Wednesday, November 30, 2005

I Sing a Song of Taxes, a Pocketful of Cries 

The feeding frenzy at the tax trough continues unabated. The latest "we're special" provision was added to H.R. 4297, the Tax Relief Extension Reconciliation Act of 2005. Under section 204 of the Act, income from the sale of musical compositions or copyrights would be taxed at the lower capital gains rates. [Note: If the link does not work, go to the main Library of Congress Thomas web site page and search for HR 4297. Then, when getting the page that informs us that there are TWO House bills with that same number, choose the Tax Relief Extension Reconciliation Act of 2005. Don't ask how they ended up with two bills with the same number. Something about left hand, right hand....]

This amendment, procured by Representative Ron Lewis of Kentucky, who according to this Wall Street Journal story, is a country-music fan and guitarist, is not in the Senate version of the bill. Yet. Advocates for this tax break plan to have it inserted during the Conference when the House bill is reconciled with the Senate bill (S. 2020). The text of the amendment is oh so innocent:

(a) In General- Subsection (b) of section 1221 (relating to capital asset defined) is amended by redesignating paragraph (3) as paragraph (4) and by inserting after paragraph (2) the following new paragraph:

`(3) SALE OR EXCHANGE OF SELF-CREATED MUSICAL WORKS- At the election of the taxpayer, paragraphs (1) and (3) of subsection (a) shall not apply with respect to any sale or exchange before January 1, 2011, of musical compositions or copyrights in musical works by a taxpayer described in subsection (a)(3).'.

(b) Limitation on Charitable Contributions- Subparagraph (A) of section 170(e)(1) is amended by inserting `(determined without regard to section 1221(b)(3))' after `long-term capital gain'.

(c) Effective Date- The amendments made by this section shall apply to sales and exchanges in taxable years beginning after the date of the enactment of this Act.
As I tell my students, the story is in the details.

The proposed new paragraph (3) of subsection (b) would block paragraphs (1) and (3) of subsection (a) (of section 1221) from denying capital gains tax rate treatment to income from selling the results of one's song-writing efforts. Paragraphs (1) and (3), as they presently exist, are designed to prevent the following approach to obtaining low tax rates. "I built a machine. When I sell the machine I ought to be treated as having sold a capital asset, and be taxed at low rates." Paragraphs (1) and (3) in effect say, "No, the proceeds from the sale of the machine that you bought reflect compensation for the services you have performed. Otherwise people whose services create products would get those capital gains low rates that are intended for investors."

Put aside for the moment that investors ought not get preferential tax treatment. After all, if there were no distinction among types of income there would be no section 1221 and the issue would not arise in the present context. The point is that song writers have decided that their compensation income ought to be taxed at rates lower than folks whose services are rendered working in factories, mowing lawns, bagging groceries, sweeping floors, tending the sick, fighting fires, etc. The song writers think they are special. Note that even other artists, such as novelists, painters, sculptors, and designers, aren't covered by this proposed legislation. They, it appears, aren't special.

So how did the song writers sell this to the House of Representatives? How do they hope to persuade the Senate? According to the Wall Street Journal story, it works like this:

Begin with Bart Herbison, executive director of the Nashville Songwriters Association International (NSAI). He describes the current tax law, which taxes the compensation earned by song writers in the same manner as the compensation earned by other workers, as follows: "This is just such a glaring injustice." Herbison claims that because the average annual income of song writers who belong to the NSAI is $4,700, it is "fair" to give them more advantageous tax treatment. Excuse me, Bart, but someone whose income is only $4,700 has no taxable income and the tax rate is irrelevant. I don't buy your argument. Try again. Oh, I see, that income is added to income from the "day job." And if the day job generates a tidy sum, what's unfair about taxing the $4,700 added to taxable income from the moonlighting song writing efforts in the same way as the $4,700 earned by a middle-aged working mother from a second job who is trying to scrape up more income so she can pay her child's school bills? Nah, Bart, you haven't sold me on this one. Pun intended.

Apparently song writers think that when they sell a song they should be taxed just as if they sold a stock. The logic fails, however, because the same argument can be made by a book author. Or a furniture maker. Or a person who grows fruits and vegetables and sells them at a truck stop. The fact that the services are embodied in a self-produced item or an item into which a person's services have been injected does not make the sale a sale of an investment.

The song writers and the NSAI point out that the lower rates would not apply to royalties earned when the songs are played, but only to sales of the song itself (which transfers royalty rights to others). In other words, the special low tax rates would apply to sales of what are called "song catalogs." But this distinction is somewhat facetious. Suppose a person writes a book. Or makes a bunch of hand-made rocking horses. When the person sells a book, or a rocking horse, the income is taxed at the regular rates because the person is being paid for his or her services. Should it make a difference if the person sells all of the horse or all of the books in a bulk sale? No. Should it make a difference if the person sells the right to manufacture more horses or to print more books? No. True, sale of a building generates capital gain taxed at the lower rates whereas the rental income from the building is taxed at the regular higher rates, but this distinction does not involve embodied services. And it demonstrates, of course, why a policy of treating capital gains as "different" is such nonsense.

Songwriters also argue that because their income comes in spurts they end up with a few taxable years in which their incomes are high, and subject to the high end regular rates, and many years in which their incomes are low, and subject to lower regular rates. They claim that unlike book authors they cannot arrange for the spreading of the payments over a number of years. Oh? There's a law against negotiating for longer contractual payouts? Professional athletes (another group that can experience wide income swings) manage to do so. And those book authors pay a price. If they wait for their royalties they don't have the use of the money. Hey, song writers, get a spreadsheet and factor in time value of money against probability-adjusted future tax rates. Use those numbers in your negotiations. And if you can't get what you want, don't ask the taxpayers to subsidize your negotiation table failures.

The very examples used to illustrate the "plight" of the song writers actually proves my point. One writer sold 200 songs for a "mid-six-figure" amount. She paid "more than $100,000 in taxes." Ok, $500,000 maybe $600,000 of income, $100,000+ in taxes (federal AND state?) seems to fit with current regular rate structures. That leaves $380,000? $450,000? Another writer, who has had 10 hits out of his collection of 800 songs, sold his songs for an amount in the "high six-digits" and claims he paid 39% in taxes. Guaranteed, he did NOT pay taxes at a rate of 39%. The rate on the top end of his taxable income was 39%. The average would have been closer to 20%. Clever, isn't it? Trying to get people to think he paid $320,000 of federal income taxes on $800,000 of income when in fact it's more likely he paid $200,000. Oh, how those rolling in money can plead poverty. Of course, the song writers are doing nothing more than taking good lessons from the multimillionaire "investors" who claim the right to be taxed at the lowest of rates. A third song writer claims that she must work in a department store selling handbags because "high taxes" prevent her from selling her songs. Excuse me, some good contract negotiations, taking advantage of what is known as installment sale tax treatment, spreading the payments over a period of years, will leave you with taxes no different than those encountered by the rest of us who work for a living. Apparently some song artists also do well as drama queens.

One song writer notes that because she hasn't had a hit in five years she has to make that money last, "When the hits do come, we have to be like squirrels and bury the money." Of course. So do all the other folks whose incomes peak and sag. Folks like farmers who deal with drought and floods, computer programmers and video game authors who hit the big time one year and then watch other designers' efforts get the attention of the game players, authors who have one great book followed by years of writers' block, professional athletes who rarely earn in middle age what they pulled down in their twenties, and so on. Yeah, it's called planning and budgeting. The fact you need to do this doesn't mean you deserve a tax break. Unless, of course, all taxpayers who need to plan and budget get the same tax break. Fat chance.

Interestingly, the NSAI does not have any paid lobbyists working on its behalf. It claims it does not make political donations or shower legislators with trips. Instead, Herbison has made more than 400 visits to Washington, bringing song writers along to plead their special status to "every member of the tax-writing committees in the House and Senate," according to the Wall Street Journal story.

So the NSAI has drummed up support from legislators representing southern states. Or perhaps I should say they have plinked and plunked and warbled up support, as they did the troubadour thing on the Hill. The song writers helped create a Songwriting Caucus in the House. Two Senators created one in the Senate. Iraq war. Terrorism. Starving children. Flooded out city. Storm damage across the nation. Energy crisis. Peak oil. Nuclear weapons in North Korea and Iran. Impending shortages of fresh water. And our legislators are creating songwriting caucuses? It's nice they have so much spare time.

But apparently the song writers knew better than to try to limit the special tax break to country music song writing. That would have been too obvious. So they generously included other genres. But not other forms of art. Or other forms of earning a living by rendering services.

What's at stake? About $4 million of annual tax revenues. Amounts that could be used to lower all taxpayers' tax bills. Or to reduce the deficit.

Sadly, one legislator predicts, "The chances are very good for this staying in the final bill." In a representative democracy, it amazes me that tens of millions of Americans will end up on the short end of yet another "we're special" stick and not even realize that they're getting ripped. We live in an information age, drowning in data, and somehow some people think they can slip this one by us.

This entire saga is raw material for a country song. So how long until we see "My Taxes Are So High I'm Stuck Behind a Store Counter" or "When You Write Country Music You Get Muted by the Tax Man"? Perhaps, "I'm Too Special and Maule Won't Admit It."

Tuesday, November 29, 2005

Tax + Maule = Not Fun? 

Rick Telberg's column this week on CPA2BIZ reviews tax and accounting blogs. Of this one, he says:
"www.mauledagain.blogspot.com isn't as much fun as "mauled again" might imply, but if you're the type who needs to know about section 164(b)(5) of the Tax Reform Act 1986 or IRS Form 4868 and its "companion" Form 7004, then Villanova Prof. James Edward Maule's blog is the place for you."
I guess all I can do is to try harder with the puns and the jokes. :-)

The thought that being mauled again can be fun leaves me almost at a loss for words. Oh, well. :-)

Monday, November 28, 2005

Planning: It Can Be Taxing 

Andy Cassel's column in yesterday's Philadelphia Inquirer set forth yet another early warning about the impending pension deficit crisis. Putting the almost inevitable crisis in the context of an "old vs. young" competition for insufficient resources, he outlined the problem in his usual clear and concise style. The problem is that the governments and businesses who promised old-age and health care benefits to workers and taxpayers have failed to fund those promises. In order to pay these pensions and health care costs, governments will need to raise taxes and businesses will try to shift their unfunded liabilities onto government, creating even greater revenue needs. Of course, as Andy points out, the younger generations asked to pay these costs will be far from thrilled and honored to do so.

