UNCORRECTED ADVANCE READING COPY NOT FOR SALE OR DISTRIBUTION This advance reader’s copy has been distributed by Oxford University Press for promotional and advance review purposes only. No copying, sale, or further distribution or transmission of this digital galley, in whole or part, is allowed, except to others on your staff and/or assigned reviewers for preview purposes only. This preview copy will NOT expire. However, we do ask that you use a finished copy of the book for fact-checking purposes. Please contact Oxford University Press for more information about this book/author or to request a finished book. 212.726.6033 or publicity@oup.com TAXES IN AMERICA WHAT EVERYONE NEEDS TO KNOW OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd i00_Burman_FM.indd i 8/24/2012 5:48:11 PM8/24/2012 5:48:11 PM OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd ii00_Burman_FM.indd ii 8/24/2012 5:48:11 PM8/24/2012 5:48:11 PM TAXES IN AMERICA WHAT EVERYONE NEEDS TO KNOW LEONARD E. BURMAN and JOEL SLEMROD 1 OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd iii00_Burman_FM.indd iii 8/24/2012 5:48:11 PM8/24/2012 5:48:11 PM 3 Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford New York Auckland Cape Town Dar es Salaam Hong Kong Karachi Kuala Lumpur Madrid Melbourne Mexico City Nairobi New Delhi Shanghai Taipei Toronto With offices in Argentina Austria Brazil Chile Czech Republic France Greece Guatemala Hungary Italy Japan Poland Portugal Singapore South Korea Switzerland Thailand Turkey Ukraine Vietnam Oxford is a registered trademark of Oxford University Press in the UK and certain other countries. Published in the United States of America by Oxford University Press 198 Madison Avenue, New York, NY 10016 © Oxford University Press 2012 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by license, or under terms agreed with the appropriate reproduction rights organization. Inquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. You must not circulate this work in any other form and you must impose this same condition on any acquirer. [Insert Cataloguing Data] 978–0–19–989026–2 (pbk.)—978–0–19–989027–9 (cloth) 1 3 5 7 9 8 6 4 2 Printed in the United States of America on acid-free paper OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd iv00_Burman_FM.indd iv 8/24/2012 5:48:11 PM8/24/2012 5:48:11 PM FOREWARD Who are we? xv Why did we team up to write this book? xvi What’s the book about? xvii Who provided invaluable assistance on this project? xviii PART I HOW ARE WE TAXED? 1 The View from 30,000 Feet 3 Why is everyone always so worked up about taxation? 3 What is a tax? 5 What are the major kinds of taxes? 6 How are taxes like ducks? 6 Are there “hidden” taxes? 8 Are there ways to raise revenue other than taxes? 10 Why not just borrow the money instead of raising taxes? 12 How can taxes be like regulations? 12 How have taxes changed over time? 13 How do state and local taxes vary? 13 CONTENTS OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd v00_Burman_FM.indd v 8/24/2012 5:48:12 PM8/24/2012 5:48:12 PM vi Contents How does the composition of tax vary across federal, state, and local governments? 14 How do tax burdens vary around the world? 14 Federal taxes in the United States have been at about 18 percent of GDP for 50 years. Does that mean that this is the natural rate of taxation? 17 Why is the long-term fi scal outlook so dire? 17 Can taxes be discussed without getting into government spending? 18 2 Personal Income Taxes 21 What’s the difference between personal taxes and business taxes? 21 Who really bears the burden of tax? 22 Are there cases in practice where it does matter who writes the check? 24 Can taxes affect asset prices? 25 What is the personal income tax? 26 Isn’t the income tax a fraud? 26 What are exclusions, deductions, exemptions, and credits? 27 Why are there itemized deductions? Isn’t it unfair that most people don’t benefi t from them? 30 At what income level do people start owing income tax? 31 Is it true that half of households owe no income taxes? 32 Is this bad for democracy? 34 Do we tax capital income the same as labor income? 34 What is economic income? 35 Why do economists think my home earns me rent? 35 Why don’t we tax economic income? 36 How do we tax capital gains and dividends? 38 What are the arguments for and against lower capital gains tax rates? 39 OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd vi00_Burman_FM.indd vi 8/24/2012 5:48:12 PM8/24/2012 5:48:12 PM Contents vii What is the “Angel of Death” loophole? 