The Impact of Trade and Tariffs on the United States

The Impact of Trade and Tariffs on the United States

The Impact of Trade and Tariffs on the United States

Key Findings

  • Trade barriers such as tariffs raise prices and reduce available quantities of goods and services for U.S. businesses and consumers, which results in lower income, reduced employment, and lower economic output.

  • Measures of trade flows, such as the trade balance, are accounting identities and should not be misunderstood to be indicators of economic health. Production and exchange – regardless of the balance on the current account – generate wealth.

  • Since the end of World War II, the world has largely moved away from protectionist trade policies toward a rules-based, open trading system. Post-war trade liberalization has led to widespread benefits, including higher income levels, lower prices, and greater consumer choice.

  • Openness to trade and investment has substantially contributed to U.S. growth, but the U.S. still maintains duties against several categories of goods. The highest tariffs are concentrated on agriculture, textiles, and footwear.

  • The Trump administration has enacted tariffs on imported solar panels, washing machines, steel, and aluminum, plans to impose tariffs on Chinese imports, and is investigating further tariffs on Chinese imports and automobile imports.

  • The effects of each tariff will be lower GDP, wages, and employment in the long run. The tariffs will also make the U.S. tax code less progressive because the increased tax burden would fall hardest on lower- and middle-income households.

  • Rather than erect barriers to trade that will have negative economic consequences, policymakers should promote free trade and the economic benefits it brings.

Introduction

Trade barriers, such as tariffs, have been demonstrated to cause more economic harm than benefit; they raise prices and reduce availability of goods and services, thus resulting, on net, in lower income, reduced employment, and lower economic output.

Since the end of World War II, the world has largely moved away from protectionist trade policies toward a rules-based, open trading system. This widespread reduction in trade barriers has contributed to economic prosperity in many ways, including large increases in trade activity and accompanying gains in economic output and income.

Openness to trade and investment has substantially contributed to U.S. growth, but the U.S. still maintains duties against several categories of goods. The overall effective rate of these tariffs appears low, but varies widely across categories of goods. Some of the highest duties apply to clothing, apparel, and footwear; some of the lowest apply to aircrafts, spacecrafts, and live animals.

This paper provides a brief overview of tariffs, the basic economics of trade and barriers to trade, and explains why the trade balance shouldn’t be viewed as an indicator of economic health. Then the paper reviews the current United States Harmonized Tariff Schedule and recent developments in United States tariff policies.

Overview of Tariffs

Tariffs are a type of excise tax that is levied on goods produced abroad at the time of import. They are intended to increase consumption of goods manufactured at home by increasing the price of foreign-produced goods. [1]  

Generally, tariffs result in consumers paying more for goods than they would have otherwise in order to prop up industries at home. Though tariffs may afford some short-term protection for domestic industries that produce the goods subject to tariffs by shielding competition, they do so at the expense of others in the economy, including consumers and other industries.[2]

As consumers spend more on goods on which the duty is imposed, they have less to spend on other goods—so, one industry is propped up to the disadvantage of all others. This results in a less efficient allocation of resources, which can then result in slower economic growth. Tariffs also tend to be regressive in nature, burdening lower-income consumers the most.

Trade and the economy

Trade makes a nation wealthy, and conversely, trade restrictions make a nation poorer.[3]

Trade enables nations to specialize in activities in which they have a comparative advantage; in other words, what they can produce at a relatively lower opportunity cost, and trade for what they would otherwise have to produce at a higher opportunity cost.[4] This means nations produce more goods and services for less and exchange those for goods and services from other countries, resulting in higher levels of consumption than would be possible without trade.

Through this process, productivity increases as resources flow to the economic activities in which a country has a comparative advantage.[5] This leads to employment gains where production is most efficient, though it can also lead to employment losses in sectors where production is comparatively less efficient—an outcome of which policymakers should remain cognizant. On net, though, trade results in higher levels of productivity, income, and output throughout the economy. And over time, increased trade has made the United States more productive and has contributed to large increases in Americans’ standard of living.[6]

Impact of Trade and Tariffs on the United States Graph

Since the end of World War II, growth in annual real global trade has outpaced GDP growth, growing on average 1.5 times faster.[7] Much of this increase in trade can be explained by reductions in barriers to international exchange, such as tariffs and quotas.[8] Post-war trade liberalization has led to widespread benefits, including higher income levels, lower prices, and greater consumer choice.[9]

Estimates of these post-war gains from freer trade range up to $10,000 per household in the United States.[10] The positive, long-term economic effects of trade – increased competition, innovation, productivity, employment, wages, and output – provide benefits that outweigh the short-term transition costs trade can cause.

But what about trade balances?

Trade clearly results in positive economic outcomes, allowing people in different countries to specialize in what they do best, and then exchange physical goods, services, and financial assets across borders. But there are often misperceptions about the measurements that economists and policymakers use to track flows of trade.

The balance-of-payments system consists of the current account, which measures the flow of goods and services, and the capital account, which records the flow of finances.[11] Walking through an example of a business that imports and exports is useful to understand how the balance-of-payments system works.[12]

Suppose an American business loads $100 million worth of goods it produced onto a cargo ship. When the ship leaves the country, it is credited to the current account as an export of $100 million. Now suppose that the business sells the goods to France; after shipping and other costs, the business makes a 20 percent profit selling to French customers.

The business now has $120 million it can use to make purchases in France. Suppose they decide to purchase wine, load it back on the now-empty cargo ship, and return to the United States; the value of the imported wine ($120 million) is debited from the current account. The business now sells the wine to its American customers, making another $10 million in profit. The business has made $20 million from the original sell of the goods in the cargo ship, and another $10 million from selling the imported wine, for a net profit of $30 million.

According to the current accounts, America has exported $100 million to France and imported $120 million from France—resulting in a so-called trade deficit of $20 million. But, we can see that the American business is clearly better off by having made these exchanges, $30 million better off.