Absent tax increases, or in some instances price increases for the products and services offered by companies with unfunded or underfunded retirement plan obligations, companies will go under. Governments will be forced to cut back on services, including, as Andy points out, hiring teachers and fixing potholes. This is not some "way in the future" problem, because the very early signs of the upheaval are already crossing the news wires. Andy mentions General Motors and the airlines, but these are but a few of the companies in deep trouble. The gap? It could be as much as $450 billion.

There are two huge lessons that America, Americans, American business, American politicians, and American governments need to learn before anyone attempts to solve the problem. After all, what's the point in repainting the foyer walls if the ice dam problem on the roof hasn't been fixed?

The first lesson is simple. Don't make promises that you cannot keep. That's at the core of the advice I gave on how to avoid being bashed by a blog. It's advice that's been favorably quoted by a broad spectrum of web sites, including The Big Picture, WFMU blog, The Center for Realtor Technology, Boing Boing, Undernews, the online report of the Progressive Review, Germany's Blogbiz, Blogzerk, Germany's Blogging Tom, Learn to Trade Futures, Wicked Word Craft, Crain's Cleveland Business on the Web, Gandalf23, Blogaritaville, Peter's Reviews, and the Head Lemur's Raving Lunacy. Apparently I hit a very responsive chord.

The second lesson is the flip side of the first. If you make a promise, focus resources and energy on keeping it. In other words, plan. If retirement pensions are promised to workers, set aside the appropriate amounts of money, in a secure pension trust, so that the pensions can be funded. Of course, with the decades-long Social Security ponzi scheme serving as a role model, private companies have adopted the same "what? me worry? (about tomorrow)" attitude that has come home to roost.

In all fairness, the Social Security arrangement is but a reflection of American culture. It's tough, isn't it, to set aside funds for a child's college education or a possible period of disability or job loss, when so many "needs" compel immediate spending. And spending is good for the economy, isn't it, almost patriotic? After all, when tomorrow arrives, and a college tuition bill looms or a pink slip is received, someone, somewhere, somehow will step to the rescue. It's not just financial matters that manifest this attitude. People go off hiking in the wilderness without appropriate supplies. Students seem shocked when December 1 arrives and there are examinations to take that require far more preparation than there is time, because not much has been done during the semester. War planners are befuddled by the need for post-invasion planning. Gasoline shortages and accompanying price hikes come as big surprises to those not able or willing to think or see beyond the horizon of the evening's last call. The long-standing Boy Scout motto, "Be Prepared," is about as popular as are the Boy Scouts.

The pension and social security shortfalls are magnificent illustrations of the planning deficiencies afflicting American culture. These aren't theoretical issues. These are real, hit-the-pockets, lifestyle-disrupting crises. These hit very close to home. These scare people. These bring out emotions. Andy's right. Dealing with these problems poses a real possibility of getting downright ugly. And nasty.

How did we get here? Does anyone care? Does it matter? Ought we not let the past be bygone and move forward? Why cry over spilt milk? How does casting blame fix things? Figuring out how we got into this mess is valuable, not for pointing fingers, which does nothing to solve the problem, but for identifying the deficiencies in thinking and the flaws in character that permeate culture and that need to be expunged before solutions can take hold. Remember, I'm not going to repaint the entrance hall until I know that there won't be more ice dams on the roof. (Good news: I finally found a roofer, who was willing to deal with the job, and who found the problem. Yep, construction errors.)

What happened is this. Promises were made to pay pensions. The amount required to fund the pension should have been calculated and set aside. I can't say that no one did this, for surely there must have been people who computed the cost, and even called for funding the promises. It's likely they were ignored, seen as Jeremiahs intent on taking the fun out of the party. So companies, awash in cash, chose to hire executives at salaries 10, 100, 1,000, even 10,000 times the salaries of the rank-and-file (or should I say, the rank-and-fodder?) who face pension-free retirements. Why? The standard defense is that these are the salaries commanded by these executives. And hindsight tells us that many of these highly compensated business geniuses didn't do much to rescue or improve the companies. They simply grabbed what they could grab, stock optioned themselves into low-taxed gains, and skipped town. Are we to believe that there were no competent, worthy, sensible managers willing to work for a fraction of what the "elite" were demanding who could have done no worse and probably a much better job? Why did no one say, "Look, the CEO can be paid $40 million instead of $60 million and we'll sink the difference into the pension fund"? Perhaps someone did ask that question so the inquiry should be: why did no one listen?

All pensions, including Social Security, ought to be funded, and that's a place to start. Existing unfunded or underfunded pensions need to be made secure. The question is, "Who pays?" Why not a user fee on corporate executives and shareholders whose failure to fund, and whose mismanagement of, pension promises and pension accounts has imposed a cost on society much like the cost imposed on infrastructure by the vehicle crossing the bridge and appropriately charged a bridge toll? Before the "it's a free market" object is raised, let's examine the market and see how "free" it is. Is it a free market when the same folks sit on corporate boards, playing round-robin games with executive appointments, as insiders move from boardroom to boardroom? Is it a free market when labor and management conspire to portray a pension plan soothing to the union but in reality a paper configuration? Is it a free market when pension plans fall short of funding goals because the accounts are not invested consistent with secure long-term pension funding growth?

A market is not, and cannot be, free in the absence of truth and candor. Otherwise the market is deceptive, and deception is not free. That's the truth of this entire mess. And truth hurts. In this instance, it's going to hurt a lot. The debate will be intense, shrill, and frightening. Let's hope it gets straightened out before American industry crashes and tens of thousands or even millions of retirees are left on the very short end of a poorly planned stick.

Friday, November 25, 2005

So Where Do (Tax) Laws Come From? 

The recent news about the guilty plea entered by a former aide to Representative Tom DeLay is most troubling. Michael Scanlon apparently conspired to bribe public officials, and has agreed to pay damages to Indian tribes whose interests were adversely affected by the attempts of Scanlon and his associates to "persuade" members of Congress to block those tribes from opening casinos. Not surprisingly, Scanlon and his crew were trying to prevent these tribes from competing with other tribes who had paid tens of millions of dollars to Scanlon et al.

It appears, according to this story, that this lobbying group had at least three dozen members of Congress on board in its Indian tribe casino efforts. Another member of the group has been indicted on fraud charges involving casino fleet boat purchases. Trips, tickets, and campaign donations flowed from the lobbyists and their clients into the coffers of politicians.

This is NOT how government should work. Years ago, when I studied civics, we were given the impression that legislators were public servants. They served the public. They made decisions based on the best interests of the nation as a nation. Of course, growing up brings all sorts of broken dreams and disappointing realities, but it is indefensible to accept government as a plaything of the moneyed interests. But that is what it has become.

How long until investigators discover what many of us already think we know? How long until we discover that what's in the tax law has been no less tainted than what's happened to native American casino enterprise efforts? Will the Republic endure? Or will the legislature follow the example of the Roman Senate, acquiescing to the wishes of an emperor and his elite? I know this sounds dramatic and exaggerated, but the bribing of legislators, overt or discreet, is thoroughly unacceptable. No law, tax or otherwise, ought exist for any reason other than the public good.

Perhaps that is why Civics disappeared from K-12 curricula. Teachers just couldn't bring themselves to set up more children for inevitable disillusions. Perhaps they came to understand that given the choice between answering the question "Where do tax laws come from?" and "Where do babies come from?" it would be easier and less uncomfortable to answer the latter.

It would be nice to think that 2,000 years of history brought some moral progress to match the technological progress achieved by the species. Somehow, it just hasn't happened. That's sad. Very sad.

Thursday, November 24, 2005

A Tax Thanksgiving 

Thanks for reading this blog, for without readers it wouldn't be much.

Thanks for sending informative and thought-provoking comments, for without feedback it wouldn't be as much fun.

Thanks for the Internal Revenue Code, for it provides so much material.

Thanks for good tax practitioners, for without them taxpayers would be adrift.

Thanks for diligent tax students, for without them the tax lore would die.

Thanks for the good that sometimes is done with tax revenues, for without those achievements it isn't worth collecting the tax.

Thanks for the First Amendment that lets criticism of tax law and its author Congress be expressed, for without it they'd be knocking at the door.

Thanks to all the folks who introduced me to the world of taxation and mentored me through my tax growth, for without their sage advice and patience I'd be doing something else and THAT is a worrisome thought.

Happy Thanksgiving to all.

Wednesday, November 23, 2005

Stereotypes in the Tax World 

It is so true that a great way to learn things is to teach. Although the principal reason for that seeming paradox is the need for the teacher to be prepared, and thus to learn what is to be taught, another reason is that students ask interesting questions that inspire teachers to do research in a hunt for a sensible response.

I had one of those moments recently in the basic federal income tax course that I teach. While examining the standard deduction, students asked why there was an additional standard deduction for the blind and for those who had attained age 65. Why not an additional standard deduction for the deaf? What is it about attaining age 65 that justifies an income tax reduction?

A bit of research turned up a fairly consistent explanation of the additional standard deduction for those who have attained age 65 or who are blind. Quoting from Jeffrey H. Kahn, "Personal Deductions - A Tax 'Ideal' or Just Another 'Deal"?," 2002 Law Rev. of Michigan State Univ. - Detroit College of Law 1 (2002), "[T]hese additional deductions ....reflect the fact that when a person or her spouse is blind or aged, she has greater subsistence expenses than do those who are sighted or young." According to Thomas D. Griffith, "Theories of Personal Deductions in the Income Tax," 40 Hastings L.J. 343 (1989), "The difference between these two interpretations of the principle of taxation according to material well-being can be illustrated by the treatment of a special tax preference for the blind. Under the egalitarian principle of taxation according to overall well-being, a tax preference for the blind can be justified simply on the grounds that a blind individual is worse off than an individual with sight, even if the tax reduction benefits the blind person less than an identical reduction would benefit a sighted person. In contrast, under the utilitarian principle of taxation according to the marginal well-being created by income, a tax preference for the blind is justified only if the blind person has greater needs than a sighted person, so that the tax reduction would be more valuable to the blind than to the sighted."

In other words, the Congress presumes that blind people and persons who have attained the age of 65 face higher costs of living and thus deserve a tax break. This sort of thinking is nonsense. Yes, there are blind people and older people whose expenditures increase because of blindness, aging, or one of thousands of other reasons one's expenses can increase. Yet there are blind people and older people whose financial resources are more than sufficient to defray those presumed additional expenses. Again quoting Thomas D. Griffith, "Theories of Personal Deductions in the Income Tax," 40 Hastings L.J. 343 (1989), at footnote 65, "For example, the additional personal exemption for the blind and the blind and the aged, now replaced with an additional standard deduction, each provided over 10% of their benefits to individuals with incomes in the top 1.4% of the population. See Emerging Issues, supra note 3, at 366-67 (citing 1977 Treasury Department figures)."

