MauledAgain

The debate between those who want to tax capital gains and dividends as all other income is taxed and those who want to bless the recipients of capital gains and dividends with special low tax rates has been underway since the first proposal to tax capital gains at low rates was presented and enacted. Arguments in favor of the special provision and against the special provision have been advanced by hundreds of commentators, and as many as several dozen arguments have been lined up on both sides of the debate. Almost nine years ago, in Capital Gains, Dividends, and Taxes, I dissected these arguments and proposed a solution that remains unpursued.

The argument presented most often and most vehemently by the advocates of special low tax rates for capital gains and dividends is that reducing taxes on this type of income is good for the economy. For example, in a 2011 interview, Grover Norquist claimed, “Every time we've cut the capital gains tax, the economy has grown. Whenever we raise the capital gains tax, it's been damaged. It's one of those taxes that most clearly damages economic growth and jobs.”

But how good for the economy, and by extension, the American people, is the special treatment for capital gains and dividends? What’s surprising is not just the answer, but the identity of the person providing it.

An extensive study released about a month ago concludes that the central cause of the explosion in income inequality during the past 15 years is capital gains and dividends. To quote the abstract:

This paper examines changes in after-tax income inequality among tax filers between 1991 and 2006. In particular, how changes in wages, capital income, and tax policy contribute to changes in income inequality is investigated. To examine the role of these three possible contributors to the increase in income inequality, the Gini coefficient is decomposed by income source using the method developed by Lerman and Yitzhaki (1985). The Gini coefficient of after-tax income increased by 15 percent (0.071 points) between 1991 and 2006. By far, the largest contributor to this increase was changes in income from capital gains and dividends. Changes in wages had an equalizing effect over this period as did changes in taxes. Most of the equalizing effect of taxes took place after the 1993 tax hike; most of the equalizing effect, however, was reversed after the 2001 and 2003 Bush-era tax cuts. Similar results are obtained with other inequality measures.

In other words, by lowering tax rates on the type of income that causes income inequality, the extent of income inequality is exacerbated. In some respects, this is not news, as it was predicted in a study on which I commented in Blowing Away Some of the Capital Gains Smoke.

The study was conducted by Thomas Hungerford. As explained in this report, it was conducted by an economist whose “data is widely cited on both sides [of the tax policy and public expenditure debate]; he’s an impeccably objective analyst.” This is information developed from deep intellectual analysis, not the limbic system outbursts that fuel most of the political sound bites drowning out sapiens sapiens thinking.

Advocates of special low tax rates for capital gains have one sensible argument, an argument that is inapplicable to dividends. To the extent that the gain reflects increases in value of property that mirror inflation, taxing the gain would be taxing non-real income. The solution, of course, is to index adjusted basis for inflation. There are dozens of places in the tax law where amounts are indexed for inflation. It’s not a new concept, it’s something easily done, and it solves the problem cited by the advocates of special low tax rates for capital gains. So why do they push that solution aside? The answer is that it would not permit real gains to escape taxation at the same rate that wages are taxed, and the advocates of special low tax rates for capital gains and dividends are intent on taxing labor at higher rates. Why? It’s not difficult to figure out that taxing labor at high rates and investment income at low rates speeds up the growth of income inequality and shuts down the upward mobility that tax-cut and tax-elimination advocates claim is their goal.

The architects of this discrimination in federal income taxation did not stop with the high-tax-on-wages-and-low-tax-on-capital-gains plan. They also figured out how to turn certain wages into capital gain. It’s something that can be done if one is wealthy enough to play the partnership carried interest game, and it’s not something available to the everyday laborer. Put simply, by performing services and taking compensation in the form of a partnership interest, the wealthy worker delays taxation and when taxation finally occurs, the income has been turned into capital gains because it comes in the form of selling a partnership interest. Oddly, if a not-so-wealthy worker is compensated by a corporate employer with stock, the value of the stock is taxed as ordinary income, and unless the employee elects to be taxed when the stock is received, the value of the stock when substantial restrictions on it cease at some point in the future is included in gross income at that future time, and it is entirely ordinary income taxed at regular rates. Though arguments have been made that it’s perfectly acceptable to treat the two workers differently, deeper analysis of the arguments reveals a lack of symmetry in the comparisons and in the opportunities available to the service providers. Their argument would be more logical if the recipients of carried interests faced the same choices as those facing a typical employee, namely, taxed on ordinary income immediately, with capital gains rates for subsequent value increases, or taxed entirely on ordinary income in the future. At the moment, carried interest recipients are not taxed immediately and are taxed in the future on capital gains. Thus, a good bit of their argument reflects the often-used approach of under-compensating investors and business owners so that larger amounts of capital gains and dividends are available to the investor and business owner, to be taxed at lower rates, and, as icing on the cake, to escape employment taxes such as social security.

Of course, as everyone experienced with the federal income tax knows, at least one-third of tax law complexity and one-third of the Internal Revenue Code and Treasury Regulations, and some meaningful chunk of audit time and litigation would disappear if the special low tax rate for capital gains disappeared. The focus of the argument ought not be on whether that should be done, but on whether the revenue impact should be permitted to play out in the form of lower overall tax rates or be used to deal with the portion of the federal budget deficit attributable to the reduction in capital gains rates that contributed to the income inequality that in turn prevents the revival of the American economy. It’s no secret that I would vote to ameliorate the impact of the fiscal foolishness of the first eight years of the past decade.

Some taxpayers who are not trained in the law think that if a law does not make sense or is unwise they can ignore it. That simply isn’t the case. To be struck down, the law must violate a provision of the applicable Federal or state Constitution.

