Taxes

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Cost of Living I: State Taxes

February 12, 2009 in Taxes | 11 comments

This June, I will finish my Ph.D. in Economics at the University of California, San Diego.  I am currently interviewing for a post-graduate employment and will likely move to another city.  Which city should I move to?  Of course, much of this has to do with personal preference.  Do you like warm weather or seasons?  City or rural?  Are there family considerations?  All these idiosyncratic issue certainly affect location choice.

However there is one issue that is important to all workers: taxes.  Most people prefer to live in a low tax state.  But what is a low tax state?  Texas has no income tax, but does has have a 6.25% sales tax.  Oregon has no sales tax, but does have an income tax of 8%-9%.  Although Maryland’s state income tax is low (around 4%), the local income taxes average about 3% of total income. Each state’s income tax rate depends on your tax bracket, plus there are state property taxes, estate taxes, etc.  This is getting complicated!

Fortunately, the Healthcare Economist has compiled a spreadsheet describing the tax rates of each state (see Table).  The data are from The Tax Foundation.  I have estimated the average tax rates in different states for individuals earning $60,000 and $100,000.  The aggregate tax rates include state and local income taxes as well as sales taxes.  The do not, however, include information on property taxes.

Which states have the highest tax burdens?  Take a look at my rankings:

I find that Alaska, South Dakota, Wyoming, New Hampshire, Delaware, and Montana have the lowest tax rates.  On the other hand, the states with the highest tax burdens are Maryland, California, Tennessee, Idaho, Minnesota, DC, and Kentucky.  

Different people are affected by different tax rates.  Retirees would prefer states with low sales tax and high income taxes.  Young workers saving in a for the future would prefer lowering income taxes rather than sales taxes.   Are taxes good or bad?  There is no shortage of opinion:

  • “There is no worse tyranny than to force a man to pay for what he does not want merely because you think it would be good for you.”  – Robert A. Heinlein
  • “Taxes, are the dues that we pay for the privileges of membership in an organized society.”  – Franklin D. Roosevelt 

Data Sources:

  • Sales Tax Data: http://www.taxfoundation.org/taxdata/show/245.html
  • State Income Taxes: http://www.taxfoundation.org/publications/show/228.html
  • Local Income Taxes: http://www.taxfoundation.org/files/localincometaxes-20080711.pdf

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Cigarette taxes are bad for your health?

January 5, 2009 in Obesity, Taxes | No comments

Many economists and public plicy researchers have found that cigarette taxes reduce smoking.  This means that cigarette taxes must be good for your health…right?

A study by Baum (2009) claims that cigarette taxes may improve health, but not by as much as previously thought.  The paper finds that increasing the cigarette tax decreases smoking, but decreased smoking–an appetite suprressant–increases obesity.  Thus Baum finds that the health benefits of cigarette taxes may be overstated.

Disclaimer: Baum does state that “this research in no way concludes that [cigarette taxes] should be decreased to prompt weight loss.”

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McCain and the Tax Deductibility of Health Insurance

October 24, 2008 in Current Events, Health Insurance, Taxes | 3 comments

What are the tax implications of John McCain’s health care proposal?  The key components are that health insurance will no longer be tax deductible but individuals will receive a $5000 credit of purchasing health insurance.  Let’s work out some simple math to see how this will impact the life of a typical American.

Example with Max, Rob and Rich

Currently, the deductibility of employer provided health insurance is highly regressive.  Let’s look at 3 individuals.  One is middle class and his name is Max; the other two are rich and their names are Rob and Rich.  Middle class Max has a 25% tax rate, while Rob and Rich pay a 40% income tax rate. Rob has the same $12,000 health insurance package as Max, but Rich has a more generous $16,000 plan.  Let’s see how this affects their tax bills.


Max Rob Rich
Tax Rate 25% 40% 40%
Health Ins. Cost $12,000 $12,000 $16,000
Health ins. tax liability
 $3,000 $4,800 $6,400
Tax liability if ins. tax-deductible
 $0 $0 $0
Net taxes w/ $5000 credit -$2,000 -$200 $1,400

The tax system as it currently stands is very regressive.  Max, Rich and Robert pay the same $0 taxes on their health care benefit regardless of their income and regardless of the size of their health insurance benefit. If health insurance was taxed, then middle class Max will pay less taxes on his health insurance than rich Rob and rich Rich because Max has a lower marginal tax rate.  On the other hand, individuals with more generous health insurance packages get a larger tax benefit when health insurance benefits are tax deductible.  Even though Rob and Rich are in the same tax bracket, Rich saves more money than Rob when health insurance is tax deductible, since Rich has a more generous health insurance plan.  Tax deductibility encourages people to buy more generous health insurance packages at the expense of the taxpayer.

The McCain plan.

Will the McCain plan lead to higher net taxes?  In my example, Max and Rob save money under the McCain plan. Only Rich owes more taxes since he is in a higher tax bracket and has a more generous health insurance plan.  Of course, health insurance costs will increase over time, so McCain may want to index his health insurance credit to inflation.

