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Week of 4.11.08

Fair Tax Options

Many experts agree that there are ways to improve tax collection in an effort to make state tax systems more equitable. Four such measures—which would impact both individuals and corporations—are described below.

1. Earned Income Tax Credit or EITC

The idea behind Earned Income Tax Credit is simple: reward working parents. Low-to income working parents will get back an income tax refund based on the number of children they have. An added benefit: giving parents a leg up helps their kids, too, according to the Center on Budget and Policy Priorities (CBPP). "The EITC now lifts more than 4 million people—roughly half of them children—out of poverty each year; it is the nation's most effective antipoverty program for working families, the CBPP says." Research shows the credits encourage single mothers to get jobs.

A growing number of state governments are also using EITCs. Some states have made the credit refundable—meaning if the refund is greater than what the family pays in state income tax, the family receives the difference. If the family doesn't pay income taxes at all—it receives the entire state EITC. Some states' EITCs only offset the state income taxes.

As revenues increase, state EITCs allow lawmakers to cut taxes for the people who need it most, according to CBPP. They cost less than 1 percent of state tax revenues each year.

Related Links:

CBPP: A Majority Of States With Income Taxes Have Enacted State Earned Income Tax Credits

State EITC Online Resoure Center

EITC Calculator: Who Qualifies?

2. Graduated Income Tax

Although the tax cuts enacted under President George W. Bush have made the federal income tax code more regressive, the U.S. government still collects proportionally more from the rich than it does from the poor. Many state governments, however, do not.

The Institute on Taxation and Economic Policy (ITEP) says that "state personal income taxes...are the main progressive element of state and local tax systems." Alabama, for example, has a nearly flat state income tax. There, a family of four at the federal poverty level, making around $21,000, pays the same percentage of their income in income tax as a family making ten times that amount.

If states want to make their tax structure truly progressive, ITEP says they should create high-income brackets. This ensures that the state collects revenue from citizens who can afford it—paying for roads, schools and other essential services—while alleviating the burden of the poor.

Related Link:

ITEP: Personal Income Taxes

3.Combined Reporting

Many businesses do not pay their fair share in state taxes, according to ITEP. If a corporation has branches in multiple states it is often able to shift its profits from where taxes are higher to where they are lower. Under combined reporting, however, states treat parent and most subsidiaries as one corporation for state income tax purposes. "Their nationwide profits are combined—that is, added together—and the state then taxes a share of that combined income," CBPP says.

Savvy multi-state corporations make use of tax shelters. The corporation transfers ownership of its trademarks and patents to a subsidiary located in Delaware or another state which doesn't tax royalties or interest. Thus, corporate profits go up—at the other states' expense.

More states like New York and Michigan are adopting combined reporting laws, according to CBPP. In Iowa, Governor Chet Culver has been embroiled in a battle over combined reporting for two years. These laws would help ensure that big business pays its fair share.

Related Links:

CBPP: State Corporate Tax Shelters And The Need For "Combined Reporting"

ITEP: Combined Reporting Of State Corporate Income Taxes: A Primer

4. Modernizing Sales Taxes For The Internet

Internet commerce has proved a bit of a conundrum for state and local tax collectors. In 1998, Congress enacted the Internet Tax Freedom Act (ITFA). The law prohibits new state and local taxes on so-called "Internet access" services like America Online or Verizon DSL. President Bush extended the act again last year.

The CBPP says this law prevents states from collecting important revenue. "Today almost 70 percent of American households subscribe to Internet access services, and hundreds of billions of dollars worth of commerce is done over the Internet annually," the CBPP says. It believes that Internet commerce is no longer an infant industry and doesn't need to be protected.

A Supreme Court decision has made it nearly impossible for states to levy sales taxes on items bought online. States are pressing Congress to pass legislation to overturn this ruling.

By failing to levy sales taxes on online transactions and Internet services, states—especially ones like Florida, which has no income tax and relies heavily on sales taxes—are losing out. A California assemblyman recently attempted to tax music downloads, but the measure failed. The Sunshine State is not alone: many states are facing budget shortfalls.

Related Link:

CBPP: A Majority of States With Income Taxes Have Enacted State Earned Income Tax Credits