businesses and families” is–not to put too fine a point on it–a lie.

The there is the matter of whether allowing all the Bush tax cuts to expire, would, in fact, be “the largest tax hike ever.”

By any fair measure, that’s not true either. To be sure, it would be a very big tax increase, raising revenues by about 2 percent of Gross Domestic Product. But the biggest ever? Not by a long shot. Back in 2006, Jerry Tempalski at the Treasury Department measured the relative size of all major tax bills just since 1940 (which fits pretty well into the definition of “ever.”).  

This is what he found: The Revenue Act of 1941 raised taxes by an average annual rate of 2.2 percent of GDP, more than the impact of letting all the Bush tax cuts expire. The Revenue Act of 1942 was even bigger. It raised taxes by a whopping 5 percent of GDP. Remember, we used to pay for our wars in the old days, instead of leaving the bill to our grandchildren. And, in case you were wondering, the three major tax increase bills signed by President Reagan– TEFRA of 1982, the Social Security Amendments of 1983, and the Deficit Reduction Act of 1984–raised taxes by a combined 1.6 percent of GDP, not much less than what we are yelling about today.

Now, there is nothing new about this “biggest tax cut ever” canard. Republicans said it about President Clinton’s 1993 tax increase (which actually raised taxes by 0.63 percent of GDP). They trotted it out again in their campaign against Obama’s health bill. Myron Ebell at Human Events probably wins the breathless rhetoric award, however. He called last year’s House energy bill the “the biggest tax increase in world history.” Whew.
 
This isn’t to say Democrats won’t stoop to their own overheated hyperbole. Just listen to what some on the left say about efforts to reform Social Security. But there ought to be limits to this stuff, even in Washington. Words still mean something and just as Republicans went far over the line last year with their accusations about death panels in the health bill, they are doing it again this year with taxes. They should be ashamed. 

Senior Fellow Eugene Steuerle suggests that there are three major features of the U.S. multi-tiered tax structure that together reveal a fundamental distrust of “bigness:” (1) the graduated rate structure in the individual income tax; (2) the corporate income tax; and (3) the estate and gift tax.

President Obama’s tax reform task force has been asked to propose ways to close the $300 billion tax gap, which is the estimated difference between taxes owed and taxes paid either voluntarily or through enforcement. But the amount of money lost to legal tax avoidance - the difference between an income tax without special tax preferences and taxes under current law - at least double that lost to outright evasion. The perpetrators of this second, “avoidance” tax gap are legislators, not taxpayers. The panel’s main focus should be on finding appropriate ways to close this second tax gap.

The federal tax system provides little incentive for participation in tax-preferred saving plans to households that most need to save more for retirement and whose contributions would most likely represent an actual increase in savings. By contrast, the tax code provides its strongest incentives to those who already are generally better prepared for retirement and who are more likely to use tax-preferred vehicles as a shelter than as an opportunity to increase overall saving. The saver’s credit, helps correct this “upside-down” structure of tax incentives for retirement saving.