MauledAgain

Thanks to a question from a subscriber to one of the Tax Management portfolios that I wrote, I had the opportunity to review an interesting tax definition issue involving depreciation.

Section 168(e)(3)(E)(iii) permits taxpayers to elect to treat “retail motor fuels outlets” as fifteen-year property for purposes of the modified accelerated cost recovery system (MACRS), which for all practical purposes, is depreciation. Though it might not surprise tax professionals, it probably surprises everyone else, that the statute does not defined “retail motor fuels outlets.” However, legislative history (S. Rep. No. 281, 104th Cong., 2d Sess. 14-16 (1996)) provides some guidance. According to the legislative history, a property qualifies as a “retail motor fuels outlet” if it satisfies any one of three conditions. The first way for property to be a “retail motor fuels outlet” is for 50 percent or more of the gross revenues generated from the property to be derived from petroleum sales. The second way is for 50 percent or more of the floor space in the property to be devoted to petroleum marketing sales. The third way is for the property to be a motor fuels outlet of 1,400 square feet or less.

Two things jump to mind. First, what would a textualist who rejects legislative history do with the term “retail motor fuels outlet”? Second, does it help to define a retail motor fuels outlet by referring to a motor fuels outlet of 1,400 square feet or less. Does that not simply push the question back one notch to an inquiry into the meaning of “motor fuels outlet”?

A little history is helpful. Before section 168(e)(3)(E)(iii) was enacted, the IRS treated gas station convenience stores as 15-year property if two conditions were satisfied (IRS Industry Specialization Program Coordinated Issue Paper, Petroleum and Retail Industries Coordinated Issue: Convenience Stores (before revision). First, 50 percent of more of the gross revenues generated by the store must have been from gasoline sales. Second, 50 percent or more of the floor space in the building, including restrooms, counters, and areas allocable to traditional service station services, must have been devoted to petroleum marketing activity. If either condition was not satisfied, the property was treated as a convenience store and not as a petroleum product marketing station, classified as nonresidential real property. When Congress changed the statute, the IRS issued a revised IRS Industry Specialization Program Coordinated Issue Paper, adopting the approach in the legislative history. In other words, the two-pronged test was replaced by the “any one of three” test. It also removed the reference to gasoline, as that description precluded diesel, which is no less a fuel than is gasoline.

Thereafter, in Publication 946, the IRS defined retail motor fuels outlet a bit differently. It provides:

Real property is a retail motor fuels outlet if it is used to a substantial extent in the retail marketing of petroleum or petroleum products (whether or not it is also used to sell food or other convenience items) and meets any one of the following three tests.
-- It is not larger than 1,400 square feet.
-- 50% or more of the gross revenues generated from the property are derived from petroleum sales.
-- 50% or more of the floor space in the property is devoted to petroleum marketing sales.

This definition shifts the focus from fuels to petroleum, and thus opens the door to the question that was posed. Specifically, does the building used to sell motor oil for oil changes and to perform vehicle lubrication, assuming that the motor oil sales generate 50 percent or more of the gross revenues, qualify for the fifteen-year property election?

For most people, the phrase “retail motor fuels outlets” is a fancy way of referring to a fueling station, such as a gasoline station, a gasoline/diesel station, or a convenience store that sells fuel. One would not think of a “lube and oil” establishment as a “retail motor fuels outlet” because those establishments often do not sell fuel. Yet, technically, the definition provided by the IRS in Publication 946, if literally applied, covers that establishment, assuming its sales of motor oil and petroleum-based grease are a sufficient percentage of revenue or the square footage is sufficiently small, because the property “is used to a substantial extent in the retail marketing of petroleum or petroleum products.” Motor oil is a petroleum product. From what I can figure out, most if not all synthetic motor oils are made from petroleum, or from a combination of petroleum and other ingredients.

The flaw in the reference to petroleum in the IRS definition is that not all fuels are made from petroleum, and not all petroleum products are fuels. Thus, under the IRS definition, a refueling station selling only pure ethanol would not qualify as motor fuels retail outlet property, and the “lube and oil” establishment might. At least this is an improvement from the amended IRS position, under which a refueling station selling more diesel than gasoline would fail to qualify. No one has provided a reason for the failure of the Congress to define the term it used in the statute. If it intended the everyday meaning, then the IRS definition is flawed. If it intended something else, it should have said so. In any event, its failure to provide a definition opened the door to a rather slippery definition from the IRS.

Peter Pappas is at it again. In More Lies about Tax Lies, he attempts to rebut the points I made in Tax Myths, Tax Lies, and Tax Twisting. In his effort, he engages in the same sort of twisting and misrepresentations that are at the root of what I set out to debunk.

Though the myths I discussed were those presented on another web site, Pappas persistently refers to them as “Maule’s . . . Myth” in a blatantly obvious attempt to cause his readers to think that I developed the myths. No, I simply was commenting on a list developed by someone else.

Pappas claims that “No serious person on the right has ever suggested that the poor should pay more taxes because the wealthy are over-taxed.” I suppose Orrin Hatch is not a serious person. He’s not the only one complaining that the poor, and the middle class, should pay more. So when Pappas claims that “Conservatives want everyone to pay less taxes,” his assertion flies in the face of what has been said. But in missing this reality, Pappas is trying to deflect attention away from the original point, which is that the failure to use the phrase “federal income” before the word taxes, in other words, the failure to be precise, creates an impression that is erroneous but intended.

Pappas then again tries to deflect attention from the error by claiming that the omission of the phrase is designed to rebut an alleged lie, that is, that the rich don’t pay their fair share of income taxes. Aside from the fact that an opinion about fairness cannot be a lie because there is no truth or falsity to an opinion, an attempt to rebut a statement, whether opinion or asserted fact, ought not be made by offering an imprecise statement that implies a falsehood. Pappas demonstrates the futility and desperation of his position when he claims that the fact that the “top 50% pays 100% of the federal income taxes” means that “the assertion that the top 50% does not pay its fair share is false.” Why? Because the assertion is that “the rich don’t pay their fair share of income taxes” which is a different question from whether the “top 50%” is paying a fair share. Lumping the top 1% with the next 49% is a sad gesture of trying to hide the wealthy among the middle class.