Notice that as one student pointed out, there are no tax breaks specifically directed to people who are deaf, or, I will add, suffering from any other debilitating or challenging condition, such as paralysis. What of persons who have not yet attained age 65 whose costs of living increase at rates outstripping increases in income? Answers in a moment.

A properly designed income tax system measures a person's ability to pay by measuring taxable income. If it is appropriate to consider the impact of medical or other conditions that impede ability to pay, a deduction reflecting those costs will reduce taxable income. For a wealthy person, the resulting taxable income will be higher than it would be for a similarly-afflicted poor person. Wealthy senior citizens don't need the benefit of an additional standard deduction. Nor do poor senior citizens. Citizens of any age, subtracting deductions from gross income, will establish ability to pay.

It's worth noting that the additional standard deduction for those who have attained the age of 65 is not the only goodie in the federal income tax law, state income tax law, or in federal and state law generally, that caters to the elderly on the principle that elderly are presumed to be financially needy. Extensive lists and descriptions of these benefits can be found in Jonathan Barry Forman, "Reconsidering the Income Tax Treatment of the Elderly: It's Time for the Elderly to Pay Their Fair Share," 56 Univ. Pittsburgh Law Rev. 589 (1995); Gail Levin Richmond, "Taxes and the Elderly: An Introduction," 19 Nova Law Rev. 587 (1995); and Louis Alan Talley, Congressional Research Service, Federal Income Tax Treatment of the Elderly (March 5, 1991), to cite but a few. Gail Levin Richmond alerts readers to the fact that the age at which various tax and other benefits kick in range from the mid 50s into the early 70s. In other words, there are almost as many definitions of "elderly" as there are senior citizens.

Nor is my criticism original or special. The title of Jonathan Barry Forman's article, "Reconsidering the Income Tax Treatment of the Elderly: It's Time for the Elderly to Pay Their Fair Share," 56 Univ. Pittsburgh Law Rev. 589 (1995), says it succinctly. The article, though, is worth the read. Only so much can be packed into a title. For example, the facts matter. Using the government's own information, Forman points out, "Indeed, the median incomes of families age 60-64 and 65-69 are greater than the median family incomes of families age 20-24 and 25-29. All and all, there can be little doubt that many elderly families have incomes greater than a significant portion of younger families[,] .... [and that] on average, the elderly are twice as wealthy as the nonelderly." He also explains that "The elderly are also less likely to be poor than are other demographic groups. For example, in 1992, when the overall poverty rate was 14.5 percent, only 12.9 percent of the elderly were poor. 6 In contrast, almost 22 percent of children were poor that year. 7 It is worth noting, however, that among the elderly, the poverty rate goes up as people get older. For example, while just 10.7 percent of those age 65 to 74 were poor in 1992; 15.3 percent of those age 75 to 84 were poor, and 19.8 percent of those age 85 and over were poor."

So how has it come to be that the elderly are in front of the line for tax breaks? Simple. For years, the elderly have been portrayed as the nation's neglected poor. Perhaps that was true at one time, but it no longer is, and once the problem is ameliorated, the remedies ought to be cut off. Unfortunately, politics being what it is, the late Claude Pepper made his career by championing the cause of the elderly, whom he portrayed to the nation as a cast-off segment of the population abandoned to widespread disease, early death, and all other sorts of evils. The reasoning deficiencies in claiming that finding a poor old person means all old people are poor somehow were overlooked as Pepper was re-elected time and again, even though similar reasoning in other areas of life would bring the political correctness police swat team within moments of its utterance.

If any age segment in American society is in need of special attention, it's the children. But they don't vote, even though sometimes they are taxed (another law review article in the making here), so apparently they don't matter as much except as pawns in the chess game of politics.

Any suggestion to repeal these special tax breaks based on stereotyping by age or affliction, relying instead on measurement of financial condition and ability to pay, has met and will meet stiff resistance. When the former additional personal exemption for those aged 65 and older was changed to an additional standard deduction, thus making the break unavailable to taxpayers who itemize deductions, the outcry was widespread and intense. In at least one instance a reporter described the affected taxpayers as "feeling cheated." I guess that's how a bank robber feels when the police take back the bank's money bags. Cheated. Oh, that poor millionaire retiree. Deprived of an additional personal exemption and not getting an additional standard deduction because there's all those real estate taxes on the resort condos to deduct.

Excuse my sarcasm. I just happen to appreciate the frank inquiries made by my students.

As I pointed out, when someone stops to pay a bridge toll, they're not asked their age (unless there is some "senior citizen bridge toll discount" of which I am unaware). And if bridge tolls were based on ability to pay, the questions would be about income and expenses, not about age or eyesight. Of course, bridge tolls aren't based on ability to pay but on user fee principles, so there's no way to prove that an ability-to-pay bridge toll would not be infected by all sorts of extraneous factors.

Now I'll sit back and brace myself for the response. I'm confident I'll be getting an email from Mom. Uh-oh.

Monday, November 21, 2005

Anyone Want to Count the Words in the Internal Revenue Code? 

Some things, like taxes, never die. For example, talking and writing about taxes seems to be a perpetual activity. Specifically, commentary about the length of the Internal Revenue Code or the size of the tax law resurface periodically as though it was a newly discovered topic.

A few weeks ago, Paul Caron posted an abstract of a Wall Street Journal article [subscription site] about the tax code:
Taxing Words:

So, just how long is the U.S. tax code? Long enough that it's hard to answer that question. These columns have recently used two different numbers -- nine million and 2.8 million words -- in two different editorials, prompting alert readers to ask which number is correct. The answer is both, and therein lies a story. The latter number comes from John Walker, who runs the Web site www.fourmilab.ch, where he has created a cross-referenced and searchable database of Title 26 of the U.S. Code -- the section of federal law that deals with taxes. Since we published that number in August, Mr. Walker has updated his site and now puts the number of words at 3.4 million.

The nine-million-word figure is arrived at by combining Title 26 with all the regulations that have been written to implement the law. The regulations are estimated to run to nearly six million words, giving us the oft-quoted nine million total. Last year, the White House noted conservatively that the tax code ran to "over one million words." Mr. Walker arrives at a figure of approximately 1.3 million words if one excludes "all the auxiliary and supplementary material (lists of amendments, cross-references, transitional rules, etc.)," which is close to the White House figure.
In September of 2004, I commented on the President's assertion that the tax code was a million pages long. I pointed out that:
As of 2000, the last year for which I have a count, the Code contained 1,669,514 words. In 1954, when its predecessor (the Internal Revenue Code of 1954) was enacted, there were "only" 409,421 words. * * * * * As of 2000, tax regulations contained 7,307,000 words. In 1954, tax regulations had already crossed the million-word mark at 1,033,000.
Clearly there are discrepancies. Either the counting methodologies differ, errors have been made, or somehow in the past five years the code has almost doubled from 1,669,514 words to 3,400,000 words, and the regulations have (gasp!) DECREASES from 7,307,000 words to 6,000,000 words.


At about the same time that I was posting my commentary on the President's observation about Internal Revenue Code length, Bob Wells of Tax Notes published "The Urban Legend That Will Not Die, 105 Tax Notes 31 (Oct. 4, 2004). Bob noted a Washington Post editorial that had corrected the President by asserting that the code was 17,000 pages in length. What Bob published was a re-run of a story published in 1997 and in 2001, and which my friend, mentor, and LL.M. thesis advisor Tom Field at Tax Notes and one of my favorite editors, Bob Wells, promise to republish every time code length nonsense gets reported elsewhere. See why I admire them? Willing to set the record straight when gross hyperbole threatens to invade our minds. Not that I have ever engaged in gross hyperbole, ha ha. Think Tom let me squeeze gross hyperbole into the thesis? NOOoooo.

What Bob's report explains is that people apparently guess at the page length by looking at the last numbered page in commercial editions of the code. Using a 1997 edition of RIA's version of the Code, they determined that the page numbering was not continuous. Pagination is not unlike the numbering of Internal Revenue Code sections, which also "skips" some numbers. After removing the gaps in numbering, the index, the amending acts table, and the table of sections, Bob and his co-counters determined that as of January 1, 1997 there were 2,434 pages in the Code. Until the explanations of amendments that follow each code section are removed. Then the count decreases to about 2,000 pages.

Of course, within days, I wrote a letter to the editor of Tax Notes on the matter, "Page Counts, Word Counts, Urban Legends, and Cookies, 105 Tax Notes 425 (Oct. 12, 2004):
I noted with interest Bob Wells's valiant attempt (Tax Notes, Oct 4, 2004, p. 31) to slay the code-size urban legend (or is that code-sized?). Urban legends (tax or otherwise) are tough to kill, something that Professor Jan Harold Brunvand, professor emeritus of English at the University of Utah knows well. He made a professional career out of debunking urban legends. I don't recall reading about the code-size legend in any of Professor Brunvand's books, but keeping such taxing material out of his books surely helped him sell book after book. I am confident that despite Bob's efforts, within four years at least one more politician will characterize the code as having a million pages.

When I read that the president had made the million-page claim, I grinned, because he did me a favor by providing fodder for one of my September 27, 2004, MauledAgain blog postings (http://mauledagain.blogspot.com/2004_09_01_mauledagain_archive.html #109629125299439055). You'll note I used the adverb "supposedly" to describe the 17,000-page claim, because I had my doubts. I thank you for sharing your research that establishes a page count in the vicinity of 2,000.

But, as I point out, perhaps the president's mistake with respect to tax size was the use of the word "pages." Perhaps he meant "words." Interested readers can visit the cited URL to read about word counts. Considering the source of my information and the exaggeration of the page count, the word count might also be inflated. But it's huge, nonetheless.

Word counts make more sense in measuring the quantity of written work product. Font size, kerning, line spacing, margins, indentation, and a variety of other variables can affect page count. Why am I telling you this? You're an editor. So this bit of trivia will come as no surprise: I use different code books for different courses, and a code subsection requiring 7 lines in one book consumes 11 in another. My appreciation for the latter could have something to do with the fact I'm nearing the event horizon for reading glasses.

