MauledAgain

Those AIG bonuses have been the talk of the town. People are outraged that a company surviving on taxpayer dollars has paid bonuses to more than six dozen executives. How, people ask, does one justify a reward for piloting a company onto the reef?

The outrage has sparked a variety of proposals. Members of Congress have proposed a 100% tax on the bonus, as reported, for example, in this story, this one, and this one. When asked if the tax would be an excise tax, or an income tax on the recipients, or both, staffers replied that they did not yet know. Others have proposed that AIG be denied income tax deductions for the bonuses, as reported here. The Senate Majority Leader suggested that the recipients return the bonuses, though he has also signed on to other reactions. Still other proposals include revealing the identities of the recipients unless they return the money to AIG and requiring the recipients to donate some or all of the bonuses to charity. There are those who think that the government should have let, and should let, AIG go into bankruptcy. One Senator put forth the idea that the bonus recipients should resign or kill themselves, though he later recanted. The Secretary of the Treasury has explained how the Treasury intends to recoup the amounts that were paid.

Yet there are those who defend the payment of the bonuses. In his Dealbook column, Andrew Sorkin explains that AIG must abide by the employment contracts providing for the bonuses, and that failure to pay the bonuses would encourage departure of employees whose talents are required to unravel the mess in which AIG finds itself. Others have pointed out that perhaps the bonus payments went to people who performed well and whose divisions showed a profit, though as the facts trickle out from behind the AIG curtain, it appears that the bonus payments are going to people who are responsible for the mess and whose decisions generated losses.

The flurry of suggestions and the continued defense of the bonus payments in some quarters indicates the turmoil and uncertainty surrounding the transactions. Piled onto this cacophony of commentary are reactions from radio talk show hosts, blog visitors leaving comments, and others who appear to lack an understanding of how the tax system works.

It is to that tax issue that my attention turns. For those who think that a 100% excise tax is unprecedented, check out what happens when a tax-exempt organization or qualified retirement plan engages in a prohibited transaction and fails to take corrective action. Yes, there is imposed a 100% tax. Though the tax has the quality of being punitive, it has an even stronger characteristic of being a deterrent. The downside to imposing a 100% tax on the AIG bonuses is that it would not serve as a deterrent. We are paying the price for decades of ineffective controls on inappropriate executive compensation and decades of weak enforcement of what restrictions are in place. There also is a risk that the tax could be challenged on the grounds it is an impermissible taking and confiscatory.

Taxing the recipients makes no sense unless the proposal envisions imposing a higher rate of tax than otherwise already applies. As it stands, the bonus payments are subject to income tax. There's nothing but symbolic value in the imposition of an addition 10 or 20 percentage points of income tax. The proposal makes sense only if it anticipates a 100% tax rate on the payment, but that in turn raises the same issues that afflict the imposition of an excise tax on AIG.

For those who think that denying a deduction to AIG for the payments that are made, that approach is not unlike denying radio access to a deaf person. AIG does not need tax deductions. It is drowning in losses. It's not even clear that denying the deduction for the bonus payments would have any long-term impact on AIG's loss carryforwards, because those carryforwards might expire in any event.

Letting AIG enter bankruptcy is an argument that has its merits. It's too bad that huge amounts of taxpayer dollars already have been dumped into what would be a black hole. The argument against letting AIG go bankrupt is proof that the American corporate system must be gutted and rebuilt. Opponents of an AIG bankruptcy claim it is "too big" to fail. Its failure, they argue, would bring down the economy in some catastrophic way. That could be true. Either way, it's absurd that any private organization is permitted to become so big that it cannot fail. An organization whose owners know it will not be permitted to fail have, in effect, a blank check to do all the unwise and misguided things that the owners and managers of large entities are tempted to do. There was no good reason to permit AIG, or any of the other conglomerate multinational giants, to become "so big" that they are beyond the restraints of a properly operating free market. In a free market, those who make foolish decisions should pay a price. The mega-sizing of corporate America put yet another nail in the "free" market, creating a situation in which a group of wealthy and wealth-manipulating self-selected "elites" hold everyone else hostage. For those who have suffered on account of the oligarchy's irresponsible behavior, is economic slavery any less life-destroying and spirit-sapping than physical slavery?

The safeguards that ought to have protected America from rapacious entrepreneurs are the provisions that never found their way into state law, or that were installed into state law by legislators anxious to appease the folks who purchase for them their position in the legislature. It's not a tax issue. It's an issue of corporate law. The nominal owners of these modern-day goliaths aren't in a position to exercise their ownership rights. Devices of all sorts dilute their voting power. Votes with respect to stocks owned through mutual funds may or may not be cast in ways that conform to the principles and views of the mutual fund investors. State corporate law has failed America.

What's left? The answer is a deeply troubling one. The enterprises that have been mismanaged, pillaged, and used as money-grabbing machines need to be nationalized, at least for some interim period. The folks who are responsible for the mess need to be removed from any further opportunities to do damage. Who cares if they have some particular skill? They're not the only people in the world who have those skills. They lack something that at least some of those other people have, and that is a respect for justice, a bit of empathy, an appreciation of wisdom, and a grasp of why the pursuit of money at all costs is a short-run mirage burdened by long-term disaster.

But it cannot end there. It's not enough to pull out the weeds, for surely more weeds will grow until the soil is modified. The culture that spawned these self-absorbed, greedy, and defiant captains of industry must be ripped apart. Years of affirming bad behavior by trying to see its good side, decades of accepting the "blame others" response to failure, year after year of being more concerned about offending wrong-doers, and days and days of pretending that things are other than they truly are because the truth is unwanted have filled America's boardrooms with creatures who come up short when it's time to account for understanding the difference between right and wrong.

While held in trust for the nation by the government, these huge dinosaurs of business activity need to be cut down to size. Corporations that become so big that no one knows what's happening throughout the company are destined to fail. The idea that an enterprise should have its hand in everything is nothing more than a reach for world domination. Instead of perfecting products and services in its original line of business, corporations shift attention to each new activity that comes down the road, jumping from bandwagon to bandwagon, unwilling to let anyone else prosper by doing well in some other line of business. The nation and the world end up with corporations that do all sorts of things and none of them very well. Investment banks wanted to be commercial banks, Microsoft wanted and wants to be Google (and Apple and Intel and.. and .. and), brokerages want to be investment banks, and without a doubt this list could be expanded for pages.

Imagine a middle school playground. One student says to another, "I'm cool and you're cool." The other student returns the favor. Together they chime, "Yeah, we're cool." The culture of the school becomes one of self-selected "cool" kids ostracizing the majority of the students in attendance at the school. Now fast-forward to the world of corporate boardrooms, high finance, wheeler-dealers, and the other "players" in the money game. "Yeah, you're cool and what you're doing is ok," says one to another. And the affirmation is returned in kind. "Yeah, we're cool, and what we're doing is ok," they chant in unison, as they not only ostracize but take advantage of everyone else. In the schoolyard, responsible adults can, and should, step in to prevent a bad situation escalating into one infused with bullying and its dangerous consequences. Who steps into the financial and corporate playground to restore order? Who takes over that playground? Surely a tax on "coolness" or on "we're ok" won't get the job done. It's too late for deterrent taxation. It soon may be too late, period.