Finally, Pappas gets to the root of the problem. He claims “Maule knows that we are and always have been talking about federal income taxes.” Of course. That’s not the issue. The issue is my concern that typical Americans who are not tax professionals don’t know that. When they ask me about what they are hearing and reading, they demonstrate the pernicious effect of deliberate lack of precision. The liars know that they might not have much of a chance of fooling some of us, but they certainly are taking their best shot at fooling most of us. Pappas then claims that because I object to these misstatements, it proves I am a liar. Yet Pappas admits that the critical words “federal income” are left out. So how am I a liar when my claim is that those words have been left out, and that by leaving them out, the statement implies something other than the truth? The answer is Pappas’ claim that I labeled the statement “47% of Americans don’t pay federal income tax” as a lie. I challenge Pappas to show us where, in any of my posts, I have asserted that the statement “47% of Americans don’t pay federal income tax” is a lie. I asserted that the statement “47% of Americans don’t pay tax” is a lie, and Pappas' only defense is that the two statements are the same. They’re not, and the inability to tell the difference between the two says a lot about Pappas and his argument.

When Pappas then claims that I plan to “confiscate wealth” from the haves, he climbs even deeper into the pit of rhetorical nonsense. All I have argued, for years, is that the Bush tax cuts were unwise, especially during a war. Letting the Bush tax cuts expire is not confiscation of wealth. And when he repeats the claim that no one has ever said that “47% of Americans don’t pay any tax at all” he conveniently ignores supporters of his outlook on taxation such as the Rev. Rick Warren, who told his followers, “HALF of America pays NO taxes. Zero.” So who’s the liar and who’s the propaganda minister?

Pappas then turns to the second myth, that “The American people and corporations pay high taxes.” He ignores the fact that I pointed out that the word “high” is “more difficult to parse.” Instead, he asserts that tax rates in other countries are meaningless. That could be so, but there are plenty of tax-reduction and tax-elimination advocates who point to tax rates in other countries as warnings of what will happen if taxes are not reduced even more. The worst part of his attempt to deal with the second myth is the way Pappas attributes things to me for which he has not proof. For example, he claims, “Most Americans don’t want to be like France, even if Professor Maule does.” Again I challenge Pappas. Show us where I have taken that position. Pappas follows that sentence with a footnote, but was I ever disappointed to discover that the footnote lacked any citation or link to proof of his assertion. Actually, I wasn’t disappointed. I was elated, because the lack of the proof demonstrates that Pappas is making up facts. After all, if he had proof, surely he would have provided it.

When Pappas gets to the third myth, he asserts that “Maule knows very well that many, if not most, conservatives don’t want to raise government revenues at all.” Of course I know that. My point is that although they want to reduce government revenue, the tax-cut proponents argue the opposite, perhaps because they know that they would lose votes if they admitted they want to cut government revenues to the extent they intend. In other words, when tax-cut advocates claim that they want to cut taxes in order to raise revenue, they know they aren’t coming clean with America.

Pappas then tries to take apart the third myth by claiming that tax cuts do create jobs and that the President has admitted that tax cuts create jobs. What the President said, however, is consistent with my point, namely, that tax cuts for the 99% generate jobs. Why? Because those cuts are an application of demand-side job growth. The tax cuts that bring joy to the wealthy, however, rest on the disproven and failed supply-side approach.

Pappas then tries to attribute to me a goal of increasing the top rates to the 70% to 90% range, but at least this time he buys himself some leeway by using the phrase “I suspect even Maule, himself [takes that position]." By phrasing it this way, he has an out when he fails in my third challenge, which is to demonstrate that I have made such an argument. That he wants to take my goal of letting the top rate return to 39.6%, where it was when the economy did well, and recast it as a claim that I want it to reach double that rate is quite revealing. He adds to that an unconditional claim that I favor increased government spending. Here’s yet another challenge for Pappas. Show us where I’ve taken that position.

Pappas doesn’t like the statistics, widely accepted, showing economic growth and tax rates, and relies on the idea that correlation is not causation. He claims that “myriad other factors” contribute to economic performance. That, however, does not remove tax rates as a factor. Some of the factors cannot be controlled, such as weather damage or overseas political conflicts, but tax rates can be controlled. Tax rates were cut in 2001. How have you fared since then?

When I characterize a book as a must-read, I try to put my characterization into context. Thus, some books that I have read are tagged as a must-read for those doing family history, whereas others are tagged as a must-read for those interested in model trains or the medicinal properties of chocolate. Today, I tag as a must-read, for every citizen of this nation who has attained high-school reading level ability, Bruce Bartlett’s book, published yesterday, with the descriptive title, The Benefit and the Burden: Tax Reform, Why We Need It and What It Will Take. If I were still teaching the tax policy course, this book would be assigned (and it has nothing to do with the fact that Bruce cites one of my faculty colleagues and articles published in my school’s law review, as that is simply icing on the cake).

In this book, Bruce provides a non-technical education, easily understood by those who are not economists or tax professionals, of how our tax system came to be what it is, why it needs to be reformed, why reform is almost impossible to achieve, and what must happen for any sort of remediation of the American economy and tax system to occur. Bruce beats down most of the myths, half-truths, and outright lies advanced by those whose attachment to their favorite special interest or single-minded ideological goal dooms progress on tax reform.

Bruce provides an easy-to-read history of the tax law and a discussion of how tax legislation is enacted. He follows that up with a discussion of income definitions, the various types of tax rates, how tax rates affect revenue, and how taxes and economic growth are interconnected. He concludes the first part of the book with an explanation of progressivity, the challenges of adjusting tax policy to react to business cycles, and a description of how tax systems work in other nations. In the second part of the book, Bruce looks at a handful of tax provisions that skew the tax system. Though he could not possibly discuss all, or even most, such provisions without writing a multi-volume treatise, Bruce selects provisions that have a wide scope and a deep revenue impact, including the tax treatment of health care premiums and expenditures, the mortgage and real estate tax deductions, charitable contribution deductions, special capital gain rates, corporate taxation, and tax compliance and audit issues. He shows how federal tax policy decisions alter state tax revenues, and, quite importantly, how tax breaks are the same as budget expenditures even though people who object strenuously to the latter refuse to admit that the former are simply disguised versions of federal spending.

For me, the third part of Bruce’s book is the most promising and the most depressing. The promise comes from Bruce’s adept examination of tax reform efforts over the years, and his careful analysis, showing both advantages and disadvantages, of the more commonly discussed tax reform ideas, particularly the value-added tax. The depressing impact, at least for me, arises from two things. One is Bruce’s no-nonsense discussion of how tax reform requires increased tax revenue, an option that the Congress seems incapable of considering, let alone implementing. The other is best described by the title of the last chapter: “If Tax Reform Happens, It Will Be Because Grover Norquist Permits It.” Not surprisingly, Bruce takes apart Norquist’s agenda with surgical precision, pointing out error after error, half-truth after half-truth, in the claims that Norquist has sold to a vocal and obstructionist minority. Perhaps what makes Bruce’s review of the tax problems of this nation so credible is that he was on the staff of a Republican member of Congress, at a time that now seems eons ago, whose contributions to tax reform at that time was far more productive than anything Norquist and his cronies have provided.