You and your readers are invited to visit MauledAgain. Described as "Prof. James Edward Maule's more than occasional commentary on tax law, legal education, the First Amendment, religion, and law generally, with sporadic attempts to connect all of this to genealogy, theology, music, model trains, and chocolate chip cookies," it may provide a few more legends, urban or otherwise, for you and your readers to ponder. It surely has some tax commentary that may be of interest.

Thanks for publishing this less-than-one-page, surely not 1 million or even 2,000 word, letter. I haven't counted the words. I'm sure someone will.
Yes, indeed, I could not resist so I didn't.

Can 2,000 pages contain 1,669,514 words or 3,400,000 words? That's roughly 830 words or 1,700 words per page. Even teenagers with magnificent eyesight would need microscopes to read the words on such a page. We may be getting there, according to this report about printing an encyclopedia on a pinhead, but, please, don't let this news reach Washington.

So how many words ARE there in the Internal Revenue Code? Rather than counting the words manually, I figured there must be some way to get a digital copy of the full Code, paste it into a word processor, and do a word count. Well, finding a full copy of the Code is difficult. Most web sites, including Lexis and Cornell's Legal Information Institute, provide only section by section access, which would require a tedious process to recompile the Code. The House of Representatives makes available what it calls the complete Code title, but it includes all of the annotated explanations of previous amendments. It is roughly 25 megabytes in size. That's a lot of words, but many of those words are not part of the code. Again, it would be a tedious task to remove the annotations.

So, at the moment, my best guess is that the Code contains about 400,000 words. Anyone who can provide more specific results, with a description of the methodology that removes any guesswork, earns a free subscription to MauledAgain.

Friday, November 18, 2005

"They" May Be Reading the Tax Analysis, But Are "They" Listening? 

It's getting a bit weird. As I noted last Friday, my previous posting about whose ox would be gored by the Tax Reform Panel's recommendations was followed by a refutation from the chair of the House Ways and Means Committee who claimed that "everybody's ox gets gored." A reply to my post? Coincidence? At the time, I figured it was the latter.

Then, two days ago, I noted that the arguments I had made against having or extending special low tax rates for capital gains and dividends had been advanced by Senator Snowe, with sufficient effect, because the provision extending those low rates was dropped from the Senate Finance Committee's tax bill. More coincidence? Perhaps. Or could members of Congress be reading this blog, or having their staffers do so for them, because they've heard I'm one of the harshest critics of what Congress has been doing and not doing with tax legislation? Again, I voted for "most likely it is a coincidence."

Then this morning comes news that late last night the Senate approved the Finance Committee's bill, and an amendment rejected by the Senate on a procedural vote, offered by Senators Byron Dorgan and Chris Dodd, would have imposed a temporary windfall-profit tax of 50% on windfall profits not reinvested in increasing domestic oil and gas supplies. It was only four days ago that I had written:
If there's going to be a windfall profits tax, add a new wrinkle. Without getting into the details, or "marking up" the previous version, I would allow a deduction for investment in energy exploration, including alternative sources other than oil and gas, that exceed the company's average investments for the past five years. Such a tax would encourage alternative energy development, and to the extent a company chose not to invest its profits in such a manner, it would pay what I prefer to call a user fee to offset the economic market disruptions that can arise by failure to develop additional and alternative energy resources.
Well, I suppose it's just another coincidence. But I'm beginning to wonder. After all, if "they" indeed are reading this blog, here's my chance. Oh, wait, I already did that when I responded to Nakul Krishnakumar's "President for a Day" challenge. So, if "they" are reading, "they" know.

The Senate's passage of the bill is worth noting for several other reasons:

1. Other windfall profits proposals offered as amendments to the bill were defeated. One would have funneled the proceeds of such a tax to funding energy costs for low-income individuals. Attempts to remove existing tax law incentives for engaging in exploration and development of energy sources were defeated.

2. The bill contains a provision that requires oil companies to change the method in which they account for their inventories. Stating the matter simply, perhaps too simply, the question is whether, in computing profits, an oil company can use the cost of its most recently acquired inventory as an offset to revenue, or whether it should use the cost of the earliest acquired oil. The former method, last-in-first-out (LIFO), tends to reduce profits (and taxable income) when prices of purchased inventory are rising, whereas the latter method, first-in-first out (FIFO) attaches cost directly to the items that are purchased and resold. Most companies, not just oil companies, use LIFO for tax purposes. The provision would require use of FIFO, the effect of which would be to increase oil company taxes when the switch over occurs. This provision brought a veto threat from the White House.

3. The bill was passed "early Friday" shortly "after midnight." Is it any wonder that tax legislation is far from ideal? Though it may be noble and courageous to pull an all-nighter, admiration of such an approach should be reserved to matters of national emergency, and not instances in which good time management would foreclose the need to be dealing with technical tax issues and tax policy matters during a person's 19th or 20th waking hour. The advice I shared with student's in last week's law school Gavel Gazette newsletter about the risks of working through the night when it's not an emergency, and of managing time so that emergencies are minimized, would be good reading for Congress and its staff.

4. Senator Rick Santorum added yet another quote to his growing inventory: "I call this bill the 'Tax Increase Prevention Act.'" Is removal of a tax decrease, especially when that decrease is unjustified, an increase? Are tax increases per se prohibited? No matter increases in government spending? What ever happened to the Balanced Budget movement, once a favorite goal of the group that now seems wedded to "no tax increases."

5. The special lower tax rate on capital gains and dividends is in place, unfortunately, until 2009. So why the effort at this point to extend those rates? The stock answer is that taxpayers need certainty? Certainty? The only certainty is that there are TWO Congressional elections between now and 2009, and not only will all seats in the House be up for grabs (theoretically) twice, but two-thirds of the Senate will be determined. The Congress elected in 2008 will do whatever it wants to do with the tax rates, and whatever extension enacted in 2005 will not present a legal obstacle. Of course, as a practical matter, it's a lot easier to reject an extension than to repeal an existing tax break, so the real answer to my question of why the effort at this point is a political stratagem. My preference for repealing immediately the special low tax rates for these types of gross income surely is not much more than a desire that can be shelved in the same place I put my hopes for the Philadelphia Eagles winning the Superbowl early next year. Yes, miracles can happen. But I'm not holding my breath.

6. The Secretary of the Treasury defended the low special rates by pointing out not only the taxpayers whose taxes are lowered but also those who get "new and better jobs and greater economic security for families." Huh? New and better jobs? What new and better jobs? The ones in China and India? The ones terminated at fertilizer, plastics and other factories that have been moved abroad because of the high price and possible shortages of natural gas? The ones that pop up in headlines almost every day as yet another company trims its workforce? And as for greater economic security, when's the last time the Secretary looked at the consumer confidence index? (Check out the graph from the the Conference Board that illustrates yet another drop in the consumer confidence index, now down to 85 from 106 in June). Why not impose the same rate on all income, which would permit lowering the rate on wages? The answer that we never hear, because it would be too revealing and thus too uncomfortable for the advocates and beneficiaries of these special low tax rates, is that the folks who derive their income from capital gains and dividends are in a better position to use their tax savings and are wiser about what to do with money than are wage earners. Well, at this point, even if there had been any empirical evidence supporting such an elitist outlook, the track record demands that the wage earners be given a chance. All things considered, how much worse could it be?

7. The other provisions, which I described two days ago, remain in the bill.

And, so the 2005 tax legislation story continues. Yes, there will be more.

Thursday, November 17, 2005

A Cornucopia of Tax Charts 

In time for Thanksgiving, TaxChartMan has delivered again. Andrew Mitchell has stuffed some more tax law graphics into his tax charts web site. This time around, to use his words, he has added:
1. Bashford (Remote Continuity of Interest)
2. Groman (Remote Continuity of Interest)
3. Nissho (Foreign Tax Credits: Legal Liability for Withholding Taxes)
4. Southwest Consolidated (Warrants are not voting stock)
5. Turnbow (If No Tax Free Reorg Exists, Then Full Gain Is Recog'd)
6. Rev. Rul. 57-465 (Downstream Merger of Fgn Corp. was a D Reorg)
7. Rev. Rul. 68-261 (Merger with Drops into Multiple Subsidiaries)
8. Rev. Rul. 68-285 (Dissenting Shareholders Paid Cash in B Reorg)
9. Rev. Rul. 68-349 (Failed 351 Exchange - Lack of Control)
10. Rev. Rul. 68-562 (Shareholder Purch'd 50% of Target Prior to B Reorg)
11. Rev. Rul. 70-107 (Parent Assump'n of Liab.s is Boot in Triang. C Reorg)
12. Rev. Rul. 72-197 (S/H's Liable for Fgn Taxes of Rev. Hybrid Entity)
13. Rev. Rul. 72-354 (Sale of Recently Purch'd Stock to Qualify as B Reorg)
14. Rev. Rul. 72-522 (Equity for Working Cap. Does Not Disqualify B Reorg)
15. Rev. Rul. 73-102 (C Reorg with Cash to Dissenting Shareholders)
16. Rev. Rul. 74-564 (Merger of Transitory Entity Treated as B Reorg)
17. Rev. Rul. 76-223 (Voting Rights Added to Qualify as a B Reorg)
18. Rev. Rul. 79-4 (Acquiror Repayment of Debt Gtd by Target S/H is Boot)
19. Rev. Rul. 79-89 (Acquiror Repayment of Debt Gtd by Target S/H is Not Boot)
20. Rev. Rul. 87-89 (Cross-Border Lending Intermediary Disregarded)
21. Rev. Rul. 98-10 (B Reorganization with Exchange of Securities)
22. Rev. Rul. 2001-26 Situation 1 (Two Step Reverse Triangular Merger)
23. Notice 2005-74, Example 1 (Tax Free Reorg Impact on GRA - Transferor)
24. Notice 2005-74, Example 2 (Tax Free Reorg Impact on GRA - Transferee)
25. Notice 2005-74, Example 3 (Tax Free Reorg Impact on GRA - Transferred)
There are three ways to access the charts:
By Topic
Alpha-numeric order
Date uploaded
If you haven't read my previous accolades for Andrew's charts (see here, here, here, here, here, and here), take a look. As those who have followed my endorsement of Andrew's tax law visualization efforts know, I and others (e.g.,here) hold them in high regard. So in the spirit of the upcoming holiday, on behalf of tax practitioners, tax students, and tax law professors, everywhere, thanks, Andrew. I'm sure we're going to gobble them up.