It was bound to happen. Andrew Mitchel, the tax chart guru, has opened up a new line of tax graphics production. This time, he's venturing into the world of animations. No, not tax cartoons, though that's a tempting idea, but animated portrayals of corporate transactions and their tax consequences.

You can get to the animations here. Give yourself a few minutes to go through them. I expect that Andrew will create more of these animations. For those who want to learn some basics or brush up on some basics, they provide an educational experience that is more effective than mere text.

I also expect that these animations will evolve into, and become part of, something more elaborate. I can see the rudiments of an on-line CLE program, and a study aid for law students. The challenge will be keeping them up-to-date, as the Congress continually fiddles with the tax law and as the IRS and the courts bestow regulations, rulings, and cases on taxpayers and tax practitioners. But that challenge exists no matter the medium through which the instructional endeavor is undertaken.

For those needing cross-references to my previous commentary on Andrew's chart work, look here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, here, and here.

The current recession, even if it doesn't grow into a depression, is a transformative one. When, and perhaps that should be if, the economy regains vibrancy and robustness, it will be an economy very different from the one that has tumbled wildly out of control in a downward spiral. There will be new industries and professions, there will be abandoned industries and professions, and there will be countless industries and professions adapted to new products and techniques. For example, if American automakers survive, their products will be very different from what they cranked out during the past fifty years. Similarly, the home construction industry will build smaller homes using energy-efficient materials in an environmentally responsible manner.

Though surely there are others who can offer predictions with respect to these and other industries, there is one area of the economy to which my professional life is very connected. I speak of law, in two manifestations, law practice and legal education. Specifically, it is the relationship between those two segments of law that need to be examined. I predict that because one is changing rapidly, the other needs to, and will, change dramatically.

By the middle of the current decade, the practice of law had evolved into a profession that dished out salaries north of $150,000 to law graduates with little or no practice experience, coming out of schools that may or may have not provided a clinic experience opportunity and that often emphasized courses focusing on philosophy, sociology, and other disciplines taught by academicians who found a home in law school by adding "Law And" to the course title. Law students continued to sit in classes set apart by doctrinal divisions with little relevance to legal practice. As the gap between law school and practice started to widen during the latter decades of the twentieth century, state and local bar associations initiated a variety of "Bridge the Gap" programs and similar efforts to ease the transition from law school to law practice. In the meantime, law firms found themselves with new associates in greater need of training but with decreasing opportunities to do the training. Not only did the need for partners and senior associates to increase their own billable hours reduce the time they could devote to mentoring recent graduates, they provided a more efficient personnel resource for doing client work because even though their hourly rates were higher than those of new hires, the reduction in the number of hours they required to accomplish a client task more than offset that difference. First-year associates making six-figure salaries need to be billed out at very high hourly rates in order for the firm to avoid losing money. Unfortunately, because they are so unprepared to do much of what need to be done, young associates end up taking two, three, or more times as many hours to do the task because of the steep learning curve that they face. Because of client complaints, billing partners often chopped a good chunk of these hours out of the invoice.

The onset of the current economic tailspin accelerated client concerns about invoices reflecting charges that were higher than they would have been had the work been done by someone not requiring additional hours of time because of inadequate preparation for practice. Other clients, for business reasons, scaled back recourse to legal advice. Still other clients went out of business. Law firm revenues have dropped, and massive layoffs have rippled throughout the law practice world. In turn, this has caused law firms to do one or more of several things with respect to hiring law graduates.

Some law firms aren't hiring. They have barely enough work to feed their current employees. Some firms are cutting out summer associate positions, while others are scaling the summer associate program back, in some instances by reducing the number of summer associates and in other instances by reducing the number of weeks. In one instance, the number of weeks has been cut 40 percent. Some law firms are withdrawing offers, causing hindsight distress for students who had turned down offers at other firms that might not have been withdrawn. More and more firms are telling 2009 graduates to show up in September 2010, and the rumor mill has it that these firms plan to tell any 2010 hires to show up in 2011. That, of course, assumes there will be hiring in 2011. Several firms have offered to pay small monthly stipends to these "suspended" hires if they work pro bono for an appropriate agency. Some firms are eliminating the hiring of law school graduates, choosing instead to hire lawyers with several years of practice. The reasoning is sound. Why pay to educate and develop an attorney when it's cheaper to let someone else take the economic loss of doing so? For students who can find positions as law clerks and government agency employees, this change won't be a significant one, but the number of students who will find such positions likely will not increase. As budget cuts ripple through governments, it is more likely that the number of these positions will decrease.

So why does this matter to legal education? It matters because it is one more nail in the coffin of legal education as we know it. The current economic downturn affects three segments of law school revenue. Schools that receive state funding have already faced big cuts, and will encounter more. Schools that use endowment income are suffering as are other institutions that rely on endowment income, and the bad news is that available endowment income will continue to fall, because the income determinations lag behind the market value changes. Schools that rely on tuition, which pretty much is every law school, must deal with the very real prospect of dwindling applicants. Applications will continue to decline because the impact of the recession, and its effect on law practice economics, will change the results of applying the financial equation that is a major component of the decision to attend or not attend law school. At best, law schools will be competing for fewer qualified applicants, and where those applicants end up studying will reflect not only law school reputation but the tuition charged by particular law schools.

The law school attendance decision financial equation, in English rather than mathematical terms, is simply this: Does it make sense to give up three years of salary and pay out law school tuition, either up front or through debt repayment, in exchange for the increased income expected to be earned by reason of having a law school education? When students in the now defunct Digital Legal Practice Skills course created spreadsheets to answer this question, the results surprised them. Unless they had a realistic prospect of earning significantly more income through having a law school education or unless their other employment opportunities offered rather low income prospects, law school made no sense financially. The transformation of law practice suggests that the financial advantage of a law school education will diminish, because law firms cannot sustain the huge salaries that have been paid in recent years to law school graduates, for the simple reason that the client revenue sources have shrunk and are being more carefully stewarded. Compounding the problem is the credit crunch, which puts at least some would-be law school applicants into a position of financial impossibility.

When prospective law school students begin to realize that the chances of getting a job upon graduation have fallen to the levels faced by college graduates with degrees in those majors that have persistently not been rewarded by the economy, even some of the more idealistic of them will view a J.D. degree as an over-priced ticket for admission to what at best is an employment lottery. When they learn that fewer and fewer law firms are hiring law school graduates because clients are not willing to pay for what little law school graduates bring to the table, some will turn away from the idea and others will join in the increasing chorus to reform legal education. Who else will be singing? Perhaps those law school graduates and current law students, who already have invested $150,000 or more in their education, only to find that they would have done better investing that money in the stock market.

Ultimately, the outcome will be some combination of a reduction in the number of law schools and a transformation of what transpires at those that survive. To make the financial equation work for applicants, law school tuition must be reduced. For that to occur, law schools must cut their biggest expense, which is total faculty salaries. Total faculty salaries can be cut through some combination of a reduced number of faculty positions and reduced salaries. The former approach would require an increase in the number of credit hours taught by each faculty member. The trend of cutting faculty credit hours, chiefly for purposes of permitting faculty to write scholarship "for the benefit of other scholars," as one visiting faculty member put it, will need to be reversed. This is not a new thought from me, for I have been asking why students should subsidize faculty scholarship ever since the rankings chase heated up several decades ago.

