Category: Uncategorized

Gas tax and inflation

Sooner rather than later, the legislature will need to address how to finance transportation – both highways and transit. This has been an ongoing and highly politicized discussion that appears unlikely to have an easy resolution as long as Minnesota has divided government. At the core of the problem with highway finance, in my view, is the basic structure of the gas tax – a fixed dollar amount per gallon of motor fuel – whose revenue yield has been eroded by inflation as a result.

The gas tax has been the centerpiece of Minnesota highway finance for nearly a century. But the tax’s structure requires ongoing legislative maintenance – regular adjustment of the rate to offset the effects of price inflation. Political polarization and/or changing political values (by Republicans mainly) have effectively made that difficult, if not impossible, for the last two to three decades. In my view, that state of affairs has largely creating the highway funding crisis in which the state is mired.

The gas tax equals a fixed dollar amount (currently, 28.5 cents) per gallon. What that means is that as prices increase with inflation, the real rate of the tax declines. Inflation provides an automatic tax cut, which also reduces the revenues for constructing, reconstructing, and maintaining highways. (The constitution has an ironclad requirement to use gas tax revenues only for highways and roads.) Policymakers and the media wring their hands over the effects of more fuel efficient vehicles and electric vehicles as causing a problem, since these vehicles use less or no taxable gasoline or diesel fuel. (EVs are a minuscule percentage (<1% of new sales!) of the fleet using highways. That will change but it will likely take a very long time.) But that effect pales relative to the impact of inflation and the failure of the legislature to regularly increase the tax to keep pace.

The table below shows how inflation has affected gas tax rates over time. The gas tax was enacted in 1925 at a rate of 2 cents/gallon. The legislature has increased the tax rate 12 times since, most recently in 2008. The table shows what the rate would have been in each year of rate increase in 2019 dollars (adjustment was made using the consumer price index) and how much the tax was as a percentage of the retail price of gasoline. That approach (imposing the tax as a percentage of the sale price) would avoid the need to adjust the rate, because it would go up or down with the price of the gas (or diesel fuel); that is why it is unnecessary to index the sales tax.

Year of rate increase	Tax rate when enacted	Tax rate in 2019 dollars	Enacted rate as % of price
1925	$0.02	$0.29	9.1%
1929	0.03	0.45	14.3%
1941	0.04	0.70	21.1%
1949	0.05	0.54	18.5%
1963	0.06	0.50	19.4%
1967	0.07	0.54	21.9%
1975	0.09	0.43	17.0%
1980	0.11	0.34	12.8%
1981	0.13	0.37	10.9%
1983	0.16	0.41	13.1%
1984	0.17	0.42	14.7%
1988	0.20	0.43	22.2%
2008	0.29	0.34	8.7%
2019		0.29	12.1%
Average	0.44	13.3%

The current tax rate (28.5 cents) equals the original tax rate enacted in 1925 updated to 2019 dollars. If the tax rate were simply the average of the rates enacted by 13 legislatures (44 cents in 2019 $), that would go a long way to providing adequate highway financing. It would be 15.5-cent (or a 50%) increase in the rate compared to present law. Governor Walz proposed a 20 cent increase, phased in, but much of that was required to make up the deficiencies caused by the long running failure of the legislature to keep updating the tax rate for the effects of price inflation. Had the rate regularly been adjusted since 1988 (keeping it at about 43 cents) that probably would have been unnecessary.

Had the tax – like a standard retail sales tax – been imposed as a percentage of the retail price, the picture would have been somewhat less rosy. The tax now is about 12% of the price, which is only a little less than the average (13%) over the period. Note that this approach would impose a stiffer tax on diesel fuel purchases, since the price of diesel fuel is higher than for gasoline. That probably would be justified, since diesel fuel contains more energy and because it is predominantly used by heavier vehicles (trucks, buses, and so forth) that do more damage to roads and highways. That would be consistent with a user fee model of the tax, which it roughly is. A percentage tax would provide a more volatile and less reliable source of revenue. See the graph in this blog post from the US Department of Energy that shows a 75-year history of retail gasoline prices to get an impression of that volatility. A tax based on price would also be less well aligned with a user fee model of the tax, since the burden of the tax would vary quite a bit over time based on world oil prices, rather than following use of roads and highways.

My observations:

To help put the effects into context, I did some back-of-the-envelop calculations. If the 1988 tax increase had been indexed to CPI inflation (and skipping the 2008 increase as unnecessary), my rough calculations show the state’s highway user trust fund would have collected about $6.5 billion more in revenue between fiscal years 1990 and 2019. That is about a one-third increase in actual collections, which were about $20.4 billion over that period. Under the constitution, that money would have funded state trunk highway costs, as well as aid payments to counties and cities. That likely would have come close to meeting much of the highway funding needs, as well as holding down property taxes which are increasingly paying for local streets and roads.
My adjustments are based on the CPI for all urban consumers. One could make a case for indexing to the cost of highway construction and maintenance. That would be more consistent with an underlying theory that the tax is a user fee, since it would be adjusted by the changes in the price of user costs. I believe that is the method used by some states with inflation-adjusted gas taxes.
The current political environment – at least since the advent of Grover Norquist and no-new-taxes Republican theology in the late 1980s – has been lethal for the efficacy of fixed dollar excise taxes as a revenue source. The biggest casualty is the gas tax and highway finance, but Minnesota’s alcohol excise tax is another victim. It is structured in the same way as the gas tax ($ per volume) and its rates were last increased in 1987. Fortunately, it is a minor general revenue source, but the social costs of alcohol abuse and their burden on the state budget are immense. Substantially increasing the excise tax rates based on those costs could easily be justified.
The no new taxes theology has not, however, prevented some very large increases in cigarette and tobacco excise taxes, and not only when the entire government is controlled by Democrats. (Governor Pawlenty’s cigarette “fee” is Minnesota’s notable exception.) That is explained (probably) by the now very small percentage of the population that smokes and that most of them want to quit.
Minnesota Republicans have idiosyncratic views on inflation indexing and taxes – views that would get an F from a neutral logic or economics grader but an A from a proponent of minimizing the size of government. Early in my career as a legislative staffer, a Republican signature issue was to index the income tax to prevent inflation from driving taxpayers into higher tax brackets and eroding the value of fixed dollar deductions and personal allowances. That was a central focus of the campaign that elected Al Quie as governor and yielded a 33-seat Republican pickup in the House in 1978. The 1979 tax bill indexed income tax brackets, the standard deduction, and personal credits for inflation, preventing inflation from imposing “unlegislated tax increases.” The federal government followed suit in 1981 and both taxes have retained core indexing provisions ever since (despite extensive opposition and complaining by DFLers about the effects on state revenues in the early 1980s). But when the cigarette excise tax rate was indexed in 2013 to maintain the integrity of the dollar value of its rate, that was a tax increase on “auto-pilot” according to Senate Republicans, which they repealed as soon as they could (2017 bill that then Governor Dayton signed under protest). Their views on indexing policy are as inconsistent with basic economic principles (premise: neutralize inflation’s effect on the tax’s dollar values) as they are consistent with their political principles (premise: reduce taxes any way you can).
I’ll write separate posts on (1) the merits of user funding for highways and (2) why there is already extensive general revenue funding of highways in Minnesota, despite the contrary perception.
The federal gas tax has exactly the same flaw. The gridlock and GOP tax aversion has prevented an increase in its rate since 1993. One obscure Democratic presidential candidate (Congressman Delany) has proposed fixing this, as I noted here. Fat chance for either his candidacy or the proposal.

