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This page contains a single entry from the blog posted on October 13, 2004 4:40 PM. The previous post in this blog was Not enough information. The next post in this blog is The liveable (stab, stab) city. Many more can be found on the main index page or by looking through the archives.

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Wednesday, October 13, 2004

My world, rocked

Just when I hit the busy time of year, Congress goes out and passes a second big federal tax bill for this fall season. This bill was spawned by the tawdriest features of our foreign trade policy, and it lives up to its ugly ancestry.

The new law, which W is prepared to sign, makes an effort (albeit a half-hearted one) to remedy the most blatant violations of the World Trade Organization rules that are present in our tax laws. Members of the WTO aren't supposed to use their tax laws to subsidize exports, but the United States has done that for decades -- including in the old days, when our tax laws broke our promises under the old GATT treaty regime.

We're now under heavy WTO sanctions for our misdeeds, and so it recently became clear that there was going to be a corporate tax law revision soon. There had to be one. And when the Gucci Gulch lobbyists see that tax legislation is inevitable and imminent, they spring into action, proposing one pet tax perk after another. If there's a congressional election just weeks away, the lobby groups get an even stronger hand than the one they normally play.

Sometimes Congress is smart enough not to load the tax bill up with pork. But definitely not this time.

The latest law runs hundreds of pages, and there's something in there for every powerful member of Congress. The New York Times scratched the surface this morning with this analysis, but it will take months before the full impact of the changes is known. Some of them affect only one or two favored taxpayers; others affect broad segments of the population.

Good news for Vancouverites and all other Washington state residents: Your state sales tax just became deductible on your federal tax return if you itemize your deductions. For someone in the 25 percent federal tax bracket, that means that for every 7 cents you pay in Washington sales tax, you'll get 1.75 cents back in federal taxes. Cool for you.

But before you Oregon sales tax advocates (including my state senator, Avel Gordly) jump up and say "Us too!" -- the new federal deduction is allowed only if the state has a sales tax but no income tax.

That's never going to happen in Oregon.

Comments (9)

Jack, great article. This is why campaigns bring in millions of dollars. There is a direct connection between money and tax laws passed.
Mover Mike

Okay, Jack, which do you prefer:

(1) keeping the current system, where state & local income and property taxes are deductible but sales taxes are not;

(2) continue to allow income and property taxes to be deducted, but if a state doesn't have an income tax, allow the sales tax to be deducted;

(3) allow all income, property and sales taxes to be deducted; or

(4) not allow any state & local taxes to be deducted?

I'm in favor of option (3). I'm also in favor of having federal income tax be fully deductible on one's Oregon income tax return. As little "tax on the tax" as is reasonably possible.

Option (1), which was the law until yesterday, was the product of a Bob Packwood-Dan Rostenkowski backroom deal in '86. Made no sense then or now.

Option (2) strikes me as kind of odd, but that's what we have at the moment.

Option (4) is a blatant "tax on a tax," which I oppose. Income taxes are supposed to be based on ability to pay. I can't pay federal taxes with the money I pay in Oregon taxes, and vice versa.

Given that I am batting .000 with you lately, Jack, I now await your devastating criticism of my position. 8c)

Actually, Jack, I would agree either with your answer (Option 3) or no deductibility (Option 4) provided overall tax rates were reduced accordingly.

The reason Congress opted for Option 2 is a combination of (1) the political clout of Texas and Washington, and to a lesser extent Nevada; and (2) concern about the revenue loss if sales taxes for all states were deductible.

I disagree with you on full deductibility of federal taxes on the state income tax. There is no double taxation now. If you get a $100 raise, you pay $9 to Oregon and the federal government only taxes you on the remaining $91.

On the other hand, let me ask you the question I used to ask Bill Sizemore in our debates on his ballot measure in 2000 and see if you can do a better job answering it (okay, that was a cheap shot):

In the situation I described above, assume you get a $100 raise. For ease of computation, assume your state tax rate is 10% and your federal tax rate is 30%, and that federal and state taxes are fully deductible on the other return.

Ignoring FICA and other payroll taxes, how much do you take home out of the $100 raise.

Ah, master, I am but a humble grasshopper when it comes to your wily ways. It depends, does it not, on which return you do first, and how much withholding was done from your pay.

Let's assume that the state withholding tables call for withholding of exactly 10%, so that $10 is paid to Salem throughout the year. The federal deduction for state taxes is done on a cash-out basis, and so on my federal return, I would deduct $10. That leaves me with federal taxable income of $90, federal income tax of $27.