Suppose in the next month, the American business sends another cargo ship to France with another $100 million worth of goods. But unfortunately, the entire ship sinks before it reaches France, leaving the business at a total loss. The $100 million export was credited to the current account; because there is no corresponding import, the national accounts show a trade surplus of $100 million. We can agree that no one has been made better off here, even though the accounting identity shows a trade surplus.

The capital account is also involved in these transactions, recording the exchange of financial assets, like currency. When the U.S. business buys wine from France, they give U.S. dollars in exchange for that wine—this is credited to the capital account. Conversely, when the U.S. business sold goods to France in exchange for Euros, this was debited to the capital account. Thus, in the example above, the capital account had a $20 million surplus. This indicates that foreigners have U.S. dollars that, at some point in the future, will be reinvested into the United States. In other words, when we spend dollars on foreign goods, those dollars do not disappear; they will return to the U.S. as a capital inflow at some time in the future.

The balance-of-payments system is simply an accounting identity; the current and capital accounts track flows of goods, services, and financial assets between people, and they move in the opposite direction of one another. A current account (trade) deficit is simply another way of stating that we have a capital account surplus; neither has a causal implication for the health of the economy. Whether a business sells to or buys from domestic or foreign consumers, they do so because the trade is profitable. Production and exchange – regardless of the balance on the current account – generate wealth.

Barriers to trade reduce economic output and incomes

When countries erect barriers to trade, such as tariffs, they raise prices and divert resources away from relatively efficient economic activities towards less efficient economic activities.[13] It is worth noting that in addition to tariffs, many other policy measures can create barriers to trade that have effects like tariffs.[14] As a result of such measures, consumers pay more for goods than they otherwise would have, businesses face higher costs than they otherwise would have, and on net, output and employment fall.

Tariffs in particular can have this effect through a few channels. One possibility is that a tariff may be passed on to producers and consumers in the form of higher prices. Tariffs can raise the cost of intermediate goods such as parts and materials, which then raises the price of goods that use those inputs and reduces private sector output.[15],[16] This would result in lower incomes for both workers and the owners of capital. Similarly, higher consumer prices due to tariffs would reduce the after-tax value of both labor and capital income. Because these higher prices would reduce the return to labor and capital, they would incentivize Americans to work and invest less, leading to lower output.[17]

Alternatively, the U.S. dollar may appreciate in response to tariffs, offsetting the potential price increase on U.S. consumers.[18] However, the more valuable dollar would make it more difficult for exporters to sell their goods on the global market, resulting in lower revenues for exporters. This would also result in lower U.S. output and incomes for both workers and owners of capital, reducing incentives for work and investment, and leading to a smaller economy.

Academic studies have quantified the costs of tariffs and shown that tariffs often fail to achieve their objectives.[19] A comprehensive study of tariffs in place in 1990 found that the annual consumer costs per American job “saved” range from $100,000 to over $1 million, with an average of $170,000.[20] More recently, a study analyzing the 2002 steel tariffs imposed by the George W. Bush administration found that the first year the tariffs were in effect, more American workers lost their jobs due to higher steel prices (200,000) than the total number employed by the steel industry itself at the time (187,500).[21]

These results aren’t unique to the 2002 steel tariffs. A Congressional Budget Office report from 1986 reviewed the effects of protectionist policies covering textiles and apparel, steel, footwear, and automobiles. The policies did effectively increase costs, which resulted in slightly higher profits for the firms. However, the report finds, “In none of the cases studied was protection sufficient to revitalize the affected industry.”[22]

The outcomes of past protectionist policies indicate that protectionism simply does not work. Any potential short-term benefits of using protectionist policies to shield domestic industries from foreign competition come at the expense of others in the economy; the consequences are higher prices, less efficient resource allocation, and job losses throughout other sectors, and in the long run, failure to help the intended beneficiaries.

The United States Maintains a Wide Variety of Tariffs

While global trade restrictions have dramatically fallen over the past several decades, the United States still maintains many tariffs on a wide variety of goods. The United States International Trade Commission (USITC) publishes the Harmonized Tariff Schedule, which contains 99 chapters describing various tariffs that apply to different categories of goods.[23] The USITC also maintains a tariff database, reporting statistics that include the value of imports appraised by the U.S. Customs Service as well as estimates of the calculated duties by commodity.

A superficial glance at the database might convey the idea that tariffs are relatively small. For example, in 2017, the total value of imports was $2.3 trillion and the total estimated duties were $33.1 billion, implying an overall average tariff of about 1.42 percent.[24] Though the average U.S. tariff looks small, some individual categories of goods are subject to much higher import barriers.

In 2017, for example, the United States imported $109.5 billion worth of textiles and textile articles, and paid $12.6 billion in tariffs on these imports, or an average applied tariff of 11.5 percent.[25] Within this category of imported goods, some subcategories faced even higher tax burdens. The rate on knitted or crocheted apparel and clothing accessories was above 14 percent in 2017.[26]

Browsing the Harmonized Tariff Schedule shows that in some cases, even higher rates may apply. The maximum rate of duty that applies to “Men’s or boy’s overcoats, carcoats, capes, cloaks, anoraks (including ski jackets), windbreakers and similar articles, knitted or crocheted – Other” is 72 percent.[27] The most recent World Trade Organization Policy Review of the United States found that:[28]

Tariffs above 25% ad valorem are concentrated in agriculture (notably dairy, tobacco, and vegetable products), footwear, and textiles. An estimated 22 tariff lines corresponding to agricultural products carry import duty rates above 100%.