Tags gas tax

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Tax v direct expenditures

Post author By saltspeak
Post date December 31, 2019
No Comments on Tax v direct expenditures

Janet Hottzblatt has a good blog post at TPC. The post’s title focuses on how the Sanders and Warren campaigns are the most restrained of the candidates in proposing tax credits, rather than direct spending programs for their policy proposals.

I find her post interesting, however, for three reasons (unrelated to that point but what I suspect is more the real reasons for her post):

She details the criteria that she would use in deciding whether it is preferable to implement or expand a social program through a refundable tax credit or a direct government spending program. Some of her criteria mirror points that I made in my 2018 House Research publication on the topic: do the recipients already file returns, are the criteria easily verifiable and reasonably simple, etc. She just says it shorter, clearer, and simpler than I did.
She provides some interesting history about decisions during the Bush I and Clinton administrations as to why Congress used or expanded refundable tax credits, rather than opting for direct spending programs. I was unaware of some of this detail.
Her post is one more modest confirmation of my perceptions about the underlying political dynamics that have led to the rampant expansion of the use of tax expenditures over the last three decades: GOP elected politicians have a professed opposition to expanding government, but paradoxically sometimes (often?) really do want government to address social problems. That is why some them ran for elective office, not just to be government naysayers, as the GOP (particularly the Tea Party iterations of it) official mantra seems to be. (In my view, most politicians, even Republicans, are preternaturally inclined to want to solve problems with government policies.) Using tax expenditures allows them to reconcile these conflicting urges and to reach compromises with the Democrats. But that sadly compels ignoring the practical factors – such as those Holtzblatt outlines – in deciding whether to use direct or tax expenditures for programs. A state of affairs that seems sure to continue for the foreseeable future. The ability to expand government and call it a tax cut is irresistible to R’s and so it is a path of least resistance for the D’s to achieve their ends as well.

My take:

It’s interesting and probably revealing that the two most lefty of the Democratic candidates are the ones who are proposing to implement their policies using the fewest tax credits or expenditures. That is so even though they have the most ambitious policy agendas. Their preference for direct expenditures may simply reflect their policy views (it’s best to use direct expenditures for most stuff), which I happened to agree with. But a more cynical and probably realistic take is that it reflects an essence of their campaigns – to wit, they are more concerned about making points (and saying what they believe under the more favorable view) than thinking about what they can get through Congress. The latter will clearly require some Republican buy-in (given the Senate rules requiring super-majorities effectively) and that can only occur by using tax expenditures, I would assume.
None of this matters. Political considerations (for the reasons I detail above) will inexorably drive the policy train down the tax expenditure track.
All this will undercut the tax system’s core function, raising revenue to fund basic government operations. I fear if the continuing expansion of tax expenditures continues at its current pace, that it will bring down the whole tax system edifice, particularly given Congress’s propensity to under fund the IRS. I hope I’m just paranoid.

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TCJA and corp revenues #3

Today’s NYT has an article on TCJA’s effects on corporate revenues. It’s a good read for anyone interested in the tax legislative process, in particular how complicated provisions are interpreted and applied by tax administrators. It’s also depressing in that it strongly suggests that TCJA’s corporate revenue offsets (i.e., the provisions intended to pay for the rate cuts) will likely yield much less revenue than originally estimated. In other words, TCJA will increase that deficit by more than Congress intended.

The article covers Treasury’s and the IRS’s implementation of two of TCJA’s most important revenue offsets (at least on the corporate side) through the process of writing regulations: GILTI and BEAT, provisions that are designed to minimize the artificial shifting of domestic corporate profits to low tax foreign countries. In both instances, the provisions impose minimum or low rate taxes on that income.

The article describes how big companies (both US and foreign – GILTI mainly applies to US based companies and BEAT to foreign-based companies) lobbied Treasury for regs that undercut the revenue yield of the two provisions. As one can imagine, the lobbying process was intense. The article suggests that in some instances top Treasury officials found the “nonstop meetings” (sometimes 10/week) with lobbyists so time-consuming that they “had little time to do their jobs, according to two people familiar with the process.”

One of the results (with regard to BEAT) that the article cites was creating an exemption to BEAT for foreign banks. The article suggests (citing JCT estimates) the exemption could reduce revenues from BEAT by $50 billion (I assume over 10 years – the article doesn’t say), about one-third of the estimated revenues from BEAT. It also cites experts (e.g., a U of Houston law professor) that the exemption was created out of whole cloth and may not be consistent with the law and apparently was controversial among Treasury officials. My observation: that may be true, but is legally irrelevant, since no one will have standing to challenge its legality in court.

