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Illinois House Speaker Michael Madigan scheduled a rare “committee of the whole” over the last two days to discuss Governor Blagojevich’s tax plan (coverage here and here). The session was called after a majority of the Illinois House signed on to a resolution condemning the tax plan. After two days of testimony the House voted 107-0 to defeat the resolution calling for the plan to be passed.

During the testimony the House heard from the Governor as well as several of his lieutenants. Unfortunately for the Governor, they weren’t loyal to him. Lieutenant Governor Pat Quinn, Comptroller Dan Hynes, and Treasurer Alexi Giannoulias all testified against the plan during the hearings.

Shortly before the vote, the Governor called on his allies to vote against the measure saying it was too quick to decide on such an important topic. Of course, since the resolution was going down to an obvious and sound defeat this allowed the Governor to claim a small victory, which he promptly did. His spokesperson said that the tax wasn’t dead despite not getting a single vote because he asked people not to vote for the proposal.

I can’t wait to see the spin that Douglas Kane at Tax Tales (coverage here) puts on the vote (if he even posts about it). I’m sure it will be in lockstep with the Governor (can’t bite the hand that feeds!).

Intuit’s TurboTax software experienced a major failure last night as slackers who waited until the last minute to complete and file their returns overwhelmed the service and took down the whole eFile process. The TurboTax message boards are lit up with irate customers demanding the heads of various Intuit executives (and the poor lacky that has to communicate with the customers, who takes the name TurboTaxPatsy).

I think the moral of the story is to not procrastinate and then hope for the best. If you leave no room for error you are hoping for perfection and that rarely happens; especially when it is a process that is completely out of your control.

Intuit is working with the IRS to try and get them to waive penalties for customers who tried to file last night but were not able to. Personally, I hope the IRS doesn’t waive the penalty but Congress would jump down their throats if they did that; so I am expecting that the penalties will be waived for any customer that can prove they attempted to file their returns on time.

I found it curious when the Illinois press release came across my desk announcing that one of the largest unions in the country came out and explicitly endorsed the Gross Receipts Tax (coverage here). It’s unusual for a union to come out and endorse any tax plan, much less one that is unprecedented in raising taxes on businesses. I believe this is true for mainly two reasons.

1. There’s no need for the unions to needlessly antagonize businesses
2. They’re afraid of the consequences if businesses cut costs to cover the increased tax burden

The union that endorsed the plan doesn’t have to worry about these issues, though. That’s because it is AFSCME, which covers municipal workers only. The obvious benefit to AFSCME is that increased government revenues generally means more government jobs which means more members for AFSCME.

However, in typical political fashion there is more than meets the eye here. I’ll just let newspaper stories from around the state tell the tale.

• The News-Gazette (Champaign) reports that Governor Blagojevich dropped a plan to lay off 203 Department of Corrections workers the day before AFSCME endorsed the plan. Guess who represents workers at the Department of Corrections?
• The Pantagraph (Bloomington-Normal) reports that AFSCME released a report that said that 2,000 more union workers should be hired by Illinois the day after endorsing the plan.

AFSCME and the Governor have not necessarily been friends since he was elected. Blagojevich has laid off workers, which obviously upset the union. The union has publicly blasted the Governor several times during his administration. All of a sudden they are chums who want to work together to pass a major tax increase?

The blog supporting the Illinois Gross Receipts Tax (coverage here) warns small businesses that they should be wary of new friends when it comes to taxes. Maybe taxpayers should heed the spin machine’s own warning?

It looks like the Governor of Illinois has launched a Blogspot blog in order to promote his tax increase and to respond to critics of the tax. The author, Douglas Kane, takes much the same tone in the blog as Mr. Blagojevich takes in his speeches, that anyone that disagrees is an idiot and beyond contempt.

Mr. Kane, from his short bio on Blogspot, is a former state representative that also writes for the group blog Illinoize, though he is not listed as an author by that website. He’s an economist (little e) and President of a public policy think tank. I don’t know what his connection to the Governor’s office is, if any. I’ve added the site to my Google Reader list and will watch how he begins to tackle other criticisms that are lobbed at the Governor’s plan.

My earlier post “Who Pays Business Taxes?” was partially in response to the political tactics of Illinois Governor Rod Blagojevich who unveiled an updated Gross Receipts tax proposal today (with even higher rates, naturally) and a website aimed at continuing the charm offensive he has unleashed in the last few days. In it, he describes why the current system is broken and why his Gross Receipts proposal is a fairer alternative that does not raise sales or income taxes (a campaign promise of his).