Source: United States International Trade Commission, “Interactive Tariff and Trade DataWeb,” https://dataweb.usitc.gov/
Table 1:Higher Average Rates Apply to Certain Sections of the Harmonized Tariff Schedule, Billions of Dollars
Section Customs Value Calculated Duty Average Applied Rate

XI: Textiles and Textile Articles

$109.5 $12.6 11.53%

VIII: Raw Hides and Skins, Leather, Furskins and Articles Thereof; Saddlery and Harness; Travel Goods, Handbags and Similar Containers; Articles of Animal Gut (Other Than Silkworm Gut)

13.8 1.4 10.20%

XII: Footwear, Headgear, Umbrellas, Sun Umbrellas, Walking Sticks, Seatsticks, Whips, Riding-Crops and Parts Thereof; Prepared Feathers and Articles Made Therewith; Artificial Flowers; Articles of Human Hair

30.7 3.1 10.09%

All Sections

2,313.0 33.1 1.42%

In addition to causing economic harm for the reasons discussed above, tariffs generally have nonneutral impacts across different goods and different sectors, and this nonneutrality can further reduce welfare. Uneven tax burdens may distort investment decisions, adding complexity that penalizes certain goods worse than others and thus negatively impacting economic growth. Though tariffs generated a relatively small amount of revenue in 2017, $33.1 billion, high rates concentrated on certain categories of imports creates distortions in the economy.

Tariffs and the Trump Administration

Within the first few months of 2018, the Trump administration enacted tariffs on imported solar panels, washing machines, steel, and aluminum.[29] The administration plans to soon impose a 25 percent tariff on $50 billion worth of Chinese imports.[30] In addition to these planned tariffs, pending investigations regarding further tariffs on up to $100 billion more worth of Chinese imports as well as automobile imports mean more tariffs could be imposed going forward.[31]

The rationale for these various tariffs range from national security to misconceptions about trade balances to alleged intellectual property theft by China. Though there is wide agreement that certain trading practices are unfair and call for a response, levying broad tariffs is not likely the approach that will result in the desired policy changes.[32] The effects of each tariff will be lower GDP, wages, and employment in the long run.[33]

For example, according to the Tax Foundation’s Taxes and Growth model, President Trump’s proposal to raise taxes by approximately $37.5 billion annually (by levying a 25 percent tariff on $150 billion worth of Chinese imports) would reduce the long-run level of GDP by 0.1 percent, or about $20 billion.[34] The smaller economy would result in 0.1 percent lower wages and 79,000 fewer full-time equivalent jobs. The tariffs will also make the U.S. tax code less progressive because the increased tax burden would fall hardest on lower- and middle-income households.[35]

Source: Tax Foundation Taxes and Growth Model, March 2018
Table 2. Economic Impact of Tariffs on $150 Billion in Chinese Imports
Change in long-run GDP -0.1%
Change in long-run GDP (Billions $2018) -$20.6
Change in long-run wage rate -0.1%
Change in full-time equivalent jobs -79,000

These estimates do not account for the uneven impact these taxes would have across sectors, nor the costs of retaliatory actions that have already been imposed and may be proposed in the future. These effects would both result in worse economic outcomes.

Conclusion

Since the end of World War II, public policy has shifted to embrace free and open trade, and reduced many trade barriers. This increase in international trading activity has led to increases in productivity, employment, output, and incomes for the countries involved.

Though historically the United States has led the movement toward free and open trade, the U.S. maintains high tariffs on select categories of goods. These sectors of the economy are not open to free trade or the competitive pressures free trade entails, and the related prices are artificially raised because of tariffs and other restrictions. Rather than focus trade policy on reducing these barriers, recent actions by the Trump administration have been to levy new tariffs and threaten further trade restrictions.

History has shown that tariffs fail to achieve their intended objectives, and result in higher prices, lower employment, and slower economic growth in the long run. Rather than erect barriers to trade that will have negative economic consequences, policymakers should promote free trade and the economic benefits it brings.


Notes

[1] Jagdish Bhagwati, “Protectionism,” in David R. Henderson, ed., The Concise Encyclopedia of Economics (Indianapolis: Liberty Fund Inc., 2002), www.econlib.org/library/Enc/Protectionism.html.

[2] Adam Smith, “Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home,” in An Inquiry into the Nature and Causes of the Wealth of Nations, Book IV, Chapter II, www.econlib.org/library/Smith/smWN13.html#B.IV

[3] James K. Glassman, “The Blessings of Free Trade,” Cato Institute, May 1, 1998, https://www.cato.org/publications/trade-briefing-paper/blessings-free-trade.

[4] Adam Smith, “That the Division of Labour is Limited by the Extent of the Market,” in An Inquiry into the Nature and Causes of the Wealth of Nations, Book 1, Chapter III, http://www.econlib.org/library/Smith/smWN1.html#B.I.

[5] Donald J. Boudreaux, “Comparative Advantage,” in David R. Henderson, ed., The Concise Encyclopedia of Economics (Indianapolis: Liberty Fund Inc., 2002), www.econlib.org/library/Enc/ComparativeAdvantage.html.

[6] Council of Economic Advisers, “Chapter 4: The Benefits of Open Trade and Investment Policies,” Economic Report of the President (2009) (Washington, D.C.: U.S. Government Printing Office, January 2009), https://georgewbush-whitehouse.archives.gov/cea/ERP_2009_Ch4.pdf.

[7] Cathleen D. Cimino-Isaacs, “U.S. Trade Policy Primer: Frequently Asked Questions,” Congressional Research Service, April 2, 2018.

[8] Ibid.

[9] Scott C. Bradford, Paul L. E. Grieco, and Gary Clyde Hufbauer, “The Payoff to America from Global Integration,” Peterson Institute for International Economics, Jan. 1, 2005, https://piie.com/sites/default/files/publications/chapters_preview/3802/2iie3802.pdf.

[10] Council of Economic Advisers, “Chapter 4: The Benefits of Open Trade and Investment Policies,” 132.