The stamp of approval that I put on this book would be granted even if many of the arguments that Bruce presents are similar or identical to the ones that I have advanced over the years, particularly in this MauledAgain blog. One of my consistent themes is the need for Americans to become educated about the realities of taxation and economics (see, e,g, Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, Is It Any (Tax) Wonder?, and Tax Myths, Tax Lies, and Tax Twisting), and here is a book that can get that job done, especially if everybody, or almost everybody, sets aside a few hours and reads it. But perhaps my enthusiasm for Bruce’s latest work comes from a suggestion that I will make even though it has absolutely no chance whatsoever of being adopted. Every candidate for Congress, whether or not an incumbent, should be required to read this book and take a test to confirm that he or she has acquired the understanding of taxation and economics that should be a prerequisite for being called to an office of public trust, and if the test is failed, the person should go back home. But the next best thing is possible. After voters read this book and understand that particular candidates are clueless or, worse, among the ranks of the truth twisters and myth makers, they will make certain that those candidates stay home or go back home. Such is the value of understanding tax and economic policy, an accomplishment that Bruce’s book (available from Amazon) makes possible for people from every walk of life.

For me, the difference between a myth and a lie is that the folks believing in the former don’t know any better and those spreading the latter surely do. In between is the twisting, which can reflect ignorance but also can be the consequence of deliberate word choice that suggests one thing even though it literally means something else. Recently, a distant cousin sent me a link to The Top 5 Tax Myths To Watch Out For This Election Season. All five so-called myths are ones that I had already seen and heard, many times.

The first myth, that “47% of Americans do not pay taxes” is a fairly new one, advanced to support the proposition that the poor should fork over more of their income and assets because the wealthy are over-taxed. The flaw in the statement is that it would be accurate if the adjectival phrase “federal income” were inserted before the word “taxes.” By leaving out those important words, the authors of the statement convey a meaning that is not supported by the facts.

The second myth, that “The American people and corporations pay high taxes” is a bit more difficult to parse. What is meant by “high”? Compared to a one-percent tax rate, there is a plausible argument that most American people and corporations pay high taxes, because even 15 percent is “high” compared to one percent. On the other hand, if the statement is intended to make people think that Americans are taxed at a higher rate than are people and corporations in other countries, the statement is misleading. In 2009, every developed nation except two imposed taxes as a percentage of gross domestic product at rates higher than those applicable in the United States.

The third myth, that “cutting taxes creates jobs and raises revenue” has been around for several decades. It makes for a great sound bite, but it’s factually erroneous. The lowest average annual growth in gross domestic product during the past 60 years has occurred when the top marginal rate is where it is today. The highest rate of growth occurred during years when the top income tax rate was in the high 70-percent range. The second highest rate of growth was when the top income tax rate was in the, indeed, 90-percent range, but that surely was attributable to the global war then being waged. The third highest rate of growth, within a whisker of second place, was when the top income tax rate was 39.6 percent, which is where it was before the Bush tax cuts went into effect. Those cuts drove the growth rate down to its lowest point. Surely the third myth is a pre-emptive strike against those who want to return to the rates as in effect before the Bush tax cuts, although opponents act as though people were advocating a return to the days of top rates in the 70-percent and 90-percent ranges.

The fourth myth, that “The US tax system is very progressive because wealthy individuals already pay a disproportionate amount of taxes” is another statement that loses its factual truth because the phrase “income tax” has been removed as a modifier of the word “system” and as a modifier of the word “taxes.” The progressive federal income tax has the effect of ameliorating what would otherwise be a very regressive overall tax system. As a practical matter, the progressive federal income tax causes the “US tax system” to be a flat system.

The fifth myth, that “The ‘Fair Tax’ or a flat tax would be more fair” simply opens up the debate about the meaning of “fair.” For many people, the rule requiring drivers in the left turn lane to turn left is “unfair” because it doesn’t acknowledge how special they are by letting them go straight out of the left turn lane, cutting ahead of the people in the go straight lane. For many people, any sort of tax system, and any sort of government reining in their impulses, is “unfair.” Certainly the flat tax is not progressive, and its adoption would remove the only thing keeping the entire tax system from being regressive.

Each of these so-called myths can be dissected by sitting down, looking at the facts, thinking carefully, and making computations (such as those that would demonstrate that most Americans would pay more federal income taxes under a flat tax that raised the same amount of revenue, because the lower income taxpayers would need to pay more to offset the revenue losses from the additional tax reductions afforded to the wealthy by the flat tax). These myths are not, of course, myths. They may become myths if they are permitted to circulate without objection. They are lies and twistings of the facts, nothing more. And as such, they need to be debunked. Progress is being made in that respect. I gladly play my part in defusing these provocative lies, as someone who laments tax ignorance. I add this post to the long list of those in which I have criticized the lack of tax education in this nation, and the opportunity for mischief it presents to those who benefit from, and seek to maintain, continued tax ignorance. Everything I’ve shared in Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind, and Is It Any (Tax) Wonder? reinforces this point.

Though the decision to cut taxes while initiating military action turned out to have had serious adverse consequences for the American economy, the temptation of using the “everyone gets a tax cut” as a political campaign ploy continues. And politicians continue to fall for it. Cutting taxes when the need for the revenue expires, such as the conclusion of a war during which taxes had been increased, makes sense. Cutting taxes when a government and its constituent agencies and localities are struggling to provide basic services is long-term foolishness for the sake of short-term political expediency.

According to this Philadelphia Inquirer article, New Jersey’s Governor Christie has proposed, in his annual State of the State speech, that “Every New Jerseyan will get a cut in taxes.” Because the proposed cut would be proportional across the board, a married couple with $100,000 of income would see a $275 tax reduction, whereas a person with a $1,000,000 income would receive a $7,265.75 cut. The effect of the reduction in state revenue likely means a $1 billion reduction in school funding. At a time when education is the pathway to success in the workplace and favorable competition with other nations’ economies, does it make sense to let education funding take yet another significant hit?

