Protecting Taxpayers: Burdens of Proof in Gov't Spending

“Charity is no part of the legislative duty of the government.”

-- Annals of the Third Congress, 794, paraphrasing a speech from James Madison

In the first session of the Third Congress in 1794, the House of Representatives engaged in a robust debate about whether to allocate $15,000 for the assistance of refugees fleeing the Haitian Revolution. The Annals of that debate showcase how James Madison (pictured), the author of the Constitution and one of the most influential voices on the shape of early American government, envisioned how debates over taxpayer-funded projects should transpire.

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Mr. Madison wished to relieve the sufferers, but was afraid of establishing a dangerous precedent, which might hereafter be perverted to the countenance of purposes very different from those of charity. He acknowledged, for his own part, that he could not undertake to lay his finger on that article in the Federal Constitution which granted a right of Congress of expending, on objects of benevolence, the money of their constituents.

Despite Madison’s consternations, Congress allocated the funds and would later go on to make similar appropriations for the citizens of Venezuela ($50,000, 1812). Today, the U.S. government continues to invest taxpayer dollars in foreign aid—a total of roughly $55 billion in FY 2012 (divided roughly 60-40 between economic and military aid, respectively). While this provision is less than 1 percent of the American budget, it consistently draws the ire of the public and politicians on both ends of the political spectrum (though louder opponents tend to be on the Right).

This column is not about the pros and cons of the American foreign aid budget—a topic for another time—but rather, as Madison grappled with 220 years ago, the process by which we make decisions about how to allocate scarce taxpayer dollars and who bears the burden of proof in the case about whether or not to spend.

While I’ve struggled to understand the “First Principles” of spending for years, I began to get some clarity last week during a group budget exercise that I took part in as part of an interview for Community Board 8 on the Upper East Side of Manhattan. For my loyal Bay State readers, community boards are the closest NYC gets to the traditional New England “town meeting.” There are between 3-18 boards in each of the five boroughs, with 50 volunteer members appointed to each board. The boards discuss an array of local issues, from land use/zoning to transportation and education.

The budget exercise involved dividing $100 million of “new” money between 10 priorities. While there was some consensus among the group that transportation, affordable housing, and social assistance (SNAP, etc.) were more important than parks and cultural institutions, there was a significant divide on the question of whether each of the 10 priorities should receive some of the $100 million.

I asked people who wanted to give each priority some funding to explain their position, given that we had agreed that certain priorities were much more important than others. Before answering my question, a fellow interviewee turned the question around on me, asking me to state why each priority should not receive some of the funds.

Luckily for the rest of the group, we did not have time to explore the subject further. However, the exchange felt familiar to me as a lawyer—a profession where questions about the appropriate burden of proof and who bears that burden are commonplace.

I posit the following first principle, in the spirit of Madison’s judgment above: that those who seek to spend taxpayer money (as opposed to not spend taxpayer money) have the burden of proof, and that they must prove that such an expenditure will address a specific, quantifiable problem that government is either uniquely or appropriately suited to combat.

I say this as a Liberal, who believes that government should invest heavily in infrastructure, both physical (roads, rails, dams, electric grids) and human (education, R&D, Social Security, Medicare). But Americans, for better and worse (and I think, generally, for better), have a historic suspicion of government overreach.

Furthermore, we’ve seen time and time again that Americans will actually embrace taxes if they believe that the funds are being spent efficiently on a priority of utmost importance. This is true in red states and blue. Just this year, Jackson, Mississippi voters overwhelmingly approved a 1 percent increase in the sales tax to fund critical infrastructure improvements. Even traditionally-car-crazed Los Angeles recently approved a sales tax increase to fund public transportation.

The bottom line is that officials should have to justify every penny of spending to the public. In so doing, we will not only root out programs that are inefficient and ineffective, we’ll also bring transparency to a budget process that has eroded public confidence in our government, creating a vicious cycle of disinvestment in our public assets.

E-Cigs and the Never-Say-Die Attitude of a Deadly Industry

“The fragile, developing self-image of the young person needs all the support and enhancement it can get. Smoking may appear to enhance that self-image in a variety of ways.”