The article includes the usual anecdotes on the revolving door – essentially, lawyers that represent the big multinationals and write the regulations, as they shuttle between big law firms and government service. I never know how much to make of that, although it does raise one’s suspicions. Full disclosure: I have personally dealt with one of the reporters (Jesse Drucker) back when I was working and he was a reporter for the WSJ covering state taxes. He tends to be a little sensational and views most corporate actions through a dark lens. (He’s not bad on that score as David Cay Johnston, though, and is much more careful with his facts and sourcing interpretations to real experts.)

Some of my observations and the Minnesota SALT angle:

Minnesota’s decision not to tax GILTI may turn out to be wise, since it avoided a potential revenue shortfall from relying on JCT estimates that were undercut by the regulatory and interpretative process. Taxing GILTI in 2021 or later may allow using more realistic estimates based on actual experience.
GILTI and BEAT, as minimum taxes, were obviously intended to raise revenue, but a secondary purpose was to deter income shifting to tax havens. On that score, it was never clear to me that they would be effective because they send conflicting signals. On the one hand, they tax away some of the benefit of doing so and, thus, making the payoff of shifting less lucrative. But they also encourage moving real income (actual operations) to foreign locations, because that reduces the minimum tax. That obviously is not what Congress intended. (I have been told by one Minnesota tax lawyer who represents some of our local multinationals that they are seriously considering locating more actual operations oversees to reduce GILTI.) Diluting GILTI will help minimize the latter effect, a potentially good thing.
The events recounted by the article support my informal rule for evaluating federal revenue estimates of corporate base expansions and contractions – the estimates of the revenue yield for expansions are almost always too high, while those for contractions (deductions, credits and so forth) are almost always too low. That especially tends to be the case for complicated provisions (like GILTI) or for provisions with general verbal standards that are open to varying interpretations. My rule is based on my experience (particularly with the 1986 tax reform). I think it is conceptually justified because (1) corporate avoidance behavior is more creative that the economists think it is, (2) administrative interpretations of the provisions typically reduce rather than increase revenues, and (3) court decisions more often than not reduce revenues. The article is a good illustration of point #2.

Tags corporate tax, TCJA

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Prez candidates tax plans

The Tax Policy Center (TPC) has a nifty website for anyone who wants to track the tax proposals that the presidential candidates have made. The site allows you to look by candidate, by tax type, or by issue area. It covers candidates from both parties, although it is fair to say that most of the proposals are made by legion of Democratic candidates.

The site is extensive, but I would not assume it is comprehensive. For example, it does not appear to include Andrew Yang’s proposed tax on state and local business location incentives that I previously posted about. Tracking down all the proposals would require a herculean effort that inevitably would miss some. But I have a lot respect for the efforts of whomever is assembling all of this data; clicking on the links sends to you a wide variety of sources beyond candidate websites and issue papers (e.g., media stories).

The proposals run from major structural changes (raising rates, imposing carbon taxes or fees, VATs, equalizing the taxation of capital gains and investment income with ordinary income, etc.) to the mundane (tax credits for any and every little thing, like gym dues).

A few of proposals I found interesting after spending less than an hour surfing the site and/or its links:

Several candidates (maybe five) want to tax capital gains and qualified dividends like ordinary income. A couple of them (Warren and Yang) also propose eliminating the preference for carried interest. I hope they (or whoever put their plans together) recognize that carried interest’s benefits depend on the capital gain preference. If it’s gone, carried interest (or at least any reason for or benefit from it) disappears. I guess the dual proposals may simply reflect their expectation that eliminating the preferential treatment of capital gains won’t happen?
Delaney would “index” the gas tax retroactively – I assume that means adjusting the rate, last increased in 1993, for the inflation that has occurred since; that would raise its rate from 24.4 cents to about 44 cents and index it for inflation, thereafter.
Yang has some of the more interesting and unique proposals (in addition to the SALT incentive tax I previously blogged about). He would impose a tax on self driving trucks to fund benefits for displaced truck drivers (that’s a tax that won’t raise much revenue for a good while, I assume); a tax credit to reduce grocery store’s food waste; a $500 floor on the itemized deduction for charitable contributions; etc.
Warren proposes to allow same sex married couples to file retroactive returns (for any year they were legally married, I assume) to get refunds. This is based on an introduced bill that I didn’t bother to look at; it likely does not require couples who would have paid more if the tax law had recognized their marriage to file and pay the added tax. It is a good thing that Warren separately is proposing increased IRS funding to fund processing amended returns from closed tax years. (More IRS funding is something everyone should get behind in my opinion. Yang is also proposing it.)
Klobuchar is proposing reinstating Build America Bonds or BABs. These bonds are taxable state and local bonds for which the US Treasury (more or less) pays 35% of the interest. BABs were issued under Obama’s stimulus plan, but Congress refused to extend them. Some version of them is a good idea, in my opinion. They help to address the problem with tax exempt bonds, which I previously posted about, that maybe 30% of the tax cost of tax exempt bonds gets siphoned off by investors, rather than reducing state and local borrowing.

There are more interesting proposals that make it worthwhile looking at the TPC page if (like me) that’s the sort of thing that turns your crank. But it can be depressing – at least to me – because so many candidates favor multiple (often hair-brained, to be charitable) tax expenditures. Biden, in particular, appears to love business tax incentives. If many of the candidates had their way, the tax code would be littered with even more tax expenditures that the surfeit it already has. Not a good thing.

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RMD changes under SECURE Act

Post author By saltspeak
Post date December 19, 2019
No Comments on RMD changes under SECURE Act

The pending tax legislation, poised to pass Congress as part of the 2020 budget deal, includes the SECURE Act, which makes a number of retirement tax changes. Among those are two consequential changes in the required minimum distribution (RMD) rules for IRAs and other qualified plans like 401(k)s:

The minimum age at which RMDs apply is increased from age 70.5 to age 72; and
“Stretch IRAs” (applying to IRAs inherited from someone other than a spouse) are limited to a 10-year period, rather than the recipient’s life expectancy.