[11] Mack Ott, “International Capital Flows,” in David R. Henderson, ed., The Concise Encyclopedia of Economics (Indianapolis: Liberty Fund Inc., 2002), http://www.econlib.org/library/Enc/InternationalCapitalFlows.html.  

[12] The illustration is based on Frederick Bastiat’s Selected Essays on Political Economy: “The Balance of Trade,” www.econlib.org/library/Bastiat/basEss.html?chapter_num=16#book-reader.

[13] Adam Smith, “Of Restraints upon the Importation from Foreign Countries of such Goods as can be Produced at Home,” in An Inquiry into the Nature and Causes of the Wealth of Nations

[14] See Scott Lincicome, “Don’t Blame Free Trade. We Don’t Have it,” Foundation for Economic Education, Nov. 21, 2016, https://fee.org/articles/dont-blame-free-trade-we-dont-have-it/.

[15] Dean Russell, “Tariffs Kills Jobs,” Foundation for Economic Education, Feb. 1, 1962, https://fee.org/articles/tariffs-kills-jobs/.

[16] Chad P. Brown, “The Element of Surprise Is a Bad Strategy for a Trade War,” Peterson Institute for International Economics, April 16, 2018, https://piie.com/commentary/op-eds/element-surprise-bad-strategy-trade-war.

[17] Kyle Pomerleau and Erica York, “Modeling the Impact of President Trump’s Proposed Tariffs,” Tax Foundation, April 12, 2018, https://taxfoundation.org/modeling-impact-president-trumps-proposed-tariffs/.

[18] Alan S. Blinder, “Free Trade,” in David R. Henderson, ed., The Concise Encyclopedia of Economics (Indianapolis: Liberty Fund Inc., 2002), http://www.econlib.org/library/Enc/FreeTrade.html.

[19] Scott Lincicome, “Doomed to Repeat It,” The Cato Institute, August 22, 2017, https://object.cato.org/sites/cato.org/files/pubs/pdf/pa-819-updated.pdf.

[20] Gary Clyde Hufbauer and Kimberly Ann Elliott, “Measuring the Costs of Protection in The United States,” Peterson Institute for International Economics, January 1994, https://piie.com/bookstore/measuring-costs-protection-united-states.

[21] Erica York, “Lessons from the 2002 Bush Steel Tariffs,” Tax Foundation, March 12, 2018, https://taxfoundation.org/lessons-2002-bush-steel-tariffs/.

[22] Congressional Budget Office, “Has Trade Protection Revitalized Domestic Industries?” November 1986, xiii. https://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/61xx/doc6186/doc25c-entire.pdf.

[23] United States International Trade Commission, “Harmonized Tariff Schedule (2018 HTSA Revision 5),” May 2018, https://hts.usitc.gov/current.

[24] United States International Trade Commission, “Interactive Tariff and Trade DataWeb,” April 2018, https://dataweb.usitc.gov/.

[25] Ibid.

[26] Ibid.

[27] United States International Trade Commission, “Harmonized Tariff Schedule (2018 HTSA Revision 5),” Chapter 61, 61-4.

[28] World Trade Organization, “Trade Policy Review, Report by the Secretariat, United States,” March 28, 2017, file:///C:/Users/rshuster/Downloads/S350R1.pdf.

[29] Erica York, “President Trump Approves Tariffs on Washing Machines and Solar Cells,” Tax Foundation, Jan. 30, 2018, https://taxfoundation.org/trump-tariffs-washing-machines-solar-cells/; and Erica York, “President Trump Announces Two Steep Tariffs on Steel and Aluminum,” Tax Foundation, March 2, 2018, https://taxfoundation.org/trump-steel-tariff-aluminum-tariff/.

[30] Donna Borak and Nathaniel Meyersohn, “White House slaps 25% tariff on $50 billion worth of Chinese goods,” CNNMoney, May 29, 2018, http://money.cnn.com/2018/05/29/news/economy/china-tariffs/index.html.

[31] Erica York, “Potential of Trade War Threatens New Tax Law’s Benefits,” Tax Foundation, April 6, 2018, https://taxfoundation.org/potential-trade-war-threatens-new-tax-laws-benefits/.

[32] Scott Lincicome, “Chinese Intellectual Property Policies Demand a Smart U.S. Trade Policy Response – One President Trump Doesn’t Appear to be Considering,” Cato Institute, Jan. 2, 2018, https://www.cato.org/blog/chinese-intellectual-property-policies-demand-smart-us-trade-policy-response-one-president.

[33] Scott Drenkard, “It’s Tariff Time: What Can Adam Smith Teach Us About Trade Policy Today?,” Tax Foundation, March 2, 2018, https://taxfoundation.org/adam-smith-trump-tariffs/.

[34] Kyle Pomerleau and Erica York, “Modeling the Impact of President Trump’s Proposed Tariffs,” Tax Foundation, April 12, 2018, https://taxfoundation.org/modeling-impact-president-trumps-proposed-tariffs/.

[35] Erica York, “Automobile Tariffs Would Offset Half the TCJA Gains for Low-income Households,” Tax Foundation, June 4, 2018, https://taxfoundation.org/automobile-tariffs-2018/.


Source: Tax Policy – The Impact of Trade and Tariffs on the United States

State Tax Changes Taking Effect July 1, 2018

State Tax Changes Taking Effect July 1, 2018

State Tax Changes Taking Effect July 1, 2018

Key Findings

  • Ten states have tax changes scheduled to go into effect on July 1, 2018.
  • Indiana has the lone corporate income tax change, with the rate decreasing 0.25 percent to 5.75 percent.
  • Kentucky is broadening its sales tax base by including select services.
  • Louisiana extended its previous temporary 1 percent sales tax hike at a lower rate of .45 percent. The state sales tax rate will be 4.45 percent.
  • Massachusetts will begin sales of recreational marijuana and levy a state excise tax rate of 10.75 percent. Localities will have the option of levying additional local taxes.
  • Oklahoma and Kentucky are increasing their cigarette taxes: Oklahoma from $1.03 to $2.03 per pack, Kentucky from $0.60 to $1.10.
  • Four states have online sales tax legislation, but may need more time to tweak legislation and issue guidance.
  • Three states, Oklahoma, South Carolina and Tennessee, are increasing their gas tax rates.