Wednesday, November 16, 2005

A New Dawn Flickers on the Tax Horizon 

A small flicker of a new dawn twinkles on the tax horizon. Gathering clouds threaten to plunge the sky into darkness.

The good news: As reported by Reuters, CCH (pay subscription site with variable URL), and other press sources, the Senate Finance Committee approved a version of the "Tax Relief Act of 2005" that does NOT extend the expiration date for those low special tax rates on capital gains and dividends that I, and others, so firmly disdain. Making arguments similar to those I have advanced, Republican Senator Olympia Snowe pointed out that the impact on the federal budget of recent disasters changed priorities. Coming days after it another member of the Congress appeared to respond to my comments about the Tax Reform Panel proposals, I'm beginning to wonder if this is all coincidence or if somehow a few members of the Congress (or their staff) are reading this blog.

Well, as quick as I am to criticize the Congress, I'll be just as quick to congratulate Senator Snowe for taking the stand she has made. One of the few remaining progressive Republicans, a dying species to which fewer and fewer of us belong, she had the courage to stand up to the special interests that dominate the Republican tax agenda. With no other practical choices open to him, Senator Charles Grassley dropped the low rate extender, and the bill was sent by a 14-6 vote to the Senate floor for debate.

Of course, advocates of limiting high taxes to wages have announced "confidence" that the extension of the low rate for capital gains and dividends would be restored by the House of Representatives and somehow survive the Conference. Last night, the Ways and Means Committee approved, by a 24-15 vote, its "Tax Relief Extension Reconciliation Act of 2005," the acronym for which, TRERA, sound a bit too much like terror for my liking. This bill DOES include the extension of reduced tax rates on capital gains and dividends, so the Conference is going to be interesting, to say the least.

Senator Crapo called the omission of the special low capital gains and dividend tax rate extension a "very serious mistake." Hardy. The mistake is requiring wage earners to bear a disproportionately higher rate of taxation than do investors, trust fund beneficiaries, and the ultrawealthy. We've had more than a few years of this bifurcated tax rate scheme, and the economic position of most Americans surely has not flourished as it has for the beneficiaries of these special low tax rates.

The Senate Finance Committee bill would make other changes to the tax law. It extends the soon-to-expire research and development credit, the state sales tax deduction, the work opportunity credit, and some minor alternative minimum tax relief for middle income taxpayers. It makes changes in the New York Liberty Zone deductions and credits, and modifies the taxation of S corporation excess passive investment income. The bill also makes modifications to the charitable contribution deduction, the most significant being the allowance of a deduction in computing adjusted gross income for charitable contributions exceeding $210 ($420 for married couples). Ah, more complexity. The Committee also approved a Republican-sponsored deduction for mortgage insurance premiums. The House Ways and Means Committee bill also extends the state and local sales tax deduction, the work opportunity credit, and the research and experimentation credit, so bank on those being in the final legislation. It also extends a long list of other expiring provision, which are listed in the Ways and Means Committee news release.

Stay tuned. This story isn't finished.

Monday, November 14, 2005

Proposed Water Tax in Maine Almost All Wet 

Tens of thousands of voters in Maine have signed petitions to place on the ballot a referendum on a proposal to tax the withdrawal of water from Maine's aquifers that is bottled. According to this Portland Examiner story, the initiative, led by Jim Wilfong, a former legislator who served in Clinton's Small Business Administration and who specializes in international trade, reflects several concerns. One is the traffic that the bottling plants bring. Another is fear that the aquifers will dry up.

Wilfong's correct that access to clean, fresh water is an emerging issue. I've noted, on several occasions (for example,here and here ) that disputes over the supply of fresh water, not oil, may well be the cause of the next world war. Wilfong, who is not alone in contemplating the shipment of water in ways not unlike present-day shipment of oil and gasoline, explains that the underlying questions of who will own the water, who will control the water, and will fresh water supply be sustainable are the root questions. But is a tax the right way to go?

If the tax passes, it could backfire. The largest water bottler in the state, Poland Springs, has threatened to pack up and leave if the 20-cent-per-gallon tax is enacted. Already, the company has put on hold its plans to add another bottling plant.

A small portion of the tax would be used to protect aquifers, enhance the water environment, and otherwise remediate the impact of withdrawing the water. Most of the revenue would be set aside for small business development. Income from the trust holding the unspent revenues would be paid to state taxpayers.

The proposed tax would cost Poland Springs each year more than it currently earns in profits each year. Does the word "confiscatory" pop into anyone's head?

Wilfong denies that Poland Spring is a target. He explained, "We don't have it in for anybody. We just think this is something that's fair and ought to be done."

There are two serious issues to consider. One is the appropriate purpose of a tax and use of its revenues. The other is a question about the ownership of natural resources.

To the extent a water bottler, like Poland Springs, is imposing a cost on society by using roads, increasing traffic, contributing to pollution, or damaging the aquifer environment, a user fee (even if called a "tax") is appropriate. Perhaps a one or two cent per-gallon fee makes sense. It might even make business sense to the bottlers, because it would contribute to the sustainability of supply.

But the idea of soaking the companies (sorry) to generate money for small business development or windfall dividend income for state residents is a not-well-camouflaged money grab. Why should water bottlers or, in effect, their customers, subsidize small businesses in Maine? Maine taxpayers and Maine small businesses did not subsidize Poland Springs. It is worth noting that Poland Springs was at one time in bankruptcy, and emerged after being purchased by Perrier. If there are entrepreneurs with ideas that would make a small business go, then have at it. That's what Poland Springs did. If the idea is a good one, the business will grow. If it's not, it will stumble. Grabbing one's neighbor's income simply because, well, they have it, is short-term greed guaranteeing long-term failure. This approach to revenue generation and use surely isn't going to be interpreted as a welcome mat by businesses thinking of carrying on activities in Maine, and will be seen as an eviction notice by many of the businesses already working in Maine.

And that leads to the second issue. Wilfong and his supporters appear to treat the water as taxpayer property that it can sell to bottlers for 20 cents per gallon. If the water is owned by the state, that is a sensible approach but for the fact that such a price is so high that there will be no purchasers. Perhaps that is what Wilfong prefers. But if the water is owned by private individuals, is it permissible for the state in effect to seize that property? States do have the right to condemn property for public purposes after paying just compensation. Unfortunately, the Supreme Court also thinks it's ok for states to seize private property to assist other private citizens who claim their private development somehow helps the state, another barely camouflaged arrangement that has the word "bribe" smeared all over it. But the idea of a state seizing property simply because its value has increased is so close to how totalitarian regimes operate that any sensible voter, in Maine or elsewhere, ought to be shaking in fear as they contemplate the logical end of their approach to the issue.

User fee for actual damage? Yes. Confiscatory tax? No. The Wilfong proposal is almost all wet.

If the proposal gets onto the ballot in November 2006, and there's some question about the validity of all the signatures, the rest of the nation ought to pay very close attention to the outcome. A small ripple of confiscatoriness could swell to a flood of state usurpation of private businesses involved in natural resource development. We could soon be drowning in a nation of five-year plans and collectives.

If There Must Be a Windfall Profit Tax, Then .... 

Someone asked me to comment on the various windfall profits tax proposals. As several commentators have noted, this issue was debated thoroughly several decades ago when the oil embargo caused market prices to increase, in turn causing increases in oil company profits. And as anyone who paid attention to the outcome knows, the effect was a downturn in oil company investments in exploration. After all, if the money is being sent to Washington, it isn't going to be spent paying engineers to prospect for oil.

One thing that a windfall profits tax does not do is to reduce the cost of gasoline, heating oil, or any other petroleum or gas product. The market sets the price, and oil companies would be sued by their shareholders if they simply reduced retail prices to less than wholesale prices. Profits surge, temporarily, because of the lag time between price changes and oil and gas shipments.

However, it seems that some degree of faith is required to accept present-day claims by oil companies that they will invest their current cornucopia of profits in exploration. True, such assertions make sense. But shareholder pressure for dividend increases is also a reality. What to do?

Here's my proposal. If there's going to be a windfall profits tax, add a new wrinkle. Without getting into the details, or "marking up" the previous version, I would allow a deduction for investment in energy exploration, including alternative sources other than oil and gas, that exceed the company's average investments for the past five years. Such a tax would encourage alternative energy development, and to the extent a company chose not to invest its profits in such a manner, it would pay what I prefer to call a user fee to offset the economic market disruptions that can arise by failure to develop additional and alternative energy resources.

Until I see windfall profits tax proposals making headway in the Congress, I'm not going to belabor this topic. But I will return to it and hammer home my proposed energy development windfall profits tax deduction if the situation warrants more intense advocacy of my proposal.

Friday, November 11, 2005

Everyone's Tax Ox to Be Gored? Not. 

It really amazes me. Last week, I asked, somewhat rhetorically, "So Whose Tax Ox Gets Gored by the Tax Reform Pane's Proposals? No, the question didn't amaze me. An answer has.

This week's Tax Notes has an article by Heidi Glenn, "Tax Panel's Report Kicks Off Tax Reform Debate," 109 Tax Notes 703 (Nov. 7, 2005), in which Rep. Bill Thomas, chair of the House Ways and Means Committee is quoted as saying, "Criticism of code provisions that the panel suggests should be scaled back or eliminated was unrealistic. At some point, everybody has to realize that fundamental tax reform by definition means that everybody's ox gets gored." The only on-line link that I can find is a long link to the Lexis pay site. UPDATE 12 Nov 2005: Thanks to Matt Gardner, State Tax Policy Director of the Institute on Taxation and Economic Policy, here is another link to the quote.

Not that I think Thomas is replying to my question, but is he serious? Does he really think that everybody's ox gets gored by fundamental tax reform? I'm not arguing that everybody should get gored, because, after all, there's no point and no worthiness in raising the tax liabilities of the poor. Yet the "reform" offered up by the Tax Reform Panel gores some people and not others, as I pointed out in my post last week. Consider, for example, someone living off a trust fund or off of investment income, and owning his or her principal residence and vacation home free of mortgages. The worst thing that happens to such a person under the Tax Reform Panel's proposals is the loss of the deduction for real estate taxes paid on those homes. A few other minor deductions might disappear. On the other hand, under the proposals, the person would be taxed at a lower rate on interest income and at a zero rate on domestic dividends income. The person would be relieved of alternative minimum tax liability. The person's regular tax rates would be reduced. Surely, this person, and others, are in the group of individuals whose tax liabilities would go down, as evidenced by the charts in the Tax Reform Panel's report that I described in my previous post on the issue.