One other possibility remains. Bar associations and bar admissions committees, and perhaps state supreme courts, will question the wisdom of limiting bar applicants to graduates of accredited law schools. Enterprising practitioners, perhaps law firms joining together in collaborative and creative efforts, will form schools focused on preparing people to practice law. Properly operated, they need not charge the tuition rates currently being charged. Wise organizers will hire people with law teaching experience and ability, who have more attachment to teaching and less concern about scholarship, to administer and teach in these new institutions. They should be able to provide more experience in the nature of clinics, practical writing, transactional courses, and marketable post-graduation skills. With sufficient clout, they and their practitioner organizers should be able to persuade bar admission authorities to accept their graduates as bar exam candidates. By hiring bright, accomplished law graduates to team teach with experienced practitioners, they will foreclose the expected arguments from the law school monopoly that only faculty at law schools of the present kind know how to teach law. Ultimately, universities will see this development as a threat to their law school revenue sources, and seek to imitate or take over these institutions, at a far greater cost than would have been the cost of reforming their own law schools. Despite that disadvantage, it would provide the benefit of returning law schools to their principal mission, and like other industries, cause legal education to emerge from this transformative recession in a new and more robust form as will happen in other professions and areas of business.

Even if it does not come to pass in precisely this way, the possibility should compel legal educators, including law faculty, to think seriously about where they've been, where they are, and where they might be going, voluntarily or involuntarily. The threat of change ought be considered not as a risk but as a welcomed encouragement.

Like just about every other state and local government, Philadelphia is facing a fiscal mess. So it wasn't all that surprising when Philadelphia's Mayor Nutter floated the idea of charging city residents and businesses for trash collection based on the number of bags of trash picked up from their properties. Nutter spoke in terms of one or two dollars per bag. Reaction from City Council was fast and furious. One member called the idea of charging by the bag "unbelievable." Another explained that people consider trash collection to be something for which they already pay taxes, and suggested instead that the number of trash collections be reduced.

This story would be an excellent tax policy object lesson, but for the fact that within days, Nutter withdrew the proposal. His rationale was insufficient time to draft language for "the complex program." Where he will come up with funds to reduce the city's projected 5-year $1,000,000,000 budget deficit remains to be seen.

The notion of paying a separate user fee for trash and garbage collection is not a new one, nor is it an uncommon one. I live in a township that includes basic trash pickup as a service rendered in exchange for the township property taxes that I pay. However, if I want to dispose of large items, I must file and application and pay a special fee. This is the first home in which I have lived, and I have lived in ten of them, where there was not a separate fee for trash pickup. As best as I can recall, all of the fees were paid to private contractors. What I don't know is whether these fees where in place from the beginning or were the outcome of a township or city deciding that it would no longer collect trash. The answer to that question matters, because once people become accustomed to a service as part of a menu of benefits obtained from paying a general property tax, they will object strenuously, as, for example, did the writers of these letters, to the withdrawal of what they perceive as a right. The only practical way to make the change is to reduce the general tax and then to add a trash collection user fee. In an era of fiscal crisis, that isn't going to happen.

Studies indicate that where per-bag or other measured trash fees exist, recycling increases. But studies also show that in some localities, trash fees cause increases in littering and illegal dumping. Whether it is cost-effective to hire people to police landfills and other areas in search of illegal dumpers is an unanswered question. It probably would require some fairly steep fines to make such a program worthwhile, although the concept of a user fee justifies slapping these folks with a substantial penalty.

The suggestion that it would be better to cut back on the number of trash pickups as a way of saving money is deceptively simple. The only way it would reduce the city's budget deficit is by reducing the number of city employees who pick up trash. Because it is unlikely that these employees can step in as police, fire fighters, librarians, or city swimming pool staff, the outcome almost certainly would be an increase in the unemployment rolls. In the short-term that doesn't save the city any money. With reduced trash pickups, the city will become dirtier, as bags of garbage and other debris pile up on the streets. If that happens in the tourist areas, even a marginal reduction in the number of visitors would curtail city tourism revenue and worsen the deficit.

Charging by the bag makes sense. Why should someone who puts out one bag of trash a week pay the same amount as someone who puts out five bags of trash a week? Is not the latter person imposing a greater burden on the environment, on society, and on the public good? Treating trash pickup as a service funded by property taxes assumes that the environmental and other burdens generated by a person is proportional to the assessed value of the property. And that simply isn't so. Trash pick-up is very different, for example, from snow removal, the benefits of which cannot be allocated to individuals with any degree of rationality, and which arguably have some sort of relationship to property values. Not that Philadelphia does much in the way of removing snow from its streets, but that's a different story.

The tax policy lesson is that nothing is free. The days of South Jersey pig farmers driving their carts through Philadelphia collecting garbage are long over. The people to whom Philadelphia's trash has any value aren't, for the most part, close enough to come around to pick through it. What does have value is, for the most part, already being separated and collected, specifically in the form of recycling. The costs of collecting trash, of hauling it to a landfill, and of operating the landfill have increased. Have property taxes increased sufficiently to cover these costs? At some point, citizens must figure out that it is not possible to freeze or cut taxes and maintain increasingly expensive services. Something must give.

In addition to the tax policy lesson, some excellent drafting challenges would have been presented had the per-bag proposal advanced through the city's legislative process. What is a bag? If a poor person puts trash out in several of those rather small ubiquitous plastic bags used by grocery stores, because they cannot afford to purchase new trash bags, would that person be charged several times as much as a person who puts trash out in one of those 90-gallon almost-as-tall-as-I-am superbags? Would there be a bag equivalency chart?Who would count the bags? Would the proposal shift to a per-pound charge or a per-cubic-foot-of-landfill-space charge, both of which make more sense, environmentally, than a per-bag fee? What if someone puts out trash in something other than a bag? Then what?

For the moment, at least in Philadelphia, these questions do nothing more than provide some fodder for speculation. But they ought not be dumped or thrown away. Mayor Nutter says that the idea of a trash collection fee might pop up again in the future. That's good news, because it means that this blog post isn't a waste of time, effort, and brain cell exercise.

Tax ignorance is disturbing. Taxation is at the core of maintaining the existence of the nation and its political subdivisions, and yet the extent to which people do not understand taxation is startling. I'm not focusing on the arcane, the computationally complex, and the definitionally intricate. I'm highlighting basics.

Tax ignorance disease afflicts both the general public and politicians. It knows no bounds, and can be curtailed only through reform of high school and undergraduate education, coupled with an effective public service campaign by the apppropriate authorities.

Turning first to the general public, consider this letter to the editor of the Philadelphia Inquirer with respect to taxation:

A letter-writer Wednesday ("Whose taxes to cut?") has a fundamental misunderstanding of what taxation is. Income belongs to those who've earned it. The government doesn't give tax cuts to people; it simply takes away less of their earnings.

The left wing's conception of income and taxation often seems more like the actions of the schoolyard bully who steals $4.50 of your lunch money while leaving 50 cents in your pocket, and then asks for your thanks because you can still buy milk.

