Sunday, January 29, 2006

No football to entertain you this Sunday? How about ... exciting tax news and analysis!

Wages Earned in Antarctica Aren't Foreign-Earned Income

The Tax Court has held that the wages a U.S. citizen received while working in Antarctica can't be excluded from income using the foreign-earned income tax credit ... because Antarctica isn't a foreign country.

Dave Arnett v. Commissioner [.pdf] ; 126 T.C. No. 5; No. 8866-03.

Sex Change Operation Costs Aren't Deductible As A Medical Expense

The IRS has determined that the costs of male-to-female gender reassignment surgery and related medications, treatments, and transportation are not deductible as medical expenses ... "[The Tax Code] provides that the term 'medical care' does not include cosmetic surgery".

IRS Legal Memorandum 200603025

Healthcare Reforms to Come Through Tax Code, Breaux Says
Now that does not sound particularly encouraging.

Although President Bush has pushed for sweeping reforms to the tax code and the Social Security system, healthcare reform will likely come through "more incremental moves" and adjustments to the tax code, former Senate taxwriter John Breaux said January 20.

Breaux, who served as the vice chair to the President's Advisory Panel on Federal Tax Reform last year, told an audience at the American Enterprise Institute that healthcare is "the largest single expenditure in the tax code," with about $141 billion annually spent on healthcare through exclusions and deductions within the tax code. The income tax exclusion for employer-provided healthcare, itemized deductions for medical expenditures, and tax-preferred health savings accounts are just a few of the policies the federal government uses to promote healthcare through the code, Breaux said.

According to Breaux, more than 27 percent of the tax code's health benefits go to taxpayers earning over $100,000 a year.... [Tax Analysts]

A Broader Perspective on the Tax Reform Debate

-- by Michael J. Boskin, professor of economics at Stanford University, and Chairman of the President's Council of Economic Advisers from 1989 through 1993.


....I use five big-picture tests to judge tax reform proposals.

1. Will tax reform improve the performance of the economy?

By far the most important aspect of economic performance is the rate of economic growth, because that growth determines future living standards. The most important way the tax system affects living standards is through the rate of saving, investment, work effort, entrepreneurship, and human capital investment.

Modern academic public economics concludes that immense harm is done by high marginal tax rates, especially on capital income. That is a major reason virtually all prominent academic economists who have studied the issue recommend taxing consumption or that part of income that is consumed....

On those criteria, low flat-rate consumption taxes work best, high-rate progressive income taxes worst. A growing body of research suggests that replacing the corporate and personal income taxes with a low-rate pure consumption tax is the single most potent policy reform available...

An important dimension of economic performance is administrative and compliance costs, estimated by the Panel at more than $140 billion per year. Here the flat tax, retail sales tax, and the VAT do far better, and the SIT and GIT somewhat better, than current law if enacted as a replacement.

But if a sales tax or a VAT were added without removing the income taxes, large additional administrative and compliance costs would result....

2. Will tax reform affect the size of government?

It is important to control spending for its effect on tax burdens and economic performance. The economic harm done by taxes distorting private decisions to save, invest, work, and so on goes up with the square of tax rates. Doubling tax rates quadruples the cost.

The marginal cost is proportional to tax rates. Hence, each dollar of additional revenues costs the economy about $1.40. When it is spent - - as legislated by Congress, adjudicated in the courts, and administered by human beings -- some of it is wasted, some not narrowly targeted on the intended purpose. Perhaps $0.80 or $0.90 contributes to the intended outcome in a well-run program; only $0.30 or $0.40 in a poorly designed and administered program.

Further, some of that government spending crowds out private spending on the targeted activity. So the net government-financed increase in spending on the activity is even less. Thus, rigorous cost-benefit tests would reveal many spending programs badly in need of reform and retrenchment.

Tax reforms that more closely tie the payment of taxes to expenditures will promote a more effective and efficient government ... If everybody pays at a common rate, it will be harder to expand government and raise the rate, because a larger fraction of potential voters will have a stake in limiting the spending.

The more progressive the tax system becomes and the more concentrated among the few taxes become, the easier it is to expand government at the expense of a minority paying the bulk of costs. That was Milton Friedman's most important insight when he first proposed a flat tax in Capitalism and Freedom. That aspect of the case for a flat tax has unfortunately almost been lost in recent decades, as attention has focused on the important goal of simplicity, as in the postcard filing in the Hall-Rabushka (1983) flat tax.

Highly progressive rates also create an unhealthy dynamic in which revenues surge disproportionately in booms: The legislature spends it all (or more) and in the next downturn it is impossible to cut spending, leaving a growing fiscal gap and pressure to raise taxes to allow spending to ratchet up in the next boom. That is precisely what happened in California in 1999-2001 when revenues surged far more than rapidly rising income during the tech bubble, and state spending went up faster still. The inevitable correction led to a crisis with the state's credit rating below Puerto Rico's and the governor recalled....

Some proponents of the retail sales tax believe it would help control the growth of government spending by forcing an explicit transparent payment in support of spending on all consumers at the point of transaction, thereby greatly expanding the fraction of voters paying something to finance general government.

Others believe a broad-based retail sales tax or a VAT would collect so much revenue per percentage point that it would too easily finance government growth...

A new tax -- a broad-based consumption tax, like a European VAT, for example -- may just be piled on top of the existing taxes and used to raise revenue to finance government growth. That is what has happened in many European countries and is now a major detriment to their economic performance....


We have a rapidly closing window within which to have this great national strategic debate about the role of government in our economy, about the level and structure of spending and taxes.

In a few years, the demographics may drive an unstable political economy with an ever-larger fraction of voters demanding higher spending financed by higher taxes on a dwindling fraction of the population.

Witness how difficult it is for the Europeans -- with their larger ratios of benefit recipients to taxpayers -- to make reforms that we would consider trivial, even from much higher levels of spending and taxes.

Our collective interest is in keeping the hand of government in the economy light. In keeping tax rates as low as possible. In preventing spending, tax, and regulation decisions from gradually turning our society into the economic equivalent of France or Germany, for that would surely portend economic and social disaster.

Replacing the corporate and personal income taxes with the GIT or something still closer to a pure flat rate consumption tax that prevents the projected increase in the tax share of GDP would be an important step in doing so. [Economists' Voice]