There are circumstances under which a change in the tax law could increase the tax liability of all taxpayers. For example, a surtax, such as the one enacted during the Vietnam conflict, would have that effect. The arguments might then be about the severity of the goring, but every taxpayer would be hit. On the other hand, when a tax reform proposal is revenue neutral (and I don't understand why that needs to be so), unless somehow every taxpayer ends up with the same tax liability (which is for all intents and purposes impossible and which would make tax reform pretty much pointless), there will be taxpayers whose tax liabilities increase and taxpayers whose tax liabilities decrease. Even the Tax Reform Panel admits as much in its report.

So, how, someone explain, does the man holding the most important position in the Congress when it comes to tax legislation, conclude that "everybody's ox gets gored"? Although his statement makes for a great sound bite, it is flat out wrong. It is more than misleading. It is irresponsible. Well, in that respect, it matches up well with the Tax Reform Panel's proposals.

Another Prof. Maule Washington Tax Day 

After responding to former student Nakul Krishnakumar's inquiry of what I would do if I were President for a day, I noted that my plans would most likely go nowhere, considering that he had not asked me what I would do if I were Emperor for a day. Jeff Jacobs soon contacted me with a variation on Nakul's challenge. Jeff asked, after noting he "loved" the President-for-a-day post:
What if someone made you Commissioner of Internal Revenue for one day? And what if your salary was based on 1% of the revenue you collected? Which of the current laws included in the Internal Revenue Code would you choose to enforce?
Jeff clarified his question by confirming my assumption that he meant 1% of the revenue collected beyond what otherwise was being collected. Jeff also revealed his plan, if he got to make the one day Washington tax trip: "send Schedule H to everyone in your area (Delaware County; Montgomery County); my area (Fairfield County, CT); and similar zipcodes around the country." Jeff's hound dogs must be picking up the scent of some unpaid household employment taxes. Jeff also posed his question to Joe Kristan.

Here is what I told Jeff:
Schedule H would be a good candidate. Another would be an audit of all "pay cash pay less" transactions. The third would be tax shelter
investments with overstated debt, overvalued property, improper allocations, etc.
When Jeff replied with his confirmation about the computation of the "1% of revenue" he noted that Joe "chose home equity (vs. home mortgage) indebtedness." By that point I had looked at Joe's response, which also included a proposal to ferret out illegal tax shelters and scams, and commented, "Joe and I are in tune on the tax shelter thing. Another interesting one would be employee v. independent contractor." Pressed for an explanation, I elaborated:
Independent contractor characterization hurts the revenue (that's why the IRS does, in fact, go after it, especially when it is being abused throughout an industry, such as the not so long ago classification of law clerks as independent contractors).

Independent contractor classification, coupled with 1099 noncompliance, takes the withholding advantage away from the IRS. Even when the independent contractor files a return, there generally is a delay in collection because many mischaracterized independent contractors don't even know to make estimated tax payments.

Also, independent contractor status cuts down FUTA collections. And I think it permits employers to exclude lower compensated "employees" from deferred compensation computations, though I'm not sure this generates a revenue loss.
For the record, someone named "Brian" commented on Joe's website that "If I were Commissioner for a day, I'd test the lower boundaries of the 7701(a)(36) definition of return preparer to see just how little preparation is needed to prepare a substantial portion of a return. Better yet, I'd rather be Secretary for a day and change the definition of 'return preparer' to include all return preparation, (though keeping the de minimis exceptions intact). I'd require USPAP for all appraisal and valuation reports." Interesting idea, as the deterrent effect might cause a lot of tax shelter and other devices to be shelved.

The other night, one of our adjuncts, who also is a former student in both the J.D. and LL.M. Programs, stopped by my office after we both had finished teaching our classes. While chatting about the Tax Reform Panel's proposals, a conversation we should have recorded and offered for sale, we found ourselves debating the impact of the proposed reduction in the mortgage interest deduction. I learned that there's a lot of "over $300,000" mortgage debt in existence, especially among taxpayers with incomes in the $180,000 to $250,000 range. I was making the point that I made in a post several weeks ago, specifically, that the upper middle class would be harmed more than the wealthy and ultrawealthy. The point that the wealthy are already limited brought an explanation that inspired another candidate for Jeff's question. Because the IRS does not require mortgage lenders to disclose the principal balance of the loan on the Forms 1098, many (most?) taxpayers and tax return preparers simply deduct the interest that is shown without applying the $1,000,000 limitation. In one instance, almost $50,000 of tax liability would be generated, aside from interest and penalties, if the IRS pursued an audit and sought payment simply for the tax years still open under the statute of limitations. So coupling this with Joe's proposal to disallow the improper deductions of interest on home equity loans, there might be some meaningful amount of revenue to be recovered.

Perhaps as Commissioner for a day, I could spend the first half-hour looking at the IRS data indicating where noncompliance is highest. Unfortunately, much of IRS data is outdated, and there's no assurance that the IRS really knows enough to identify the most revenue-expensive misreporting. Perhaps getting partnerships to allocate income and losses in compliance with subchapter K would raise the most "additional revenue" but the shortage of tax practitioners and IRS employees genuinely expert in subchapter K would stymie that effort.

But to get anything done, the Commissioner needs a good Chief Counsel. So here's the deal. Joe can be Commissioner for a day, and I'll be his Chief Counsel for that day. We'll split the 1%. Neither of us are greedy, so we each could be content with one-half of 1%. Of course, I'm expecting Joe would spring for that day's lunch tab.

Yet I'd rather be Congress for a day. After all, given the choice between designing the system or cleaning up the mess under the existing system, I'd rather set up a system that requires far fewer mess cleaners. Something like a "low maintenance" appliance.

Wednesday, November 09, 2005

Restoration of the Sales Tax Deduction = Restoration of Old Authorities? 

Recently, while revising a treatise chapter dealing with the federal income tax deduction for taxes, I noticed a serious technical question generated by the restoration of the sales tax deduction. Although I have addressed the policy issues raised by the restoration (here, here, and here), I had not paid attention to this technical and practical aspect of the restoration. So, without further ado, here are my thoughts:

In the American Jobs Creation Act of 2004, Pub. L. 108-357, Congress enacted a limited restoration of the deduction for state and local sales taxes. Instead of permitting the deduction in addition to the deduction for state and local income taxes, Congress provided taxpayers with an election under which they could choose to deduct state and local sales taxes instead of state and local income taxes. As a practical matter, this means that taxpayers living in states that have no personal income tax will choose to deduct state and local sales taxes.

Mechanically, Congress restored the deduction by re-enacting the text of the deduction provision as it existed before the Tax Reform Act of 1986, Pub. L. 99-514, repealed the deduction. The text had been in section 164(b)(2), but on restoration it ended up as section 164(b)(5). The language for the election was placed in paragraph (A), which required relocation of the original subparagraphs (A) through (E) as (B) through (F). The separately stated sales tax rule that had been in section 164(b)(5) and which had also been repealed in 1986, was restored to paragraph (G) of the new section 164(b)(5), with the deletion of references to the still-extinct gasoline tax deduction. Congress also added specific instructions with respect to optional sales tax tables that had not been in the previous edition of the sales tax deduction statute.

What is now section 164(b)(5)(B) through (G) is identical to what was the pre-1986 section 164(b)(2)(A) through (E) and (b)(5). Accordingly, the question is the level of deference that should be accorded to regulations, judicial decisions, revenue rulings, and other administrative issuances addressing the pre-1986 statutory material. Nothing in the legislative history addresses this particular question.

It is this commentator's opinion that the deference ought to be as high as it would be if all of these authorities were re-issued under the restored statutory language. As a practical matter, the regulations issued under the pre-1986 statute are still in the Code of Federal Regulations (see Regs. sections 1.164-3(e) through 1.164-3(i) and 1.164-5). The IRS could, though it is unlikely, issue a revenue procedure that republishes the pre-1986 rulings and other administrative issuances. Of course, courts will not and cannot republish judicial decisions affecting section 164(b)(5) until there is a case in controversy for a judge to decide.

When advising a client, it would be most sensible to treat the pre-1986 interpretations of what is now section 164(b)(5)(B) through (G) as authoritative. Surely a disclosure should be made to the client that reliance is being placed on these old authorities, and for good reason. Taking a return position contrary to one of these authorities should be undertaken only in the most special and unusual of circumstances, where some fact indicates that the authority is somehow not deserving of deference. At the moment, I cannot think of any reason that the interpretation of the statutory language should be changed when the statutory language has not been changed but merely restored.

As for the election and the optional sales tax tables, it is not impossible for new issues to arise that have not been the subject of previous determinations. To this extent, client advising and tax practice decision making would follow the usual principles that apply when novel issues arise.

Monday, November 07, 2005

How Halloween Will Become Tax Time While August Vacations Are Returned to Tax Preparers 

The IRS has released a new Form 4868 which will permit individuals to obtain automatic six-month extensions for filing their tax returns. A companion new Form 7004 will permit business taxpayers, including not only corporations but also trusts and partnerships, to do the same thing. Note that the filing extension does not permit a delay in paying any tax that is due. The changes take effect for returns due in 2006.

For all individuals except those few without a calendar taxable year, this means that filing can be extended from April 15 until October 15. Just in time for Halloween. Actually, it’s very close to Columbus Day. How fitting. Taxpayers can celebrate what they’ve discovered as their returns are prepared.

In its announcement, the IRS explained that the new procedure will save taxpayers between $73 million and $94 million each year by eliminating or consolidating several existing IRS forms. How do they figure out those numbers? How do they know it’s not $52 million or $116 million?

Formerly, the automatic extension for individuals was a four-month extension, with a follow-up two-month extensions for taxpayers with acceptable explanations. That’s why tax return preparers weren’t taking vacations in August. August 15 had become a second April 15. Even though only 6 percent of taxpayers, according to the IRS, asked for the four-month extension, and only 2 percent asked for the second extension.

How can 6 percent of taxpayers make August such a busy month for tax return preparers? These aren’t the taxpayers with the simple returns filed in March and early April. These are the taxpayers with partnership and LLC interests, who don’t receive their Schedules K-1 until after the April 15 deadline passed. These are the taxpayers with complicated returns. These are the taxpayers who struggle to gather all the information required to complete the return. These are the procrastinators, about whom I shared some thoughts about three weeks ago.

Six percent of taxpayers providing perhaps 30 or 40 percent of a tax return preparer’s annual workload hopefully provide 30 or 40 percent of the preparer’s fee income. But can that make up for the disappointment of the children who learn that August isn’t the month for family vacations?