-- Claude Teague, Senior Researcher, R.J. Reynolds Tobacco, 1973

“The use of e-cigarettes does not discourage, and may encourage, conventional cigarette use among U.S. adolescents.” That was the conclusion of a new study published in the Journal of the American Medical Association last week, highlighting the continued challenge facing public health officials in determining appropriate regulation of a booming new market that simultaneously promises a less harmful alternative to conventional cigarettes, but may well be an end-around the anti-tobacco efforts that have driven youth smoking rates down since the 1990s (see chart from the CDC). Indeed, since 1997, smoking among 8^th, 10^th, and 12^th graders in the U.S. has declined by nearly two-thirds.

Within the public health community, the conclusions reached in the JAMA study are far from consensus. As Thomas J. Glynn, a researcher at the American Cancer Society, told the New York Times, “The data in this study do not allow many of the broad conclusions that it draws.” Furthermore, the study fond that youth who used e-cigarettes were more likely to plan to quit smoking.

While a consensus remains elusive about the effects of e-cigarettes on youth and the population writ large, the plans of the tobacco industry could not be clearer. The tobacco industry has invested heavily in e-cigarettes (see list below) and it is actively working to develop a more addictive cigarette. 

·      Lorillard (LO) (Blue eCigs/SKYCIG)

·      Altria Group (MO) (Markten ecig)

·      British American Tobacco (BTI) (Vype ecig)

·      Reynolds American (RAI) (VUSE ecig)

As RJR researchers noted above 40 years ago, “Realistically, if our Company is to survive and prosper, over the long term we must get our share of the youth market…[T]his will require new brands tailored to the youth market.” This statement is as true today as it was then. As the Surgeon General reported earlier this year in a landmark report, 87 percent of smokers use their first cigarette by 18 years of age, with 98 percent starting by age 26.

It comes as no surprise, then, that the tobacco industry views e-cigarettes, like Joe Camel before them, as a gateway to hook youth on nicotine.

According to the CDC, nearly 7 percent of American youth in grades 6 through 12 tried an e-cigarette in 2012, more than double the rate in 2011. This shouldn’t be a surprise, given that e-cigarette marketing is transparently directed toward kids, both in terms of cost (e-cigs cost significantly less on average than conventional packs) and flavoring. Indeed, as USA Today noted, while the FDA banned flavored tobacco cigarettes, there are no such restrictions on cigars or e-cigarettes. This regulatory loophole has led to flavors like Fruit Loops and cookies and cream.

The tobacco industry is once again leaving no stone unturned to get at this potentially lucrative market. In January, a group of tobacco companies sued the City of New York in federal court to halt new regulations slated to go into effect this month. The companies allege that the City’s ban on coupons and otherwise promotionally priced tobacco products are an unconstitutional restriction of free speech (in addition to being preempted by both federal and New York State law).

If you are rolling your eyes at the idea that barring coupons from being used to circumvent national efforts to boost the price of cigarettes in order to (a) pay for a portion of the health costs imposed by the industry’s product and (b) dissuade children from picking up the deadly habit, implicates the First Amendment, you aren’t alone.

Last week, the Campaign for Tobacco Free Kids filed an amicus brief on behalf of the City, highlighting the inverse relationship between cigarette price and cigarette use. In particular, the Campaign noted how Philip Morris’ 1993 “Marlboro Fridays” program (and the corresponding cuts in prices by competitors) led to an immediate and sharp increase in youth tobacco consumption.

So what are public health officials to do while we await better data about the effect of e-cigs? I think they need to do three things, keeping in mind our first principles:

1.     The government should fund independent research into the effects of e-cigarettes on users and others who breathe in supposedly harmless “water vapor”. Until the “vapor” is found to be safe, e-cigarette use should be banned in public accommodations to reduce the chances of second-hand harm.

2.     The government should aggressively restrict marketing of e-cigs to youth and should, in the interim, classify e-cigs as tobacco products (as the FDA has) for the purpose of taxation, all while keeping in mind that tax breaks (and even credits) could be worthwhile if e-cigs are shown to enable smoking cessation (like nicotine gum).

