A Small Step toward Tax Equality for Same-Sex Couples

A trio of recent IRS rulings (here, here, and here) has rekindled debate on how our tax system should treat same-sex couples.

Under the Defense of Marriage Act, the federal government does not recognize same-sex marriages. As one consequence, same-sex couples must file individual tax returns even if they are married or registered as domestic partners under state law.

The new rulings were prompted by a 2007 California law that requires registered domestic partners to treat their earnings and some investment returns as common property for state tax purposes. Under this approach, the partners share equally in their combined income, regardless of which partner earned it. If one partner earned $50,000 and the other nothing, for example, they would each be viewed as having $25,000 of income.

Because “federal tax law generally respects state property law characterizations and definitions,” the IRS decided to apply that approach to federal taxes. As a result, domestic partners in California (most of whom are same-sex couples) will each report half their combined income from earnings or community property on their individual federal tax returns.

That approach will lower the tax burden for many eligible same-sex couples. For example, if one partner earns $50,000 per year and the other has no earnings, the couple’s combined federal tax bill would fall from about $6,000 to $3,000 (assuming they have no children). That decline is identical to the “marriage bonus” that the federal tax code currently provides to heterosexual married couples at that income level.

For that reason, some commentators have characterized the rulings as tax equality for same-sex couples (e.g., the Wall Street Journal ran the headline “Gay Couples Get Equal Tax Treatment”). But that interpretation exaggerates the impact of the rulings and understates the differences in taxation between same-sex and heterosexual couples.

First, the rulings apply only in states with these community property rules for same-sex partners. According to the WSJ, besides California, only Nevada and Washington might currently be affected.

Second, same-sex partners still can’t file joint returns. As a result, their tax burdens can differ from those of otherwise identical heterosexual couples. For example, one domestic partner might have investment income from assets that are not community property and thus are not shared with the other partner. Depending on their income, that can result in the same-sex couple paying more or less than a heterosexual couple.

Dividing income under the community property approach may also allow same-sex couples with high incomes to pay less in federal taxes than heterosexual couples. For example, a same-sex couple that earns $300,000 would pay about $66,000 in tax under the new ruling, while a heterosexual married couple would pay about $78,000.

Finally, the rulings don’t address a host of other ways in which same-sex couples face less-favorable tax treatment. At a recent TPC event, for example, Michael Steinberger of Pomona College noted that same-sex couples can face significantly higher estate taxes because they aren’t eligible for tax-free bequests to spouses.

For all these reasons, same-sex couples and heterosexual couples still aren’t treated the same under the tax code. The recent IRS rulings narrow the gap in some cases, but create new gaps in others. Given the complexities of our tax code, separate treatment will inevitably mean that some same-sex couples will pay more or less in taxes than comparable heterosexual couples do. If policymakers ever want same-sex couples to be taxed the same as heterosexual couples, the only practical way to do so would be to allow same-sex couples to file their tax returns as married couples.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.

Underemployment Fell in May

The headline jobs report on Friday was disappointing, as temporary Census workers accounted for almost all of the 431,000 of May’s increase in payroll jobs. As the economics team at PNC put it, the jobs report was “all frosting, no cupcake.”

The household survey provided a little more substance, as the headline unemployment rate fell to 9.7% in May from 9.9%. More encouraging, the U-6 measure of underemployment (which includes not only those who are unemployed but also marginally attached workers and those who are part time for economic reasons) fell sharply. The underemployment rate was 16.6% in May, down from 17.1% a month earlier (and from its peak of 17.4% last October):

As you can see, the headline unemployment rate (U-3) and the underemployment rate (U-6) have been moving sideways or slightly downward over the past eight months. That’s a step in the right direction after the sharp increases in 2008 and 2009. But we have a very long way to go.

Fannie & Freddie Reform Gets a Boost from the Washington Post

Sunday’s Washington Post has an encouraging editorial about the Fannie Mae and Freddie Mac reform proposal that Phill Swagel and I recently put forward. An excerpt:

[Their plan would] abolish the most toxic features of the old “government-sponsored enterprise” model. In particular, the plan would get Fannie and Freddie out of the business of directly purchasing mortgage-backed securities, which was highly profitable to them in large part because their implicit government guarantee enabled them to fund a large portfolio at artificially low rates. Their existing $5 trillion pile of securities and guarantees would be wound down or sold off to the private sector.