Individuals are also worried that if they pay for health insurance themselves, this is a pure transfer of cost.  If I support McCain, will my health insurance costs go up by $12,000?  or $7000?   In reality, if employers stop paying for health insurance and transfer the burden to employees, in a competitive market employers will increase wages to compensate for the loss of the health insurance benefit. Most economic research has found that the cost incidence of employer-provided health insurance appears almost 100% through lower employee wages.

We do have to worry that as individuals start to pay for individual health insurance plans, the problems of adverse selection may worsen.  Further, non-group plans are more expensive to administer than group plans.  Thus, the shift in the type of plans individuals select may affect the cost, but the direct tax effect of the McCain plan will lead to a reduction or small increase in tax liability from health insurance benefits.

Effect on Employers

Some individual believe that the McCain plan would increase taxes for business.  This is incorrect.  If health insurance businesses were taxed, individuals would pay the tax.  For businesses, health insurance still counts as a labor cost and would reduce their profit and thus tax liability.  If individuals would receive a $12,000 health insurance package from work, currently they do not owe any taxes on this benefit.  If individuals were taxed on  this benefit, then an individual in a 25% tax bracket would owe $3000 in additional taxes.  If you are in the 40% tax bracket, you will owe $4800.  This means on net, the McCain plan would decrease your taxes by $2000 for the 25% tax bracket and $200 in the 40% tax bracket.

Also, even if the employer paid for health insurance for a group, each individual would be taxed according to the average cost of the health insurance plan per worker (likely weighted by whether it was a family or single plan).

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Taxpayer money used to lobby politicians

October 17, 2008 in Current Events, Taxes | No comments

What is AIG doing with the bailout money it has received from the federal government?  The Wall Street Journal reports that AIG is “…using taxpayer money in its effort to soften new federal controls over the mortgage industry.”

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How San Diego is solving it’s traffic problem

July 21, 2008 in Economics - General, Taxes | Permalink

Last year, I wrote a blog post about how Los Angeles could fix its traffic problems.  Today, the San Diego Union Tribune reported that traffic has decreased between 3.3% and 9.1% during the week and between 5.2% and 11.9% on the weekends.  How has San Diego accomplished this?

Higher gas prices are the reason.  A pleasant byproduct of higher gas prices are that less people will drive.  Of course, when less people drive, traffic decreases.

As mentioned in the earlier post, instead of building more and more freeways, southern California should have implemented a gas tax or implement more toll on freeways.  Higher gas prices are in essence doing the same thing that a gas tax would.  Higher gas prices, however, end up in the pockets of oil companies whereas a gas tax could be used to create better public transportation infrastructure, thus making it easier not to use one’s car and thus further decreasing traffic.

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Junk food tax and Pringles

July 7, 2008 in Obesity, Taxes | 2 comments

Pierre Dubois of VoxEU has a suggestion to reduce obesity rates: a junk food tax. Dubois claims that a junk food tax of 5% would reduce junk food consumption by 15% and thus reduce obesity.

While junk food is not healthy, it offers the most calories per dollar. Thus, a junk food tax would fall disproportionally on the poor. Dubois states that “poor consumers [affected by the junk food tax] could then find cheap calories in less-dense food items, like starchy foods which are less apt to be overeaten.”

From a philosophical point of view, I generally do not like government officials making rules about what type of food you can eat. If you want to have a banana split every day that is your choice.

Some “experts” argue that in countries with public health care systems, however, the public does end up paying for the additional health costs of obesity. Yet it not been conclusively showed that obesity leads to higher health care costs. While obese individuals generally have higher health care costs each year, those who are extremely overweight also have lower life expectancy. According to a PLoS study, obese individuals actually cost the NHS less money due to their lower life expectancy.

Further, as a practical matter, it is difficult to determine which food are junk foods. Most people would claim that Pringles are junk food. In the UK, food is exempt from their 17.5% sales tax with the exception of potato chips. According to the L.A. Times, a British court has ruled that Pringles are not potato chips and thus are exempt from the tax.

If Pringles don’t count as junk food, then what does?

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Increase the income tax on men only?

February 13, 2008 in Economics - General, Public Policy, Taxes | Permalink

According to optimal tax theory, taxes should be highest on relatively inelastic activities.  For instance, most men work full-time and and the tax rate does not affect this.  On the other hand, it has been should that the labor supply of women is much more sensitive to wages and income tax rates.  If we follow the conclusions from the optimal taxation literature we should tax men more than women.

This is what Harvard economists Alberto Alesina and Andrea Ichino propose (see Vox EU).  The Free exchange blog as well as Gilles Saint-Paul of the Toulouse School of Economics, however, are more sensible and reject this proposition.  Free exchange concludes on a particularly interesting point:

“…The economist’s idealised utilitarian social planner does not take seriously the costs incurred by the conflicts that will flare up when some are made ‘more equal than others’.  Perhaps liberal constitutions prominently feature equality before the law for a good reason: official non-discrimination works as a truce, a way of keeping the social peace.“

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Flat Tax – Part II

January 29, 2008 in Taxes | Permalink

Earlier this month, I wrote about how the flat tax has been gaining popularity in Russia and Eastern Europe.  It seems that businesses like the flat tax as well.