About a year ago, in The Price of Insufficient Tax Revenue, I described how the City of Camden, New Jersey, was compelled to make substantial reductions in its police, fire fighting, and other departments because New Jersey was compelled to reduce its funding assistance to its most economically devastated locality. A few months ago, in When Tax Revenues Are Insufficient: Affordability, Resistance, and Diversion, I described the impact of the New Jersey cuts on Pennsauken Township, which gave notice it would release 12 police officers, joining the almost 1,400 police officers and fire fighters who were laid off in New Jersey in 2010. As I pointed out in that post, when the carrot of tax cuts is waved before voters as the means to force cuts in government spending, “Though it sounds good at a theoretical level, the practical problem with cutting taxes in order to force a cut in government spending is that the health and safety of citizens is what gets cut.”

When the citizens who had been the beneficiaries of government services such as police protection, fire prevention, education, health, animal control, and the like, realize that the consequence of tax cuts disproportionately favoring the wealthy are being financed with reductions in the condition of ordinary people, they might consider again the question, “When taxes are cut, what’s really being cut, and for whom?”

The other day, in a conversation with someone, the focus turned to lotteries, sweepstakes, and whether it made any sense to enter allegedly “free” contests. One of the “opportunities” available to the other person was for a $1,000,000 annual prize. At one point, the other person commented, “Plus, why bother? If I win anything, the government will take fifty percent of it.” I asked why they thought half the winnings would be taken by the government. “Taxes” was the reply. I explained that the highest federal income tax rate was 35 percent, a rate that would apply to only part of the winnings, and that the likely impact, without doing actual computations, was closer to 28 percent. In Pennsylvania, the state income tax is slightly more than 3 percent. I commented, “Ignoring for a moment that whatever you would net is better than nothing, where did you get the idea that taxes would reach fifty percent?” The answer was not surprising. “That’s what they say.” I knew, of course, who the “they” are. So I explained, “They say this because they want to rile people up, to put taxation in a bad light, to make the impact of taxes look worse than they are, in an effort to ramp up opposition to taxation.” The other person became very quiet. I could tell some thinking was underway. Finally, “So they are twisting the truth.” My reply was simple. “As ever.”

Is it any wonder that the nation is so misinformed about taxation? Aside from the lack of tax education, a problem on which I’ve posted many times ( e.g., Tax Ignorance, Is Tax Ignorance Contagious?, Fighting Tax Ignorance, Why the Nation Needs Tax Education, Tax Ignorance: Legislators and Lobbyists, Tax Education is Not Just For Tax Professionals, The Consequences of Tax Education Deficiency, The Value of Tax Education, Tax Ignorance of the Historical Kind), there is the crisis of propaganda, deliberate lies, and half-truths advanced by the anti-tax crowd. Yet is it any wonder that the anti-tax crowd engages in this sort of scare-mongering? Surely they have concluded that stating the truth would not get the reaction that they need for their ultimate purposes, so they lie. I do wonder how many people believe the nonsense that is being spewed by those who appear unable to tackle the issues based on the actual facts. It is essential that these lies, half-truths, and misrepresentations be combated at every turn. I may have enlightened only one person the other day, but if everyone who understands the truth of taxation enlightens one person every day, and each enlightened person in turn does so, within months tax truth can go viral, and the darkness of the tax lies will be extinguished.

Jared Eutsler, a faculty member at Rasmussen College who writes for the colleges’s Business School blog, has released his 20 Blogs Accounting Students Will Love. Included among his selections is none other than MauledAgain, joined by Paul Caron’s TaxProf blog, Kay Bell’s Don’t Mess With Taxes, Byrne Hobart’s Tax Rascal, Russ Fox’s Taxable Talk, and more than a dozen accounting blogs.

It would be wonderful if accounting students, to say nothing of law students, loved this blog. My less ambitious hope is that law and other students, tax practitioners, and taxpayers generally find MauledAgain interesting, provocative, and challenging. True, I prefer that people not hate the blog, either, though the worst reaction, as far as I am concerned, is apathy.

Eutsler describes me as having “taught federal income tax for 20 years.” Oh, I wish I were as young as I was when I attained my twentieth tax-teaching anniversary in January of 2000. I’ve been teaching federal income tax as a member of a law faculty for 31 years. Because I make every effort to be honest, I simply cannot claim to have started teaching law school when I was 15. However, I can say that when I started teaching, the combination of my age and law school student demographics at the time left me younger than at least one-fourth, and perhaps even one-third, of my students. That’s no longer the case. Oh, well. But I’m still younger than the federal income tax, and always will be.

It is not difficult to guess what part of the second paragraph of the opinion in United States v. Allen, Nos. 10-2160, 10-2161 (1st Cir. 01/06/2012), caused me to stop reading, go back, and re-read the paragraph:

Frederick and Kimberlee Allen—husband and wife—appeal from their convictions for tax-related offenses. For some years the Allens filed annual federal income tax returns reporting their income. However, for tax years 1997 through 1999, despite reportable income, the Allens filed returns reporting zero income. On the advice of their dentist, and their own research, they concluded that no provision of the Internal Revenue Code imposed “liability” on them for taxes, and attached this explanation to their returns.

On the advice of their DENTIST? My dentist is a great dentist, a conversational fellow, a very good golfer, a savvy observer of life, and interested in tax and politics, but I’m not going to take tax advice from him, and I would not take tax advice from him even if I were not a tax professional.

Almost seven years ago, in The First Ten Tax Urban Legends, I noted the risks of obtaining tax advice from people who are not tax professionals:

One story tells of a high school teacher and coach who concluded that money earned during the summer as an umpire was not taxable because umpiring was a hobby. When challenged by a very bright and experienced tax lawyer turned tax professor, the teacher-coach dismissed the explanation because, get this, the commissioner of the baseball league had explicitly told the umpires that their income was not taxable. Amazing. Get your tax advice from a baseball commissioner, and have your surgery done by a lumberyard sales clerk.

Apparently this is not an unusual situation. Another experienced, able tax lawyer turned tax professor reported that a basketball referee he knows claimed that HIS fees were not taxable. Apparently steroids aren't the only problem in the sports world.

The taxpayers in the Allen case are tax protesters, who simply do not want to pay taxes. After their dentist steered them in the direction of a tax protester organization and a tax protester organizer who later was convicted of criminal tax fraud, the taxpayers tried to demonstrate a lack of criminal intent by claiming that they acted in good faith. One does not act in good faith in the tax world by getting one’s tax advice from a dentist and from a convicted tax protester organizer. One acts in good faith by getting a tax education or by relying on advice from a tax professional who has a tax education.