A recent example of this principle showed up in Fite v. Comr. T.C. Summ. Op. 2013-12. The taxpayer purchased a residence and on his tax returned claimed the section 36 first-time homebuyer credit. One of the requirements to qualify for the credit is that the residence not be purchased from a related person. The taxpayer purchased the residence from his father, who is a related person for purposes of section 36. Section 36(c)(3)(A)(i) clearly defines a purchase as “any acquisition, but only if . . . the property is not acquired from a person related to the person acquiring such property.” Section 36(c)(5), incorporating section 267 in modified form, provides that a related person includes an ancestor.

The IRS argued that because the taxpayer purchased the residence from his father, the acquisition did not qualify as a purchase for purposes of the credit. The taxpayer did not deny that he acquired the residence from his father, but argued that “[t]here shouldn’t be a rule that you bought a home from a relative when you buy the house for fair market value & you have a mortgage payment.”

The court explained that it “recognize[d] the logic of petitioner’s position,” but that unless the statutory provision has a “constitutional defect,” the court is required to apply the statutory provision. The court noted that it cannot rewrite law simply because it might find ways of improving the provision. Citing and quoting previous cases, the court explained that “[t]he proper place for a consideration of petitioner’s complaint is the halls of Congress, not here.” Thus, concluded the court, the taxpayer was not entitled to claim the credit.

Although there seems to be logic in the taxpayer’s position, the provision in question is not the unwise or unfair requirement that the taxpayer suggests. The purpose of the first-time homebuyer credit was to encourage home sales that would stimulate the economy. Purchasing a home from a related person doesn’t have the same sort of economic impact, and presents a serious opportunity for tax abuse. The property would remain in the family, the occupants could be the same people, up to $500,000 of gain recognized by the seller could be excluded from gross income, and the family would receive a tax credit for having done essentially nothing in terms of the purpose of the credit. So it makes sense for Congress to disqualify residence sales between related parties. It’s not the illogical, unwise, or unfair provision that the taxpayer suggests.

Yet the point of the case is that even if the provision were unwise, unfair, or illogical, there’s nothing the court can do about it unless the provision violated the Constitution. It doesn’t, nor did the taxpayer suggest that it did. The simple truth of the matter is that the only way to prevent Congress from enacting foolish or illogical laws, in contrast to unconstitutional ones, is to persuade members of Congress to refrain from enacting foolish or illogical laws. That’s the theory. In practice, the chances of succeeding depend on how much money is behind the foolish or illogical law.

On Wednesday, in Tax Commercial’s False Facts Perpetuates Falsehood, I lamented the ease with which the false claim that the Internal Revenue Code fills more than 70,000 pages has gone viral. I wondered whether this misinformation was generated by ignorance or by deliberate misstatement. Later on Wednesday, a reader sent me links to stories that attempt to explain what happened.

On October 26, 2011, in a Washington Post article appropriately named “Rick Perry’s Flat Tax Plan, Built on Misleading Statistics,” Glenn Kessler quoted Texas Governor Rick Perry, who on the previous day explained his view of taxation by saying, “Central to my plan is giving every American the option of throwing out that 3 million words of the current tax code and, I might, add, the cost of complying with all of that code in order to pay a 20 percent flat tax on their income. You know, the size of the current code is more than 72,000 pages. That's represented by this pallet right over here and the reams of paper. That's what the current tax code looks like.”

So the question gets pushed back one step. It becomes a matter of determining how and why Rick Perry came to the very erroneous double conclusion that the Internal Revenue Code fills 72,000 pages and contains 3,000,000 words. Kessler points out that Perry’s claim means there are 42 words on each page, which is an absurd outcome. So, on its face, Perry’s statement is nonsense. As I explained in Anyone Want to Count the Words in the Internal Revenue Code?, the Internal Revenue Code contains roughly 400,000 words, filling about 2,000 pages depending on font size, margins, and similar typographical decisions.

So where did Perry get the 72,000-page figure? Kessler points out that the CCH Standard Federal Tax Reporter is roughly 72,000 pages long, but that it includes not only the Internal Revenue Code, but also the Treasury Regulations, annotations of every tax case published by the courts, annotations of every administrative publication issued by the IRS, legislative history, commentaries by the editorial staff at CCH, charts, graphs, and a variety of other analytical tools.

In an update, Kessler reveals that the Perry campaign obtained the 72,000-page figure from the Cato Institute. Yet the Cato Institute explanation noted that this included regulations and rulings, though it did not mention that material that is not part of the law, such as editorial commentary and charts, are part of the 72,000-page looseleaf tax service from CCH.

Kessler things that Perry “managed to mix up his facts.” That’s possible. It’s also possible that in order to strengthen his advocacy for a flat tax, Perry found it helpful to exaggerate the size of the Internal Revenue Code in order to stir up negative reaction to it so that the flat tax plan appeared far more sensible that it really is, which isn’t much.

Perry isn’t the only politician making erroneous statements about the size of the Internal Revenue Code. Republican Senate candidate Barry Hinckley tossed out the claim that the tax code consists of 80,000 pages. Last month, Republican Representative Sam Graves posted the 70,000-page tax code nonsense on the Chamber of Commerce website, ensuring that this piece of ignorance and misstatement will go viral in the small business community. The How Long Is It website has republished quotations about the size of the Internal Revenue Code from the official web sites of 13 politicians, with claims ranging from plausible conclusions that the code fills roughly 3,500 pages to outlandish assertions that the code contains more than one million words, or 5 million words, or 7 million words, filling 9,000 pages or 9,500 pages or 17,000 pages, but the prizes for ignorance and misstatements go to Republican Representative Spencer Bachus, who claims that the Code contains 500 million words on 6,000 pages, Republican Representative Bobby Jindal, who claims that the code fills 60,000 pages, Republican Representative Jim DeMint, who claims that the code fills 44,000 pages, and Republican Representative Dave Hobson, who not only claims that the code fills 1.3 million pages but that War and Peace measures in at 650,000 pages.