So perhaps the six-month extension is a good thing. It means that tax returns not completed by April 15 while the children are in school will be occupying the preparer’s time in October, when the children are in school. It is highly unlikely that the August tax return flood will survive this change. The same few clients who ask that their returns be completed in May or June once the expected K-1 schedules arrive, and whose other return data was probably inputted early in the process, will still do so. The rest of the group, especially the procrastinators, will now wait until October 15 because there will be no reason for them to stop by the preparer’s office on October 14.

Too bad the extension deadline wasn’t changed to October 31. Imagine the glee of a tax return preparer who could greet each client with "Trick or Treat?" After all, there is a scary relationship between Halloween and tax.

It could be worse. Every so often, some clueless member of Congress proposes that tax returns be due on the taxpayer’s birthday. One of my favorite questions is what happens to joint returns filed by married couples who don’t share the same birthday? Of course, I can’t imagine that the proposal would extend the due date for paying any additional tax that is owed. Yes, the proposal, in its many variants, isn’t much more than political grand-standing.

So, next October, be patient with your friends, relatives, and neighbors who prepare tax returns. They’re going to be busy and harried. They’ll be digging through a combination of what had been the "August pile" and the "October pile." But at least, hopefully, they’ll have had a chance to relax in August.

Friday, November 04, 2005

A Thousand Tax Words 

Is that what a tax picture is worth?

This morning's post has inspired a response from Joe Kristan that is well worth, well, I can't say "reading" because that's not the right verb, so, well, it's well worth viewing.

Yes, there are some comments to read (including a good one suggesting use of a corporate dividends paid deduction to work through the dividend issue I discussed).

But there's also something to see. I laughed out loud. You might, too. Or you might scream. In fear or delight.

Joe, good work.

"Professor Maule Goes to Washington" 

Relax, it's not news. It was the subject heading of an email that I received from a former student, Nakul Krishnakumar, who keeps a close eye on what I write. In his email he sent a request. It's a scary one, but let's go along with him:
If someone were to make you President for a day, what would your tax policy be? In other words, if you were to be tasked with re-writing the tax code, what would our tax code look like? Obviously, I've heard/read various proposals that you have, but I wanted to know what your policy would be if you were given the chance to come up with a comprehensive plan. Would the tax code be progressive or regressive? Would there be a capital gains tax? Would you allow for deductions? How about a national sales tax? I'm pretty sure you would have a fuel tax!

I think that might be an interesting discussion ...
I suppose, since the odds of my being made President are about equal to the odds of my becoming Commissioner of Baseball, there's no harm in responding to Nakul's inquiry. In other words, I doubt anything I say will positively or negatively affect those odds (for either position!)

As I mentioned to Nakul privately, a full and complete response to his questions would require a treatise. I'm not about to do that, even though, as many know, the temptation is strong. Instead, I will try to explain how my taxation philosophy would manifest itself in a tax structure.

I begin with three ideas. First, by taxation I mean government revenue generation. In other words, whether something is called a tax or something else isn't critical, other than, perhaps, in the practical world of politics. So, for me, taxation includes user fees, tolls, taxes, and even, yes, "revenue enhancements" for those who remember how that creative phrase entered the public policy lexicon. Second, there is a distinction between federal and state (and local taxation) and it is important, and necessary, to consider those differences in responding to Nakul's question. Third, government revenue ought to be collected for one purpose, and one purpose only, and that is to fund the legitimate purposes of government.

My first idea probably doesn't trigger much controversy. My second idea is pretty much unavoidable and pretty much states the obvious. My third idea, however, certainly does open up a debate. Until and unless society agrees to the scope of "legitimate purposes of government" there is no firm foundation on which to construct a tax system. Even the purposes that seemingly are "easy" to define can generate disagreement. For example, national defense may not find advocates among genuine "turn the other cheek" pacifists. Environmental protection and regulation by the government does not find 100 percent support among voters. Maintaining the life and health of the economically disadvantaged is viewed by many as a business for the private sector and not government at any level, and some others consider it the bailiwick of state and local governments but not the federal government. I am not going to answer these questions. They are not tax questions. They are public policy questions. They ought not be decided as part of drafting the tax law. In other words, once the people, through democratic processes, agree that a government (federal, state, or local) ought to do X, Y, and Z, then the question of how the funds can, and if so, should, be raised sets up the tax policy issues.

I favor user fees, and thus government functions that can be funded through user fees ought to be so funded. For example, if the nation decides that the government should be responsible for the construction, protection, and maintenance of airports, highways, tunnels, bridges, and other facilities, the cost should be borne by the users. There is one caveat. To the extent that the users are financially disadvantaged, the question of whether they should be exempt naturally comes to mind. The answer is simply this: a user fee is an expense of life, just as the cost of groceries, clothing, and rent are expense of life. If the nation agrees that there is a valuable societal benefit in shielding the financially disadvantages from the ravages of poverty, user fees would be included with the other expense of life in determining how and to what extent society, through government, can and should step in to supplement or nurture improvements in the financial status of the poor, whether through grants, education assistance, job placement, or business development.

One of the tricky parts of user fees is the question of "who is the user?" It's easy when it comes to crossing a bridge. It's far more difficult when it comes to other functions, such as providing a public education. Is the user the child attending a public school? The parents of the child who attends public school? The employees who can hire graduates of the school without needing to provide the training that the school has provided (assuming it's doing its job, which is another, though related, issue)? Is it society, which benefits from the education of the electorate? If it is, as I think it is, society, the second tricky part of user fees arises. It's fairly easy to calculate the cost of crossing the bridge, at least for the engineers and cost accountants who sit down together to do the computations. It's almost, if not, impossible, to calculate the cost imposed by each citizen's "use" of the public school system. Thus, some other form of revenue generation must be found.

And so, leaving out the many chapters of the treatise that would carve citizen-approved government purposes into those sensibly funded by a user fee and those needing to be funded by some other revenue source, I'll turn next to what those other sources might be. In doing so, I am getting a little closer to answering the specific questions in Nakul's inquiry. What I'm also going to omit, for the most part, is the determination of which government (federal, state, or local, or some combination) ought to provide a specific governmental purpose activity and thus seek revenue to fund it. Traditionally, public education is provided by state and local governments, although federal funding is significant. The states use property taxes, income taxes, other taxes, and combinations, whereas the federal financial inputs pretty much come from the federal income tax. Without getting into the debate over the appropriateness or Constitutional legality of a federal property tax, and without trying to lock states into a tax structure that mimics the federal tax structure, I will describe non-user-fee revenue generation in terms not necessarily limited to federal taxation but reflecting federal taxation as the primary consideration.

Once user fees have been determined for those government activities appropriately funded by user fees, the choices left fits into several categories. There are status taxes, such as a tax on wealth (annually or at a specific time, such as an estate tax) or a segment of wealth (e.g., a real property tax). There are transaction taxes, such as a tax on retail sales (either in full or on specified items), a tax on financial transfers, a tax on net increases in wealth (such as an income tax), a tax on the making of gifts, a tax on transfers of property (such as real property realty transfer taxes), a tax on the value added to the economy by a particular activity of manufacturing or providing services (e.g., a VAT), a tax on the transmission of property at death (such as an inheritance tax), a tax on gross receipts (again, on all gross receipts, on business gross receipts, or on specified types of gross receipts). There are consumption taxes, such as a tax on the burning of fuel, a tax on the purchase of items for consumption, or a tax on the disposition of waste into a landfill. Some of these taxes, such as a tax on landfill deposits, are not all that different from a user fee. In many respects, a consumption tax is a user fee, reflecting the cost to society of a person's or a business' use of what ultimately is a natural resource.

As a practical matter, the types of taxes that get the most attention when federal tax reform is discussed are a sales tax, a consumption tax, a VAT, an income tax, an estate tax, and a gift tax. There are hybrids. There are all sorts of variation in the specific details. Selecting one sort of tax rather than another may appear to be a matter of general conceptual policy, but the details are what provide the salvation or the death writ. Details can make a seemingly unworkable tax work, or make a sensible tax a disgrace.

Again, I begin with a basic principle. It makes no sense to adopt a variety of taxes that do not mesh well together. It makes no sense, for example, to tax both wealth and income, because a sensible system either taxes the wealth as it is generated (an income-type tax), or at specified points in time while it is being held or transferred (an estate tax, a property tax, etc.) Combinations become defensible when a flaw in one tax creates the need for a backstop. The gift tax is an example of such a backstop, for it makes the estate tax effective, by foreclosing most tax-free lifetime transfers that would shrink the estate tax base. Unfortunately, imperfections in that meshing is part of what taxpayers pay estate planners to exploit.

The estate tax, as I've noted in other posts, would not be necessary if the income tax did not permit unrealized gains to go untaxed during lifetime and at death, and if gift transfers did not escape income taxation. The "a little of this" and "some of that" approach to taxation, as in cooking, is just as likely to generate slop as it is to brew up a delightful stew. Perhaps Nakul's basic inquiry reflects his understanding that the odds of getting a tasteful dinner when multiple chefs are messing with the ingredients are slim, indeed.

In the end, the sales tax does not earn points because it imposes the cost of government on the very activities in which people need to engage in order to live the lives that government exists to protect and defend. Existing sales taxes are regressive, and designing them to be progressive, though possible, would be unduly complex. Even as so designed, reliance on a sales tax would shift the cost of government onto those least able to pay, relatively speaking.

The VAT strikes me as ultimately counter-productive. Government and society want citizens and businesses to add to the value of the nation's economy. Because taxes act as brakes on economic growth, it makes little sense to impose a tax on those activities that are building up the nation's economic strength. It is possible for a person to add far more value to the economy through an activity than the person receives from that activity, unless, of course, the VAT is passed along to the next person or business in line. Ultimately, the VAT becomes a differently-measured sales tax, with variances in the timing of the imposition.

Consumption taxes present similar conundrums. Consumption taxes act as brakes on consumption, which isn't good for the economic well being of a nation dependent on the economic well being of its businesses and citizens who produce goods and services for consumption. But, wait, perhaps consumption taxes acting as a brake would be good, because we are told that too much consumption and insufficient savings is bad for the nation's economic well-being. So perhaps a consumption tax could be used not only as a revenue raiser but also as a throttle providing a means to nudge consumption up and down, though that power would be more efficiently exercised by the Fed or a similar board than by a Congress that has demonstrated little, if any, understanding of how public finance can and should function.

