States Rain Down Taxes on Fourth of July Celebrations

Tax Policy – States Rain Down Taxes on Fourth of July Celebrations

No Fourth of July celebration is complete without fireworks, and Americans are willing to pay for their colorful displays of patriotism. According to the American Pyrotechnic Association, Americans spent over $1.2 billion on fireworks in 2017, with consumer fireworks accounting for $885 million of that. Some states see this as an attractive source of revenue, and have imposed excise taxes and licensing fees on fireworks sales.

Currently, six states impose statewide excise taxes on fireworks sales, and another two permit excise taxes in select localities. These taxes are imposed on top of each state’s existing sales tax, and range from 2 percent in Texas to 12 percent in West Virginia and Pennsylvania.

Pennsylvania’s 12 percent tax is new this year, and heading into Independence Day weekend, local fireworks dealers are not happy. Pennsylvania instituted the tax and legalized the sale of consumer-grade fireworks to its residents simultaneously, which might seem like a fair trade. However, anyone who has driven across the state’s borders knows that roadside stands have long done a brisk trade selling consumer-grade fireworks to nonresidents. Now these transactions – along with the sale of Roman candles and firecrackers – are subject to a high excise tax.

At this point, many shoppers are unaware of the new tax. According to retailers, the tax has disrupted many shoppers’ annual tradition of traveling to Pennsylvania to buy fireworks, with some shoppers even leaving behind full shopping carts to go to another location. Phantom, a major retailer, has begun issuing notices in its magazines encouraging shoppers to drive to Ohio, where there is no added tax.

With the exception of Maryland, all states which permit the sale of fireworks – whether they only legalize sparklers and Pop-Its or permit the sale of 500-gram repeaters with names like “Hypersonic X-Celerator” – charge a retail registration fee, essentially a license for the privilege of selling fireworks. These fees are as varied as fireworks themselves and range from trivial $5 paperwork charges in Coventry, Rhode Island, to $20,000 permits for 15,000-square foot stores in Pennsylvania. These license and permit fees are a hidden cost for consumers.

In some areas, nonprofits sell fireworks as a fundraising activity. Licensing fees can be particularly burdensome for such operations. For example, if a community organization wanted to sell fireworks in Maine to raise revenue, it would have to pay a $5,000 fee, which would be prohibitive for many organizations. By contrast, Guernsey, Wyoming, takes this into account and allows nonprofits to pay a discounted fee of $25.

The following tables shows fireworks excise tax rates in the eight states which currently impose such a tax, and retail license fees for all states. Will your Independence Day celebrations be taxed?

(a) Tax only in Cleburne County
(b) Tax only in Houston City
Sources: State Departments of Revenue, State Fire Marshals’ offices, State Departments of Labor, State Departments of Agriculture, County Commissioners’ offices, American Pyrotechnics Association
State Tax Rate
Alabama (a) 8%                 
Alaska (b) 2%
Georgia 5%
Indiana 5%
Michigan 6%
Pennsylvania 12%
Texas 2%
West Virginia 12%
The Distributional Impact of the Tax Cuts and Jobs Act over the Next Decade

The Distributional Impact of the Tax Cuts and Jobs Act over the Next Decade

Tax Policy – The Distributional Impact of the Tax Cuts and Jobs Act over the Next Decade

Key Findings

  • The Tax Cuts and Jobs Act (TCJA) made changes to both the individual income and corporate income tax, while scaling back the estate and gift tax.
  • Over the next decade, we estimate that the TCJA will reduce federal revenues by about $1.8 trillion on a conventional basis. In addition, we estimate that the economy would be about 2 percent larger on average than it otherwise would have been between 2018 and 2027.
  • Lower tax liabilities and higher output will boost taxpayer after-tax income, but the impact will differ over time due to many provisions phasing in or expiring over the next decade.
  • Using the Tax Foundation model, we estimate the distributional impact of the TCJA for each year over the next decade (2018-2027) on both a conventional and dynamic basis.
  • On a conventional basis, the TCJA would result in an increase in after-tax income for taxpayers in all income groups from 2018 to 2025.
  • In 2026 and 2027, the expiration of the individual income tax cuts will result in a reduction of after-tax income for taxpayers in all income groups relative to prior law on a conventional basis.
  • On a dynamic basis, the larger economy will result in higher after-tax incomes. However, the economic impact of the TCJA will be modest in the first few years but increase as the economic effects phase in over time.

Introduction

On December 22, 2017, President Donald Trump signed into law the bill known popularly as the “Tax Cuts and Jobs Act” (TCJA). The TCJA made changes to both the individual income and corporate income tax, while scaling back the estate and gift tax. Over the next decade, we estimate that the TCJA will reduce federal revenues by about $1.8 trillion on a conventional basis. In addition, the TCJA is projected to improve the incentives to work and invest, boosting the size of the economy. We estimate that the economy will be about 2 percent larger than it otherwise would have been between 2018 and 2027.

The reduction in tax liability will boost taxpayers’ after-tax income. However, the tax law’s impact on taxpayers each year over the next decade will vary due to the phase-in and phaseout of many provisions and, most notably, the expiration of most of the individual income tax cuts. While most taxpayers will see a tax cut in 2018, many will end up seeing a tax increase by 2027 if the individual income tax cuts expire as scheduled.