It’s not just politicians who get it wrong. Journalists easily fall into the error-ridden abyss of sizing up the tax code, including this report that treats the 70,000-page tax code assertion as an indisputable fact. Hundreds of similar articles have been published in newspapers and on web sites across the nation.

Worse, the self-appointed crusader for the elimination of taxes and government, Grover Norquist, demonstrates his lack of knowledge about the Internal Revenue Code. In a letter to Representative Bob Goodlate, Norquist writes, “The code already runs 65,000 to 70,000 pages long.” This sort of statement raises the question of whether his other assertions are similarly suffering from ignorance, deliberate misstatement, or both.

Even tax professionals don’t have it right. In a Forbes Magazine article, woefully entitled, “How The Tax Code Grew To 70,000 Pages: Dems Seek To Limit 'Facebook' Deduction for Stock Based Compensation,” Tony Nitti presented section 83(h) as an example of why the Internal Revenue Code is 70,000 pages long. He refers to the Code as having 70,000 pages not only in the title of his article but also twice in the text. According to his profile, Nitti is a tax partner in WithumSmith+Brown’s National Tax Service Group, is a CPA, earned a Masters in Taxation degree from the University of Denver, and has written several articles. It is appalling that a tax professional with these credentials thinks that the Internal Revenue Code consists of 70,000 pages. One need only pick up the two-volume heavily annotated CCH version of the Internal Revenue Code to realize that it isn’t even close to one-tenth of 70,000 pages.

It is understandable, though deplorable, that politicians begging to be handed the keys to government power will say all sorts of things in an attempt to rustle up votes, including absurd claims about the size of the Internal Revenue Code. It similarly is understandable but deplorable that lobbyists seeking to control the nation from behind the scenes resort to these sorts of tactics. It is disappointing and depressing that tax professionals, who ought to know better, participate in the propagation of tax falsehoods.

In the long run, it doesn’t matter so much whether these error-packed declarations are the product of ignorance or deliberate misrepresentation as it does that the nation gets its facts correct. Making decisions based on erroneous factual information is dangerous. Whether it is a decision to go to war or a decision on how to reform the nation’s tax laws, common sense and faithfulness to the principles of democracy demand that more care be exercised in checking factual assertions than has been evident in the past several decades.

A goodly portion of the citizens of the United States claim that they live in the greatest nation on earth, the greatest nation in history, or some similar honor that suggests a dominion populated by the best and the finest. Under those circumstances, one would think that its leaders, academics, journalists, and advertisers could get simple facts correct.

More than eight years ago, in Bush Pages Through the Tax Code?, I criticized George W. Bush because he asserted that the Internal Revenue Code was “a million pages long.” I noted that perhaps he was trying to refer to the number of words in the code, which at that time came close to 1.7 million. About a year later, in Anyone Want to Count the Words in the Internal Revenue Code?, I revisited the issue to focus on claims by academics and journalists with respect to the size of the Internal Revenue Code, claims infected with all sorts of errors.

Now comes a television commercial from the folks at 1800accountant.com, which also appears on its web site. When I saw the commercial, I knew instantly I needed to write about it. The commercial features Ben Stein, who at seven seconds into the ad claims that the Internal Revenue Code is 73,000 pages long. The commercial shows Stein surrounded by several dozen piles of books, each containing from 10 to 30 books, for a grand total of 500 books. If each book has 200 pages, that’s 100,000 pages of material. The problem with this commercial is that it is flat out wrong. The Internal Revenue Code does not contain 73,000 pages. I have an edition of the Internal Revenue Code that contains not only the statutory language, but annotations of amendments, and the text of Code provisions as they existed before amendment or repeal. It is a two-volume set that contains roughly 2,500 pages. After removing annotations and superseded text, the Internal Revenue Code is probably somewhere on the order of 1,500 pages using the font, page size, and margins applied in this two-volume edition.

Even if the folks who wrote the commercial were confused and included the Treasury Regulations as part of the Internal Revenue Code – they’re not, as my students learn within the first week of the basic federal income tax course – the total would reach perhaps 6,000 pages, and that’s being generous, and that’s including Proposed Regulations, which account for one of the six volumes of Treasury Regulations sitting on the shelf behind me and published by the same publisher who cranks out the two-volume Code set that sits on my desk.

Did the folks writing the commercial bother to check with someone who knows? Were they misled by some other person’s ignorance or deliberate misstatement? Claiming that the Internal Revenue Code is 73,000 pages long is not a rounding error. It’s either ignorance or, as I suspect, deliberate misstatement of fact.

If the misstatement is the result of ignorance, there is no excuse, as I pointed out in posts such as 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, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, When Tax Ignorance Meets Political Ignorance, Tax Ignorance and Its Siblings, Looking Again at Tax and Political Ignorance, and Tax Ignorance As Persistent as Death and Taxes.

If the misstatement is caused by someone trying to whip up antagonism against taxes by casting the Internal Revenue Code as some sort of humongous giant of oppressive tyranny, it is an unacceptable attack on the fundamental need of democracy for truth. Let’s face it, the phrase “fifteen hundred pages of tax code” just doesn’t have the limbic system appeal as the outrageously incorrect “73,000 pages of tax code.” It’s much easier to argue that “government is too big” when overstating the size of the tax code by a multiple of fifty. As long as this sort of nonsense is propagated on television and the internet, in newspapers and magazines, in speeches and in commercials, the nation will continue to make mistake after mistake because it is saddled with lies and misrepresentations intended to bring about the very result that those things generate.