But consumption taxes, like sales taxes, are regressive. Perhaps the consumption that harms the economy is not all consumption but excess consumption. So perhaps a consumption tax ought to be imposed on consumption in excess of a particular dollar amount, in the nature of some sort of luxury consumption tax. But that would require record keeping almost as burdensome as that required by the current income tax. And surely consumption of products manufactured outside the country does not return as much to the national economy as does consumption of products manufactured within the country. So perhaps a consumption tax ought to be imposed on the consumption of imported products. Unfortunately, some things necessary for life cannot be consumed unless they are purchased from a person who has imported them because they're not manufactured in this nation.

Another problem with consumption taxes is that it shifts the cost of government away from those who hold investments. Although a consumption tax is an incentive to save, it is not an incentive for someone who inherits wealth without having had to generate it, and who needs to consume only a small fraction of the wealth in order to meet life's needs. The consumption tax entrenches the haves, and leaves economic power in the hands of a few rather than in the hands of the many, where it must be for a democracy to function well. After all, a democracy functions best when each citizen has a stake in the nation's economic well-being and encounters an economic and tax system that fortifies the protection of that stake.

Oh, I'm very good, it seems, at trashing just about every tax that isn't a user fee. But there are two major types of taxes still to consider. One is the income tax. The other is the wealth tax.

Both the income tax and the wealth tax can be designed to provide controlling throttles for consumption and to place the burden of the cost of government on those whose ability to pay reflects the benefit that the nation's economy, as protected and nurtured by the government, has provided to those with ability to pay. The undesirable structure is one that combines a bit of one and a bit of the other.

Using a wealth tax to generate revenue is less attractive than using an income tax. Imposition of a tax on wealth poses the risk that the taxpayer would need to liquidate an investment at the wrong time in order to generate cash to pay the tax. Imposing the tax only at death poses cash flow problems for the Treasury. Imposing the tax annually raises a variety of valuation issues, probably dwarfing those that bedevil state and local governments that impose real property taxes.

Using an income tax makes sense if income is appropriately defined to reflect increases in wealth. Of course, one can measure increases in wealth by measuring wealth at the beginning and at the end of a period, and then comparing the two. That approach, however, poses the same problem as does the wealth measurement aspect of a wealth-based tax. However, increases in wealth can be measured indirectly, by tracking income and what I will call outgo. Of course, this sort of measurement does not account for valuation increases that arise from market changes, at least not until something is done that fixes that increase in value as something more than speculative. If an income tax base is measured by subtracting certain outgo from income, the income tax also can serve as a luxury consumption tax without the need to track consumption expenditures.

So, I'm back at an income tax, though I'd design it very differently. Again, without writing a Code, even though it would be shorter than what now exists, I will outline the main features of such a tax.

Income would include income, with very few exclusions. It ought not matter whether the income is from wages, employment benefits, pensions, annuities, life insurance, dividends, interest, rents, royalties, gains from the disposition of property, or other sources. Taxing dividends means, of course, that corporate income would be taxed twice. Does it make sense to impose a second level of tax simply because the business is conducted in the form of a C corporation and not a partnership, LLC, or S corporation? Perhaps, if one wants to laugh at those who didn't know any better, or dish out "serves 'em right" if there were tax-savings motivations for forming a C corporation that didn't pan out. Unless one imposes a flow-through regime on C corporations, corporate income that is not distributed would not be taxed unless there were a corporate-level tax. Just as important, dividends paid to tax-exempt persons and entities would escape taxation if there were no corporate-level tax. The second problem is more easily solved, namely, taxing tax-exempt persons and entities with respect to dividends paid from income earned by corporations within the jurisdictional reach of the United States government. The first problem is more challenging. Ultimately, so long as the other tax escape routes for corporate earnings are foreclosed, the undistributed income of the corporation will be taxed when the shareholder's stock is sold, redeemed, or canceled upon corporate liquidation. It's a timing problem. Perhaps the solution, a bit complicated, is to impose a corporate earnings tax on undistributed income, and to allow that tax as a credit when the sale, redemption, or liquidation generates income at a later time.

Surely the arguments that taxing interest income, or dividend income, or gains from the disposition of property would hurt the economy or is somehow unfair have been made and would be repeated in response to my approach. Considering that someone once put together the top 80 or so arguments in favor of special treatment for capital gains and the top 80 or so arguments against such special treatment, it would be inefficient to repeat those analyses. Suffice it to say that the only thing of which I have been persuaded is to index basis so that the gain from the disposition of property is real gain and not imaginary inflation reflections. And, of course, the disposition of property at death, by will or otherwise, would be a disposition subject to income tax.

Why include life insurance? Because it is income, at least to the extent it exceeds the amount paid for it. Won't this make life miserable for the "widows and orphans"? No. After taking into account the proposed deduction/credit for outgo required for poverty-level existence (or some multiple thereof), the poor orphans would not be taxed, but the ones hauling in tens of millions of dollars from "super life insurance trusts" would no longer get treated by the tax law as if they were "poor orphans" in need of an exclusion.

What of retirement plans? There is societal value in having a citizenry so financially well prepared for retirement that social security becomes totally or almost totally unnecessary. Rather than encouraging a proliferation of various plans in a complex maze of sometimes inconsistent provisions, the tax law should simply provide that up to $x of contributions to retirement are untaxed (excluded from gross income if done by the employer, deductible if done by the employee). Whether $x ought to reflect income, or, as I prefer, be set at an amount (adjusted for inflation) that will generate a "sufficient" retirement income can be debated. And, yes, retirement income would be taxed because it very well could exceed the "sufficient" level because of additional amounts set aside by taxpayers willing and able to do so.

What of gifts? The transfer of property would be treated as a realization event and thus the gain would be included in income. What of nonrecognition provisions? I'm not yet certain that I would retain more than just a few of them. They are invitations to abuse, to the structuring of transactions that would not otherwise be conducted, and in many instances far more generous than they need to be, offering protection from taxation in instances where the justified rationale does not apply.

As for outgo, there would be two basic deductions. One would be for the expense of producing the income. In other words, I reject gross receipts taxes, which are one of the most perfidious exactions imposed by state and local governments except in those instances where gross receipts is a proper measure of a user fee, but I've yet to see such a situation. The other would be a deduction (or perhaps a credit) that would reflect the wisdom of not imposing a tax on those whose incomes were barely sufficient to live life. Whether that amount should be equal to (or be a credit amount equivalent to the amount equal to) the poverty level or a greater percentage thereof is a detail that I've not yet fully pondered. Perhaps, because all citizens ought to contribute something to the cost of government, a small ($10) tax ought to be imposed on taxable incomes under the cutoff, and a very low rate imposed on taxable income above the cutoff but below, say 125% of the cutoff.

There would be no depreciation on real property. Business real property so rarely goes down in value over the long-term that those few instances where it does so would be taken into account when the property is sold for a loss. Depreciation on personalty used in generating income would be computed over five years. Period. Arbitrary? Yes. Simple? Yes. Sensible? Yes. Most equipment currently is depreciated over a period equal to or nearly equal to five years. Equipment that currently is depreciated over longer periods is heavy duty infrastructure, investment in which ought to be encouraged because it provides the goose that lays the income egg for the national economy.

Oh, wait, cry the charities. With no deduction for charitable contributions, people will give less to charity. Well, if that's true, it tells us a lot, doesn't it, about the American people. Of course, the allegation is not true. People give to charity because they are theologically driven, morally compelled, or just flat-out nice. Think of all the charitable contributions that are made by people who don't itemize deductions and get no tax benefit. If, in fact, the government needs to bribe people with tax deductions in order to get them to give to charity, perhaps we should just close up shop and go home. With this plan's reduction in tax rates, people may "feel" more generous and even increase giving.

Of course, no surprise, when it comes to rates, all taxable income is taxed under a rate schedule. There is no special rate for capital gains. That alone takes about 30 percent of the current tax law and trashes it. Also trashed are all the social policy provisions that ought to be in some other law, if indeed the citizens think that the federal government should be providing financial assistance to particular individuals or communities or to those who engage in particular activities. I understand that the Congress, which consistently criticizes the IRS, has a habit of demonstrating its true thoughts about that particular federal agency by putting into the tax law provisions that deal with matters that are within the purview of other federal agencies because the IRS appears to be more capable of administering these programs, but it's time for Congress to demand of the other agencies the same sort of competence that it attributes to the IRS when it turns to the IRS to handle its pet project of the week.

This approach permits lowering the tax rates. The base would be broadened, and thus rates could be reduced. I would not make the plan revenue neutral for the simple reason that doing so would perpetuate the current revenue shortfall built into the federal budget by the deficiencies of the current income tax law. Thus, the budget deficits that have arisen could be reduced, perhaps with a trigger that lowers the income tax rates when the deficit is eliminated. Even so, the rates would be so much lower that there would be much less incentive to play tax shelter games. When's the last time someone trying to work around a 5 or 10 percent state income tax made the news?

Finally, there is the matter of credits. Of course the credits for taxes withheld (and I'd withhold on all income payments exceeding $500, not just wages and certain other payments) and estimated tax payments would be retained. The "poverty level" deduction probably would end up as a credit, because the arguments for making it a credit rather than a deduction are very strong. Should that credit be refundable? Yes, and it could serve therefore as an expanded version of the current earned income tax credit, which ought not be as limited as it is (for under present law it has become an incentive for fraud, is difficult to administer, and baffles almost all the taxpayers it is designed to assist).

This is a fairly straight-forward plan. Granted, I've not jumped into a lot of issues that would need further discussion, such as international transactions. The point of this already-too-long essay is to give Nakul (and others) a big picture of how I would approach the tax reform question. It should be rather apparent that I'd come at this with a totally different perspective than did the Tax Reform Panel, even though it was operating under stated (but unfulfilled) objectives that are the same as those that energize my approach. And thus I reach a different result, one far more simple, imbued with far more fairness, and with at least as much a chance, if not more, to maintain a healthy economy.

However, like the Tax Reform Panel report, this short essay serves as a nice catalyst for conversation and discussion, but is otherwise worth little, if anything. Neither will get to, or through the Congress in any form, other than Congressional cherry-picking of revenue raisers in the Tax Reform Panel report. Both, if introduced in some legislative form, would attract every tax-seeking "I'm special" hornet intent on stinging it with its particular "my tax break cannot be touched" venom.

Remember, Nakul asked what I would do if I were President for a day.

He didn't ask what I would do if I were Emperor for a day.

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