The analogy fails, because unlike the writer of the letter to whom the writer in question is responding, the writer in question has a fundamental misunderstanding. The schoolyard bully who steals the lunch money gives nothing in return. In contrast, the government provides something in return for taxes that are paid. Though it is possible to argue about the value of what is taken and given, on both a macro and micro level, the letter writer in question surely cannot think that when he pays taxes he gets nothing in return. He, like most other Americans, don't necessarily see what they are getting in return. Their homes have not been invaded by foreign nationals because the military provides a deterrent. When they fly on an airplane, ride a train, drive a car, or jump into a taxi, tax dollars make it possible. Airplanes don't collide because the FAA supervises and cares for airspace. Trains operate because they receive tax subsidies in the absence of which they would cease running. Tax dollars provide resources to ensure that the gasoline purchased at the pump is unadulterated, that the pumps properly record quantity and price, and that the roads on which the car is driven are maintained. By paying taxes, the citizen funds the commissions that oversee taxi drivers, with the goal of keeping bad drivers from behind the wheel and protecting the rider from being cheated on fares. Taxes fund the CDC's monitoring of sickness outbreaks to fend off epidemics. These are but a few examples of what people are getting for their tax dollar without being conscious of the benefit.

The flaw in the letter writer's reasoning is the notion that "Income belongs to those who've earned it." That statement is correct only if "income" means income net of the cost of producing the income. One reason I support user fees is that it highlights the cost of services, benefits, privileges, and protections that otherwise go uncharged against the person earning income. Without user fees or taxes, a person's income is overstated because the person is shifting costs to the general public. There may be administrative reasons that make it impractical to get the charges measured down to the penny, but the refusal to accept taxation as a cost of civilized society is not so much the cause of the ignorance but a symptom of a deeper culture of self-centeredness. Where in our educational systems do we teach that so many things that are taken for granted indeed have a cost, and that someone will bear that cost?

Turning now to the politicians, consider this snippet from the latest Kevin Ferris Back Channels column, in which he summarizes the economic and budget plan put forth by Paul Ryan, ranking Republican on the House Budget Committee. According to Ryan, one alternative is to "Simplify the tax code down to two lower rates, 10 and 25 percent, depending on income." Setting aside the "same old, same old, tried-and-failed" qualities of this nonsense, let's turn to the thoroughly ignorant notion that reducing the number of tax brackets to one or two somehow "simplifies" the tax law. It's a simple sound bite for simple minds. It thrives on tax ignorance. A closer examination of the tax law illustrates the misleading quality of the proposal.

The number of tax brackets affects the computation of tax liability, a task undertaken after taxable income has been computed. It is purely computational. It is built into tax software. It has been done for most taxpayers by the IRS, so that a person not using tax software merely looks at a tax table, finds the row with his or her taxable income and easily spots his or her tax liability. That process is awfully simple. Even creating the tax table isn't rocket science.

What's complicated is the determination of taxable income. Determining taxable income requires determining gross income, adjusted gross income, and deductions. Whereas determining regular tax liability is a one-step matter, determining gross income requires dozens, hundreds, and even thousands of steps. The same, or worse, can be said of determining deductions. It is in the gross income inclusion provisions, the exclusion provisions, the deduction provisions, the deduction limitation provisions, and the deduction denial provisions that one finds thousands of exceptions, thousands of defined terms, and hundreds, if not thousands, of complex computations. The flow charts for each provision can fill multiple pages in fine print, and there are thousands of provisions. Further complicating the tax law are timing issues, questions with respect to identifying the taxable year in which a particular item of gross income must be reported or in which a particular deduction is allowable. More complications arise when dealing with the identification of the taxpayer obligated to report a particular item of gross income or entitled to a particular deduction. Changing the number of tax brackets or adopting a so-called "flat tax" does absolutely nothing to reduce this complexity. But it sounds good and suckers in the tax ignorant.

There are several things that could be done with tax rates that would simplify tax liability computation, but they have nothing to do with the tax brackets. One would be elimination of special low rates for capital gains and qualified dividends. Eliminating these rates would not only jettison multiple-page capital gains tax liability worksheets, it would also permit ditching the numerous Internal Revenue Code provisions that define capital gains and qualified dividends or focus on attempts to make something that is not a capital gain or qualified dividend appear to be eligible for special low tax rates. Eliminating these rates would reduce tax compliance costs, IRS audit expenses, tax litigation, and taxpayer confusion. It is estimated that eliminating these preferences would remove one-fourth to one-third of the substantive provisions in the Internal Revenue Code. Yet the "nice sounding" two-rate sound bite completely ignores these special low rates, because there is no intention whatsoever on the part of flat taxes or two-rate taxation advocates to repeal the good deal put in place for those with sufficient wealth to benefit from special low rates for capital gains.

Another change that would reduce complexity is the elimination of the alternative minimum tax. It has its own rates, designed to take away the tax-lowering benefits of particular deductions and exclusions. Why the game? Why not one tax system, instead of two, with rates, deductions, exclusions, and credits structured in a sensible way? The answer is that by clearing away the tax underbrush, there are fewer places in which to hide special interest tax breaks. Someone benefits from complexity, and it isn't the tax return preparer, and it isn't the majority of tax planners. It's the tax camouflager.

So long as steps are not taken to eradicate tax ignorance, one must ask why it is permitted to exist. The answer is simple. Tax ignorance benefits those who are trying to pull the tax wool over the revenue eyes of the nation and its honest taxpayers. The advocates of reduced taxation manage to gather together people who get their hopes up thinking that their taxes will be reduced, when in fact what happens is a wicked combination: (1) their taxes are reduced ever so slightly, (2) their incomes are reduced significantly, especially in real-dollar terms, leaving them worse off net of taxes, and (3) the proponents of lower taxes see to it that taxes are reduced for themselves and their friends. Now that the truth is being uncovered, the culprits are stepping up their efforts to take advantage of others' tax ignorance, making them think that it is the tax of the working-class laborer or middle-income manager that will be hiked. They make this effort in order to strike up a chorus of petitioners seeking relief from tax hikes that don't threaten them, so that in the end, the repeal of unwise tax reductions for the wealthy will be blocked.

Perhaps the time is nigh for a coordinated attack on tax ignorance. The nonsense that is being circulated, as evidenced by the letter to the editor and the two-rate sound bite but including many more foolish items, is a rerun of claims made in years past. Those claims found buyers, those buyers cried for adoption of the plan, and then their worlds collapsed while the designers of the tax nonsense pocketed their tax breaks. While the wealthy gambled the money in a variety of high risk markets, and while the people who wanted to be wealthy or simply tried to stay upright on the economic treadmill borrowed money in a futile attempt to get the promised benefits of the plan, the economy tanked. What further proof is there that the nation was fleeced? Why would anyone continue to support the policies and tactics that promised jobs and delivered unemployment, that promised home ownership and delivered foreclosures, that promised prosperity and brought economic disaster? The answer is simple. Ignorance persists. So long as it does, we're in for a horrific economic ride.