Either way, the people of the supposedly greatest nation on earth or the greatest nation in history deserve better. A lot better.

According to this story, Philadelphia property owners now have, or will shortly have, the assessments placed on their properties under the new Actual Value Initiative conducted as part of the reform of the Philadelphia real property tax. This new chapter in the story is a significant one, because it reduces the years of theoretical discussion, conceptual commentary, and practical problems to a direct “how does it affect me?” status. The long story, at least insofar as I have commented on it, began with An Unconstitutional Tax Assessment System, and continued with Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, A Tax Agency Rises from the Dead, and Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation, How to Kill a Bad Tax System That Will Not Die?, The Bad Tax System That Will Not Die Might Get Another Lease on Life , Robbing Peter to Pay Paul, Tax Style, Don’t Rob Peter to Pay Paul: Collect Unpaid Taxes, The Philadelphia Real Property Tax: Eternal Circles , A Tax Problem, A Solution, So Why No Repair?, Can the Philadelphia Real Property Tax System Be Saved?, and Alarm Bells Ringing for Philadelphia Property Tax Reform.

Of course, having the assessment is only part of the picture, because the amount of tax for which the property owner will be liable depends on the rate and on the availability of exemptions. Until a decision is made about exemptions, the City Council will not be setting a rate. It is possible to estimate a rate that assumes no exemptions and no change in the total revenue collected by the tax. As I’ve commented in earlier posts, bringing assessments in line with actual value shifts the burden of the tax from those whose properties were relatively over-assessed to those whose properties were relatively under-assessed. As recently as 2010, only 3 percent of Philadelphia properties were assessed at actual value. Assessments varied from actual value by as much as 39 percent.

One of the procedural questions facing property owners is figuring out how to contest an assessment with which they disagree. The plan is to permit property owners to contact the assessor who put a value on their property and to try to persuade the assessor to make a change. If that doesn’t work, then a formal appeal must be filed with the Board of Revision of Taxes.

Presumably, some owners will handle the challenges themselves. Others will seek to retain help, and one might expect that a batch of new work will flow into lawyers’ offices. But as the Chief Assessor noted, it’s not worth arguing that a $310,000 assessment should be $300,000, because no matter what the rate is, the difference in the tax on account of a $10,000 valuation difference is far less than what it would cost, in time and money, to fight for a change.

One might expect that taxpayers facing increased assessments will challenge the assessment while those whose assessments declined will do nothing. That’s not, however, how things work. Though most property owners facing small increases will choose to leave things alone, some taxpayers will challenge a small increase on principle alone. Many taxpayers facing significant increases will try to get the assessment lowered, though how far into the process they will go remains to be seen. But there will be property owners who, though looking at significant increases, decide to do nothing because they realize that the assessment could have ended up even higher and they don’t want to risk opening up that possibility. And some property owners with reduced assessments will try to obtain larger reductions.

So perhaps unemployment in Philadelphia among appraisers and lawyers will decline, though appraisers have been busy for many years. Interestingly, though there may be some work for lawyers once the assessments are released and analyzed, it won’t fall to recent law school graduates because very few J.D. students and only a handful of LL.M. (Taxation) students take courses that focus on state and local real property taxes. Let’s see how long it takes for the “New assessment too high? Call the law firm of [fill in names here]” advertising to appear.

The Philadelphia real property tax system is a mess. For years, it has been beset with inconsistent valuations, miserable administration, ever-increasing delinquencies, and political gyrations afflicting both the board charged with implementing it and the government officials responsible for designing and implementing it. Though the problems reach back for decades, I’ve been writing about this problem for “only” six years, and yet the number of my posts dealing with the issues continues to grow. It started with An Unconstitutional Tax Assessment System, and continued with Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, A Tax Agency Rises from the Dead, and Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation, How to Kill a Bad Tax System That Will Not Die?, The Bad Tax System That Will Not Die Might Get Another Lease on Life , Robbing Peter to Pay Paul, Tax Style, Don’t Rob Peter to Pay Paul: Collect Unpaid Taxes, The Philadelphia Real Property Tax: Eternal Circles , A Tax Problem, A Solution, So Why No Repair?, and Can the Philadelphia Real Property Tax System Be Saved?. As I wrote several posts ago, “But that is not the latest chapter in the everlasting story about tax administration gone awry.” How sadly true.

According to this story, Philadelphia’s plan to move to a new system, one that values properties at market value using uniform standards across the city, will produce outcomes that have alarm bells ringing in City Council and elsewhere. The city controller, Alan Butkovitz, who doesn’t like the new policy, predicts that the new assessments will cause property taxes to increase in certain parts of the city and to decrease elsewhere. The areas where increases will be most significant are those areas that have been gentrified, where property values have skyrocketed. Yet is that not how value-based real property taxes work? Butkovitz points out that not all of the property owners facing increases necessarily have the cash to pay the tax increases. Some property owners might face increases in the thousands.

Defenders of the new system point out that under the old system no one knew where the values placed on their property originated or how they were computed. The values were haphazard, people living in identical or very similar houses faced widely disparate tax bills, and breaks were apparently given to well-connected individuals and businesses.

So now the question is how to cushion taxpayers from the impact of straightening out the mess. Every mechanism for doing so will require an increase in the property tax rate to maintain the revenue at current levels, which means that those not getting a break will be financing those who do get a break. One proposal would reduce valuations for people living in gentrified neighborhoods whose homes have increased in value but who purchased the homes when values were low. Another proposal is to create a homestead exemption that removes the first $30,000 of value from the tax base. Yet another proposal would limit the homestead exemption to 5 percent of the property’s value.