Introduction

The majority of states enact tax changes at the start of the calendar year; however, some states implement changes at the beginning of the fiscal year. Ten states have tax changes taking effect on July 1, 2018, the beginning of the 2019 fiscal year.  

Corporate Income Tax

Indiana

Indiana has been taking steps to reduce its corporate income tax rate since 2011. As part of an additional tax package passed in 2014 to phase down the corporate income tax to 4.9 percent by 2022,[1] Indiana’s corporate income tax rate will decrease from 6.0 percent to 5.75 percent on July 1.[2]

Gasoline Tax

Oklahoma

As part of the funding package passed to raise teacher pay in the state, Oklahoma will levy an additional 3 cents per gallon tax on gasoline, and an additional 6 cents per gallon tax on diesel fuel.  These increases are in addition to the existing 16 cents per gallon rate on gasoline and 13 cents per gallon tax on diesel fuel.[3] All revenues from the additional gas taxes will be deposited into the General Fund until July 1, 2019, when new revenues will then be directed to the Rebuilding Oklahoma Access and Driver Safety Fund.[4]

Oklahoma’s Supreme Court is currently hearing two challenges to a referendum petition being circulated to repeal House Bill 1010, the legislation responsible for Oklahoma’s tax changes in July. One challenge contends that the referendum petition process being pursued by opponents of the funding package is prohibited for matters including public education. The second challenge contends the petition’s summary is misleading, incomplete, and lacks the basic requirements, including providing an exact copy of the bill the petition addresses.[5]

South Carolina

An infrastructure bill that passed in 2017 will increase the gas tax from 18 cents to 20 cents per gallon.[6] This increase is part of a five-year plan that ultimately raises the gas tax to 28.75 cents per gallon in 2022.[7] Revenue generated through the five-year increase will go toward the Infrastructure Maintenance Trust Fund.[8]

Tennessee

As part of a road funding bill passed in 2017, the gas tax will increase this year from 24 cents per gallon to 25 cents per gallon.[9] The diesel tax will also increase, from 21 cents per gallon to 24 cents per gallon.[10] The road funding bill will ultimately raise the gas tax by 6 cents, from 21.4 cents per gallon to 27.4 cents per gallon, and the diesel tax by 18.4 cents, from 17 cents per gallon to 35.4 cents per gallon, by 2019.[11]

Sales Tax

Online Sales Tax Collection

After the U.S. Supreme Court handed down its decision in South Dakota v. Wayfair permitting states to collect sales taxes on sellers with no physical presence in the state, states rushed to understand what it meant for the tax base.[12] Several states – Connecticut, Hawaii, Kentucky, and North Dakota – already had some form of online sales tax legislation with an effective date of July 1, 2018. Several of these states prepared their legislation with the Wayfair case pending and will likely need to make legislative tweaks and issue more guidance to retailers before they are ready to begin sales tax collections from out-of-state sellers.

Kentucky

Kentucky’s House Bill 366 broadens the sales tax base by now including select services previously exempt from taxation. The sales tax base expansion is part of a larger tax reform package passed earlier this year that cuts rates on the individual and corporate level and broadens the tax base. Extended warranty services, facility/event admission fees, indoor skin tanning services, janitorial services, labor charges for installation or repair of personal or digital property, or services sold, landscape services, limousine services, laundry/dry cleaning services, nonmedical and weight-reducing services, pet care services, campsite rentals, and veterinary services are now subject to a 6 percent sales tax, effective July 1, 2018.[13]

Louisiana

In the state’s third special session, Louisiana approved a partial extension of the state’s temporary sales tax hike. A 1 percent increase in the sales tax was scheduled to expire July 1, but after heated debate, legislators have approved an extension at a lower rate, a .45 percent increase. As of July 1, the state sales tax rate will be 4.45 percent.[14]

Cigarette Tax

Oklahoma

Included in the same funding package as the gas tax, House Bill 1010 also increases the tax on cigarette sales from $1.03 per pack of 20 cigarettes to $2.03 per pack of 20 cigarettes.[15] Additional revenues from the tax increase will be deposited into the the General Fund for one year. After July 1, 2019, funds will be deposited into the Health Care Enhancement Fund.[16]

Kentucky

An additional component of Kentucky’s House Bill 366, which broadens the sales and income tax bases and lowers the corporate and individual income tax rates among other changes, is an increase of the cigarette tax from $0.60 to $1.10 per 20-count pack of cigarettes.[17]

Marijuana Tax

Massachusetts

Voters approved the sales of recreational marijuana via Question 4, a ballot initiative, in November 2016.[18] After more than a year spent crafting regulations and rules, Massachusetts will begin recreational marijuana sales on July 1, 2018.[19] Worried the tax rates outlined in Question 4 were too low, policymakers increased the rates. The state sales tax of 6.25 percent was maintained, the state excise tax was increased from 3.75 to 10.75 percent, and the localities’ option of levying a maximum 2 percent tax was increased to 3 percent, for a maximum tax rate of 20 percent.[20]


[1] Scott Drenkard, “Indiana’s 2014 Tax Package Continues State’s Pattern of Year-Over-Year Improvements,” Tax Foundation, April 7, 2014, https://taxfoundation.org/indiana-s-2014-tax-package-continues-state-s-pattern-year-over-year-improvements/.

[2] Indiana Department of Revenue, “Corporate Tax Rate History,” IN.gov, 2018, https://www.in.gov/dor/3470.htm.