As I noted in a previous post, these provisions will automatically decrease (#1) or increase (#2) Minnesota state income tax revenues, just as they will have those same effects on federal revenues. I assume Congress was using #2, the new limits on stretch IRAs, as a way to offset the revenue losses under other SECURE Act provisions. But I’m perplexed as to the policy rationale for increasing the minimum age for RMDs.

Congressional documents do not state a rationale. One might guess that it was based on a concern that more people are working after 70.5 and so should not be required to start taking IRA distributions until later. Or that some individuals with small IRAs should not be required to start draining them if they have other resources, such as wages or pensions. (My cynical view: the financial institutions who receive fees for holding and managing retirement accounts likely lobbied for the change. Because of those fees, they surely view policies that augment balances in those accounts, such as looser RMD rules, to be in their interest.)

If either of those were the rationale, Congress should have limited the age increase to individuals who still have material labor earnings or small IRA balances (e.g., less than $200k or something like that). (RMDs don’t apply to a 401(k) if you’re still working for the employer.) That would have prevented the main effect of the change – which seems nonsensical to me – giving holders of large IRAs who don’t need to take distributions one or two more years of tax deferral.

Most IRA holders don’t have the luxury of deferring distributions until RMDs apply; they need to take money out of their IRA to live on. The age increase will mainly be a boon to upper income IRA holders. By contrast, the limits on stretch IRAs move in the opposite direction, since this modestly reduces the income tax benefits of inherited IRAs, especially for younger beneficiaries. One would assume that disproportionately will hit heirs of those with big IRAs.

In other words, Congress seems to pushing policy in opposite directions with its two RMD policy changes. One rationale for RMDs is to prevent affluent individuals from just stockpiling money, tax deferred in their IRAs and, then, passing them on to their heirs. (Treasury regulations describe the purpose of RMDs as “to ensure that the
favorable tax treatment afforded a qualified plan is used primarily to provide retirement
income to a participant and a designated beneficiary, rather than to increase the estate
of a participant.”) The taxes would be deferred longer (without RMDs or with lower RMDs), and the heirs frequently will be in lower tax brackets to boot. Here, the age increase allows deferring more taxes by the IRA holder, while the limits on stretch IRAs require heirs to pay their taxes more quickly.

To me, a couple of interesting elements of the age change are (1) going to a full year (age 72) rather than a half year (70.5) and (2) the likely unintended effect on qualified charitable distributions for some in the year when they turn 72.

Going to a full year means that people born after July 1, 1949 with birthdays in the first half of the calendar year will get two extra years of deferral, while those with birthdays in the second half of the year will only get one more year. I’m not sure why the current regime uses 70.5 years (rather than 70 or 71), since the RMD is set based on the account value at the end of the prior year and distributions can be taken at any time during the taxable year or up until April 1 of the following year. Thus, it isn’t an administrative issue. A little mystery I have never tried to track down. But whatever the reason, Congress has decided to change it.

A quirky effect on qualified charitable distributions (or QCDs) is more concerning and something that I doubt the relevant congressional staffers thought about. The law (not changed by the SECURE Act) allows an individual who is subject to RMDs in a traditional IRA to have distributions (up to $100,000 per year) be paid directly to a charity. Making a QCD avoids the distributions from being included in the IRA holder/taxpayer’s income. That, as has been widely noted, is preferable to making an itemized deduction for a contribution, since it keeps the distribution totally out of your income (e.g., no need to forgo the standard deduction and doesn’t count toward any of the AGI limits, etc.). But in the first year RMDs apply, a QCD can only be made after the taxpayer meets the age requirement. See IRS Publication 590 which (mirroring the statutory language) says “You must be at least age 70½ when the distribution was made.” That will become 72 when the SECURE Act is signed into law. Thus, along with being able to defer taxes longer means that younger IRA holders will need to wait one or two more years before they can use QCD to make their charitable contributions.

Note how this could be a problem if your birthday is late in December. Assume your birthday is on December 30th, which is a Saturday in the year you turn 72. Qualified distributions are made by requesting the trustee of the IRA to cut a check to the charity. That check must be dated on or after the birthday on which you turn age 72 to qualify – i.e., on or after December 30th in this case. That effectively means the QCD will be made in the next calendar year (and tax year for a calendar year taxpayer, which virtually all individuals are). That in itself isn’t a big deal, since RMDs for the first year can be taken up until April 1 of the following year and still meet the requirement. (Unlike claiming an itemized deduction for a charitable contribution, it doesn’t need to be made in the taxable year. All you are doing is keeping the distribution out of your income.) Thus, the charity can receive the check in the next calendar year and the taxpayer can still exclude it from his or her income, IF the April 1st deadline is met AND the taxpayer gets a qualifying receipt from the charity. That is where the rub may come in, since charities typically issue those receipts on a calendar year cycle. They may have to make adjustments to accommodate people with birthdays very late in the calendar year who become subject to RMDs in that calendar year, so they can satisfy the IRS documentation requirements.

One might assume that it is concerns like this that led to the use of half year (70.5) rule. But 70.5 age was set well before QCDs were even a thing.

Congress could fix this by allowing QCDs to be made any time a qualifying RMD can be taken (i.e., at any time during the taxable year when the taxpayer becomes subject to RMDs). Why Congress required taxpayers to meet the minimum age requirement before making a QCD when a similar requirement does not apply to RMDs themselves is unclear to me.

Dated: December 19, 2019

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Zombie extenders are back

The congressional budget deal will breath continued life into the now slimmer, but still robust, list of tax extenders. These are provisions that Congress has been extending for 1 or 2-year periods for years, rather than making them permanent or allowing them to die a dignified death. (In 2018, Congress did make others of the extender list permanent.)

Congress has long been playing this extender game because the budget rules require 10-year scoring of permanent provisions, while 1-year or 2-year (temporary) provisions appear to cost only 10% or 20% as much. Of course, since the provisions inevitably get extended by later congresses and presidents, that’s an illusion at best. A full employment practice for lobbyists. Given that both parties now appear to eschew almost any concerns about deficits, one would think they could get beyond that, but apparently not.