If the rate is increased to provide for a $30,000 homestead exemption, the number of property owners facing a tax increase will rise from 60 percent to 75 percent. Most of those increases “will be modest” although 633 owners face increases of more than $5,000. The tax bills on more than 100,000 properties will go down.

The dilemma is not an unusual one. Whenever something isn’t being done properly, and some people are getting a break they ought not get and others are getting the short end of it, fixing the imbalance creates winners and losers. Rather than counting the blessings of having been undertaxed for many years, most people who get the news that their taxes will be going up because they were undertaxed react negatively. The key, though, is that a mistake causing taxes to be lower than they should have been for a particular property ought not be perpetuated. For decades, Philadelphia’s governments and politicians had been told there was a problem and that it needed to be fixed. They also were told that the longer they waited to fix it, the more difficult it would be to get it fixed. Yet, despite those alarm bells going off, the city’s leaders chose to do nothing or to make meaningless gestures. Now the price must be paid. Such is the nature of something called consequences.

Two stories caught my eye this morning. The connection between the two is significant.

According to the first story, on Friday, Feb. 15, an asteroid will pass very close to the earth. Carrying the name 2012 DA14, it will be closer than some communications satellites that orbit the earth. We’ve been assured that this asteroid will not hit the earth. If it did, it would wipe out 1200 square miles of whatever is in its path. Though we’ve been told not to worry about this one, we’ve also been told that 99 percent of asteroids of this size have not yet been discovered nor their paths identified.

The task of protecting society from the threat of asteroids is, according to all but the anti-government crowd, a legitimate function of government, arguably a part of national defense. Finding asteroids, identifying their paths, and doing something about the ones headed for a rendezvous with the planet costs money. At the moment, NASA runs a Near Earth Object Program designed to identify these asteroids, although agencies in other nations also conduct these searches.

The second story describes continuing efforts, on the part of both political parties, to cut NASA’s budget even more than it already has been cut. Even though all sorts of benefits have flowed into the private sector as a consequence of NASA programs funded with tax dollars, those who claim they have the best interests of Americans at heart have chopped the NASA budget repeatedly. At the moment, the United States lacks the ability to put a human into space, and is reduced to hitching rides from other nations. Yet, apparently unsatisfied with leaving manned space exploration to China, Japan, Russia, Europe, and other nations, the anti-spending crowd thinks we should be content relying on other nations to tell us when an asteroid is about to hit an American city. Surely they cannot be so naïve. Some nations might sound a warning, but others might sit back and calculate the benefits of such an event.

The NASA budget is a microscopic component of the federal budget. In fiscal 2010, the NASA budget was roughly $18.7 billion. Federal spending for the same period was roughly $4.5 trillion. The NASA budget is 4/10 of one percent of the federal budget. Yet it is a favorite target of the anti-tax, anti-spending, anti-government crowd. Why? Surely, as explained in Taxes and Spending: Theory Meets Reality and Questions Go Unanswered and the earlier posts cited therein, cutting the entire budget of a miniscule agency does nothing to deal with a budget crisis triggered by unwise tax cuts for the wealthy, military spending funded by borrowing, and disguised spending hidden as tax breaks for special interest groups that the anti-spending crowd refuses to acknowledge as spending.

Would it not be a matter of just desserts if an asteroid crashed into the planet, and some survivor or later visitors from some other, more intelligent place discovered that the asteroid in question had not been discovered because of spending cuts? The problem with regret is that it comes too late.

Much of the debate surrounding the size of the federal debt, a situation that surely poses grave danger to the nation, involves claims that federal spending is too high. On the other side, there are those, including myself, who claim that federal revenue is too low. To the anti-tax anti-government crowd, my position is unacceptable, because that group’s goal is to shrink or eliminate government. They use the debt as an excuse to advance their agenda, and considering that they helped enlarge the debt by pushing through unwise tax cuts at the same time they significantly increased military spending, it is indeed a clever and manipulative ploy.

Now comes some interesting analysis about the extent of federal revenue and spending, especially the changes that have occurred during the past 30 years. In We Don't Have a Spending Problem. We Have an Aging Problem, Kevin Drum points out some important information:

• In 1981, federal spending was 22.2 percent of GDP.
• By 2000, federal spending had dropped to 18.2 percent of GDP.
• By 2017, it is estimated that federal spending will increase to 22.2 percent of GDP.
• There have been spikes in federal spending during recessions, after which spending goes back down.
• There was a huge spike in federal spending in the 2000s due to the cost of fighting two wars, expanding Medicare, establishing TARP, and increasing spending for other domestic and defense programs.
• There was another big spike in spending as a result of the Great Recession, which was the biggest recession since the Great Depression.
• In 1981, federal revenue was 19.6 percent of GDP. By 2017, it is estimated that it will be 19.2 percent of GDP.

Drum points out that what is driving future federal spending is chiefly health care costs, in part because the population is aging. He thinks that barring a decision, to use his terminology, to immiserate the elderly, federal spending will climb to 23 or 24 percent of GDP over the next 20 or 30 years. He concludes that the problem is an “aging problem” and a “taxing problem.”

In Revenue Problem or Spending Problem?, James Joyner questioned Drum’s conclusion. Joyner’s position is that if federal spending was “the problem” in 1980 when it was 22.2 percent of a much smaller GDP, then the current problem is not a revenue problem if huge increases in the debt are taking place with a “negligibly smaller revenue share of GDP.” He notes that the budget could be balanced if spending were cut to 19.2 percent of GDP. Joyner does agree that healthcare spending is a significant factor in the analysis, suggests that there are ways to reduce healthcare spending “without immiserating the elderly,” but concludes that the massive restructuring of the healthcare system that would be required isn’t going to happen. Joyner points out that the only other “big ticket item” in the budget that could be cut is defense, that as a percentage of GDP it is almost double the comparable percentages in China, France, and the United Kingdom, that bringing it down to those nations’ percentages would almost balance the budget, but that this won’t happen considering the reaction to the possible sequestration of a much smaller piece of the defense budget. He concludes that without cutting spending, the choice is one between more revenue or more national debt.