[3] Oklahoma Tax Commission, “Important Changes to Impact July 2018 Motor Fuel Sales,” ok.gov, 2018, https://www.ok.gov/tax/documents/IMPORTANT%20CHANGES%20TO%20IMPACT%20JULY%202018%20MOTOR%20FUEL%20SALES.pdf

[4] Oklahoma Tax Commission, “Fiscal Impact Statement and/or Administrative Impact Statement,” oklegislature.gov, 2018, http://webserver1.lsb.state.ok.us/cf_pdf/2017-18%20SUPPORT%20DOCUMENTS/impact%20statements/fiscal/senate/HB1010XX%20ENR%20FI.PDF

[5] Chris Casteel, “Oklahoma Supreme Court to hear arguments on tax repeal as group warns of teacher walkout,” newsok.com, June 11, 2018, https://newsok.com/article/5597640/oklahoma-supreme-court-to-hear-arguments-on-tax-repeal-as-group-warns-of-teacher-walkout.

[6] South Carolina Department of Revenue, “Motor Fuel User Fee,” dor.sc.gov, 2018, https://dor.sc.gov/tax/motor-fuel.

[7] Morgan Scarboro and Andrew Eichen, “State Tax Changes Taking Effect July 1, 2017,” Tax Foundation, June 27, 2017, https://taxfoundation.org/state-tax-changes-july-1-2017/. 

[8] South Carolina Department of Revenue, “Motor Fuel.”

[9] Tennessee Department of Revenue, “Due Dates and Tax Rates,” TN.gov, n.d., https://www.tn.gov/revenue/taxes/motor-fuel-taxes/due-dates-and-tax-rates.html.

[10] Ibid.

[11] Scarboro and Eichen, “State Tax Changes Taking Effect July 1, 2017.” 

[12] Joseph Bishop-Henchman, “Supreme Court Decides Wayfair Online Sales Tax Case,” Tax Foundation, June 21, 2018, https://taxfoundation.org/supreme-court-decides-wayfair-online-sales-tax-case/.

[13] TaxAnswers, “Sales and Excise Taxes,” ky.gov, 2017, https://taxanswers.ky.gov/Sales-and-Excise-Taxes/Pages/default.aspx.

[14] Louisiana Department of Revenue, “Revenue Information Bulletin 18-016,” revenue.louisiana.gov, 2018, http://revenue.louisiana.gov/LawsPolicies/RIB%2018-016%20Decrease%20in%20State%20Sales%20Tax%20Rate%20to%20be%20Effective%20July%201%202018.pdf.

[15] Laura Lieberman, “Extras on Excise: Oklahoma’s New Tax Bill Spells Big Changes for Excise Tax Regimes,” Bloomberg BNA, April 4, 2018, https://www.bna.com/extras-excise-oklahomas-b57982090816/. 

[16] Oklahoma Tax Commission, “Fiscal Impact Statement And/Or Administrative Impact Statement,” oklegislature.gov, 2018, http://webserver1.lsb.state.ok.us/cf_pdf/2017-18%20SUPPORT%20DOCUMENTS/impact%20statements/fiscal/senate/HB1010XX%20ENR%20FI.PDF

[17] Morgan Scarboro, “Kentucky Legislature Overrides Governor’s Veto to Pass Tax Reform Package,” Tax Foundation, April 16, 2018, https://taxfoundation.org/kentucky-tax-reform-package/.

[18] The New York Times, “Massachusetts Question 4 – Legalize Marijuana – Results: Approved,” Aug. 1, 2017, https://www.nytimes.com/elections/results/massachusetts-ballot-measure-4-legalize-marijuana.

[19] Nik DeCosta-Klipa, “Marijuana shops become legal in Massachusetts in less than two months. Here’s what to expect,” boston.com, May 7, 2018, https://www.boston.com/news/local-news/2018/05/07/massachusetts-recreational-marijuana-stores-july-1.

[20] Morgan Scarboro, “Massachusetts Increases Marijuana Tax Rate,” Tax Foundation, Aug. 1, 2017. https://taxfoundation.org/massachusetts-marijuana-tax-increase/.


Source: Tax Policy – State Tax Changes Taking Effect July 1, 2018

Testimony: California’s SALT Deduction Cap Workaround is Legally Dubious and Needlessly Regressive

Testimony: California’s SALT Deduction Cap Workaround is Legally Dubious and Needlessly Regressive

Testimony: California’s SALT Deduction Cap Workaround is Legally Dubious and Needlessly Regressive

Written Testimony for the California Assembly
Committee on Revenue and Taxation on SB 227



Senate Bill 227 has gone through multiple iterations since its introduction, but from the initial language to the substitute before you, the bill’s basic intention has remained constant: to provide a credit against state income tax liability for contributions to government-linked funds, with the intent of allowing high-income taxpayers to recharacterize their tax payments as charitable contributions to reduce tax liability under the new federal tax law.

The federal Tax Cuts and Jobs Act caps the state and local tax deduction at $10,000 as part of the offset for rate reductions. Senate Bill 227 is designed to allow taxpayers to retain the effect of the uncapped deduction by reclassifying tax payments as charitable contributions. There are two primary objections to this approach: first, that it is legally dubious and could leave taxpayers worse off; and second, that it is a regressive policy which doubles down on tax reductions for some of the highest-income earners in the country.

Let me take those in reverse order.

Our analysis at the Tax Foundation agrees with that of groups across the ideological spectrum, groups like the Tax Policy Center and the Institute on Taxation and Economic Policy: under the new federal law, most California taxpayers will see a tax cut, and often a significant one. This is true for low- and high-income taxpayers alike, and it’s true in every single congressional district in the state.