It is amazing that people who almost certainly would not ask a lumberyard sales clerk to do their surgery so readily start filling their heads with tax, estate planning, and similar advice from people who are not expertised in tax or estate planning. Not getting one’s tax advice from a tax professional is certain to gum up the tax return. The ensuing audit, and in some instances, criminal trial, can be far more painful than a root canal.

The IRS has just released its latest tax gap estimates. Because the collection and analysis of data lags behind the filing of returns and the conducting of audits, the latest information if for the taxable year 2006. It is unlikely that compliance has improved in later years.

According to the IRS, taxpayers underpaid their tax liabilities by $450 billion in 2006, an increase from the $345 billion shortfall in 2001. The compliance rate fell from 83.7 percent to 83.1 percent. Although the IRS chased down $65 billion of the unpaid taxes for 2006, an increase from the $55 billion it recovered for 2001, the increase in IRS collections did not keep pace with the increase in the tax gap. Some commentators think that the actual tax gap is higher than what the IRS reports, and I favor that perspective.

Why is there a tax gap? There are two major categories of causation. One is mistake, triggered either by carelessness or by the complexity of the tax law that makes “getting it right” a rather daunting task. The other is fraud, triggered either by the greed of those who think they are special, entitled to go straight out of the left-turn lane and to reap the benefits of living in civilized society while paying less than the law requires, or by the frustration of those who think that cheating is the only way they can level the playing field made uneven by the greed of the first group.

As the IRS explains in its news release, compliance is best when information reporting is required. For example, the noncompliance rate with respect to wages is in the vicinity of one percent. On the other hand, the noncompliance rate with respect to income for which reporting is not required is a whopping 56 percent. Efforts to reduce this shortfall by requiring information reporting and withholding have failed. In 2005, Congress enacted a law requiring businesses making payments to independent contractors to withhold 3 percent, but the effective date was postponed time and again until the Congress repealed the requirement in November 2011. In 2010, Congress enacted a law requiring businesses and landlords to file Form 1099 for payments to corporations exceeding $600 a year, but this requirement was repealed in April 2011. Justification for the repeal of the 3 percent withholding was that “it would have hurt cash flow for many small businesses.” That is nonsense. Business A contracts to pay $20,000 to Business B for services. Whether Business A pays $20,000 to Business B, or, under the repealed law, pays $19,400 to Business B and $600 to the Treasury has no adverse consequences on Business A’s cash flow. Business B’s cash flow is unaffected because it would reduce by $600 the estimated taxes it should be paying on the $20,000 received from Business A. In other words, absent the withholding, Business B is operating on the taxpayers’ dime. Justification for the repeal of the information reporting requirement was simply a matter of Congress and the Administration giving in to pressure from the private sector that it would be burdensome. Filing forms W-2 is burdensome, but Congress hasn’t bowed to any pressure to repeal that requirement, for the simple reason that wage earners are the backbone of the nation’s revenue system, and the privileged business class refuses to subject itself to measures that will up its compliance rate from 44 percent to 99 percent. In and of itself, that contrast is quite telling.

Imagine what the financial situation of the federal government would be had it collected, using a conservative estimate, $4.5 trillion of unpaid taxes over the past 10 years. Though it would not have wiped out the deficit, that sort of collection success, easily obtained through reporting and withholding requirements, would alleviate the threat to national security posed by pending cuts and would alleviate the poverty, hunger, and medical crises afflicting the nation because 20 percent of taxpayers not only can’t live with lower tax rates but insist on self-enacted zero percent tax rates. I am confident that most of the compliant 80 percent would welcome the enactment and enforcement of reporting and withholding requirements that would bring tax receipts to what they should be under existing law and would be delighted by a consequent reduction in tax rates for the compliant wage-earners of the nation. Does anyone think the other 20 percent will let that happen?

ADDENDUM: This post has generated all sorts of reactions, via email and on listserves. Some have disagreed with my analysis or terminology, while others have expressed disappointment in how Congress backed down.

The word "nonsense" is a bit strong for some situations. Here is an example where there is a problem. Suppose an S corporation with 10 equal shareholders enters into a contract with a government agency to perform services for $1,000,000, and its expenses are $950,000, leaving $50,000 of nonseparately stated income. Without withholding, the 10 shareholders collectively estimate that each will have $5,000 of income and thus add, let's say, $1,400 to their estimated tax payments. So the corporation makes distributions to each shareholder totaling $1,400 to cover that increase. Assume withholding is enacted. The payor government withholds $30,000 from the payments. According to the FAQs issued by the IRS before the repeal of section 3402(t), provision would be made to treat the S corporation shareholders as having paid the amounts withheld from the payments received by the S corporation. Presumably the IRS would treat each shareholder as having paid $3,000 of tax. The shareholders would reduce estimated payments and even wage withholding by as much as $3,000. In the worst case situation, only the $1,400 payment would be eliminated, and the shareholder is overwithheld by $1,600.

Reading between the lines of the FAQs that the IRS issued suggested that there would be adjustments permitted for instances where the payee could demonstrate this sort of problem. The same sort of problem exists in the world of wage withholding, and there are mechanisms to alleviate, though not necessarily eliminate, the impact. Consider the employee who loses a job part way through the year, and ends up with zero tax liability but has had taxes withheld on the assumption that the paychecks would continue through the year. The withholding surely exacerbate the cash flow problem. If withholding returns, perhaps there will be an exception for businesses that can demonstrate that they do not make money or that they (or their pass-through owners) are in tax compliance.

For many businesses, even if withholding was extended beyond the reach of the repealed section 3402(t) -- which had its own long list of exceptions -- many business receipts would not be subject to withholding. For example, one person commented that retail businesses have low profit margins, and thus a 3 percent withholding on gross receipts would generate significant tax overpayments. But retail businesses receive their gross income from payors -- customers and clients -- who have not been required and almost certainly would not be required to withhold.

In sum, withholding can generate a cash flow problem for a limited number of businesses, just as wage withholding can generate a cash flow problem for a limited number of wage earners. To elaborate on why I used the word "nonsense": If the consequence of a few businesses having a cash flow problem is to repeal withholding for all, then why not let the consequence of a few wage earners having a cash flow problem be the repeal of all wage withholding? I am confident that repealing all wage withholding is an idea that would earn the label "nonsense" from almost all tax practitioners and almost all members of Congress. In other words, I should have more clearly stated that it's not nonsense to claim that there is a cash flow problem, but it is nonsense to repeal all of section 3402(t) as a solution, and it's debatable whether "many" businesses would have had negative cash flow from the withholding.