Myth #1: Gross Receipts Taxes are Fair

The Governor’s first assertion is that “most economists agree that the least disruptive tax on business is one with a broad base and a low rate”. That is true for income taxes. However, a lot of economists also agree that Gross Receipts taxes are among the most disruptive form of taxation because of the pyramiding and distortion effects that they have. Governor Blagojevich, naturally, leaves this corollary out of his argument.

Myth #2: A Lot of Companies Won’t Pay the Tax

His next “fairness argument” lists all of the industries that will not pay the tax. His list includes insurance, gaming, retail food and drug, securities, and not for profits as all exempt from the tax. Well of course they are! Insurance companies pay the premiums tax and are not included in the corporate income tax. Gaming companies pay a tax on wagers and are also exempt from the corporate income tax. Securities traders will pay on profits not proceeds of sales, which is their true income. And how nice of Governor Blagojevich to exempt not for profit entities that can’t be taxed.

The Governor also points out that businesses with less than $2 million in receipts will not pay the tax. That would seem to say that small businesses will be exempt from tax. Wrong! They will simply continue to pay the old income tax rather than pay the new gross receipts tax. The enabling legislation says that the income tax will phase out for small businesses on December 31, 2011, if and only if another tax is implemented to make up the revenue from the repeal of the income tax on small businesses. Another switcharoo from the Governor.

Myth #3: Our Gross Receipts Tax is Different 

The Governor goes on to list why the gross receipts tax won’t have the pyramiding effect. His first argument is that exports from Illinois won’t be taxed. That’s because Illinois can’t tax sales in other states under Federal law. How nice of the Governor to respect Federal law like that. He also says that transactions between affiliates won’t be taxed. Illinois requires a combined return from companies and intercompany transactions are eliminated from a combined return. Again, he can’t really tax these transactions, so he is graciously exempting them from the tax. And his argument that goods being taxed at a lower rate to avoid pyramiding is ludicrous. It’s a bone thrown to the manufacturers in the state and has nothing to do with the economics of the tax.

Myth #4: We’re Like All the Other States 

In the last section he lists other states that have adopted Gross Receipts taxes in the past year. He cites Ohio and Texas specifically.

Ohio did enact a Gross Receipts tax at a rate of 0.26%. The legislation also eliminated the personal property tax in Ohio and exempted sales of business assets from the tax. Illinois doesn’t have a personal property tax because it has what is known as the Replacement Tax. The Replacement Tax is levied at 2.5% of a corporation’s Illinois profits. The Gross Receipts tax will be creditable against the 4.8% Corporate Income Tax but not the Replacement Tax. So, Illinois is citing a state that eliminated the personal property tax, exempted sales of business assets, and levied a 0.26% tax rate to support a tax that does not eliminate the Replacement tax, doesn’t exempt sales of business assets, and has a tax rate of 1.95%?

A better example might be Texas, which enacted the Gross Margins Tax last year. It has tax rates of 0.5% for retailers and 1% for everybody else. That’s closer to the 0.85%/1.95% rates of Illinois, right? Well, not really every taxpayer gets a deduction for Cost of Goods, Compensation Paid, or 30% of the tax base. Basically, that means that the highest possible rate a taxpayer will pay is 0.35%/0.70%. A company with low margins will likely pay a lot less. The Texas bill also lowered property tax rates by 33%. So, again the Texas tax significantly lowered property taxes and is at rates significantly smaller than Illinois’ tax.

Once you begin to analyze the Governor’s positions with an educated mind, his arguments fall flat. He’s exempting companies that either pay other taxes or cannot be taxed and he’s exempting sales that he can’t tax anyway. What a deal for Illinois!

I don’t dislike Blagojevich and I usually vote Democrat, but I can’t stand when politicians flat out lie to their constituents in an attempt to get a bad idea through. This bill will hurt business in Illinois and will drive new business away. I’m not saying that as an anti-tax conservative, I’m saying it as someone that has studied other taxing structures developed by the states. This goes so far beyond the pale that Illinois will look like Michigan in twenty years, a state desperate to replace an unfair, job-killing taxation system that was designed when times were good.

Please Mr. Blagojevich, stop this madness! 

For the most part, I’m fairly liberal in my beliefs. There are a couple of places where I diverge from the liberal dogma and one of those is the taxation of corporations. Every once in a while, you will hear a howl of protests from the left about how {insert evil corporation here} is not paying their fair share in taxes or that businesses as a whole are not paying enough taxes. On a state level, the latest protest comes from Rod Blagojevich, the Governor of Illinois, who is using the “big business as tax bogeyman” argument to push through his plan to quadruple taxation of businesses by instituting a gross receipts tax to replace the current net income tax.

