Court ruling allows more MBAs to take tax deduction

Saturday's WSJ reports great news for MBAs for the coming school year: more of you will be able to write off your tuition against your tax liability.  Here are the rules as stated by the IRS:

To be deductible, your expenses must be for education that (1) maintains or improves your job skills or (2) that your employer or a law requires to keep your salary, status, or job. However, even if the education meets either of these tests, the education cannot be part of a program that will qualify you for a new trade or business or that you need to meet the minimal educational requirements of your trade or business.

Professional MBA programs, such as NC STate's evening and online MBA, have qualified for some time, especially for those who plan to stay with their current firm.  The new ruling apparently opens the door for Executive MBA programs too.  Also, the new ruling allows a deduction even for those who are unemployed part of the year.

I am not sure these changes will make a big difference for NC State MBAs, but all MBA students need to be aware of the opportunity to take a tax deduction for their schooling expenses, including tuition, books and transportation.  

One "tax" that makes economic sense

I ran across two pieces this week about the "Cadillac tax" on high-cost health insurance plans.  This tax, part of the Affordable Care Act, goes into effect in three years.  It will tax as ordinary income employer-provided health insurance premiums in excess of $10,200 for individuals and $27,500 for families.  It has been in the news because a number of politicians (including Hillary Clinton) have endorsed its repeal.

Ritu Agarwal, a b-school prof at the University of Maryland, argues the tax is an essential element of any policy that can successfully reform our health-care system.  The revenue from the tax finances ACA subsidies for health insurance purchases.  Also, the tax will force employers to shift more health care spending to individuals, who will be more careful with their own money than with someone else's when making decisions about their own care.  This will help bring down costs.

WP columnist Catherine Rampell points out another benefit from this tax: it will increase take-home pay.  One reason employee benefits represent at least 25% of the cost of labor is that many of these benefits are tax-deferred or are not taxed at all.  If the employer spends $1000 on wages, the employee takes home less than that after taxes.  If the employer spends $1000 on health insurance, the employee gets full value.  But total spending on compensation must equal the value created by the employee for the company, so an extra dollar spent on health insurance means one less dollar in wages.  And as premiums rise over time, wage growth slows.  So the Cadillac tax, which will lead employers to cut back on premium expenditures, will mean a raise for many employees!

Most economists would go one step further and tax all employer-provided health insurance premiums.  Why should individuals buying insurance on their own get no tax benefits, whereas those with employer-provided insurance get a big break?  Rampell points out that employer-provided health insurance was quite rare until wage controls were imposed during World War II.  Employers then used health insurance as a way to get around the controls and raise pay as labor became more scarce.

We are already in the 2016 election cycle and whoever is elected to national office will have to make a decision on what to do with the Cadillac tax.  Will they let it go into effect in 2018?

Guess what I am doing this weekend?

One clue -- it will take 2-3 hours on a computer.  Another -- it is something that I have to do, either myself or pay someone to do it for me.  Giveaway clue -- must be done by April 15 every year. 

The United States is one of the few countries in the world where there is a remarkably high rate of compliance with income taxes.  Chicago economist Casey Mulligan reports in a NYT blog entry that 99% of wage and salary income is reported.  The economic puzzle, Mulligan notes, is that the odds of being audited are quite low (1%) and the penalty for being caught is quite modest (10% of the under-reported amount).  For instance if I received a $10k check on a consulting gig and failed to report it (perish the thought), there is a 1% chance that I would have to pay taxes on the $10k plus a $1000 fine.  Assuming taxes are about 40%, that means there is a 99% chance that I get to avoid $400 in taxes and a 1% chance that I have to pay $1400.  You never get odds that good at a race track or casino. 

Mulligan notes that compliance is much higher for income reported on W-2 forms than for self-employment income or payroll taxes for household help, which is consistent with the odds of getting caught for under-reporting being much higher on the former.   Also audits are targeted, not random.  For instance, claiming a home office deduction raises a flag. 

In all too many other countries, payroll data is not efficiently communicated to the federal government, which makes it much easier for wage and salary workers to under-report income.  I have told many of my colleagues in Latin American countries that many of their budget deficit issues would go away if they would adopt the methods of the IRS.  Presumably a critical majority of those in power likes things the way they are in those countries, e.g., more discretion in enforcement allows them to reward friends and punish enemies. 

Tax the rich, but not too much

Seems to be the message from a recent WSJ piece on tax policy in various states.  The top 1% of the income distribution pay 40% or more of the state income tax in states such as California, Connecticut, New Jersey and New York.  Although this seems like great news for the other 99%, there are two catches.

First, much of the income received by the top 1% is highly variable, consisting of bonuses, stock, and other forms of one-time payouts.  When the economy went south in 2008, the incomes of the rich declined much more than the average income (after all, they had further to fall) which put these states in a precarious position.

Second, the rich have discretion about where they live and pay taxes.  Some states (e.g., Florida and Texas) do not have an income tax; others charge much lower rates than California and New York. 

Bottom line: states need to design tax rates and policies so that they receive a smooth stream of income to finance government commitments.  If tax rates rise too much at higher levels of income, this becomes harder to do.