3.     Public health officials should actively market smoking cessation products to young people—with PR campaigns focused near schools, parks, and malls. Whether hooked on conventional cigarettes or the trendy-tech version, all people—but especially our children—deserve a chance to wean themselves from addiction.

Despite a multi-billion dollar settlement in 1998, the tobacco industry has proven resilient in developing new and deadly campaigns to hook young people on nicotine. We are in the opening stanzas of the E-Cig industry and it is incumbent upon us to not exhibit the same naïveté in the face of the tobacco companies as we did for much of the 20^th century. If we do, the effects will continue to be measured in billions of dollars and millions of lives.

Tax Time, Part IV: Retirement Security for the 21st Century

“Properly integrated, they may be looked upon as a three-legged stool affording solid and well-rounded protection for the citizen.”

-- Reinhard A. Hohaus, actuary, Metropolitan Life Insurance Company, 1949

Last year, the National Institute for Retirement Savings released a report showing that the average working household has virtually no retirement savings. In fact, as shown in the chart below, NIRS found that the median retirement account balance is $3,000 for all working-age households and $12,000 for near-retirement households.

There are many reasons why this crisis has come to past, but one of them has been the steady erosion of the “third leg” of the American retirement stool: the defined-benefit pension. In 1975, there were 2.4 participants in defined benefit pension plans for every one participant in a defined contribution plan (Department of Labor, 2007). However, by 2011, Treasury Department data showed that out of $11.2 trillion of private pension assets, only 21 percent were maintained in defined benefit plans, with the remainder held in defined contribution plans (36 percent) and IRAs (43 percent).

However, the decline in DB pensions—while of great concern to many on the political Left—is not the only contributor to America’s retirement problem. A major reason for the lack of savings is the fact that many American families do not earn sufficient wages in the first place to set aside money for retirement, particularly with stagnant wage growth over the last 20 years.

Furthermore, our tax code also does working-class Americans few favors. Let’s take a closer look at the code and what can be done to boost security for working class Americans.

Last year, the Center for Budget and Policy Priorities found that nearly 2/3 of the benefits of the retirement tax incentives went to the top 1/5 of U.S. income earners (see chart, left).

Despite noble and consistent efforts by federal, state, and local governments to boost financial literacy and encourage individuals to open retirement accounts, low-income Americans who have retirement accounts continue to be the exception rather than the rule. Indeed, as of 2010, only 1 in 9 Americans in the bottom 1/5 of income had a retirement account, while nearly 8 in 9 at the top 1/5 had such an account.

While far from a panacea for the retirement security crisis, universal savings plans offer an elegant solution. Legislators on both sides of the political spectrum have long embraced these plans.

In 2006, Senators Rick Santorum (R-PA), Jon Corzine (D-NJ), Chuck Schumer (D-NY), and Jim DeMint (R-SC) proposed the ASPIRE Act, which would have would have automatically opened a KIDS Account for every child assigned a Social Security number. The account would be funded with a one-time $500 contribution, and children in households earning below national median income would be eligible for up to an additional $500.

In a similar vein, Senator Jeff Sessions (R-AL) proposed PLUS Accounts that would be automatically opened for citizens born after 12/31/07 and funded with a one-time $1,000 contribution. The PLUS program would have later expanded to all U.S. citizens under the age of 65 and included mandatory, pre-tax contributions of 1% of each worker’s income (the worker could choose to contribute up to 10%). Under the Session plan, employers would also be required to contribute at least 1% (and up to 10%) of earnings.

While the Tea Party has made such automatic savings/retirement accounts anathema to many in the GOP, these universal, automatic plans continue to be one of our best hopes for helping boost retirement savings for all Americans—particularly those at the bottom end of the income scale. Indeed, according to the Brookings Institution, these types of automatic savings systems “have proven remarkably effective in raising 401(k) participation rates,” particularly for populations that are traditionally vulnerable to retirement insecurity, including women, Hispanics, and low-income Americans (see chart, below).