In the case of the ACA’s previously delayed pay-for taxes (medical device tax and Cadillac tax on high cost health plans), Congress took the other tack of permanently repealing those taxes, bowing to the inevitable. That’s a much bigger budget deal (North of $370 B over the 10-year window). Joint Committee Estimates are here.

The deal also includes passing the SECURE provisions, a collection of smallish retirement-related tax changes. These changes will reduce revenues overall and are unrelated to the budget, but the right members of Congress must have felt that they were important enough to include in the budget deal. I’ll write a separate post about SECURE’s changes in the RMD (required minimum distribution) rules for IRAs and other qualified plans, which strike me as unnecessary and I think may have unintended consequences.

Some quick observations (all based on the assumption that this budget deal gets enacted into law as written – i.e., that Trump doesn’t decide to shut down government as he did with the last year’s iteration):

This will put the Minnesota income tax out of conformity with federal AGI – in most cases for tax year 2020 – putting some pressure on the 2020 legislature to enact a conformity bill. I doubt that pressure will be sufficient to get a tax bill through the 2020 legislature, but I’m now out of touch with legislative dynamics.
Some provisions will automatically reduce state revenues without legislative action – e.g., delaying the age when RMDs must be taken. This is so because taxpayers will withdraw less money from their IRAs and other qualified plans as a result and there is no state penalty for doing so. The federal penalty for not taking an RMD is an excise tax; Minnesota has no comparable provision so taxpayers can do whatever they want without incurring a Minnesota tax consequence.
Some provisions will raise state revenues without legislative action – the RMDs for inherited IRAs and other retirement plans will compel taxpayers to pay state tax when they take distributions to comply with the new federal rules. But these revenues will not be enough to offset the automatic reductions (in the short run).
Repeal of the ACA’s pay-fors, particularly, the Cadillac tax is bad from a policy perspective or if you are concerned about deficits. Of course, given the GOP implacable opposition to raising any taxes and the thinking of organized labor (a key Democratic constituency, at least traditionally) that the Cadillac tax hits their plans hardest, that tax probably never had a snowball’s chance of going into effect. But it (or capping pretax employee health benefits) was a consensus choice of economists as a way to fund the ACA’s costs. It might have put a tiny brake on the inexorable inflation of health care costs.

Bottom line: well intended budget rules (here, requiring 10-year scoring) has unintended and stupid consequences. The beat goes on.

Tags ACA, Extenders

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Bad Sign: Retail Job Shrinkage

Post author By saltspeak
Post date December 17, 2019
No Comments on Bad Sign: Retail Job Shrinkage

The STRIB reprinted a column by Justin Fox (Bloomberg economics writer) with more evidence of traditional retailers’ woes. This follows up on my recent post on the use of the Bloomington/MOA tax to help finance MOA’s proposed waterpark, which it appears to hope will get more open wallets into MOA’s stores, hotels and restaurants.

Fox reports that in-store retail jobs have dropped by over 400k since 2017 – despite a growing economy and retail sales. The obvious explanation is more online sales and less buying in stores. Employment growth in online retail jobs has not totally offset the decline of in-store jobs and many of those online jobs (no surprise) are in “couriers and messengers” with smaller growth in warehouse employment.

Some observations:

These jobs data underline the challenges faced by traditional retailers, including MOA.
The data reflect some fundamental shifts in the character of jobs (clerks versus stockers, pickers, and drivers).
Most retail jobs have never been very good (high paying) so it is hard to get too choked up about this, BUT
Conversion of sales from bricks and mortar to online sales appears to yield productivity increases, as one would expect, and that should lead to compensation (wage) increases as employers share some of the productivity dividend with their workers, BUT
The modern (post 1980s) pattern by businesses is to not share much of their productivity dividends with lower wage workers, but rather to channel them back to capital (shareholders or owners) or more highly compensated employees (i.e., management, particularly top management).
This is just one more data point in what appears to be the inexorable growth in inequality.

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Financial alchemy & the MOA tax

Post author By saltspeak
Post date December 16, 2019
2 Comments on Financial alchemy & the MOA tax

Retail malls face daunting challenges – the specter of Amazon and online shopping is dramatically reducing purchases at malls and big box stores. Bankruptcies, including outright liquidations (Herbergers and Pamida to name two affecting Minnesota), of malls and retailers show the harsh reality of this phenomenon. This WaPo article describes the challenges and how they have resulted in closures. According to a Credit Suisse study it cites, 25% of malls are expected to close by 2023.

The WaPo story describes how more successful malls are adapting. Thriving malls, according to the story, are doing so by reinventing themselves as “integrated lifestyle hubs” whatever that is. It appears to mean figuring out alternative way beyond a standard shopping experience of attracting customers to show up and spend money – e.g., providing yoga studios, fitness centers, microbreweries (what else?), health clinics, and so forth.

One assumes that this challenge must be hitting our local giga-mall, the Mall of America (or MOA). Moreover, because MOA is so big and, thus, must lure many more customers to its premises, the challenge is much bigger than adding a few yoga studios, microbreweries, and other trendy stuff can solve.

Rather than its years-ago plan of simply adding more of same in phase II, MOA’s answer is to build a big waterpark. The theory is that adding a large waterpark as part of Phase II will attract enough people to MOA who will spend money at its hotels, restaurants, and shops to keep most of them afloat. [I have thoughts about whether this will work, but I have no comparative advantage in judging such things so won’t spend any time on it. I think, though, we can safely say the move is risky.] This is a variation on what Triple Five (MOA’s owners) are doing at their just opened giant mall in NJ. The WaPo story discusses the Ghermezians (Triple Five’s owners) and their strategy as it relates to the NJ mall and its plans for another big mall in Miami, so I’m not totally making this up.

As with all things related to MOA, one can safely predict that its response will both:

Be risky
Involve government reducing MOA’s costs and risk.

What I find interesting about this is the creativity of MOA’s advisers in devising a way to use decade-old (2008) special legislation to put together a financing plan that snags government subsidies and reduces the credit risk to Triple Five’s enterprises, including MOA. How they did that can only be described as financial alchemy. Whoever came up with this should get the Rumpelstiltskin award (to mix two metaphors involving gold). It’s a story worth outlining.