Tax practitioners are very cognizant of how tax can be used as a retaliatory tactic. Consider the disgruntled employee who reports, or threatens to report, the employer to the IRS or a state revenue department for skimming revenue from the books. Surely people who are not tax practitioners have heard similar stories.

Late last week, the Philadelphia Inquirer reported an AP story concerning the use of tax as a retaliatory tactic by an employer against retired employees. The employer in question is a government agency, the Port Authority of New York and New Jersey. Until the end of 2010, employees, retirees, and officials of the Port Authority were permitted to use Port Authority bridges, tunnels, and other facilities toll-free. After criticism by New Jersey’s Governor Christie, the Port Authority revoked the toll-free privilege for all but a few employees. The perk remains in effect for marked emergency vehicles, employees compelled to commute to locations other than the former World Trade Center headquarters, and spouses of employees killed in the 1993 and 2001 attacks.

Two retired employees filed suit against the Port Authority, claiming they are contractually entitled to the toll-free perk, and at least one plaintiff intends to obtain class action status for his lawsuit. Whether the Port Authority is contractually prohibited from cutting off the retirees’ toll-free privileges is a question that cannot be answered until the facts are discovered and subjected to legal analysis.

In the meantime, the executive director of the Port Authority disclosed that he has asked the New York and New Jersey revenue departments to “investigate whether the retirees owed taxes, interest, and penalties on the free benefits they received until the program was discontinued.” Clearly annoyed with the litigation, which he called, “offensive to me,” the Port Authority’s executive director has taken what surely must be considered a retaliatory tactic in the nature of a complaint to a tax agency.

The irony of the situation is apparent from the possible outcomes. One possible outcome is that the perk is excludible from gross income as a no-additional cost service, for which retirees count as employees, considering that no one is barred from a bridge or tunnel to make way for the retiree. In this instance, the request will waste the time of some state revenue department employees, and annoy the retirees, but otherwise have no bearing on the litigation. Another outcome is that the fringe benefit should be included in gross income, the employees received a Form 1099-R or other documentation from the Port Authority reporting the value of the perk – which the Port Authority can compute from the retiree’s EZ-Pass account – and failed to report it. In this instance, though the request for audit of the retirees’ returns will generate some tax revenue for the state, it will have no impact on the factual and legal issues in the litigation. Yet another outcome is that the fringe benefit should be included in gross income, and the Port Authority did not provide any information to the retirees. In this instance, ought not the Port Authority be estopped? Unfortunately, estoppel does not apply in this situation, but one must wonder about an equivalent situation, an employer complaining to the IRS or state revenue department that employees failed to report wages and yet not pointing out that the employer did not file Forms W-2 for the employees.

Using tax as a retaliatory tactic can backfire. For a private sector employer, it can bring all sorts of negative consequences. For a government employer, it isn’t clear that the adverse consequences can be as severe as they can be for a private sector employer, but it isn’t beyond the realm of possibilities that individual employees of the agency can suffer consequences such as dismissal or public reprimand.

About a month ago, the Tax Court, in Rodriguez v. Comr.,, 137 T.C. No. 14 (2011), considered whether corporate earnings included in a married couple’s gross income under sections 951(a)(1)(B) and 956 were dividends eligible to be taxed at the special low rates applicable to qualified dividends. The taxpayers, citizens of Mexico and permanent residents of the United States, owned all of the stock of a Mexican corporation that conducted activities in the United States. The corporation owned real and personal property in the United States. Under sections 951(a)(1)(B) and 956, the taxpayers, as shareholders, were required to include in gross income, and did include in gross income, the portion of the corporation’s earnings invested in United States.

Under section 1(h)(11)(B)(i)(II), qualified dividends eligible for the special low rates include dividends received from qualified foreign corporations. The corporation in question is a qualified foreign corporation. The issue for the Court was whether the gross income inclusions constituted qualified dividends.
Under section 316(a), a dividend is “any distribution of property made by a corporation to its shareholders” out of earnings and profits. The Supreme Court, in Comr. v. Gordon, 391 U.S. 83 (1968) defined a distribution as a “change in the form of . . . ownership [of corporate property,] separating what a shareholder owns qua shareholder from what he owns as an individual.” The Tax Court concluded that the section 951 gross income inclusion was not a distribution, and thus not a dividend, because it did not change ownership of corporate property. The Court noted that there are no provisions in the tax law treating a section 951 gross income inclusion as a dividend for section 1 rate purposes, unlike the regulated investment company provision in section 851(b) that treats section 951(a) gross income inclusions as dividends to the extent there is a distribution under section 959(a)(1) out of the RIC’s earnings and profits, the section 904(d)(3)(G) provision that treats section 951(a) gross income inclusions as dividends for foreign tax credit limitation purposes, or the section 960(a)(1) provision that treats section 951(a) gross income inclusions as dividends for purposes of the indirect foreign tax credit rules. Similarly, although Congress has enacted provisions treating distributive shares and similar amounts as distributions, there is no provision treating a section 951(a) gross income inclusion as a distribution. The Court explained that when Congress enacted section 951, it also enacted section 1248, which treats certain gain from the disposition of stock in corporations such as the one in question as includible in gross income as a dividend, and that the deliberate decision of the Congress to treat section 1248(a) gross income as a dividend but to not so treat section 951(a) gross income solidifies the conclusion that the latter is not a dividend. Reflecting this analysis, Treasury regulations also distinguish between “deemed dividends” and “deemed inclusions.”

The taxpayers sought support in the fact that the legislative history described section 951(a) inclusions as “the equivalent of a dividend” and on statements in judicial opinions that a “dividend equivalency” rationale underlies section 951(a). The Tax Court explained that characterizing something as equivalent to a dividend or as “much like” a dividend is not the same as concluding that it is a dividend. The taxpayers also pointed out that an introductory paragraph in one of the opinions stated the issue as whether uncollected payables balances “constitute investment in U.S. property within the meaning of section 956, resulting in dividend income” and that the headnote puts the issue in the same terms. The Tax Court explained that the body of the opinion did not address whether the section 951(a) inclusion was a dividend, nor was that question essential to resolving the issue in the case, which was the character of the uncollected payables balances as U.S. investments.

The Tax Court also noted that dividend distributions reduce the distributing corporation’s earnings and profits, whereas section 951(a) inclusions do not. Similarly, a dividend distribution does not increase the shareholder’s adjusted basis in the stock, but the section 951(a) inclusion does.