In addition, Congress must make the “Saver’s Credit” refundable to encourage additional savings by lower-income families. The credit provides a tax credit of up to $1,000 (up to $2,000 if filing jointly) on eligible contributions to a qualified retirement plan, an eligible deferred compensation plan, or an IRA. However, because it is non-refundable, it provides no incentive for nearly 50 million households that have no income tax liability.

Lastly, we need to change our eligibility rules for public benefits so that low-income Americans should not be needlessly penalized for making smart decisions to plan for retirement. For instance, in New York, the asset cap for Temporary Assistance for Needy Families (TANF) does not exclude retirement savings.

By creating new carrots to nudge low-income families to save when possible and eliminating needlessly cruel sticks that penalize these families for prudent financial planning, we can work to build new legs of a retirement stool for the 21^st century.

Tax Time, Part III: First Principles for Tax Expenditures in NYC + Beyond

New York City’s FY 2014 budget officially stands at nearly $74 billion. New York State’s FY 2014 budget clocks in at $136 billion. The true numbers, however, are much higher, as both the City and the State give away billions of dollars in so-called tax expenditures: the breaks that allow individuals, institutions, and corporations to avoid paying tax in the first place.

According to the Government Accountability Office, the federal government sacrificed more than $1 trillion in tax revenue through 169 tax expenditures in FY 2012—roughly equivalent to the federal budget deficit that year and nearly 7 percent of GDP. The largest tax expenditure in the nation is the tax free status of employer-sponsored health care benefits ($184 billion), followed by retirement savings plans (401(k)) ($91 billion), and the mortgage interest deduction ($82 billion).

These tax expenditures inure largely to the benefit of the wealthiest Americans. As Robertson Williams of the Tax Policy Center reported in 2011, the top quintile receives nearly 65 percent of the value of tax expenditures (roughly equivalent to the share of total taxes paid), while the bottom quintile receives less than 4 percent of income from tax expenditures (but pays very little in federal income tax).

While arguments about the costs and benefits of these expenditures will continue to rage in Congress, we’re going to focus on New York City’s tax expenditures using the City and State’s annual tax expenditure reports.

New York City doles out over $6 billion in tax expenditures every year. Without throwing the whole system out (which is the preference of many economists), it is difficult to determine first principles for addressing these expenditures. However, I believe the following should guide policymakers in their efforts:

(1) That expenditures that support the poor are generally better than expenditures that support the well to do;

(2) That expenditures with provable outcomes are generally more supportable that expenditures with uncertain effects; and

(3) That expenditures with shorter time horizons are preferable to long-term expenditures (i.e. a 30-year abatement), given both the uncertainty of the future (i.e. what the “value” of the abatement will be) and the potential for additional experimentation (say, in how to structure an affordable housing situation)

Moreover, these expenditures must be made more transparent during the budget process itself, rather than simply as a report to be issued after the Fiscal Year ends. The public deserves to understand who benefits from abatements and what benefits are accruing to the public as a result. One way to do this is by launching a uniform development budget, which Bay State Brahmin will investigate further in a later post.

For now, let’s take a dive into NYC’s expenditures, starting with property tax abatements, then moving to business taxes, and sales/income tax breaks.

PROPERTY

I. The Senior Citizen Homeowners' Exemption applies a sliding scale of property tax relief to homeowners earning less than $37,399. However, no asset limit exists, which is potentially problematic because seniors have often paid off the fixed costs that take up so much of a working individual’s income (education debt/housing cost/etc.). 

II. The Clergy Exemption is unique in that it can apply to property owned by a member of the clergy that is not the clergy’s primary residence. Indeed, it can even be an income generating property. No similar exemption exists for other leaders of non-profits. I believe the Clergy Exemption, standing alone, is unconstitutional.

III. The Commercial Expansion Program is designed to stimulate office space development in Manhattan North of 96^th Street and all areas of the other four boroughs. It might be time to reexamine the geographic parameters, given that some neighborhoods in the boroughs today do not need this abatement to stimulate demand. Similarly, the Commercial Revitalization Program, which focuses on Lower Manhattan, should be reconsidered in light of Lower Manhattan’s immense growth/demand relative to other neighborhoods.