In spring 2008 (after the Great Recession had begun but before its existence was commonly recognized), the legislature enacted special legislation to help Bloomington finance and finally develop Phase II of MOA. (Why Phase II took so long to develop is a separate story with many twists and turns. The delays probably helped MOA dodge a bullet of holding too much obsolete retail space in the current environment.) This legislation was controversial (both in the legislature and in Bloomington). Controversy centered on whether the public should provide more subsidies to MOA’s owners beyond those approved in the 1980s and 1990s. Opponents (including Rep. Ann Lenczewski who chaired the Houses Taxes Committee and represented Bloomington) felt that more public assistance was inappropriate. (MOA’s increased property tax, through TIF, had paid for the Phase I’s parking ramp and built up a war chest of development money, so the city, county, and school had to that point had not received any expanded property tax base as a result of MOA construction nearly 20 years earlier.) By contrast, construction trade unions (who generally favoring spending more on projects that their members work on) and legislative supporters of the mall supported more TIF for Phase II by allowing an extended TIF period. Because that would have exceeded what is permitted under Minnesota law generally, it required enactment of special legislation for Bloomington.

A compromise was reached that became law in 2008. One element of this compromise – inserted by opponents to permit the city to make MOA pay more of the development’s cost – allowed the city to impose a sales tax that would apply ONLY TO MOA. 2008 Minn. Laws, ch. 366, art. 5 § 28. This was done by limiting the taxing authority to the area of the two TIF districts in which MOA is located. Imposing the “tax” would have raised the price of taxable purchases at MOA and was for obvious reasons opposed by MOA. In effect, it would have been little different than expecting the owners and their tenants to pay more of the mall’s infrastructure costs (parking ramps and so forth), rather than taxpayers.

This “tax” is a tax in name only. MOA could have reached the same result by charging more rent to its retail tenants (e.g., a lease can have a “gross receipts” clause that varies the amount of rent based on how much revenue the tenant generates, adding such a clause to MOA’s retail leases could easily include a sales calibration to rent which replicated the effect of a sales tax). Although Bloomington approved the special law to use its other provisions, it did not impose the tax. I assume it made that choice because MOA opposed paying more of the cost of Phase II’s parking ramps or whatever else was planned for the TIF money.

The Great Recession put most development of Phase II on hold shortly thereafter. Legislation enacted in 2013 provided a wholly different funding mechanism (i.e., not a standard TIF extension) for Phase II that relied on the Fiscal Disparities taxes paid by MOA, rather than diverting city, county, and school property taxes as TIF does. This mechanism will be used to finance the second big parking ramp and other infrastructure to serve MOA. But the MOA sales tax remained on the books, essentially a vestige of the 2008 legislative negotiations.

But as MOA formulated its waterpark plan in 2017-2018, the MOA sales tax provided an opportunity for it to snag some government subsidies. Bloomington apparently is more than happy to oblige MOA, since the costs will be born by the feds. As I noted in my earlier post, Bloomington choose to skip tapping potentially a small state subsidy under the Minnesota income tax. For that, other Minnesota governments should be thankful.

The proposed waterpark will be, for all intents and purposes, a private facility. The normal way to finance it would be for MOA or a new for-profit entity formed by Triple Five to finance it with some combination of equity and debt. I’m sure that is the way the waterparks in Wisconsin Dells have been financed and I suspect that to the casual observer, the MOA waterpark will appear little different functionally than those at the Dells.

I have no knowledge of the financial condition of Triple Five, a private entity, but assume that its credit must be stretched (maybe to the max) by the amount it has spent on its mammoth NJ mall that just opened and its Miami plans. The media has reported that Triple Five pledged 49% of MOA to secure its borrowings for the NJ mall. That likely made the cost of it borrowing to finance the MOA waterpark unaffordable (relative to projections of waterpark revenues), if lenders or bond market were willing to make credit available at all.

So how can MOA successfully borrow money to finance the waterpark? Enter the 2008 MOA tax, which I had always considered a dead letter, as an enabling mechanism. There were essentially two steps involved:

Have the waterpark owned and operated by a nonprofit, but not just any nonprofit but a 501(c)(3) entity, a charity under the federal tax code that qualifies to have its facilities financed with tax-exempt bonds. I’m not sure exactly what the “charitable” purpose is (and haven’t made any effort to find out), but the federal tax law is malleable and expansive when it comes to the types of charitable purposes that qualify. (You don’t need to be a classic charity that helps the poor; in fact, I doubt poor people will get a break when they try to use the waterpark. They probably would rather not have poor people show up at all, since they won’t be prospective shoppers with fat wallets.) If a state or local government is willing to issue debt to finance the facility, the interest on the debt will be exempt from federal tax. That will, as I described in my previous post, lower the interest rate on the bonds, making it easier for the project to cash flow after paying its debt. The government subsidy is courtesy of the lower federal income tax revenues resulting from the foregone tax on the bonds’ interest.
Pledge the MOA sales tax as additional security for the bonds. Although revenues from the waterpark itself will be pledged to pay the bonds, that probably won’t do the job. Without some unknown amount of equity and/or a track record or some assurance that the waterpark will generate enough revenues, a pure revenue pledge is unlike to be enough to induce bond buyers to fund the project. In their minds, it’s too risky. MOA could pledge its revenues and/or equity but remember much of that has already been pledged to the NJ Mall and doing so would cause the bonds to lose their tax-exempt status under the federal tax law. The latter is so, because the project would be secured (too much) by a private business, not a government or qualifying nonprofit. That is where the goofy MOA sales tax comes in. Recall its proceeds are really not functionally different than mall revenues but the federal tax law considers it to be a real tax, so pledging it does not contaminate the project with private business revenues or security interest, as pledging MOA lease payments would.

Voila, problem solved – at least in theory – (1) the federal subsidy through tax exempt bonds lowers the interest rate; (2) compartmentalizing the waterpark in a separate, unrelated nonprofit entity insulates MOA’s credit from being on the line; (3) pledging the MOA tax, effectively means the mall and its tenants, are standing behind the waterpark, making Bloomington happy; and (4) the MOA tax appears to the federal tax law and to MOA’s and Triple Five’s creditors to be government support, rather than MOA’s support.