Taxpayers with incomes above $200,000 would be the primary beneficiaries of this proposed workaround to the state and local tax deduction cap. We looked at how they fare under federal tax reform in every congressional district in the country (https://tax.foundation/2tD54iL). In California, this class of taxpayers sees its after-tax income rise by 4.1 percent on average.

It’s important to understand what this means. Imagine, for simplicity’s sake, that you had $200,000 in taxable income and paid $40,000 in federal taxes, for an effective tax rate of 20 percent and an after-tax income of $160,000. A 4.1 percentage point increase in after-tax income for this taxpayer represents a tax cut of $6,560—a reduction in tax liability of more than 16 percent!

The distribution of these tax reductions varies, of course. The smallest benefit is in California’s 14th Congressional District, centered in San Mateo County, where after-tax income increases by just under 2.5 percent. For someone facing an effective tax rate of 20 percent before federal reform, that’s a 10 percent tax cut. If the effective rate were higher, the reduction would be as well. The median California congressional district sees a 4.5 percent increase in after-tax income for filers with income of $200,000 or more.

These taxpayers, therefore, are already getting a good deal under the new federal tax law. So do those whose incomes aren’t as high, it’s important to add, but the focus here is on higher-income taxpayers, because they’re the ones who stand to benefit from SB 227. Given that most of these taxpayers are already receiving a substantial net tax cut, allowing them the benefit of the rate reductions and attempting to restore an uncapped deduction is curious from a policy standpoint.

It is also legally suspect. Amendments to SB 227 may have been intended to cure certain defects and improve the legislation’s chances of surviving legal scrutiny, but ultimately, they are likely to prove little more than window dressing. In its current form, the offsetting tax credit is not one-to-one, meaning that the taxpayer’s liability to state and local government actually increases for those taking advantage of the credit program, but this does little to render the program genuinely charitable in nature, since its primary – arguably, from the taxpayer’s standpoint, only – purpose is to decrease overall tax liability. A payment intended to improve the payor’s financial standing is not a charitable gift, and the Internal Revenue Service is not going to regard it as one.

Under SB 227, taxpayers can elect to write a check to the Local Schools and Colleges Voluntary Contributions Fund in lieu of ordinary tax payments, but semantics aside, there is no doubt that this payment is made in satisfaction of tax liability, and that most of the contribution (85 percent of it) is offset by the recipient in the form of a corresponding credit against California individual income tax liability.

We are still awaiting formal IRS guidance, but the IRS has issued a notice indicating where it is headed, specifically referencing the principle of substance over form—that the IRS cares about the purpose and effect of the payment, not what it is called or what form it takes. If a payment is made in satisfaction of tax liability, it’s probably a tax payment, even if technically the recipient was a “voluntary contributions fund.”

It has always been the case that taxpayers could only claim a deduction for charitable contributions above and beyond the value of any benefit received. If you buy a $250 ticket to a benefit dinner, and the dinner itself has a market value of $50, then only $200 (not $250) is eligible for the deduction. Under existing law, regulations, and case law, the most generous interpretation would be that an 85 percent credit allows the taxpayer to take the remaining 15 percent as a deduction for federal tax purposes. And that math doesn’t add up.

Imagine a taxpayer with $50,000 in state tax liability. (We’ll assume that they’ve used up the $10,000 state and local tax deduction on local property taxes and want to convert the full state amount into charitable contributions.) If they contributed $58,824 to the Local Schools and Colleges Voluntary Contributions Fund, they would receive a $50,000 credit, wiping out their state tax liability. They’ve increased their state tax (and tax-like) payments by nearly $9,000, but if they face the top marginal rate of 37 percent at the federal level, they’ll cut their federal tax liability by $21,765, for a net savings of $12,941.

If, however, they can only claim the residual 15 percent of that contribution at the federal level, then their federal tax savings are only $3,2645, for a net tax increase of $5,559 after taking the higher payments to California into account. Californians who took the state up on this proposal could face a serious tax hike.

Proponents have argued that the existence of charitable tax credits for purposes ranging from free clinics to mental health services to education scholarships provides a foundation for state and local tax deduction workarounds. Lawmakers should be wary of this theory.

Designed when the state and local tax deduction was uncapped, these existing programs were not designed as, and rarely functioned as, a workaround. (They incidentally offered an additional tax benefit to AMT filers.) The lack of IRS interest in these programs when their use as a tax avoidance strategy was modest should not be interpreted as a grant of permission for taxpayers to engage in aggressive tax avoidance tactics using contributions which lack donative intent. It is, moreover, possible – even likely –  that existing programs will see greater scrutiny now that their use actually changes federal tax liability, and it would not be surprising for the federal benefit to be limited to the portion of the contribution not offset by a state tax credit.

These existing programs would, presumably, still exist and enjoy considerable popularity. A taxpayer who cares about a particular charitable cause may be quite happy to claim, say, a state credit for 50 percent of the contribution, and a federal deduction for the remaining 50 percent (but not the full amount), which make her cost less than $32 for every $100 received by the charity. That’s a pretty good deal. But if the overriding goal is to recharacterize payments to reduce tax liability, then whether the credit certification is at 50 percent, 85 percent, or 100 percent, the strategy is highly unlikely to work.

We have explored the legal challenges at greater length, in our own white papers (see, e.g., http://tax.foundation/2DrX0Z1) and in a symposium on the topic hosted by the Columbia Journal of Tax Law (https://tax.foundation/2Iu52yW), among other venues. States adopting the contributions in lieu of taxes approach are not only pursuing a doubtful strategy, but one that could leave taxpayers facing greater tax liability.

The IRS has broad latitude in defining eligible charitable contributions, and ample legal basis for doing so. To avoid steering California taxpayers wrong or dealing with angry filers who overpaid to the state without receiving their expected federal windfall, it would probably be prudent to shelve tax recharacterization plans pending the issuance of IRS guidance on the subject.