IV. Lower Manhattan Conversion: What if I told you that we spent $85 million in FY 2013 giving tax breaks to developers to convert non-residential buildings to residential use in some of the richest neighborhoods in the City (i.e. where residential development is already incredibly profitable). You’d say that was crazy. Well, color us crazy. We continue to do this in Lower Manhattan, though only for buildings that were issued permits prior to 2007 (thus, we should see this figure sunset over time).

V. The “Green Roof” Abatement only cost $100K in 2013 (which signals that it may not be well-known). Notably, it sunsets this year and the City Council should strongly consider pressing for renewal.

   

BUSINESS

I. Insurance Corporations: One of two big ones (the other being Business and Investment Capital, which provided $320 million to only 32 corporations), insurance corporations don’t pay the General Business Tax in NYC. This costs the City about $365 million annually (they used to pay taxes, but the tax was eliminated in 1974, when New York City was desperate to hang on to whatever business it could). It’s not at all clear why this one industry (which is quite wealthy and dominated by a handful of multi-national corporations) should receive this benefit.

II. The Film Production Credit cost the City $33 million last year. These credits have been widely criticized nationwide. Ironically, NYC probably needs the tax credit least since the City itself is such an immense draw for shows/movies (the world recognizes our skyline, not Milwaukee’s…)

III. Relocation and Employment Assistance Program (REAP): $32 million spent on helping firms relocate from outside NYC to locations north of 96^th Street in Manhattan, Lower Manhattan, and the boroughs outside Manhattan. It is far from clear that Lower Manhattan (or other neighborhoods in the City, such as Downtown Brooklyn) need a special incentive program (indeed, it wasn’t part of the program until 2004).

SALES/INCOME

I. Aviation Fuel Sold to Airlines: I wouldn’t have guessed this, but fuel sold to airlines at LGA and JFK is tax-free. Why? Certainly not to stimulate demand—the City’s airports have no vacant landing/takeoff slots. This giveaway to the airlines it cost you and me $117 million in 2013—the largest sales tax expenditure (as an aside, millions of New Yorkers continue to pay sales tax when they fill up at the pump). In addition, Airline Food and Drink for In-Flight Consumption is exempt (an additional $4 million).

II. Cable Television Service: Not only are we subsidizing the airlines, we are subsidizing the cable companies, to the tune of $101 million a year.

III. Credit for Unincorporated Business Tax Payments: This one gets a special star for incompetence, not because it is necessarily a bad credit, but because of how it is structured. The goal of the credit is not to “double tax” individuals who own/operate unincorporated businesses that pay the UBT (unincorporated business tax). Therefore, the credit lowers personal income tax (PIT) liability. It offers a 100% credit up to $42,000 in income, a sliding scale between 100%-23% up to $142,000 in income, and 23% for all income above $142,000.

So who benefits? You might think the dude earning $42,000 who gets the 100% credit. And, in a way, you are right (his PIT is eliminated completely). But really, you’d be wrong. Why? Because $97 million of the $126 million in benefits went to New Yorkers earning more than $1 million a year. Another $11 million went to folks earning between $500,000 and $1 million.

Tax Time, Part II: Eliminating Predatory Tax Return Services

Yesterday, we examined how expansions in the Earned Income Tax Credit (EITC) at the federal, state, and local levels can improve life for the working poor in the five boroughs and beyond.

Unfortunately, it is not enough to simply boost the EITC. We need to make the credit real by addressing the scourge of tax refund services that offer fast cash in exchange for significant fees associated with filing taxes.

We can do this in two ways. First, we need to partner with non-profit community organizations to expand successful PR campaigns to highlight the fact that NY provides FREE tax filing to people who earned less than $58,000 (adjusted gross income) in tax year 2013 (that’s nearly 60 percent of NYC households), both online and in person at dozens of locations throughout the five boroughs. Refunds for e-filing are usually issued within 30 days.

Second, we need legislation to limit predatory behavior that siphons EITC and other credits from those most in need. Currently, the vast majority of tax return advance companies aren’t actually committing fraud. All that means is that people can be ripped off and have no recourse.