But Mr. Marron and Mr. Swagel would keep a government role in Fannie and Freddie’s other business: securitizing conventional, moderately sized “conforming loans,” which is both necessary to mortgage liquidity and relatively less risky. And instead of a non-transparent, implicit government guarantee, the new securities would carry an explicit one, for which the securitizers would pay a fee. Accumulated fees, in turn, would cover losses, thus shielding taxpayers. To promote innovation and competition, this business would be open not only to Fannie and Freddie but to any other well-capitalized financial institution capable of taking it on.

How Blurry is the Line between Monetary and Fiscal Policy?

Economists have traditionally drawn a sharp distinction between monetary and fiscal policy. Monetary policy should try to promote growth and limit inflation by setting short-term interest rates, managing the money supply, and providing liquidity during times of financial stress. Fiscal policy should also encourage growth and, more broadly, promote the general welfare through careful choices about spending, taxes, and borrowing. The Federal Reserve has responsibility for monetary policy, while Congress and the President handle fiscal policy.

That clean distinction was one of many casualties of the financial crisis. As credit markets froze, the Fed pursued unconventional policies that blurred the line between fiscal and monetary policy. For example, it purchased more than $1 trillion in mortgage-backed securities (MBS) issued by Fannie Mae and Freddie Mac, created new lending facilities for commercial paper and asset-backed securities, and provided special support for such key financial institutions as AIG, Bank of America, and Citigroup.

Those actions differed from conventional monetary policy in two ways. First, they exposed the Fed to more financial risk. Short-term Treasury securities, the Fed’s usual fare, carry no credit risk and almost no interest rate risk. In contrast, the Fed’s new portfolio has healthy doses of both. Second, in several cases the Fed offered to purchase financial assets at above-market prices or, equivalently, to make loans at below-market interest rates. In effect, the Fed chose to subsidize some specific financial activities.

Both changes increased the Fed’s fiscal importance.

Most visibly, Fed profits have jumped as its portfolio expanded and it acquired higher-yielding assets. Indeed, the Congressional Budget Office (CBO) projects that Fed profits will hit $77 billion in 2010, up from $32 billion in 2008. That makes them the fourth largest source of federal revenues, after personal income, social insurance, and corporate income taxes, but ahead of estate and excise taxes. Actual returns could be higher or lower, however, depending on how well its investments perform.

Also important, though less visible, are subsidies implicit in some of the Fed’s financing programs. The Term Asset-Backed Securities Loan Facility (TALF), for example, offered favorable long-term funding to investors who wanted to finance investments in securities backed by auto loans, student loans, and certain other types of debt. Similar programs provided favorable funding to support commercial paper markets and to assist AIG, Bank of America, and Citigroup. CBO recently pegged the initial cost of the resulting subsidies at $21 billion.

Not all programs created subsidies, however. CBO concluded, for example, that the MBS purchase program did not involve subsidies because the Fed made its purchases at market prices.

To be sure, the Fed’s fiscal initiatives were dwarfed by the explicitly fiscal actions taken by Congress and Presidents Bush and Obama. The Troubled Asset Relief Program (TARP), for example, was originally estimated to involve subsidies of $189 billion (a figure that has fallen as financial markets have healed), and support to Fannie Mae and Freddie Mac has added tens of billions more. Still, CBO’s estimates do highlight the Fed’s move into fiscal territory as it battled the financial crisis.

Those steps were appropriate given the severity and suddenness of the crisis, but have fueled concerns about the Fed’s scope of authority. Some members of Congress, for example, have questioned whether the Fed should be able to engage in even moderate amounts of fiscal policy without congressional oversight. Their increased interest in Fed oversight, in turn, has raised concerns about defending the Fed’s traditional independence in making monetary policy.

As Chairman Ben Bernanke argued in a speech last week, maintaining the Fed’s independence in monetary policy would be easier if policymakers would “further clarify the dividing line between monetary and fiscal responsibilities.” Let’s hope such guidance comes along before the next financial crisis strikes.

This post first appeared on TaxVox, the blog of the Urban-Brookings Tax Policy Center.