Turning to the question of why Congress enacted the special low rates for dividends, the Court looked at the legislative history and focused on the stated goal of removing a disincentive for corporations to pay out earnings as dividends rather than retaining them. In contrast, section 951(a) inclusions represent earnings that are retained and invested in U.S. property rather than being paid out as dividends. Logically, the section 951(a) inclusion is not a dividend.

As a technical matter, the language of the special low rates for dividends determines whether the taxpayer has the requisite holding period in the stock on which the dividends are paid by referring to the ex-dividend date. Section 951(a) inclusions do not involve dividends and thus there is no ex-dividend date and no way to apply the special low rate provisions to section 951(a) inclusions.

For unknown reasons, the instructions to the 2004 Form 5471 provide that section 951(a) inclusions should be reported as ordinary dividend income. The IRS, describing the instructions as “ambiguous,” explained that the same instructions require corporate taxpayers to report the inclusions as “other income” and not as dividends. The Tax Court simply pointed out that IRS instructions inconsistent with the statute are not determinative.

The time, resources, effort, and energy invested by the IRS, by the taxpayers, and by the IRS in resolving this issue is but one of many examples of how the existence of special low rates for capital gains and dividends is wasteful. Taxpayers generally, and their advisors, not only try to find ways to bring income within the special low rates but also to structure their business activities in ways that they otherwise would avoid, simply to take advantage of special low rates. Repeal of these rates would not only allow removal of at least one-third of the Internal Revenue Code and a similar substantial part of the regulations, it would free taxpayers, the IRS, and the courts from a huge chunk of planning and litigation that consume far more of the economy than the special low rates contribute to it.

On Saturday, 71 federal income and excise tax provisions “expired.” In other words, as of January 1, 2012, these provisions are no longer effective. The simplicity of that information is deceptive. It would not be surprising if at some point, the Congress reinstates some, most, or even all of these provisions, making the reinstatements effective as of January 1. Unfortunately, for taxpayers who are trying to make plans for 2012, they are in tax limbo, uncertain of what the rules will be. Many tax-paying individuals and businesses will play it safe, waiting until the Congress clarifies what the rules will be. This waiting process will inject some degree of stagnation into the economy.

In Punting on Taxes and in Tax Politics and Economic Uncertainty, I explained why playing politics with tax and economic policy is a dangerous game.

The list of recently “expired” provisions demonstrates not only the wide scope of the taxpayer activities that are pushed into the shadow of uncertainty but also the absurd extent to which the tax law and the IRS are used to implement policy decisions that ought to be enacted in other law and administered by other agencies. Skim the list. Is it not interesting that Congress, so critical of the IRS and so anxious for its reduction and even removal, turns time and time again to the IRS to implement its agenda?

Here is a list of the 71 provisions, taken from the Staff of the Joint Committee on Taxation’s List of Expiring Federal Tax Provisions, 2010-2020, omitting provisions that expired earlier in 2011:

1. Credit for certain nonbusiness energy property (sec. 25C(g))
2. Personal tax credits allowed against regular tax and AMT (sec. 26(a)(2))
3. Credit for electric drive motorcycles, threewheeled vehicles, and low-speed vehicles (sec. 30(f))
4. Conversion credit for plug-in electric vehicles (sec. 30B(i)(4))
5. Alternative fuel vehicle refueling property (non-hydrogen refueling property) (sec. 30C(g)(2))
6. Expansion of adoption credit and adoption assistance programs (secs. 36C, 137, sec. 10909(c) of P.L. 111-148)
7. Alcohol fuels income tax credit (secs. 40(e)(1)(A), (h)(1),(2))
8. Alcohol fuel mixture excise tax credit and outlay payments (secs. 6426(b)(6), 6427(e)(6)(A))
9. Income tax credits for biodiesel fuel, biodiesel used to produce a qualified mixture, and small agri-biodiesel producers (sec. 40A)
10. Income tax credits for renewable diesel fuel and renewable diesel used to produce a qualified mixture (sec. 40A)
11. Excise tax credits and outlay payments for biodiesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
12. Excise tax credits and outlay payments for renewable diesel fuel mixtures (secs. 6426(c)(6), 6427(e)(6)(B))
13. Tax credit for research and experimentation expenses (sec. 41(h)(1)(B))
14. Placed-in-service date for facilities eligible to claim the refined coal production credit (sec. 45(d)(8))
15. Indian employment tax credit (sec. 45A(f))
16. New markets tax credit (sec. 45D(f)(1))
17. Credit for certain expenditures for maintaining railroad tracks (sec. 45G(f))
18. Credit for construction of new energy efficient homes (sec. 45L(g))
19. Credit for energy efficient appliances (sec. 45M(b))
20. Mine rescue team training credit (sec. 45N)
21. Employer wage credit for activated military reservists (sec. 45P)
22. Grants for specified energy property in lieu of tax credits (sec. 48(d), sec. 1603 of P.L. 111-5)
23. Work opportunity tax credit (sec. 51(c)(4))
24. Qualified zone academy bonds – allocation of bond limitation (sec. 54E(c)(1))
25. Increased AMT exemption amount (sec. 55(d)(1))
26. Deduction for certain expenses of elementary and secondary school teachers (sec. 62(a)(2)(D))
27. Parity for exclusion from income for employer-provided mass transit and parking benefits (sec. 132(f))
28. Treatment of military basic housing allowances under low-income housing credit (sec. 142(d))
29. Premiums for mortgage insurance deductible as interest that is qualified residence interest (sec. 163(h)(3))
30. Deduction for State and local general sales taxes (sec. 164(b)(5))
31. 15-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (secs. 168(e)(3)(E)(iv), (v), (ix), 168(e)(7)(A)(i), (8))
32. Seven-year recovery period for motorsports entertainment complexes (sec. 168(i)(15))
33. Accelerated depreciation for business property on an Indian reservation (sec. 168(j)(8))
34. Additional first-year depreciation for 100% of basis of qualified property (sec. 168(k)(5))
35. Special rules for contributions of capital gain real property made for conservation purposes (secs. 170(b)(1)(E), (2)(B))
36. Enhanced charitable deduction for contributions of food inventory (sec. 170(e)(3)(C))
37. Enhanced charitable deduction for contributions of book inventories to public schools (sec. 170(e)(3)(D))
38. Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes (sec. 170(e)(6)(G))
39. Increase in expensing to $500,000/$2,000,000 and expansion of definition of section 179 property (secs. 179(b)(1), (2), (f))
40. Election to expense advanced mine safety equipment (sec. 179E(a))
41. Special expensing rules for certain film and television productions (sec. 181(f))
42. Expensing of “brownfields” environmental remediation costs (sec. 198(h))
43. Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (sec. 199(d)(8))
44. Above-the-line deduction for qualified tuition and related expenses (sec. 222(e))
45. Tax-free distributions from individual retirement plans for charitable purposes (sec. 408(d)(8))
46. Special rule for sales or dispositions to implement Federal Energy Regulatory Commission or State electric restructuring policy (sec. 451(i))
47. Modification of tax treatment of certain payments to controlling exempt organizations (sec. 512(b)(13)(E)(iv))
48. Suspension of 100-percent-of-net-income limitation on percentage depletion for oil and gas from marginal wells (sec. 613A(c)(6)(H)(ii))
49. Treatment of certain dividends of regulated investment companies (secs. 871(k)(1)(C), (2)(C), 881(e)(1)(A), (2))
50. RIC qualified investment entity treatment under FIRPTA (sec. 897(h)(4))
51. Exceptions under subpart F for active financing income (secs. 953(e)(10), 954(h)(9))
52. Look-through treatment of payments between related controlled foreign corporations under the foreign personal holding company rules (sec. 954(c)(6))
53. Special rules for qualified small business stock (sec. 1202(a)(4))
54. Basis adjustment to stock of S corporations making charitable contributions of property (sec. 1367(a))
55. Reduction in S corporation recognition period for built-in gains tax (sec. 1374(d)(7))
56. Designation of an empowerment zone and of additional empowerment zones (secs. 1391(d)(1)(A)(i), (h)(2))
57. Increased exclusion of gain on the sale of qualified business stock of an empowerment zone business (secs. 1202(a)(2), 1391(d)(1)(A)(i))
58. Empowerment zone tax-exempt bonds (secs. 1394, 1391(d)(1)(A)(i))
59. Empowerment zone employment credit (secs. 1396, 1391(d)(1)(A)(i))
60. Increased expensing under sec. 179 for empowerment zones (secs. 1397A, 1391(d)(1)(A)(i))
61 Nonrecognition of gain on rollover of empowerment zone investments (secs. 1397B, 1391(d)(1)(A)(i))
62. Designation of DC Zone, employment tax credit, and additional expensing (sec. 1400(f)(1))
63. DC Zone tax-exempt bonds (sec. 1400A(b))
64. Acquisition date for eligibility for zero percent capital gains rate for investment in DC (secs. 1400B(b)(2)(A)(i), (3)(A), (4)(A)(i), (B)(i)(I), (e)(2), (g)(2))
65. Tax credit for first-time DC homebuyers (sec. 1400C(i))
66. Definition of gross estate for RIC stock owned by a nonresident not a citizen of the United States (sec. 2105(d))
67. Disclosure of prisoner return information to certain prison officials (sec. 6103(k)(10))
68. Excise tax credits and outlay payments for alternative fuel (secs. 6426(d)(5), 6427(e)(6)(C))
69. Excise tax credits and outlay payments for alternative fuel mixtures (secs. 6426(e)(3), 6427(e)(6)(C))
70. Temporary increase in limit on cover over of rum excise tax revenues to Puerto Rico and the Virgin Islands (sec. 7652(f))
71. American Samoa economic development credit (sec. 119 of P.L. 109-432)