Now, I’m not here to defend the use of tax strategies that shift income from state to state to avoid income taxes. I think they are shady and they’ve caused problems for every company that is not doing it (and it’s far from a majority that are using these strategies). I’m also not here to say that businesses shouldn’t pay taxes. I’m here to discuss the economic incidence of taxation and who really pays when business taxes are raised.

It was brought on by a discussion in a forum of people that I often disagree with, but respect (for the most part). They raised the idea that if corporations paid their fare share in taxes, we could have universal health care. That’s the basic idea of Governor Blagojevich’s plan, though he’s raising money for other pet projects along with health care. Again, I’m not arguing what we should do with health care (though it is a broken system).

Business entities don’t really exist. They’re a legal fiction created by governments so that individuals can raise money to expand their businesses easily and will take chances without putting all of their own assets on the line. In the end, businesses are really an extension of the owners and nothing more. For instance, if a business goes under what does the corporation itself lose? Nothing, because it had nothing to begin with. Who loses? The owners that put their money into the corporation and the employees that were employed. The economic loss of a business going under is borne by individuals, the owners and employees that will no longer generate income from that business. You can extend this to creditor in the above example. It’s the owners of the corporation that ultimately bear the loss through smaller returns on the money that they invested.

A similar situation happens with taxes. Let’s say that business taxes are immediately raised by 20%. Businesses have three choices: they can eat the tax, they can raise revenues to cover the increased tax, or they can cut costs to cover the increased tax. Let’s see what happens with each situation.

In the first option, the business decides to take a hit to its profits and simply eat the increased tax. This lowers profits and in a perfect market, the price of the stock is lowered to compensate for the fact that shareholders will receive less profit because more is going to the government. The lowered stock price hurts the individual investor, not the corporation itself. A private business works the same way. The owners of the business will realize less profit and therefore will have less income generated by the business. In the end, it’s the individual owners that take a hit.

In the second option, the business decides that it can raise revenues to cover the tax. How is it going to do this? By raising prices. Let’s take the example of Halliburton, a favorite of the left. Halliburton decides it is going to raise prices to compensate for the tax. It charges the oil companies more for its services in order to raise the revenue needed to cover the tax. The oil company will then raise its prices to not only cover the increased cost of business from Halliburton but to also cover its raised tax liability. So, now the tax increase is priced into oil twice. The refiner buys the oil from the oil company. It has to raise prices to cover the increased cost of the oil and the increase it sees in tax. Now the tax increase is in the fuel three times. Your local gas station buys fuel from the refiner. The gas station has to now price the fuel it sells to you for its cost plus the effect the tax has on them. The loser? The consumer that buys the fuel. The consumer has to pay for the increased cost at each step because the tax was raised. None of the business entities themselves are hurt. If one of the steps in the chain decides to not pass along the increase in cost, we’re back to scenario one and the individual owners of the firm bear the tax.

Now, let’s take a look at the last scenario. If a business wants to cut costs in order to cover the tax, what is the highest cost for most firms? Bingo, wages. The way most businesses would recoup the tax is through lower wages. Whether it is not hiring that next person, lowering annual pay increases, or cutting jobs entirely, wages would likely be lowered to offset the effects of the tax. It’s not hard to see who bears the true burden of the tax in this scenario.

Politicians like raising business taxes because they can use populist slogans and claim that they are not raising your taxes, just evil businesses that don’t pay their fair share. Next time you hear that claim, think about it twice before joining the chorus.

Yesterday, the IRS sent out a press release identifying 40 tax positions that will be eligible for the maximum $5,000 penalty. The penalty is not automatic but can be levied at the discretion of the IRS. The IRS also released four Revenue Rulings debunking several of the most prevalent tax protester freedom fighter arguments.

Most of the arguments revolve around two primary focii: that the 16th Amendment was not properly ratified or that wages are an equal exchange for labor and therefore non-taxable. If someone ever presents you with these arguments, or really any argument that says you can avoid taxes, run really fast. Courts do not take kindly to people making tax protester arguments, and neither does the IRS.

A virtual encyclopedia of tax protester freedom fighter arguments can be found at Daniel Evans’ Tax Protester FAQ. Mr. Evans has done a fantastic job of listing and debunking various tax myths. It’s a fantastic resource if anyone ever presents you with something that doesn’t seem right (or for fun casual reading if you’re a tax nerd like me).