For me, this discussion reinforces several points that I have been making over the years. First, the decision to cut federal income taxes while simultaneously increasing military spending to fight two wars contributed to the economic disaster of the last decade. I’ve made that point many times, including posts such as A Memorial Day Essay on War and Taxation, Peacetime Tax Policy While Waging War = Economic Mess, Some Insights into the Tax Policy Mess, and What Sort of War is the “Real Budget War”?. Second, there simply is no way around revenue increases to bring revenue back in line with where it was when the economy was in much better shape, before the unwise tax cuts of the last decade were enacted. I made that point in posts such as The Grand Delusion: Balancing the Federal Budget Without Tax Increases. Third, the people who want to cut federal spending need to step up and identify what would be cut, with more specificity than simply cutting a particular department or some general conceptual theme. I stressed the need for this sort of spending cut proposal transparency in posts such as Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?, Spending Cuts, Full Disclosures, Hearts, and Voices, and Taxes and Spending: Theory Meets Reality and Questions Go Unanswered.

If there is a spending problem, it’s the problem of tax breaks that are, in reality, expenditures on behalf of special interest taxpayers. If there is an aging problem, it’s that the debate between the anti-tax anti-government forces and those who appreciate the positive value of government on society has endured too long without any worthwhile outcome. If there is any problem that lies at the heart of the deficit and debt mess, it’s the revenue problem. It’s the revenue problem that was created by lowering taxes for taxpayers who promised to do wonderful things for employment and the economy and who have done nothing of the sort. If the Congress does not straighten out the tax and spending mess, and if Americans fail to pressure Congress to do what is right rather than what is politically expedient for purposes of guaranteeing re-election, the problem is going to tower over revenue, spending, and aging. It’s going to be an existentialist problem, and when enough people finally recognize it, they will recognize its causes and unfortunately realize it’s too late to turn back and fix it. This nation can do better than it has for the past decade and a half. And if it doesn’t, then we have no one to blame but ourselves.

With all the opposition to tax increases overshadowing the needs of the nation, it is important to identify tax increases. One way of avoiding opposition to a tax increase is to claim that it is not a tax increase. Personally, I’d rather call a tax increase a tax increase and argue about why it is or is not necessary. I prefer that approach to the alternative of claiming that the tax increase is not a tax increase because it is something else.

So who would claim that a tax increase is not a tax increase? For one, the governor of Pennsylvania. Governor Corbett, according to this report, has proposed an increase in the state gasoline tax. Corbett, who ran for office with a “no tax increase” plank in his platform, explained that what he is proposing is not a tax increase. It is, he says, “merely the lifting of ‘an artificial and outdated cap’ on a wholesale tax paid by oil and gas companies. Removing the cap, in stages, will cause the oil company franchise tax to increase by 28.5 cents over five years. As a practical matter, it will show up at the pump, either totally or in part if oil companies or dealers absorb part of it.

It is easy to understand why Corbett wants to characterize the tax increase as something other than a tax increase. As I explained in If the Government Collects It, Is It Necessarily a Tax?, Corbett, who has signed the Grover Norquist anti-tax pledge, came under fire from Norquist when he proposed an impact fee on Marcellus shale drillers. Corbett knows that the wrath of Norquist will descend on him if he supports a tax increase. The irony is that Norquist surely will conclude that what Corbett is proposing is a tax increase. Not that I oppose the increase, but I think it ought to be called what it is.

The lifting of a cap on a tax is a tax increase. There’s no way around that conclusion. Many years ago, when federal income tax rates were very high, there was a maximum rate on earned income. Here’s the 1972 Form 4726 and instructions, for those who are curious or bored and need something to read. When that provision (section 1348) was repealed, it was because the regular rates were reduced and the maximum rate limitation was no longer required. If the maximum rate had been repealed while the regular rates were unchanged, taxpayers with earned income above the appropriate level would have encountered a tax increase.

There are some who argue that if a rate is left unchanged, there is no tax increase. That, of course, is not true. Suppose a state with a food and clothing exemption to the sales tax repeals the exemption. Almost everyone will pay more sales tax. Eliminating the exemption, without changing the sales tax rate, generates a tax increase. Thus, removing the cap on the oil company franchise tax is a tax increase.

Corbett not only wants to remove the cap, which makes sense at a time when Pennsylvania’s transportation infrastructure is falling apart, but he also wants to reduce the liquid fuels tax by 2 cents from its current 12 cents per gallon rate. This would cushion the impact of the cap removal, but it also reduces the funds available to deal with the state’s four thousand – yes, four thousand, not four hundred – structurally deficient bridges and its more than 10,000 miles of below-standard highways, up from 7,500 miles six years ago. Despite inflation and the continuing deterioration of its roads, Pennsylvania has not raised the liquid fuels tax since 1997, more than 15 years ago.

What often gets overlooked is that if the funds available to repair highways and bridges increase, construction contractors will have more jobs to do and thus will need to hire workers. With all the talk about job creation, here’s something that, unlike tax cuts for the ultra-wealthy, actually creates jobs. But don’t call it a tax increase. The people who claim they want to see an increase in jobs will oppose the very thing that will create jobs. So it’s understandable why Governor Corbett is trying to do linguistic gymnastics by finding some other way to describe a tax increase.

