Federal Tax Changes

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A new report from the non-partisan Institute on Taxation and Economic Policy says federal tax changes have made itemized deductions more unfair to low-income taxpayers and more costly for government. Dana Naimark of the Children’s Action Alliance and Kevin McCarty of the Arizona Tax Research Association discuss the report.

Ted Simons: A report released today says that federal tax changes have made itemized deductions more unfair to low-income taxpayers and more expensive to government. The report is by the institute on taxation and economic policy, a nonpartisan, nonprofit research organization that advocates reforms to itemization rules to increase revenue for governments. Here to talk about the report is Dana Naimark of the Children's Action Alliance, and Kevin McCarthy, of the Arizona Tax Research Association. Good to see you. Thanks for joining us. Dana, as regarding this report, what are we talking about here as far as deductions?

Dana Naimark: We're talking about money that we right off of our taxes when we pay or state income tax. I think all of us would be shocked if any politician stood up and said, I want to promote homeownership and I'm going to give out the biggest checks to the wealthiest people. In fact, when we do itemize deductions, that's what happens.

Ted Simons: Does it make sense for itemized deductions in these times of bad budget climates?

Kevin McCarthy: I think there's a fair degree of exaggeration going on with the study in terms of what itemized deductions are for and why they were put in the federal code. This study speaks specifically to its impact on state and local government. The truth is, itemized deductions were -- are carried over from schedule A from the federal return for simplicity purposes, and it was I'm sure the same in other states as it is in Arizona, was designed to make the payment of your taxes not as -- not overly complex. We all know it's difficult to file our income taxes, if you can imagine having significant differences between federal and local and state returns, it would just make matters worse.

Ted Simons: How do you see that?

Dana Naimark: There's a lot of ways to make it simple, but not have the itemized deductions the same way they are. In fact, in Utah, they do one of the models that the report suggests. So instead of using the same itemized deductions as do you in your federal return, they do a percentage of that as a credit. 1%age calculation that's very simple, it adds no complexity at all.

Ted Simons: Converting to credits, what do you think?

Kevin McCarthy: You could do that, but why stop there? What's lacking in the report for what you want is simplicity or transparency on top of it, and you want to try to make things fair for everybody involved, you get rid of all of the deductions and go to a flat tax. You have a flat rate that's been debated in some states and some states have moved in that direction, it's been debated in recent years at the capitol. That would be honesty, we're going to get rid of all of the nuances that people might gain, we're going to get rid of the deductions, tax federally adjusted gross income, everybody at 4%. That would be a real reform, and then if you wanted more money you raise all the rates to accomplish that. This is really just a mechanism to try to increase progressivity and state income tax codes by dramatically increasing taxes on upper income earners who are already paying most of the income taxes both at the federal and local level.

Ted Simons: Respond to that, please.

Dana Naimark: Arizona is in the top 10 list for the most regressive tax systems. Our state income tax is somewhat progressive, but the rest of our tax system is not. So the income tax has to kind of balance that out.

Ted Simons: So when critics will say this is basically a de facto tax increase, you would say --

Dana Naimark: Oh, if some of these reforms would be a tax increase. So I think the question is, we all heard all of the supporters for prop 100, the temporary sales tax increase say it's a temporary measure, overall our tax and budget system are broken and we need to look at long-term issues. These are long-term, systemic issues that should be on the table as we're examining overall tax reform.

Ted Simons: One of the ideas, one of the options mentioned in the report is to cap the total value of itemized deductions at a certain level. Make sense to you?

Kevin McCarthy: Well, we already are doing that at the federal level. You could do that if you're -- I'm glad Dana admitted this is just about increasing income taxes. If you want to increase income taxes, there's a multitude of ways that experts can lead to you do that. You increase rates, you get rid of deductions, the less transparent way to do it is to start attacking deductions as opposed to increasing rates on everybody. But, yeah, make no mistake, there's a lot of different ways to do it. The feds have done it with the alternative minimum tax, and there's a variety of ways in the federal return that are already capped those deductions. So that's been done. Those caps are carried forward on the state return.