A colleague passed along to me this URL, which provides the text of a proposed amendment to the West Virginia statutes. Introduced by Delegate Jeff Eldridge and referred to the Committee on the Judiciary, the bill would add a new §47-25-1 to the laws of West Virginia. The proposed legislation provides:

Be it enacted by the Legislature of West Virginia:

That the Code of West Virginia, 1931, as amended, be amended by adding thereto a new article, designated §47-25-1, to read as follows:
ARTICLE 25. BARBIE DOLLS.

§47-25-1. Unlawful sale of Barbie dolls. It shall be unlawful in the state to sell "Barbie" dolls and other similar dolls that promote or influence girls to place an undue importance on physical beauty to the detriment of their intellectual and emotional development.

NOTE: The purpose of this bill is to ban the sale of Barbie dolls and other similar dolls.

So where's the tax angle?

The tax angle is this. People do all sorts of things that are detrimental to the development of important skills and traits. Unless the behavior infringes on another person's rights, it is not the practice in this country to criminalize the behavior, though surely some exceptions to that general principle exist somewhere. Instead, there is a long tradition of imposing taxes, or user fees, on behaviors or materials that contribute to detrimental consequences. Smoking eventually destroys brain cells, directly or indirectly, and thus impairs intellectual skills. Excessive drinking has the same effect. Gambling poses a variety of risks to intellectual and emotional development. Certain foods, for example, those heavy in transfats, damage circulatory systems so that nourishment provided to brain cells declines, ultimately triggering diseases that cause intellectual decline. Proposals have been circulated to impose "sin taxes" on fast food, carbon-based fuels, and ammunition, and furs.

So why not deal with this concern with a tax on Barbie dolls? Imagine the stimulus to the economy when Mattel brings out the "Barbie the Enrolled Agent" line of accessories. Undeniably, such a tax would make Barbie dolls less affordable for children in families with lower incomes. Yet somehow lower-income families figure out how to purchase tobacco and alcohol, so perhaps a Barbie doll tax would compel some people to give up smoking so their children can have Barbie dolls.

Experience teaches us that when a state imposes a user fee, sales tax, or other imposition on a product, consumers will seek to make their purchases elsewhere. For example, tales abound of Pennsylvania Liquor Control Board agents watching for vehicles with Pennsylvania license plates parked outside major beverage stores in the District of Columbia and elsewhere. A tax on Barbie dolls might encourage West Virginians to shop in neighboring states. I'm sure the neighboring states would appreciate the economic stimulus, for when people head out to find a cheaper Barbie, they'll surely make other purchases outside of West Virginia that otherwise would have been made in-state. But this effect is no different from the effect of the proposed bill, which would compel West Virginians to seek Barbie dolls by making purchases in adjacent states or through the internet. The proposed statute does not ban possession of Barbie dolls. Wouldn't that be amazing? Imagine someone being denied permission to sit for the bar exam because when they were 8 years old they were convicted of possessing a Barbie doll. Perhaps possession of multiple Barbie dolls would bring longer prison terms?

Pardon my not-so-disguised sarcasm. Doesn't the West Virginia legislature have more important things to do? But lets' suppose for a moment that the notion of banning the sales of Barbie dolls because they presumably warp the minds of girls with respect to beauty and brains is a good one. What about Ken dolls? Ought not boys be protected from dolls that warp their minds with respect to brains and looks? What about items other than dolls? Perhaps the sale of mirrors could be outlawed because they encourage people to check themselves out before heading out, all in the interest of looking good to get attention. What about the sale of cosmetics? Don't they exist simply to alter a person's appearance in order to improve looks? And why the emphasis on the supposed conflict between beauty and brains, a conflict that has been disproven time and time again. Ought not Delegate Eldridge be more concerned about violence? How many people have killed or been killed with a Barbie doll or on account of a Barbie doll? Ought not there be a ban on the sale of action figures that encourage violence? How about "It shall be unlawful in the state to sell items that promote or influence people to place an undue importance on fisticuffs and other violent physical approaches to solving problems to the detriment of the development of negotiation and compromising skills."

But, perhaps there is a silver lining in this barbed cloud. Anyone who has dealt with, conversed with, or knows a lawyer understands that the phrase "other similar dolls" will open up all sorts of opportunities for lawyers. It's an economic stimulus, particularly welcome at a time when lawyers are losing jobs and law graduates are struggling to find work. There are all sorts of types of dolls. Is a Miss Piggy doll within "other similar dolls"? How about a "Chatty Cathy" doll? Whether the legislature bans "other similar dolls" or imposes a tax on "other similar dolls," the hours that need to be invested answering these sorts of questions will keep lawyers busy for quite some time. "Your Honor, my client contends that the item in question is a mannequin and not a doll, and thus is not subject to tax."

In the meantime, it's time to check out the proper legal and tax treatment of voodoo dolls. Perhaps a pin-sticking tax?

In his Tuesday New York Times column, David Brooks criticizes the Obama tax and budget plan with these words:

The U.S. has never been a society riven by class resentment. Yet the Obama budget is predicated on a class divide. The president issued a read-my-lips pledge that no new burdens will fall on 95 percent of the American people. All the costs will be borne by the rich and all benefits redistributed downward.

Brooks laments what he sees as the " polarizing warfare that is sure to flow from Obama’s über-partisan budget." He claims the seemingly high ground of the moderate, bashing both Obama's alleged uncompromising, partisan, transformational liberalism and the "Rush Limbaugh brigades" associated with a Republican Party … currently unfit to wield …politcal power."

Brooks claims that the "U.S. has always been a decentralized nation" but that the Obama budget "concentrates enormous power in Washington." He also claims that the "U. S. has traditionally had a relatively limited central government" but that federal spending will spiral out of control.

Brooks suggests that moderates assert themselves, pushing a previously "politically feckless and intellectually vapid" centrist tendencey into "an influential force." Moderates, he says, need to provide an "alternative vision," one in which "we're all in it together -- in which burdens are shared broadly, rather than simply inflicted upon a small minority." It is wrong, he claims, to try "to build prosperity on a foundation of debt." It is wrong, he says, to put "redistribution first."

No matter how Brooks describes himself, his unhappiness is the credo of the folks who ran Washington for eight years. If it is so important to share burdens broadly, where were his objections when the tax cuts of eight years ago were being doled out to the wealthy, while phaseouts and other gimmicks were saddling the middle class with the highest applicable marginal rates? When a small minority, under the pretext of promising jobs growth that turns out to be job destruction, obtains a tax cut while supporting massive increases in federal spending to finance a war, was the foolishness of racking up debt in order to avoid repealing those senseless tax breaks for the wealthy any less horrible than is taking on debt to solve the disaster caused by the failed tax policy of trickle-down economics? In other words, why is debt acceptable to finance tax cuts for the wealthy when the promised benefits aren't forthcoming but not acceptable when undertaken to fund survival for those crushed by the financial market gambling games played by the wealthy with money generated by their tax breaks?