Sometimes tackling tax ignorance appears to be as pointless a task as trying to shovel all the sand off a beach. Every time I blink, I read or hear some manifestation of tax ignorance that erodes my confidence that this nation can get its tax policies in order. If I wrote a commentary for every bit of tax ignorance that I encounter, I would set a record for the number of blog posts. As it is, I’ve returned time and again to this democracy-threatening condition, in posts such as 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, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, When Tax Ignorance Meets Political Ignorance, Tax Ignorance and Its Siblings, and Looking Again at Tax and Political Ignorance.

Several days ago, in reading this letter to the editor of the Philadelphia Inquirer, I was reminded how herculean a task it is and will continue to be, to purge America of the tax nonsense that feeds on tax ignorance. The letter writer argued:

With the federal government (over half of its budget being military) hard-pressed for revenue, programs have been cut that once funded states. State budgets are then cut, forcing schools and municipalities to raise property taxes. So, if you are a fan of the military-industrial-congressional complex, you're also a fan of higher property taxes. Money that should fix potholes is going for bombs.

The errors in this letter jumped out at me.

First, although I am no fan of the decision to increase military spending to fight two wars without raising taxes and simultaneously cutting taxes, it simply is not true that “over half of [the federal government’s] budget [is] military.” In 2012, military spending accounted for roughly 20 percent of federal spending. Defense spending has not been at or above 50 percent of the federal budget since before 1962.

Second, when the federal government cuts funding to states, it almost always is cutting a federal program that is administered by the state. In most instances, the state does not make up the difference by cutting other state programs. In most instances, the federal program administered by the state ends up shrinking.

Third, when state budgets are cut, local municipalities and school districts may or may not be impacted. They are, if the state legislature decides to reduce funding to localities and school districts as part of the budget cutting. State budget cutting occurs for a variety of reasons, including reduction in state tax revenues and political decisions to cut state government spending as a matter of economic philosophy. Blaming federal government cuts to federal programs administered by states for reduction in state funding of local municipalities and school districts is a matter of ascribing universality to an incidental situation.

Fourth, property taxes are raised for a variety of reasons. Property taxes, however, are used for the most part to fund schools, local police, local trash and recycling, local zoning code enforcement, and the maintenance of local roads. Most potholes occur on major roads, such as state and federal highways, because, as explained in this article, the number of potholes is pretty much proportional to the volume and weight of traffic. The cost of fixing potholes on federal and state highways is funded by liquid fuels and similar taxes, not property taxes.

Fifth, money being collected from liquid fuels taxes is not being diverted into federal military spending. It is being used to repair roads. The problem is that there isn't enough money being collected from liquid fuels taxes.

In addition to these issues, the letter writer assumes that if federal military spending is cut, local property taxes would be cut. That’s not going to happen. It isn’t going to happen because the presumed chain of connection imagined by the letter writer doesn’t exist, nor does its opposite-direction counterpart exist. It also isn’t going to happen because if federal military spending is cut, it will be as a deficit-reduction measure, and will not trigger increases in funding to states.

The letter-writer’s approach to tax issues reflects a conflation perspective that afflicts too many Americans. How often does one hear or read a reference to “the government”? When I hear that phrase in a conversation, I ask, “Which government? Federal? A particular state? A particular county? A township?” There are multiple governments, they act independently, they often act inconsistently, and although influenced by each other, they make their own decisions. There is no one “the government.” Similarly, too many people think that tax is tax, and fail to grasp the peculiar characteristics of different taxes, including which jurisdiction imposes them, how they are computed, and the extent to which their revenues are dedicated to specific purposes. There is no one “the tax.”

This conflation gets in the way of solving the nation’s problems. Yes, there are potholes that need to be repaired, and this problem is part of a larger transportation infrastructure challenge. If potholes are to be fixed, road funding needs to be fixed. That’s a different issue from federal military funding, and the solution to the road, bridge, and tunnel funding needs has been discussed in Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, and Liquid Fuels Tax Increases on the Table.

A little more than a week ago, in Tax Ignorance and Its Siblings, I lamented the adverse impact that ignorance has on the nation’s political system and its tax system. My visit to this topic was just the latest in a long series of reactions to tax and political ignorance, in posts such as 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, More Tax Ignorance, With a Gift, Tax Ignorance of the Historical Kind, A Peek at the Production of Tax Ignorance, and When Tax Ignorance Meets Political Ignorance.

Today I return to this topic because I’ve been made aware of a new study from the American Political Science Review. According to this article, the authors of “Sources of Bias in Retrospective Decision Making: Experimental Evidence on Voters’ Limitation in Controlling Incumbents” have shared the outcome of their exploration of voter decisions. One description of the study says it “has thrown doubt on the ability of the average voter to make an accurate judgment of the performance of their politicians, showing that voter biases appear to be deep-seated and broad.” According to the study, voters ignore cumulative incumbent performance because they focus on the most recent performance of incumbents, voters are distracted by “rhetoric and marketing,” and voters often vote against incumbents because of events not within the control of the incumbents.

None of these findings surprise me. When the authors explain that voters lack attention spans sufficient to analyze an incumbent’s entire record, it simply reminds me of what an older student told me some years ago when I was struggling with understanding why students could not sustain analysis through a multi-step tax checklist. “Professor,” he said, “understand you are dealing with the MTV generation. We don’t stay focused on much of anything.” I see evidence of this almost every hour, and not only is it sad and unfortunate, it’s dangerous in many ways. When the authors point to the effect of “rhetoric and marketing,” I think of my statement in Tax Ignorance and Its Siblings, “To me, it seems that those who don’t stand a chance of prevailing when the facts are accepted try to win by twisting, distorting, or hiding the facts, using misinformation as one of their tools.” And, of course, blaming incumbents for things beyond their control, while absolving them of responsibility for what they have mismanaged, is a classic symptom of what the authors kindly call “irrational behavior.”