In addition, the larger economy will also mean higher incomes for taxpayers. However, the economic effects of the tax law will take time to materialize. As a result, individuals’ after-tax incomes due to higher wages and capital income will not occur immediately. Rather, they will gradually increase over the next decade.

In this paper, we use the Tax Foundation Taxes and Growth Model to provide detailed estimates of how after-tax incomes will change in each year from 2018 to 2027 for taxpayers in different income groups, both on a conventional basis and on a dynamic basis.

Overview of the Main Provisions of the Tax Cuts and Jobs Act

Individual Income Tax

The TCJA reduced statutory tax rates across the board (except for the 10 percent bracket) while slightly altering the width of tax brackets for taxpayers with taxable income over $200,000.[1] In addition, the TCJA reformed family benefits by doubling the standard deduction to $12,000 ($24,000 married filing jointly), eliminating the deduction for personal exemptions, and increasing the generosity of the Child Tax Credit from $1,000 to $2,000, while capping its refundability at $1,400. The Child Tax Credit was also expanded to high-income taxpayers by increasing income at which it begins to phase out from $75,000 ($110,000 married filing jointly) to $200,000 ($400,000 married filing jointly). The TCJA also created a nonrefundable $500 credit for non-child dependents.

The TCJA also broadened the individual income tax base by eliminating and scaling back several itemized deductions. The state and local tax deduction was capped at $10,000. The home mortgage interest deduction was also scaled back so that borrowers can only deduct interest on loans with a principal balance of $750,000 (down from $1,000,000). The TCJA also eliminated the “Pease” limitation on itemized deductions.

The TCJA established a 20 percent deduction of qualified business income from certain pass-through businesses. Specific service industries, such as health, law, and professional services, are excluded. However, joint filers with income below $315,000 and other filers with income below $157,500 can claim the deduction fully on income from service industries. Individuals earning about these thresholds are also subject to additional limitations, meant to prevent abuse of the provision.

The Alternative Minimum Tax was retained, but was scaled back by increasing the exemption level and the income level at which it phases in. The exemption level was increased to $70,300 ($109,400 married filing jointly) and the phaseout of the exemptions begins at $500,000 $1 million for married filing jointly).

Tax parameters will now be adjusted based on chained CPI-U instead of CPI-U. Chained CPI-U measures inflation by considering consumers’ behavior, resulting in a measure of inflation that rises more slowly than CPI-U. As a result, individual income will tend to rise into higher tax brackets, or phase out of tax benefits such as the Child Tax Credit and the Earned Income Tax Credit more quickly.

Corporate Income Tax and other Business Provisions

The TCJA cut the corporate income tax rate from 35 percent to 21 percent and eliminated the corporate alternative minimum tax.

The TCJA also expanded expensing for all businesses (corporations and pass-through businesses) by increasing bonus depreciation from 50 percent to 100 percent for five years, while increasing the expensing cap for Section 179 from $500,000 to $1 million.

The TCJA changed the treatment of the foreign profits of multinational corporations. It introduced a “participation exemption,” which exempts foreign profits paid back to the United States from domestic taxation. It also defined two new categories of foreign income, “Global Intangible Low Tax Income” (GILTI) and “Foreign Derived Intangible Income” (FDII), which are taxed at a lower rate than the statutory corporate tax rate of 21 percent. Lastly, the TCJA introduced a new minimum tax, “The Base Erosion and Anti-Abuse Tax” (BEAT), aimed at preventing multinationals from stripping income from the U.S. tax base with excess payments to foreign-affiliated corporations.

At the same time the TCJA limited the deductibility of net interest expense to 30 percent of earnings before interest, taxes, depreciation, and amortization (EBITDA) for four years, and 30 percent of earnings before interest and taxes (EBIT) thereafter. It also eliminated net operating loss carrybacks and limited carryforwards to 80 percent of taxable income. It also eliminated the Section 199 deduction for manufacturing income and introduced many miscellaneous base broadeners.

Lastly, the TCJA doubled the estate tax exemption from $5.6 million to $11.2 million.

Many Aspects of the TCJA Will Phase Out or Expire over the Next Decade

For lawmakers to satisfy Senate budget rules, while still providing a net tax cut during the decade, major portions of the TCJA were set to phase out or expire. These changes have a direct impact on the distribution of the tax changes each year. The timeline below shows how major features of the TCJA are scheduled to change over the next decade.

From 2018 until 2021, all business and individual provisions will be in effect (Figure 1). At the end of 2021, two business base broadeners will be phased in. First, businesses will no longer be able to expense research and development costs. Instead, they will need to amortize those costs over five years. Second, the limitation on interest expense will tighten from 30 percent of EBITDA to 30 percent of EBIT, a narrower definition of corporate income.

At the end of the next year (2022), 100 percent bonus depreciation will begin to phase out, further increasing tax collections from businesses. Bonus depreciation will slowly phase out between 2023 and 2027, when the depreciation system will revert to MACRS.