Similarly, Brooks' concern that enormous power will become concentrated in Washington, supposedly a turning away from tradition for a nation that "always" has been decentralized, is another shift in perspective that reflects the score at the ballot box. The United States may have been a decentralized nation in the century of its existence preceding the flowering of the industrial revolution, but it has been a very centralized nation for the past 75 years. Through the ravages of the Great Depression, a massive global war, efforts to combat poverty and deprivation of civil rights, through a technology-based narrowing of the spaces between cities and towns, the country has functioned with retirement policy, poverty relief, retiree health care, civil rights protection, food and drug approval, broadcast spectrum allocation, and many other significant aspects of life managed by the federal government. To claim that the nation's central government has been "relatively limited," implying that it would be something else under the Obama budget, is a bit too disingenuous. It was fine, apparently, when the federal government told states and localities to ease up on monitoring, regulating, and preventing wild financial excesses by those wallowing in tax break funds, but a very bad idea when the same government wants to lay down the law and take the financial toys away from those who prefer to spend their days playing with derivatives and other toxic concoctions.

The idea put forth by Brooks, that redistribution, or at least putting it first, is a bad idea, is another twist reflecting the outcome of November's elections. For eight years, tax and economic policy reflected the principle that redistributing wealth in favor of the wealthy, on the pretext that doing so was the fastest, best, and most efficient way to enrich the have nots. For Brooks and those who think as he does, putting redistribution first wasn't so horrible at that time. But when redistribution becomes implemented by steering wealth directly toward the poor and struggling middle class, redistribution becomes a terrible thing. It's ironic that the need for the latter redistribution approach was exacerbated by the deprivations caused by the previous redistribution scheme, one in which the gap between the haves and the have-nots, and have-littles, widened.

What is particularly galling about Brooks' commentary is the accusation that Obama has triggered class warfare. To be honest, Brooks isn't alone in this assertion, and almost surely is not the author of its most recent manifestation. The message from the "Rush Limbaugh brigades" flooding the airwaves, the blogs, and the unrequested emails has been unrelenting in this respect. Oh, how cruel, so the complaint goes, to dump the cost of fixing the nation on the rich. Yes, indeed, how cruel it is to dump the cost of fixing a mess on the folks who created it. Rather than thanking the nation's majority for looking forward instead of focusing on recrimination and criminal prosecution of the fraud merchants who undermined the global economy, the spokespersons for the failed fiduciaries of the nation's wealth want their game to continue unchecked. They prefer, I suppose, that the people already reeling under the consequences of Wall Street wizardry clean up the mess.

This particular class war, if that's what it is, began when the wealthy decided to widen the gap between nobility and peasant. Tax cuts for the wealthy dwarfed the few made available to the poor. Jobs were shifted overseas in an effort to maximize profits for the captains of industry. Executive pay skyrocketed, while the inflation-adjusted wages of the typical American fell. Customer service was cut back, replaced by robots in other countries and voicemail menus that played on for longer than one of my MauledAgain posts, while hapless consumers frittered away time "on hold" waiting for the sole remaining customer service employee to get to their calls. Health care and other benefits for the rank-and-file were cut, while the corporations replaced their private aircraft with bigger and more luxurious models. In all fairness, not all corporate executives and not all wealthy individuals sought, argued for, or defended the ravages of the past decade. Some even tried to re-balance the economic status of the nation through a variety of private programs, including charitable endeavors, but their efforts fell short.

When Brooks claims that "The U.S. has never been a society riven by class resentment," he not so subtly tries to suggest that class warfare and even class divide have been strangers to this nation until the current Administration took office. Hah! One need only study American history, something fewer and fewer Americans do, to find the robber baron episodes of the late nineteenth century, the class-based admissions to most Ivy League colleges that predominated higher education until the Second World War, and the 1913-1914 Colorado Coal Field Strike and War, including its Ludlow Massacre, to give but three examples demonstrating that class warfare in this country is nothing new. For example, the Pullman Strike occurred during what one historian called "the most intense period of class warfare in American history," as recounted in Robert D. Sampson's "Fight Like Hell for the Living": A Brief Sketch of Working People's History in Illinois. Not long ago, Warren Buffet, an example of a wealthy individual who disfavors the tax breaks for the rich, sardonically noted "Oh, yes, we have class warfare in America. My class is winning." It is sad, of course, that Brooks is wrong, for if he had been correct in his implication that class warfare and class divide had never afflicted this nation, it is unlikely we'd find ourselves in the mess with which we must now contend and which we must fix or perish.

Brooks makes one observation which is painfully correct. He notes that much of the current Administration's budget and tax planning " emanates from a small group of understaffed experts." Key tax policy positions in the Treasury Department, for example, go unfulfilled. Why is that? In part it's the need to find the almost-perfect appointee, and in part it's the obstructionism rearing up from the defeated, many of whom subscribe to the Rush Limbaugh prayer, "I hope Obama fails." If Obama fails, the outcome won't be Brooks' prediction of a Republican Party re-taking control of the nation. The outcome will be the very real possibility that there won't be a nation to control or worth trying to control.

We wouldn't be in this mess had more reasonable minds succeeded in derailing the radicals who tore apart the economic well-being of the people whose sweat and toil made the nation the great experiment in democracy that it has been. Surely the bad decisions need to be un-done. It is mind-boggling that the people who engineered the economic train wreck want back into the locomotive's cab, and failing that, are busy obstructing the tracks on which the rescue equipment is being brought to the scene. All the while complaining that the rescuers are responsible for creating the wreckage.

In a world that permits just about anybody to publish his or her assertions about any topic, it's not surprising that we've been bombarded with all sorts of statements concerning taxes and taxation, some accurate and some misleading or downright false. In a world drowning in information, it might seem surprising that many people don't know or understand all that they need to grasp with respect to taxes. In many instances, these folks end up paying more in taxes than they are required to pay.

So it's fortunate for these people that S. Kay Bell, who blogs at Don't Mess With Taxes, and who also is a member of the Taxpayer Advocacy Panel, has come out with a book called, "The Truth About Paying Fewer Taxes." The truth is that this book is not a tax protestor tome, as the title might suggest. It's quite the opposite. Kay takes pains to explain why people ought not listen to the siren songs of the "we prefer life without any taxation" crowd, though she doesn't get to that until chapter 46. Instead, she focuses on the basic principles of federal income taxation and on some of its nuances to open people's eyes to the realities of tax law. It's a small book, and because it doesn't focus on taxes other than income taxes or jurisdictions other than the United States, one must wonder if a series of "The Truth About Paying Fewer [insert state name here] Taxes" is contemplated by the publisher.

"The Truth About Paying Fewer Taxes" is divided into 52 chapters, grouped into 11 parts. Each part focuses on a particular area of life, and is captioned "The Truth About …." The topics are Filing Requirements, Taxable income, Credits and Deductions, Taxes and Your Family, Taxes and Your Employment, Taxes and Your Home, Investment Taxes, Retirement Taxes, Tax Compliance, Audits, and Special Tax Situations. Some parts have as few as two chapters, and one has as many as ten. Each chapter zeroes in on a specific transaction or issue, and explains in plain English what the implications are for federal income taxation. Both compliance concerns and planning tips are sprinkled throughout the text. The book is up to date, including, for example, the real property tax standard deduction enacted by the Congress less than a year ago. I could not find any errors, though if I were to nit-pick I could find points on which to disagree. For example, in the chapter, "Not Everyone Has to File," Kay spells out the rules that are set forth in the tax law with respect to filing requirements. She points out that people who are not required to file may want to do so if they're entitled to a refund. What she doesn't mention is something I explain to my basic tax law students, and that is, once a person has filed, the person ought to continue filing, even if not required, in order to avoid having the IRS conclude that the absence of a return means that the person died, left the country, or turned to the dark side of refusing to file tax returns for tax protest or other reasons. But because not everyone agrees with those of us who advocate the "once filed, always file" approach, Kay's omission of that issue is not a matter of inaccuracy but a concession to the seeming goal of keeping the book manageable in size and comprehensible by the ordinary reader.