40 If we want to favor capital gains and dividends, does it make sense to do it via lower rates? 41 What is the AMT? 42 Where the heck did this turkey come from and why is it so hard to get rid of? 43 What is the AMT patch? 44 What is the “Buffett Rule?” 44 What are hidden tax brackets? 46 Does Uncle Sam really want you to live in sin? 46 How does infl ation affect the income tax? 50 What are payroll taxes and how are they different from income taxes? 52 Aren’t other taxes also dedicated to Medicare and Social Security? 53 Is it true that most taxpayers owe more payroll than income tax? 55 3 Business Income Taxes 56 How do we tax corporations’ income? 56 Why do economists say that we “double tax” corporation income? 57 What are the others ways business income is taxed? 58 Why tax corporations? 60 Which people bear the burden of the corporate income tax? 63 What are the impacts of double-taxing corporate income? 63 What would happen if we just eliminated the corporate income tax? 64 How can some companies get away with paying no income tax despite billions in profi ts? 65 Why is it troublesome that some companies view their tax departments as profi t centers? 67 Income earned by corporations is double-taxed, and tax avoidance opportunities abound. Make up your mind—Is corporate income taxed too much, or too little? 67 OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd vii00_Burman_FM.indd vii 8/24/2012 5:48:12 PM8/24/2012 5:48:12 PM viii Contents What is depreciation? 69 What is “bonus depreciation?” 72 Are there implicit spending programs run through the corporate income tax? 73 Are multinational corporations taxed differently than domestic companies? 75 What is a foreign tax credit? 75 Why do we try to tax corporations on their worldwide income? Why not follow the practice in most of Europe and simply exempt foreign income from tax? 76 What is transfer pricing? Why is it important to multinational corporations (and taxpayers)? 79 What is formulary apportionment? Would that be a better option than trying to enforce transfer pricing rules? 80 What are tax havens? 81 How does the U.S. corporate tax rate compare to the rate of other countries? 83 Does our relatively high corporate tax rate hurt our companies’ competitiveness and the country’s competitiveness? 85 How do recent corporate tax reform proposals work? 87 4 Taxing Spending 90 What is a consumption tax? 90 Why tax consumption rather than income? 90 A consumption tax sounds great. What’s the catch? 92 What is a retail sales tax? 94 What is a use tax? 95 What is a luxury tax? 96 What is an excise tax? 97 What is a sin tax? 97 What is a Pigouvian tax? 98 What is a VAT? 99 OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd viii00_Burman_FM.indd viii 8/24/2012 5:48:12 PM8/24/2012 5:48:12 PM Contents ix The credit-invoice VAT sounds really complicated. Why do it that way? 100 Are small businesses subject to the VAT? 100 Why doesn’t the United States have a VAT? 101 How much money would a VAT raise? 102 What is the typical VAT rate in other countries? 102 How would a federal VAT interact with state and local sales taxes? 103 Does a VAT promote exports? 104 What is the fl at tax? 105 Wouldn’t a fl at tax be super simple and fair? 105 There are fl at taxes all over Eastern Europe. Are they the same as the fl at tax advocated for the United States? 107 What is the X Tax? 107 What is a consumed income tax? 108 Are tax breaks for saving and retirement indirect steps toward a consumption tax? 108 Do these tax breaks actually encourage saving? 109 If the economy runs on consumption, why would we want to encourage saving? 111 What’s the difference between Roth and traditional IRAs? 112 Do consumption taxes disproportionately burden the old? 115 5 Other Kinds of Taxes 116 What is the estate tax? 116 How is estate tax liability calculated? 119 Why tax estates when the assets that went into them were already subject to plenty of tax? 121 What are the estate tax’s effects on work and saving? 122 How does the estate tax affect small businesses and family farms? 123 What is the difference between an estate tax and an inheritance tax? 123 OUP UNCORRECTED PROOF – FIRST-PROOF, 08/24/12, NEWGEN 00_Burman_FM.indd ix00_Burman_FM.indd ix 8/24/2012 5:48:12 PM8/24/2012 5:48:12 PM [...]