IR 2007-61

BNA ($) is reporting that House Democrats have stated that they are three weeks away from having a complete overhaul bill for the AMT (UPDATE: free article on same topic). The reporting on the AMT has reached a fever pitch in the last few weeks, with the latest story I’ve heard was on NPR’s Morning Edition just this morning (though it was almost comical rather than newsy with rich people whining).

For those that need an AMT primer, see my story from last year. Basically, the problem with repealing the AMT is that every year that Congress postpones doing something the worse the fix is going to be from a revenue perspective. Senate Democrats want a two year fix in order to study the tax code and make suggestions. That also gets us to 2010, when all of the Bush tax cuts expire and the revenue hit will be much less.

I don’t see an AMT repeal happening without fundamental tax reform. The cost of the bill alone would require such large “revenue raisers” to fall under the Pay as you Go rules that the Democrats have put in place that it will basically require a large deduction to be taken away or tax rates to be raised.

The problem that I see is not that we need to repeal the AMT. I think we need to repeal the regular code and move to the AMT. There are far fewer deductions and far fewer complications than the regular tax code. The biggest current complication is having to calculate your income twice.

I firmly believe that we need to trash the entire IRC and start again. Starting with the AMT would be a grand idea, but I’d go even further. Take all of your income from whatever source (including dividends, capital gains, and inheritances), apply a large standard deduction, and have tax rates of 25% and 30% in similar places to the current AMT’s rates of 26% and 28%. Make the standard deduction large enough that someone at 150% of the poverty level pays no income taxes and index that puppy for inflation.

Do away with all of the giveaways under the Code and take out the complications. Make it so just about anyone that does not own a business can file their own taxes. Take out the Estate Tax and the special tax rates for dividends and capital gains. Take out everything that complicates the Code needlessly.

The income tax would still be progressive because the large standard deduction will be enough to make the effective tax rate climb upwards for a long time before hitting the marginal tax rate. Progressivity doesn’t just come from having 15 different tax bands.

Taxing all income the same also makes the system way more progressive than it currently is. The wealthy generally rely on dividends, capital gains, and inheritances for their income. The less wealthy generally rely on their wages for their income. Currently, dividends and capital gains are taxed at 15% and wages at rates up to 35%. That puts the onus of the tax on people that rely on wages (the less wealthy) rather than on those with the best ability to pay (the wealthy). Taxing all income the same fixes this issue with the Code.

A simple, fair, and efficient tax code should be the goal of us all. Unfortunately, the lobbyists and easily swayed Congresscritters stand in the way (not to mention tax complexity is a gold mine for my profession). Do I think I’ll ever see an easy tax code? No, but I can dream.

The IRS has released it’s annual list of their “Dirty Dozen” tax scams. The scams that they want taxpayers to avoid are:

• Telephone Excise Tax Refund Abuses
• Abusive Roth IRAs
• Phishing
• Disguised Corporate Ownership
• Zero Wages
• Return Preparer Fraud
• American Indian Employment Credit
• Trust Misuse
• Structured Entity Credits
• Abuse of Charitable Organizations and Deductions
• Frivolous Arguments

Many of the scams are completed and this list is really, really broad. How do you spot preparer fraud or frivolous arguments if you are a common taxpayer? While they do give some examples of frivolous arguments in the release, there are many more that are commonly made by tax cheats freedom fighters when they sell their particular method to an unsuspecting person.

The bottom line rule is that if it sounds too good to be true it is. You have to pay taxes and you cannot deduct personal expenses as business expenses no matter how hard you try. If someone is trying to sell you tax advice unsolicited, they’re probably cheating.

Which means it won’t go anywhere.

Sen. Joe Lieberman, I-CT., said Tuesday that Congress should consider a special tax to pay for the nation’s war against terrorism. The Republicans and the Bush administration have tried to hide the costs of the war since the very beginning burying it in off-budget requests and refusing to include any money in their “official” budget that kept showing an improving fiscal situation. Even today, they included the money for 2007-2008, but nothing thereafter which makes their goal of eliminating the deficit a lot easier to do on paper. A special tax would make the American public think about the war every time that they have to pay it.

The problem is that special taxes to pay for things generally become permanent. Think of the telephone excise tax that was overturned last year that was designed to pay for the Spanish-American war. Generally, politicians have the spines of jellyfish and even if a tax was passed, it would be buried similarly to the telephone excise tax (how many people knew they were even paying it?).

I really don’t expect this proposal to go anywhere but with the cuts to social programs looming, and the Social Security/Medicare timebomb after that, we’ll need to fundamentally rethink how we fund the Federal government.

If you want to see where each dollar of taxes go, check out my post from last year detailing the percent of the budget going to various programs. You’ll see that there’s not much there to cut outside of defense and health spending.