"The Truth About Paying Fewer Taxes" is not for the tax professional. Anyone claiming to be a tax professional who does not know what Kay explains in the book ought not be claiming that distinction. On the other hand, people who enter into the tax return preparation field when January rolls around, and who haven't been keeping on top of tax law changes, should pick up this book and read. So, too, should people who do their own tax returns and, yes, they exist. I personally know a few individuals in that category. Even if the self-prepared return is put together with the assistance of tax software, it doesn't hurt at all to take in the view that Kay provides. Most people who prepare their own returns tend to follow the previous year's pattern, and if they have a question, turn to the software's help feature or IRS instructions or publications to obtain clarification. Unless the person has been tracking the dozens if not hundreds of tax law changes that have occurred since the previous year's filing, he or she may not even think to consider a new credit or deduction, or some other feature, that has been inserted into the Internal Revenue Code or that otherwise has modified the tax law. Tax law changes listed on the front of the Form 1040 instructions or in some other IRS or private sector software summary often do not include the changes that are likely to affect only a few people. Kay's work has things organized by transaction, and not by tax law outline, so that a person can turn to a particular part and eyeball the possibilities.

This book also should be considered by people who are entering the workforce for the first time. This includes 16-year-olds taking on a part-time job and college graduates bringing home their first full-time paycheck. Chapter 24, "Getting your withholding right" should be required reading for new employees. It probably should be explored by people who haven't modified their W-4 forms for several or more years. Chapter 22, "When a child has to file" is a good read for the teenager who starts baby-sitting, mowing lawns, or shoveling snow. Even the people who are looking for jobs without having yet found one can benefit from chapters such as "Writing off job-hunting costs," "Tax help in paying work-related moving costs," and "Self-employment tax considerations."

If I were teaching a tax policy course in an undergraduate school, I could make use of "The Truth About Paying Fewer Taxes" by having the students react to the wisdom of the tax rules that are explained by Kay in a way that an undergraduate can understand. Even high school students would learn quite a bit of useful information about the nation in which they live and the facts of tax life that they will encounter after graduation if they were assigned the book. Tax ignorance, and by that I mean total lack of knowledge and not inability to zip around the tax law as do tax experts, is inexcusable. Kay's book would do much to dispel the tax ignorance so prevalent among high school and college students, and likewise would function as a good remedial device to bring young adults, and even older folks, up to speed with respect to taxes.

The book's price would pay for several cups of expensive coffee. In other words, for what it delivers, it's a bargain. It's published by Financial Times Press, and the person to contact is Julie Phifer (julie.phifer@pearson.com).

My top ten tax blogs are now on Blogs.com. No, they're not ranked. They're the ones I visit most often, but I don't log my tax blog web surfing so I doubt I could be accurate trying to generate a ranking in that manner. To my tax-blogging colleagues, thanks for the material, the comments, the links, and the inspiration.

Just as a foolish idea is about to fade away from the tax law, the new Administration seeks to bring it back in an even more perverse form. I'm talking about tax increases masquerading as phaseouts. Many years ago, some clever but manipulative members of Congress decided that they could fool the American public into thinking that they did not raise taxes if they found a way to raise tax revenue without raising rates. Their thinking was that by leaving tax rates alone they could argue that they had not raised taxes. What they did was to reduce itemized deductions and the deduction for personal and dependency exemptions by a percentage or amount reflecting the extent to which the taxpayer's adjusted gross income exceeded a defined threshhold. The result was an increase in taxes without an increase in rates. To call this deceptive is to be too kind.

It took years to persuade the Congress to rid the Internal Revenue Code of these provisions, which have taken on the names Pease and PEP. The former is a unwarranted memorial to the member of Congress who shared this confidence game technique with the rest of the legislature. PEP is an acronym for personal exemption phaseout. It's technically inaccurate, but generates something that can be pronounced even though it hardly adds any energy to anything. What it does, along with its analogous Pease of junk, is to sap the energy of taxpayers trying to prepare returns, students and citizens trying to learn the tax law, and teachers trying to explain something that imposes a ten-fold time requirement on what was once a fairly simple tax topic.

As can be seen from page 123 of the President's Budget Proposal, the Administration wants to "reinstate the personal exemption phaseout and limitation on itemized deductions." Why? If the goal is to raise revenue, and I cannot think that the goal is anything but to raise revenue, why fall back to a failed mechanism? Why not have the courage to raise tax rates? Aside from the absurd complexity of Pease and PEP, it imposes a higher marginal rate on taxpayers with incomes just above the threshhold than it does on the megamillionaires who ought to be bearing the brunt of the revenue increases. I wrote about the problem in Getting Hamr'd: Highest Applicable Marginal Rates That Nail Unsuspecting Taxpayers, 53 Tax Notes 1423 (1991). I suppose if Congress is going to bring Pease and PEP back to life, I may need to put my pen to work and produce an updated version of that article. And then find a way to persuade members of Congress, the President, and his staff to read it and get a free education.

Worse, the Budget Proposal contains an even more complicated rate phaseout mechanism, designed to "limit the tax rate at which itemized deductions reduce tax liability," as summarized on page 128 of the proposal. As explained on page 29 of the proposal, the revenue raised from this mechanism would go into a reserve fund to be used for health care purposes. I can guarantee that the tax computation form on which this mechanism is worked out will be even more complicated than the one on which the special low tax rate on capital gains and dividends is computed. It is an extremely inefficient way in which to raise revenue. For example, why not convert itemized deductions into a credit equal to 28% of the amount otherwise qualifying for a deduction? That accomplishes the same goal, and actually benefits some taxpayers in the lower tax brackets.

What's missing from the proposal is any sort of forward-looking change in the way tax policy is developed and implemented. Pulling a failed idea from the trash heap is unwise. Why are taxpayers earning $500,000 a year treated in the same manner as those earning more than $5,000,000 a year? Why not a progressive rate structure that increases the rate by 1 or 2 percentage points for every $1 million or $2 million increase in taxable income? Why not total elimination of the special low rates on capital gains and dividends? Why not termination of depreciation for property that does not go down in value? Would not streamlining the tax law do more for lubricating the national economic engine than fooling around with mudflaps and exhaust pipes?

How did this happen? The answer is fairly easy. There still has not been anyone nominated and confirmed to serve as Assistant Secretary of the Treasury for Tax Policy. It is unlikely that the Secretary of the Treasury paid any attention to these matters, and even if he did, it's unlikely he has any clue as to what's going on, considering he cannot do his own tax return properly. One would think he'd be an advocate for simplification, not for more megacomplexity. My guess is that these ideas were tossed in by some young, eager staff at the White House and/or the Office of Management and Budget, perhaps influenced by some old-timers who remember the "good old days" when they were able to infect the tax law with gimmicks more reminiscent of toxic derivatives manufacturing rather than wholesome economic productivity. I'm confident none of these folks has any sort of worthwhile experience with tax compliance, tax return preparation, business planning, or even tax policy, other than having some conceptual and theoretical notions that do not translate very well from the world of philosophy to the world of real life.