Ted Simons: The idea of capping these deductions, why does that make sense?

Dana McCarthy: Well, again, because right now the benefits are so skewed to higher income households. And in Arizona, higher income households already pay a very low percentage of their income in taxes compared to middle income households in our state. So it's a way to balance that out. The feds have capped the deductions, but that cap is being phased out, which is one of the reasons this report came out now. That's one of the things that's been changing. Plus, other states around the country are looking at these kind of reforms as they look at tax reform.

Ted Simons: Is there a fairness issue here? From the report and from what Dana is saying, it sounds like the upper income, in general, the report is saying, not necessarily paying a fair share here.

Kevin McCarthy: Well, that's what makes this relatively absurd. They're using personal income taxes and making an argument for fairness, and progressivity and regressivity. That's where all the progressivity exists, in federal and state taxes, is with the personal income taxes. In Arizona, 13% of the filers pay 61% of the taxes. We all know who those 13% of the filers are. Those are the folks with 100,000 in income and above. They're already carrying the burden. It is -- it takes a fair degree of hutzpah to do an analysis to say those people are not paying their fair share. You can say we want to raise taxes on them further, which is what the objective is. But you can't do it under the banner of fairness.

Ted Simons: What do you say about that?

Dana Naimark: Well, Kevin's wrong. The income tax is the only aspect of the tax system that is progressive. But when you combine that with our huge emphasis on sales tax, low-income households pay more than twice the percent of their income as high income households in Arizona. So we do not have a fair tax system now. I think these are some really good options to look at to improve fairness, and some options that give us some tax reform when we desperately need it.

Ted Simons: Do you agree low-income taxpayers pay twice as much?

Kevin McCarthy: Well, what -- again, what Dana is conveniently leaving out and what the authors of this report left out is -- are federal income taxes. Anybody that does an honest analysis of progressivity versus regressivity starts at the federal level and goes right through state and local taxes. The progressivity and taxes in the United States are in incomes tackes. So if you include those, no analysis would show you that our taxes in the United States are regressive. Where there is regressivity in our system, Dana is correct, is at the local level in sales taxes and to a lesser extent with property taxes. You can't bifurcate state and local taxes from federal income taxes and make regressivity arguments. They do here, but they conveniently when they make the argument, forget about the federal income taxes that are paid.

Ted Simons: Is there a picking and choosing going on in this report regarding state and federal?

Dana Naimark: This is a report that focuses on what's under state control. And our state tax system is like a crazy house that's been remodeled room by room, or one ceiling lowered or raised, and one wall knocked out with no big picture design. No architectural plan. So I think we really need overall looking at our tax system and not just leaving things in place because they have been there before.

Ted Simons: I notice somewhere along the line in my research the never ending deduction was looked at. What is that?

Dana Naimark: Arizona is one of only six states where we allow people, everybody is allowed to do this, we allow people to double dip. So we get to deduct our state income taxes paid off of our federal income taxes, but then we get that same deduction again when we do our state income taxes again. Only six states have that, most states you add back when do you your state tax form, you add back what you've paid for state taxes.

Ted Simons: Is that a start in terms of reform?

Kevin McCarthy: If you want to raise taxes on the very people who are paying income taxes now, you -- again, there's a lot of different ways to do it. To view that as somehow that is a nuance that has just developed is -- defies all the history of state income taxes. That's merely -- the states that don't allow that pass-through probably did at one point, and in an effort to raise taxes, took away that pass-through on deductibility and mortgage interest.

Ted Simons: I've only got time for a yes or no -- itemize deduction, get rid of them, or raising taxes? Is there a better option?

Kevin McCarthy: If we're going to raise income taxes under the banner or reform, go to a flat tax and tell people how much you want and raise the rates across the board.

Ted Simons: Even quicker, flat tax on option?

Dana Naimark: Worst way to government absolutely not.

Ted Simons: Great stuff. Thanks for joining us.

Dana Naimark:Children's Action Alliance;Kevin McCarty:Arizona Tax Research Association;

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