... building a plant in Michigan, but the corporate income tax may do that Likewise, no politician wants to discourage spouses from entering or staying in the workforce, but the individual income tax can do that Some taxes, though, are intended to change behavior One reason for taxing gasoline is to induce people to use less energy Carbon taxes are designed to reduce emission of greenhouse 01_Burman_01.indd... postpones the reckoning of this burden, which will be felt through higher taxes in the future, cutbacks in future government spending or the inflation tax just discussed (See page 000, “Why not run deficits forever?”) How can taxes be like regulations? In most cases taxes are designed to raise revenue, and the changes in behavior they induce are unintended, undesirable byproducts No policymaker intends to deter... corporations Thus, in principle, one can legally avoid income tax by not earning any income (or have income below a threshold amount), avoid retail sales tax by not buying anything, and avoid property tax by not owning any residential or commercial property Of course, earning no income at all is not advisable even though it lowers tax liability; our point is that the amount of tax due 01_Burman_01.indd 5 8/23/2012... the minute In the spring of 2006, the New York Times reported that in hyperinflating Zimbabwe, toilet paper cost 417 Zimbabwean dollars—not per roll but per single two-ply sheet—a roll cost $145,750, and Zimbabwe printed $100,000,000,000,000 (100 trillion dollar) bank notes!!6 Why not just borrow the money instead of raising taxes? The federal government can borrow money to fund its operations, and in. .. financial institutions to hold public bonds at below-market interest rates—a practice called “financial repression”—which is another way to effectively obtain wealth from the private sector The United States does not typically print money to fund a nontrivial fraction of its operations But in the past century several countries in desperate fiscal situations have resorted to the printing press, causing... contours of federal and state tax systems For instance, in a recent poll a majority of Americans either think that Social Security tax and Medicare tax are part of the federal income tax system or don’t know whether it is or not, and more than six out of ten think that low-income or middle-income people pay the highest percentage of their income in federal taxes Neither is correct Thus, there is a desperate... (“inside the sausage factory”) covers tax politics and tax reform Although taxes can be a mind-numbing topic, we hope to key our discussion to issues that are or are likely to be on the mind of the average taxpayer and be in the news, as well as interesting information that many readers might not know about (such as how the IRS decides whom to audit) We have tried to employ a light touch, interjecting... explain why people don’t like economists? 130 PART II THE COSTS AND BENEFITS OF TAXATION 6 Taxes and the Economy 133 How do taxes affect the economy? 133 Why do economists think that raising funds costs much more than the tax sticker price? 134 Do some taxes help the economy? 134 What is the Laffer Curve? 135 Which is a better economic stimulus, cutting taxes or spending more? 135 What kinds of taxes. .. causing hyperinflation and disastrous consequences for the economy During the single year of 1923, the Weimar Republic of Germany saw its price level increase by the mind-boggling factor of 481.5 billion.5 The printing presses ran all night and issued notes of larger and larger 01_Burman_01.indd 11 8/23/2012 6:16:30 PM OUP UNCORRECTED PROOF – FIRST-PROOF, 08/23/12, NEWGEN 12 HOW ARE WE TAXED? denomination,... “see-through” office buildings (which could be profitable in the early 1980s because of tax benefits despite a dearth of tenants) Tax policy affects the rewards or costs of nearly everything you can think of It increases the price of cigarettes and alcohol, lowers the cost of giving to charity, reduces the reward to working, increases the cost of owning property or transferring wealth to your children, . outlook so dire? 17 Can taxes be discussed without getting into government spending? 18 2 Personal Income Taxes 21 What’s the difference between personal taxes and business taxes? 21 Who really. the major kinds of taxes? 6 How are taxes like ducks? 6 Are there “hidden” taxes? 8 Are there ways to raise revenue other than taxes? 10 Why not just borrow the money instead of raising taxes? 12 How. really want you to live in sin? 46 How does in ation affect the income tax? 50 What are payroll taxes and how are they different from income taxes? 52 Aren’t other taxes also dedicated to Medicare