The Cato-at-Liberty blog notes (“…Losing Business to Flat Tax Neighbors…“) that many businesses are leaving ‘high tax-Hungary’ for its flat tax neighbors.  According to a Budapest Times  story,”flat tax is now the preferred system among the post-communist economies of Central and Eastern Europe. Is Hungary – already suffering the lowest rate of economic growth of the new EU member states – in danger of being left behind?…Thousands of Hungarian companies have already relocated their headquarters to Hungarian-speaking southern Slovakia – not only are taxes lower, but accounting has been made child’s play.”

Why do people like the flat tax so much?  The reason is that it is simple, fair, and decreases tax evasion.  The  flat tax is “…a simple, low-rate tax which is easy to collect and difficult to evade is likely to raise more money than a high-rate tax system that is full of loopholes and which nobody fully understands.”

Score one for economists Robert Hall and Alvin Rabushka who have consulted extensively in designing the flat tax systems in Eastern Europe.

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Russia’s Flat Tax

January 18, 2008 in Taxes | Permalink

According to the Wall Street Journal (“Flat Tax Fred“), Presidential-candidate Fred Thompson has recently proposed instituting a flat tax in the United States “…with two tax rates of 10% and 25%.” One country has already beat Thompson to the punch: Russia.

In 2001, Russia enacted a flat tax rate of 13%.  The reform has been popular and has since been adopted by countries such as Serbia, Ukraine, Georgia, Romania, Slovakia and Macedonia.  But is the flat tax a good thing?

This is the question which Gorodnichenko, Martinez-Vazquex and Sabirianova Peter try to answer in their NBER working paper titled “Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia.”  It has generally been found that tax collections drastically increased after the introduction of the flat tax.  This trend, however, may not be due to the flat tax specifically.  Increased GDP from 2001 until the present certainly accounts for much of the increase in collections.  Also, an increase in voluntary tax contributions or stricter enforcement may be the cause of the increase in tax collections.

The authors use data from the Russian Longitudinal Monitoring Survey and measure tax evasion as the difference between  household consumption and reported household income.  Of course, this is not a perfect measure, but as long as the quantity of the measurement error remains constant over time, this methodology will provide researchers with a good understanding of how tax evasion evolved after the institution of the flat tax.

The authors find the tax evasion is more prevalent among younger, unmarried, individuals with fewer years of job tenure.  Individuals working at small companies were more likely to evade taxes, but surprisingly government workers tend to be among those who most frequently evade taxes.  This is likely due to increased non-reported income from accepting bribes.

The authors use a difference in difference technique comparing changes in tax evasion from low and high tax brackets.  The lower tax brackets were not significantly affected by the changing tax laws, but the higher tax brackets did see a substantial change in their marginal tax rates paid.  The authors also employed a regression discontinuity framework.  This methods compares income groups just below and just above discrete changes in marginal tax rates.

The authors found that the flat tax lead to a significant decrease in tax evasion.  This is likely due to the fact that lower marginal tax rates decreases the incentive to avoid reporting income.  Further, if there is a decrease in tax evasion, policy makers can lower the marginal tax rate further while still collecting the same amount of revenue.

Lower marginal tax rates should also lead to an increase in the labor supply.  The authors, however, did not find this to be the case.  The flat tax had minimal or no impact on worker productivity.  This is likely due to the fact that the supply of labor is very inelastic on both the intensive and extensive margins.

It seems that the flat tax is not only attractive according to economic theory, but may also work well in reality–at least in terms of reducing tax evasion.

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Implicit Tax: Medicare as a Secondary Payer

October 10, 2007 in Academic Articles, Medicaid/Medicare, Taxes | Permalink

“Medicare adopted its [Medicare as a Secondary Payer] MSP policy in 1982, effective January 1, 1983. This legislation states that for individuals working at firms with 20 or more employees, and otherwise eligible for Medicare benefits, Medicare serves as a secondary payer for health care expenses. The employer’s health insurance is the first payer. Because employer-sponsored health plans tend to be more comprehensive than Medicare, these workers are effectively foregoing their Medicare benefits by working. If these same individuals were not working, they would receive Medicare as their primary health insurance.”

A recent NBER working paper (“A Tax on Work for the Elderly: Medicare as a Secondary Payer“) claims that the MSP policy creates an implicit tax for elderly workers and thus creates disincentives to work. The authors calculate that the implicit tax is 15-20 percent at age 65 and increases to 45-70 percent by age 80. Making the Medicare the primary payer (MPP) will have two fiscal impacts. First, the cost of Medicare will increase. Since Medicare will be the primary payer, it will then be paying for more treatments. Secondly, enacting an MPP policy will decrease the implicit tax, increase the income and hours worked of elderly individuals and thus increase income tax receipts. The authors claim that since the second fiscal impact will dominate the first and thus recommend that an MPP system be implemented.

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