How many of these tax breaks benefit you? Would it not be nice if tax punting, tax uncertainty, and tax complexity expired?

Ian Ayres and Aaron Edlin have come up with an interesting tax idea. In Don’t Tax the Rich. Tax Inequality Itself, they propose that whenever the ratio of the average income of the nation’s richest one percent to the median household income exceeds 36, a tax bracket is added to the existing rate schedule to generate enough tax on the richest one percent to bring the ratio back to 36. The idea is interesting if for no reason other than it forces the advocates of tax cuts for the wealthy to step up and show confidence in their rationales.

Those who want to shift the tax burden away from the wealthy claim that tax cuts for the rich create jobs. Though the facts show otherwise, they stick with this argument because, among other things, it makes for a good sound bite. A misleading one, but short and simple. Apparently the predecessor rationale, the so-called “trickle down” theory, has been pushed off center stage because it doesn’t quite have the same resonance, to say nothing of the fact that it was tried and failed. So, too, was the “rising tide lifts all boats” claim, one that fails because boats with holes in the hull don’t rise with the tide.

If the advocates of tax cuts for the wealthy are sufficiently confident that their approach works, they should endorse the Ayres-Edlin proposal because the tax bracket it contemplates would never be triggered. The guardians of the Bush tax cuts should rest easy, that as the tax burden on the wealthy is reduced, the ratio is maintained or reduced, and the wealthy don’t risk a tax increase. But I doubt the advocates of tax cuts for the wealthy will jump on board, because they can look at history and realize that if the Ayres-Edlin proposal had been put in place ten years ago, tax rates for the wealthy would have increased.

Ayres and Edlin quote Louis D. Brandeis. It’s a bit longer than a sound bite but it conveys the seriousness of what has been done to this nation by unwise tax cutting during wartime. Said Brandeis, “We may have democracy, or we may have wealth concentrated in the hands of a few, but we cannot have both.” During the past 30 years, the top one percent of Americans, in economic terms, have doubled their share of the nation’s pre-tax income. It now is higher than what it was when Brandeis reacted to the social turmoil generated by inequality when he made his astute observation. Ayres and Edlin note that in terms of after-tax dollars, the top one percent has more than doubled its take. In other words, tax policy has made inequality worse rather than reducing it.

The ratio of 36 measures the pre-tax income of the average person in the top one percent compared to the median income in 2006. By picking this number, Ayres and Edlin are being generous. In 1980, before the so-called Reagan Revolution, the ratio was 12.5. If anything, a good argument can be made that the Ayres-Edlin tax bracket should be triggered when the ratio exceeds 12.5 or 15 or 20 or 25 or 30 or some other factor that is less than 36. In some respects, using 36 suggests an acceptance of the status quo.

Ayres and Edlin suggest that if nothing is done and the ratio reaches 40 or 50, democracy will erode even more than it already has. They predict that if nothing is done, the ratio will reach 80 within 20 years. It would be interesting to hear a defense of a nation in which the inequality reached to double what it now is and quadruple what it was thirty years ago. At what point does the nation awaken and comprehend the seriousness of the problem? At what point does it demand that the Congress do something? Ayres and Edlin have put something on the table that not only is interesting but deserves careful study, close attention, and widespread publicity.