Next, I do my state return, which in Oregon you do after your federal return. My federal taxable income is $90, I start with that. To that, I add back my Oregon income tax deducted on my federal return, so I'm back up to $100. Since Bogdanski became king of the state, I get to deduct my federal taxes -- not on a cash-out basis, but bottom line tax liability -- and so that's a deduction of $27, for an Oregon taxable income of $73. The state income tax on that is $7.30 (and I get a refund of $2.70, plus my kicker eventually, LOL).

In the end, you get federal tax on the raise of $27, and state tax of $7.30 under the Bogdanski system. A combined tax burden of 34.3 percent on the raise.

Did I get that right?

Note that if I did, the State of Oregon gets to tax me on $73 -- which includes the $7.30 that I have to pay to Oregon. In that sense, I have paid a state tax on my state tax.

Likewise, Uncle Sam gets to tax me on $90 -- which includes the $27 that I have to pay the feds. Again, a tax on a tax.

I'm willing to live with those multiple layers of tax, but that's enough. Under the system we have now in Oregon, the state taxes not only its own tax, as it does in this illustration, but also the money I send to Uncle Sam. If you agree I've got these figures right, let's do it the way it's actually done in the Beaver State today and we can see whether there's multiple taxation or not.

"For someone in the 25 percent federal tax bracket, that means that for every 7 cents you pay in Washington sales tax, you'll get 1.75 cents back in federal taxes. Cool for you."

Yeah! Happy Day!

I can't follow this advanced tax deduction calculation discussion. However, I do think Oregon's top rate at $6,250/income is gross.

If you want to see disparity, look at what the property tax limitation measures have wrought in inequity, one house to the next. I've wondered why some enterprising reporter didn't comb through assessor's data and compare sales prices with tax rates. Especially in changing and escalating neighborhoods, there are wild disparities wherein a house valued (market value, ie, sold) at 1/3 the price of a neighboring one can be assessed three times the property tax.

I suspect these random throw-a-dart-and-assign-the-tax rates are not widely appreciated, though they may be widely (and unintentionally) in effect.

Pretty good, Jack, and much better than Sizemore (whose answer was, “I have an accountant to figure that out.”) And, not surprisingly of course, you get extra credit for recognizing that the deduction for state taxes on your federal return is computed on a cash basis, while the deduction for your federal taxes on your state return (capped though it is currently) is computed on an accrual basis.

Still, your example assumes you voluntarily overwithhold your state taxes throughout the year and make it up when you file your tax return. A lot of use object to making an interest-free loan to the government. What if we’d like to know exactly how much to withhold for state and federal purposes from the beginning?

If you start by figuring you owe the state $10 out of your $100 raise, then you would compute the federal tax based on the $90 you have left. Your tax on that would, as you accurately compute, be $27. But then you would recomputed your state tax because now you are applying the 10% rate not to $100 but 100-27= $73. Your Oregon tax, as you point out, would really be $7.30, not the $10 you initially computed. But then your federal tax needs to be recomputed on $92.70, not the $90.00 you used the first time. So your federal tax would be $27.81, rather than simply $27 as before. But now you have to go back and recalculate the Oregon tax again, because you once more have a larger federal deduction on your state return, etc.

Eventually you can get to a final answer, and mathematically there is a more straightforward way to do this, but what a pain! Wouldn’t it be much simpler to forget about the deductions all together and simply say (for example) pay 7% of your gross income (over a certain amount) to the state, pay 20% (over a certain amount) to the feds and don’t worry about the deductions?

Not to mention the fact that otherwise people in different states who have equal incomes pay differing amounts of federal tax depending on the amount (and, currently, the type) of their state taxes. How is that fair?

But what is a tax here in Oregon? All the fees that the state and local municipalities have foisted on us since 1990 and the passage of Measure 5. It used to be I could deduct all of my property taxes, now these fees (DMV, tickets, gas taxes, etc) are not deductible, and I now pay a bigger portion of my income to the government. How is that fair?

The cost to register a car has risen, and this is a tax. All of the new items the state has come up with to write us tickets for (the convoluted school speed limits, that I have to find and read the sign to find out what I am supposed to do in this school zone) are just another tax. In fact, Marion County has hired several new deputies with the plan to pay them with the proceeds from tickets.

Bill Sizemore has made this state less livable, but the governor and legislature's failure to take the lead on tax reform has lead to people like Bill Sizemore, Don McIntyre and lobbyists having the power.

Unless the Federal government mandates how much states can charge for taxes and allowable deductions, fairness will be relative.

Indirectly, those special interests feed my children. If the tax laws were simple, all of us tax lawyers would have to pump gas. I'm against that.

Until my kids finish college.


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