At the end of 2025, a significant number of policy changes are scheduled to occur. All three of the new international provisions (GILTI, FDII, and BEAT) will change. All three scheduled changes are set to raise the tax burden on U.S. multinational corporations. The estate tax exemption will revert to pre-TCJA levels. Most significantly, however, is that nearly all the individual income tax cuts will expire. The new statutory tax rates and brackets, the standard deduction, the personal exemption, the Child Tax Credit, the Alternative Minimum Tax will all revert to pre-TCJA rates and levels. The only significant individual income tax change that will remain is the use of chained-CPI to adjust tax parameters for inflation.

Figure 1.

Congressional Budget Office Projects Spending Growth Will Outpace Revenue Growth

Tax Policy – Congressional Budget Office Projects Spending Growth Will Outpace Revenue Growth

This week, the Congressional Budget Office (CBO) released the 2018 Long-Term Budget Outlook. The CBO projects that over the next 30 years, government spending will grow faster than government revenues, leading to an increase in debt that could surpass 150 percent of GDP by 2048. Three highlights of the report are:

Federal debt is projected to increase sharply over the next 30 years

The CBO projects that deficits would rise from 3.9 percent of GDP in 2018 to 9.5 percent in 2048. This structural imbalance would lead to federal debt held by the public rising from a projected 78 percent of GDP this year to 152 percent of GDP by 2048. This is significantly higher than the average over the past 50 years (41 percent of GDP) and higher than the peak of 106 percent of GDP recorded in 1946.

Debt is projected to grow because the gap between spending and revenue will continue to increase

The CBO projects revenues to increase from their current level of 16.6 percent of GDP to 19.8 percent of GDP by 2048, above the 50-year average of about 17 percent of GDP. These revenue levels assume that current laws will remain unchanged, including the individual income tax cuts in the Tax Cuts and Jobs Act (TCJA) expiring as scheduled after 2025, and that certain taxes from the Affordable Care Act will go into effect in 2022. Revenues also increase because the TCJA permanently changed the measure used to index tax brackets, and incomes are projected to grow faster than inflation.

Even though revenues are projected to grow faster than GDP, spending is projected to grow even faster. Federal spending today is 21 percent of GDP, and the report shows that increasing to 29 percent of GDP by 2048, also above its 50-year average (20 percent). These spending increases occur primarily because spending as a share of GDP would increase for Social Security, the major health-care programs, and interest on government debt.

Another Look at Reforming the Health Insurance Exclusion

Tax Policy – Another Look at Reforming the Health Insurance Exclusion

Health policy expert Avik Roy recently announced a new proposal to repeal and replace the Affordable Care Act. According to Roy, the framework of this new proposal bears some similarities to the Graham-Cassidy bill that failed in the fall of 2017. One area that this new framework does not address (likely for political reasons) is the exclusion for employer-sponsored health insurance. Under current law, health insurance provided by employers is not included as taxable income, which leads employees to favor health insurance over regular wages as compensation. This distortion leads to more spending on overly comprehensive insurance plans than would otherwise occur, and lower tax revenue.

There are a few different approaches to addressing the health insurance exclusion. The Affordable Care Act sought to curb the distortionary nature of the exclusion by creating the “Cadillac Tax,” a 40 percent excise tax on high-end employer-sponsored health plans, specifically plans valued above $10,200 for individuals and $27,500 for families. The benefit of this proposal is that it discourages employers from purchasing expensive, tax-excluded health insurance plans and encourages employers to compensate workers with normal wages. On the other hand, the point at which the Cadillac Tax begins is arbitrary, and furthermore, the Cadillac Tax has been postponed until 2022 thanks to political opposition.

Instead of using an excise levy like the Cadillac Tax, a better way to curb the exclusion would be to place a cap on the value of health insurance that can be excluded. For example, instead of subjecting plans that exceed a certain threshold to a new tax, it would be better to simply cap the value of the exclusion. Anything in excess of the cap would be counted and taxed as ordinary income. Directly curbing the exclusion of employer-sponsored health insurance in the context of the income tax code, instead of trying to achieve the same ends with a new excise tax, is more sound tax policy.

The most ambitious solution to this distortion is to eliminate the exclusion for employer-sponsored health insurance entirely. This way, the entirety of health insurance in-kind compensation would be treated exactly the same as monetary compensation. This option could significantly raise revenue: according to the Joint Committee on Taxation, ending the exclusion would lead to $157.2 billion in new revenue in 2018 alone. Furthermore, ending the exclusion and subsequently lowering tax rates in a revenue-neutral way could lead to economic growth. The benefits of making the tax code more neutral and allowing for lower tax rates aside, getting rid of this exclusion would also stop incentivizing overconsumption of health care.

Despite the policy benefits that capping or ending the exclusion would bring, it remains politically perilous. Organizations that tend to offer large health-care benefits, in addition to the public, tend to strongly support the exclusion. For that reason, it’s understandable that the health policy working group avoided this issue while trying to draft a new repeal and replace bill. Nonetheless, it remains good tax policy to rein in this exclusion.


 


Source: Tax Policy – Another Look at Reforming the Health Insurance Exclusion