Some of my random observation on all of this:

The unclear color of the money. This only works (we’ll know whether it does work, if bond sale goes through) because of the chameleon-like character of the MOA tax. Its color or true nature depends upon your angle of view: from the federal tax law’s, MOA’s, the bond market’s, and MOA creditors’ perspectives, it’s a tax; from the perspective of Bloomington and financial realists, it is a private contribution or payment by MOA and its tenants. For the former, that means the MOA tax provides an independent, government source of funding for the waterpark other than MOA itself. For the latter, it means that the city is not taxing its constituents to pay for a private waterpark and keeps the viability of the waterpark from being tangled up with the city’s finances. Which is correct? I would tend to the latter view, but Bloomington is inextricably linked to MOA’s success, as I note below.
Clothing retailers at MOA won’t care. I’m curious what MOA’s tenants think of this scheme. They certainly have a stake in the ongoing success of MOA and so, I’m sure, would like to see the water park succeed – success being defined as attracting sufficient customers to ensure the ongoing viability of the overall development and their own operations. It is worth noting that the MOA tax will hit those tenants very unequally: because of Minnesota’s clothing exemption, clothing retailers will be spared. Those who sell taxable goods will be more directly affected.
Nobody will notice (okay, most won’t notice). The structure of the sales tax, as an add-on at the cash register, makes it an effective way to disguise its price-raising effects to shoppers. Research on the behavioral effects of taxes shows that taxes that are built into the explicit prices of commodities (e.g., excise taxes like the gas tax and cigarette taxes that show up in the sticker price of the product) have much larger effects on purchasing behavior, as contrasted with a tax, like a retail sales tax, that only shows up at the cash register – probably after the consumer has already decided to buy the item. That should provide small comfort to MOA’s tenants who may have their sales taxed, if the water park’s finances go South.
Is it worth it? The real public policy question here is whether the government (whether city, state, or federal) should go on subsidizing MOA. Answering that question would typically be done with a thorough and careful cost-benefit study, something that has never been done throughout this process (from 1984 on). (Full disclosure: As a legislative staffer, I worked on MOA state legislation from 1985 through 2018 and so was complicit in that failure.) Given that this “sales tax” is really little more than an odd sort of rent increase at MOA, it’s hard to get too excited about that issue here, although issuing more tax-exempt bonds for private projects is never good in my mind. I totally understand why Bloomington is going along (see the next bullet for more on that).
It ain’t easy to dismount a tiger. The current dilemma Bloomington faces illustrates how long-ago decisions effectively bind a city or put it on a course that is very difficult to deviate from. It’s like the old Chinese proverb of how difficult it is get off the back of tiger. The state’s 1977 decision to build the Metrodome effectively required Bloomington to redevelop the Met Stadium site, a prime piece of real estate that was close to the airport and on 494. The city in 1982 had two basic choices, a classic fork in the road:
1. It could have allowed the private market to redevelop the site without government assistance. That likely would have resulted in some mix of retail, hotels, and offices and would have generated immediate tax base as the site gradually built out. Given how prime a site it was, the development likely would have been high value and would have contributed to Bloomington and its 494 strip being a classic “Edge City.” (Interestingly, Wikipedia does not list Bloomington as an Edge City. I had always assumed it was.)
2. The other path, chosen by the city as encouraged by then Governor Perpich, opted for a signature development, MOA. That approach was perceived to help give Bloomington a national reputation (sort of like a corporation buying naming rights, I guess), making up for the loss of hosting the Twins and Vikings at Met Stadium. That loss, by most accounts, stung Bloomington public officials and business community as a big loss of prestige and visibility for the suburb. But that required the city (and county and school) forgoing increased property taxes from the site for well over 30 years because TIF was used, recycling the increased property tax back into the development. That period has now ended (thanks to the 2013 special legislation which shifted the ongoing property tax costs to the fiscal disparities program spreading costs over the entire metro area), but that doesn’t end Bloomington’s costs and responsibility.

Opting for a mega development, like MOA, is much higher risk – obviously because of the public investment (cost), but also because a big single use development is less certain to generate a return, long run. In investment terms, it is not diversified the way a market-driven, but more modest development of mixed uses would be. It’s like investing all your money in one growth stock, rather than buying a diversified mix of stocks and bonds. Your chances are greater of striking out or hitting a home run, but it’s safer to try and hit a single.

Another consequence of choosing path #2 that probably was not recognized by Bloomington in 1985 is the ongoing effects of opting to fund a signature development like MOA. A mammoth development like MOA in a modest sized city will always be an implicit city responsibility. If MOA falls on hard times and requires extensive repurposing or new investment, there is little question that city will feel it is practically and politically necessary to help pay for that and will undoubtedly ask for the state’s help as well, at least if past experience is any guide. The city’s behavior with regard to the waterpark is instructive in this regard. It illustrates a sobering, but often little recognized cost of not just allowing the private market to determine the course of real estate development.

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Corp tax forecast bleak

MMB released the November 2019 forecast on Thursday (12/5/19). As was widely expected, it showed a substantial surplus ($1.3B). Forecasts of individual income and sales tax revenues were both up; the one sobering point was that corporate revenues are forecast to drop from the prior forecast by a fair amount.

The forecast of corporate revenues essentially confirms the trends in collections noted in my earlier post. The third quarter report of revenues showed a drop of about 9 percent in corporate tax collections over forecast levels and the forecast adjusts estimated future collections down by about that much. The forecast writeup attributes that to a drop in the GII forecast of corporate profits, which for 2020, are down from the levels forecast in February. Corporate profits are still forecast to increase, just by less than the levels in the February forecast.