Source: Tax Policy – Testimony: California’s SALT Deduction Cap Workaround is Legally Dubious and Needlessly Regressive

New Study Raises Questions about European Commission Proposal to Tax Digital Companies

New Study Raises Questions about European Commission Proposal to Tax Digital Companies

New Study Raises Questions about European Commission Proposal to Tax Digital Companies

A new study by the European Centre for International Political Economy raises five questions about the European Commission’s proposal to place a new tax on the revenues of large digital services companies that the Commission has not answered. This study follows a previous report showing the Commission’s justification for the new tax (that digital companies are undertaxed, or have caused tax collections to slump) is not supported by the underlying data. The author of the new study, Dr. Matthias Bauer, analyzes the proposed tax on digital services using economic evidence of other business taxes. He finds that such a tax would likely lead to many negative, unintended consequences, and that the European Commission should consider these negative effects before proceeding with the new tax.

Who would pay for the digital services tax?

The study notes that the Commission has not addressed one of the most critical aspects of tax policy: economic incidence, or who actually bears the cost of the tax. People, not organizations, pay taxes. And in the case of corporate income taxes, the people who bear the brunt of the burden are workers.

It is not likely that a revenue tax would fall hardest on shareholders, especially in the case of digital services, because capital is mobile and can flow to where it will earn the highest after-tax return. This means that others in the economy would be most impacted by the tax—the study suggests the burden would fall on self-employed persons and workers employed by firms that depend on digital advertising and online platform sales, as well as final consumers.

How would the tax affect others in the economy? And, would the tax have a disparate impact on certain firms?

Because it is unlikely that the brunt of the increased tax burden would rest with shareholders, it’s important to evaluate which economic agents the tax would impact. Many firms would pass the cost of the tax to downstream users and customers, and it is possible that firms could over-shift the effects, leading to greater changes in price than the original tax increase. The study points out that this could affect customers, other businesses including small and medium enterprises, self-employed persons, as well as public institutions that utilize digital advertising and other online services.

Using European Union (EU) survey data, the study then raises the question of whether small and micro businesses would be particularly hurt by the digital services tax. If smaller businesses comprise the largest share of digital services consumers, which evidence suggests, then such a tax could adversely impact smaller firms relative to larger firms.

Would the tax discourage investment in the European Union? Would the tax hurt innovation and prevent convergence?

The study also notes that the Commission has not evaluated how the digital services tax would affect investment or innovation. Bauer argues that the effects of a tax on revenues could look like the effects of a tax on corporate income; meaning, this new tax would amount to a tax on investment. Any tax on capital increases the cost of capital (the cost of investing) and thus discourages investment. Additionally, it would make the EU a less attractive place for digitally-enabled businesses to be located, discouraging companies from growing and investing in the EU.

The report also notes that taxing the revenue of digital services companies is akin to taxing the benefits of their innovation. Increasing the cost of adopting these innovations risks creating a barrier for firms to grow and innovate, causing a drag on economic growth and convergence.

The report concludes by pointing out that the European Commission has not presented sufficient evidence of the consequences of the digital services tax. It is incorrect to assume that shareholders of digital services companies will bear the burden of this tax without any downstream consequences or harm to others in the economy. The questions Bauer asks the Commission to address, about economic incidence and secondary economic effects, are important questions for all policymakers to keep in mind when evaluating tax policy.


Source: Tax Policy – New Study Raises Questions about European Commission Proposal to Tax Digital Companies

New Budget Resolution Gives Hope for Phase Two of Tax Reform

New Budget Resolution Gives Hope for Phase Two of Tax Reform

New Budget Resolution Gives Hope for Phase Two of Tax Reform

Tax reform is not over, and Congress is proposing to save enough money to begin phase two. House Republicans recently released a 2019 budget resolution called “A Brighter American Future,” which included provisions that propose saving enough money to make some of the nonpermanent aspects of the Tax Cuts and Jobs Act (TCJA) permanent.

House Republicans say that the budget resolution includes “pro-growth reforms that build on the economic successes of tax reform.”

What Does the Resolution Say?

Budget resolutions are essentially blueprints of what a party wants the government to spend money on (and not to spend money on) over 10 years. It sets party priorities but is neither a law nor a very detailed document. Still, it is a good sign to see that Congress is looking towards extending provisions in the TCJA.

Section 403 of the current version of the resolution, titled “Reserve Fund for Extending Pro-Growth Tax Policies,” states:

In the House of Representatives, if the Committee on Ways and Means reports a bill or joint resolution that extends the pro-growth tax policies of Public Law 115–97, the chair of the Committee on the Budget may adjust the allocations, aggregates, and other appropriate budgetary levels in this concurrent resolution for the budgetary effects of any such bill or joint resolution, or amendment thereto or conference report thereon.

In essence, this section, in traditional Washington, D.C., parlance, is stating that they want to extend the TCJA (Public Law 115-97) provisions that will provide more growth.

If it Has No Direct Power, What Can it Do?

Building on the economic success of the tax reform involves making more provisions permanent. Many parts of the TCJA were not made permanent, because the TCJA was passed under budget reconciliation, which means that the tax cuts couldn’t increase the deficit outside of a 10-year window.

House Ways and Means Committee Chairman Kevin Brady (R-TX) told Fox Business that “[phase two of tax cuts] will lead with permanence…the tax cuts for families and small businesses were long term, but they weren’t permanent. We think that’s important for growth and certainty.”

The budget resolution may not pass in its current form, and a concurrent resolution (a resolution passed in both houses) could lead towards easier reconciliation, but it is still an uphill battle. Republicans being able to pass some of the tax measures through reconciliation without support from the Democrats (as they did with the TCJA) is seemingly unlikely for now.

The road towards a phase two of tax reform may take some time, but the Republican budget resolution is headed in the right direction.


Source: Tax Policy – New Budget Resolution Gives Hope for Phase Two of Tax Reform

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