The author of the article describing the report suggested that the using the term “irrational” is “a nice way of refraining from calling them ‘stupid’.” They conclude that the report “is perhaps a reminder that voters are not blameless and bad choices don’t exist in a vacuum.” There is no better proof than the fact that approval ratings for the Congress are in the single digits and yet incumbent after incumbent is sent back to Washington to do more of the same. In professional sports, when the team isn’t playing well, rosters experience turnover. There’s a lesson there.

The study’s conclusion is disheartening. The authors conclude that incumbents can get themselves elected by associating themselves with good news for which they ought not take credit because they are not responsible, support policies that generate good news for their districts even if they are bad for the nation, and to use rhetoric to distract voters from the incumbents’ histories. Ever wonder why so much junk ends up in the tax law? Though it has been said that crime does not pay, it appears that propaganda works. No wonder there is so much ignorance.

I suppose it’s expecting too much to discover that there are points on which all people can agree. After all, there still exists a Flat Earth Society. So it ought not be a surprise that the advocates of the “flat tax solves all problems” myth persist in trying to persuade the rest of us that a flat tax will solve the federal budget problem while making the federal income tax as easy as filling out a postcard. This is not the first time that I have described the failings of the flat tax movement. I did so, to cite a few posts, in The Flat Tax Myth Won’t Die, Fighting Tax Ignorance, Flat is Not Simple, At Least Not with Taxes, and The Revived Forbes Flat Tax Plan.

Earlier this week, in The 12% Revenue Solution, Prof. Michael Busler added his reasons for proclaiming the flat tax as the savior of all things financial, economic, and budgetary. He contends that replacing “the tax code with a single-rate of 12 percent on all income above a livable minimum, with absolutely no deductions” would raise $2.5 trillion in additional revenue over a ten-year period. He claims that this approach would “please . . . Republicans who want tax rates as low as possible.” He also claims it would make “the economy grow at a more rapid pace” and “creat[e] numerous entry-level positions for young people.” He explains that to determine tax liability, a taxpayer would “simply add up her income from every source, subtract the livable minimum, and then multiply the balance by 12 percent.”

Flat tax advocates are big on theory and fall short on practical application. Nowhere does Prof. Busler define income. Students in the basic federal income tax course invest several classes and a few hours outside of class dealing with the question, “What is income?” Nowhere does Prof. Busler address exclusions. Under current law, gifts are income but are excluded from gross income. Do flat tax advocates plan to remove all exclusions? Is it any less complicated to administer a tax system in which gifts are included in gross income? What about scholarships? What about inheritances? What about life insurance proceeds? If they retain that exclusion, the complex question of what constitutes life insurance proceeds remains.

What does Prof. Busler think will happen if the section 121 exclusion is eliminated? Taxpayers who are required to pay tax on the gain realized from the sale of their principal residences will be compelled to “downsize” because of the liquidity issue that is the reason for section 121 being in the tax law. And if section 121 is retained, it will continue to contribute to the complexity of tax law. What is the principal residence? What is use? What is ownership? How are surviving spouses treated? What happens if there was business use of the home? And so on.

Speaking of gains, how would they be computed? Would basis and adjusted basis be retained? If so, how does the complexity contributed by basis issues diminish or disappear?

Consider deductions. Prof. Busler suggests eliminating all of them. Does that include business deductions? He refers to “business profits” as a type of income but how are business profits computed? Answering that question adds all sorts of complexity to the tax law. Keep in mind that being employed is a business, and there are employee business deductions. Does he propose eliminating those? And what of the alimony deduction, designed to prevent double taxation of alimony payments. By eliminating deductions, Prof. Busler would remove the deduction for investment losses. Is that what he truly intends?

To the extent that deductions are eliminated, even if some of them remain, taxpayers will increasingly turn to nonrecognition provisions, and to the use of timing techniques. Nowhere does Prof. Busler address those issues. Both types of provisions are responsible for a significant amount of tax law complexity. Removing the like-kind exchange nonrecognition provision would afflict businesses with liquidity and compelled down-sizing issues similar to those arising from repeal of the section 121 exclusion.

When Prof. Busler suggests a “livable minimum,” he simply suggests it could be one dollar amount per adult and a lower dollar amount per child. But who gets to claim which child? The determination of who is a dependent child for which adult is one of the most vexingly complicated issues facing substantial numbers of taxpayers. Prof. Busler provides not a whisper of how his “livable minimum” is less complicated that current law, let alone how it would create jobs or raise revenue.

Whether the proposal that Prof. Busler offers in fact would raise revenue cannot be determined, because there is a total lack of information on how “income” would be computed, which exclusions, if any, would be eliminated, which deductions, if any, would be retained, how installment sales would be treated, and so on. If it did raise revenue, it would meet objections from the anti-tax crowd because they are opposed not simply to high rates, but to revenue increases. So on that score the proposal falls down.

Prof. Busler ends his commentary with a question. He asks, “who could possibly oppose such a plan?” My answer is, “I do.” And I would guess that many tax professionals, honed on the tax law and tempered by the experience of working with tax clients and preparing tax returns, would also object. And I would guess that many other professionals would raise the same concerns and criticisms.

The flaw with flat tax plans is that most of them are offered by people who have little practical on-the-ground experience with the reality of taxation. Philosophical concepts make for interesting chats at dinner, but they are useless without practical details. Yes, the devil is in the details, which is why a flat tax proposal in the form of “here is what the Internal Revenue Code would be” would be far more instructive and valuable than simplistic sound bites. I’m looking forward to seeing the Prof. Busler version of the Internal Revenue Code. Only then does his conceptual idea stand any chance of finding defensible support.