In 2013, the Federal Government largely banned regulated banks from offering “refund anticipation loans” (RAL), which for years had swindled millions of low-income Americans (7.2 million in 2009) out of a significant portion of their tax returns in exchange for getting fast cash a few weeks in advance (in other words, it was a payday loan in disguise).

To give you a sense of just how usurious RALs are, consider that the last bank to offer an RAL in 2012—Republic Bank & Trust Company of Louisville, Kentucky—charged individuals $61.22 for a $1500 tax refund advance, the equivalent of an APR of 149 percent.

However, while the RAL is now technically a thing of the past, it lives on in a variety of guises—most notably the “refund anticipation check” (RAC) which is not a loan, but which carries fees of around 30 dollars and can include “add-on” surcharges running into the hundreds of dollars. The elimination of the RAL has led directly to growth of RACs—from 12.9 million in 2009 to 18.3 million in 2011.

Consumer champions in Congress—including Senator Elizabeth Warren (D-MA)—should work with the Consumer Financial Protection Bureau and state/federal law enforcement to prosecute fraudulent actors and identify gaps in existing law.

But New York shouldn’t wait for D.C. to act. Legislators should pass existing legislation in Albany that seeks to improve transparency of RACs and set limits on the usurious loan rates they currently impose.

The Empire State has one of the toughest payday loan laws in the nation— any non-bank lender who charges more than 16 percent interest in New York is subject to civil prosecution; charging above 25 percent can subject lenders to criminal penalties up to a Class C felony—and as the financial capital of the world, we should continue to lead the nation in progressive regulatory policy that protects consumers while permitting legitimate actors in the banking industry to offer a wide variety of services.

Tax Time, Part I: The Continued Promise of the EITC

As we enter tax season, Bay State Brahmin is going to have a series of posts on the federal, state, and local tax codes—identifying a variety of changes that can benefit the working class and the need for additional regulatory structures to protect vulnerable taxpayers.

Today, we’ll take a look at the Earned Income Tax Credit (EITC)—both its remarkable success since its launch under President Reagan, and the opportunity for New York City to use its municipal EITC to help the most vulnerable New Yorkers.

First, the good news: the EITC continues to be one of the most effective anti-poverty programs in U.S. history (alongside Social Security, Medicaid, and Food Stamps). According to the Census Bureau, the EITC lifted some 6.5 million people above the poverty line, in 2012—including over 140,000 residents in Massachusetts and nearly 550,000 New Yorkers—roughly half of whom are children. All told, in Massachusetts, more than 394,000 tax filers received $784 million in EITC credits in 2012, while 1.7 million New Yorkers qualified for $3.9 billion in support.

The EITC is particularly valuable because its effects are more highly concentrated among the very poor. The Congressional Budget Office (CBO) found that 15 percent of wage benefits from a federal minimum wage hike would go to households living below the poverty line, while 60 percent of expanded EITC benefits would reach poverty level earners. Furthermore, the EITC has been shown to encourage work and improve the health and academic performance of poor children.

Despite the success of the EITC at the State and Federal levels, many poor NYC residents continue to face considerable City income tax burdens. According to the Drum Major Institute, 224,200 low and moderate-income New York City households (about 720,000 people—including many children) paid New York City income taxes in 2008 even though they owed no federal and/or state income taxes. These families accounted for $71.9 million in NYC taxes in 2008— less than two-tenths of one percent of total city revenue for the year.

This effect is due largely to the fact that New York City’s income tax lacks the broad exemptions in the state/federal tax codes and that the City EITC (which took effect in August 2004, joining San Francisco as the only other major U.S. City with a municipal EITC) is worth only 5 percent of the federal credit. 

Indeed, while the City EITC has grown in recent years (see chart, above), providing $93.1 million to over 882,000 households in 2010, the average credit was only $105.

NYC should target relief to the working poor by increasing its municipal EITC. If the City can afford a dramatic cut in the corporate tax rate ($2.7 billion in savings to 27,000 companies, including many of the city's largest, over the first 10 years, starting in FY 2010), surely it can do something to help New York households struggling to make ends meet.