But something more seems to be going on here. Revenues in the last half of FY 2019 were up about $136 million over forecast, but now the forecast is that refunds will be $100 million higher (I presume in FY2020 and FY 2021), giving back three-quarters of that increase. That seems odd to me, given that the economy and profits are up (even if by not quite as much as expected). Why did corps overpay so much that they’re now getting larger than previously expected refunds? I wonder if this weird pattern of refunds results from the 2019 tax bill inadvertently exempting cash dividends that corporations used to meet their obligations under TCJA’s repatriation tax (IRC § 965), as briefly noted in my earlier post? Those payments would have been made in TY 2017 and TY2018, since TCJA’s repatriation tax took effect in TY 2017 and under prior Minnesota law those dividends would have been taxable (just not the deemed dividends which required conforming to the TCJA). That is the only thing that makes sense to me, but the forecast writeup says nothing about that. Normally, if that were the case it would be included in the writeup. So, I don’t know what to make of it.

As a separate matter, the drop in forecast corporate revenues is troubling. Corporate tax collections for the current biennium are forecast to be lower than in the prior biennium in nominal terms. The difference is small: (1) FY2018-19 actual revenues were $2,974.5m and (2) forecast revenues for FY2020-21 are $2,896.9m – about a $78m difference. If we adjust that for the refunds, decreasing FY2018-19 by $100m and increasing FY 2020-21 by the same amount, that wipes out the difference. However, the forecast writeup says it reduced the estimated amount of historic credit refunds by $41m, which would again indicate next biennium’s forecast corporate revenues will be lower than last’s by a very small amount.

BUT with corporate profits increasing, that still should not be the case, especially given the fact that the 2019 tax bill, on net, increased corporate taxes by conforming to most of the TCJA business tax provisions without cutting rates or adopting its big revenue losing base expansions, like section 179 or bonus depreciation conformity. The fiscal tracking sheet for the tax bill suggest that those provisions would increase corporate revenues for FY2020-21 by $191m.

Corporate revenues are very volatile; it’s not unusual for them to go up or down by a lot more than 9%. Recessions can easily cause them to drop by more than 25% year over year. But what is unusual is a material drop when the economy is expanding, and corporate profits are growing, even if modestly.

All this is very puzzling to me and suggests the corporate revenues bear watching. My fear is that the TCJA may be starting to cause corporate revenues to decline, although it is too early to make judgments about that possibility. I’ll write more about TCJA and its potential effects on Minnesota corporate revenues later.

Tags corp revenues

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Yang’s Tax on SALT incentives

Post author By saltspeak
Post date December 5, 2019
1 Comment on Yang’s Tax on SALT incentives

I have not been following Andrew Yang’s presidential campaign, so I missed his proposal to impose a federal tax on state and local tax incentives for economic development. I became aware of it when two law professors, David Gamage and Darien Shanske who specialize in SALT issues, posted a paper about it on SSRN. I am familiar with and respect their work and recommend reading their paper; it’s short and reprints Yang’s proposal in full so it saves going to his website to read it.

Yang’s proposes to impose a 100% federal tax on state and local governments that provide targeted tax incentives to businesses to locate in the state or locality. This is the equivalent of an outright prohibition – if the feds tax the incentive away, why would anyone provide one? Yang’s proposal, as is typical of campaign positions, does not have much detail as to how taxable incentive would be defined.

Gamage and Shanske like the idea, but don’t think It should be an outright prohibition. They would use a lower tax rate (maybe 50%).

It is worth noting that this or variants on it are not new. For example, two former staffers at the Minneapolis Federal Reserve Bank, Art Rolnick and Mel Burstein, made a similar proposal in 1995. It attracted some attention and then Minnesota Congressman David Minge (later a Court of Appeals) introduced a bill (HR 1060 in 1999) to implement their proposal. It too was structured as a confiscatory tax.

Like Gamage and Shanske, I’m attracted to the idea of doing something like this in theory. There are number of reasons why targeted (deal-by-deal) incentives are bad policy, aside from the race-to-the-bottom argument that is commonly cited (e.g., by Yang). What is most persuasive to me is simply that this is not what government should be doing (which is to provide public goods, education, assistant to poor people, etc.) and it is not what the government is competent at doing. On the latter front, government will, almost by definition, always overpay (only the business knows how much it needs to change its behavior) and what the public gets will rarely be worth it. States and cities feel that they need to engage in this type of behavior to be “competitive” – a sort of prisoner’s dilemma. A federal law that ruled these inefficient and parochial practices out of bounds could be viewed as saving the states from themselves – in theory anyway. [Note: In my view, general state tax competition – on rates and general tax bases and on the type, quantity, and quality of government services – is good just as a market economy is a good way to allocate scare resources. It’s the deal-by-deal incentives that are bad.]

That said, I’m skeptical about how anything like this would work out in actual practice. The devil is in the details of how you define the incentives that are subject to the tax, how the IRS enforces that, how states and businesses try to work around it, and how the courts apply the rules. Litigation under existing federal restrictions on state taxation – e.g., under the 4R Act which prohibits the state and local taxes from discriminating against railroads – has resulted in immense amounts of litigation, uncertainty, and some court decisions that in my opinion are based on junk economics read into the general terms of the federal statute.

As an aside, the fact that Yang structured this as a tax, rather than a regulatory prohibition, is likely a result of Chief Justice Roberts decision in the first ACA case upholding the ACA’s insurance mandate as a tax, rather than a regulation. Gamage and Shanske discuss this and suggest a 100% might be unconstitutional (I doubt it). My observation is that this is pushing us back to the future – e.g., to the days when Congress styled child labor regulations as taxes to avoid the pre-FDR Court’s narrow view of Congress’s Commerce Clause powers. Given that the Court has regularly been judicially enforcing dormant commerce clause rules to prevent states from discriminating against out-of-state businesses (interstate commerce), I have a hard time getting my mind around the idea that this needs to be done as a tax, rather than a prohibition. Of course, if you want to go the route suggested by Gamage and Shanske, a tax is the better approach, since it allows structuring it as a disincentive, rather than an outright prohibition. Making it a tax allows the IRS to enforce it; a regulatory regime might be an orphan with no federal agency enforcing it and few private parties having standing (or an economic incentive to do so even if they have standing) to challenge state incentives in court. So those are the arguments, I guess, for doing it as a tax.