It's likely that the response to my advocacy for increased rates scaled throughout the upper income ranges, rejection of complex gimmicks such as Pease and PEP, and repeal of the special low rates for capital gains and dividends is that these things are not "politically" feasible. So what? The nation, the President, the Administration, and the Congress should be doing what is right and necessary for the economic survival of the nation, and not what sells politically. Politics has become nothing more than a series of manuevers in which office holders engage in order to grab and hold power. For a moment, it appeared as though the current President wanted to rise above politics, spurn partisanship, and read the riot act where and when it needs to be read. What is emerging has too much "let's not ruffle the feathers of the powerful" and too little "let's listen to the American citizen who voted for change and step forward with those folks behind us."

Let's face it. The days of using Pease and PEP to hide tax increases are long gone. Everyone knows the score. Aside from the impropriety of raising taxes using clandestine gimmicks, there's no need to do so. There's no genuine impediment to doing what needs to be done in the way it needs to be done. The bleating from the privileged few that taking away their capital gains break or their special dividend rate will destroy the economy should fall on deaf ears. The special interest groups have cried wolf too many times.

Change is defined as "a transformation," as "novelty," as "the passing from one … form .. to another," as "the supplanting of one thing by another." To change is defined as "to transform." It is time for transformation with novel approaches, as the tax law passes from its current and past form into one that is suitable for the challenges of the twenty-first century. Running on a tax treadmill is not change. Turning back to the failed policies of Pease and PEP is no better than turning back to the failed policies of tax cuts, as I described on Friday. President Obama, you're an advocate of change. You and your crew can do better than to breathe new life into a stale, unwise, and inefficient idea. And you know that. Change means scaled progressive rates, no more special rates for capital gains and dividends, itemized deductions replaced by credits or eliminated, no more depreciation on property not going down in value. Don't back down in the face of the bullies. Don't be reluctant to propose and fight for the tax law changes that need to be made. Some wealthy folks and some powerful politicians may be unhappy, but the overwhelming majority of Americans who take the time to study and understand the realities of the current crisis will appreciate your decision and applaud your determination.

Apparently when it comes to tax policy, certain things are acceptable if they're done by one group but not by another. In his reply to the President's economic speech on Tuesday, Governor Jindal of Louisiana, explained to the nation:

Democratic leaders say their legislation will grow the economy. What it will do is grow the government, increase our taxes down the line, and saddle future generations with debt. Who among us would ask our children for a loan, so we could spend money we do not have, on things we do not need? That is precisely what the Democrats in Congress just did. It's irresponsible. And it's no way to strengthen our economy, create jobs, or build a prosperous future for our children.

But is this not what was done for the past eight years? Did not the debt of the national government increase from roughly $5.7 trillion at the end of 2000 to roughly $10.7 trillion at the end of 2008? Why is it acceptable to impose a huge debt on our descendants in order to fight a war but not acceptable to do the same in order to rebuild infrastructure, develop means of eliminating dependence on foreign energy, improve health care, and retool the education system so that our descendants have an opportunity to develop marketable skills that will generate national income to be used to repay the debt? Is it not possible that one of the significant factors in the current economic meltdown is the reduction, rather than increase, in taxes during wartime and the "it's ok to borrow beyond one's means" message that this unwise decision sent to the nation's consumers?

The solution is more of the same. Louisiana's governor then proposed the solution:

To solve our current problems, Washington must lead. But the way to lead is not to raise taxes and not to just put more money and power in hands of Washington politicians. The way to lead is by empowering you, the American people. Because we believe that Americans can do anything. That is why Republicans put forward plans to create jobs by lowering income tax rates for working families, cutting taxes for small businesses, strengthening incentives for businesses to invest in new equipment and hire new workers, and stabilizing home values by creating a new tax credit for home-buyers. These plans would cost less and create more jobs.

In other words, more of the same failed tax and economic policies of the past eight years. The deficit-generating tax breaks for the wealthy were defended as job-creating propositions. In February of 2009, the question is, where are the jobs that these tax breaks created?

The answer is in something I wrote three and a half years ago. In Government Budget Math: $1 + $1 + $1 = $1 + $1, I explained:

I'm not going to regurgitate all the arguments of why the [federal budget] deficit poses a long-term threat. Most of those arguments are economic. I will emphasize a different one. The deficit threatens our national security. When the deficit is increased, the government must borrow money. From whom does it borrow? From people and institutions with dollars. Who has this sort of money? China. Yes, China. For a President trying to make his mark as a defender of national freedom and independence, it strikes me as short-sighted to let another nation, and one with visions of military glory at that, own this one.

* * * * *

The defense of deficit spending, namely, that it is necessary when there is an emergency, is one that I can accept. Had there been no deficit spending during World War Two, when revenue was close to being maxed out, the outcome of that conflict could have been different or perhaps achieved at a greater cost in human life. The current difficulty, though, is that the existence of the Katrina emergency, which standing alone might justify deficit spending, comes at a time when the budget deficit already is out of control because of imbalances caused by non-emergency decisions. The huge capital-gains tax cut and the dividend tax rate reduction might be defensible in a time of peace and quiet on the military and weather fronts. But this is not such a time. Incidentally, the taxes that would have been paid by the investor community don't appear to have been channeled into projects such as energy independence, but appear instead to be chasing oil, gasoline and other energy futures. In other words, gambling. And we've seen how one great gamble, ignoring the improvement of the Louisiana levee system, brought the wrong sort of jackpot.

As the current President noted on Tuesday, the "day of reckoning has arrived." After years of neglecting the care of the nation's infrastructure, after years of handing out no-bid government contracts, after years of handing out tax breaks to wealthy individuals who gambled with derivatives, Ponzi schemes, and other non-productive wastes of money, the folks who created the mess now purport to claim high ground in the debate over how to clean it up. They had their chance. They failed. In sports, they'd be benched. In the world outside of politics, they'd be fired. They'd do a great service to the nation by stepping forward, admitting that they made a mistake, thanking those who have stepped in to rebuild the nation for undertaking such a herculean task, and doing their best to stay out of the way. Who was it that said, "If you're not part of the solution, you're part of the problem"? We're told by Inspirational Words of Wisdom that it's an African proverb. The nation does not need more tax credits, more first-year expensing, and more tax breaks for the wealthy. It's too bad that the American Recovery and Reinvestment Act is saddled with too many of these things, as I noted, for example, in So How Does This Tax Provision Stimulate the Economy?, and considering that the unwise tax break provisions were a bone tossed to an unpersuaded faction, it is absurd that they cry for more of what they ought not to have received in the first place. So much for bipartisanship. The elevation of party affiliation above the national good isn't very well disguised, as is evident from threats made by certain partisan groups against those who voted conscience rather than party allegiance.

It is disappointing to watch the nation's economic survival, and perhaps its very survival, fall hostage to partisan politics. It's as frustrating as listening to a drunk driver who has caused an accident tell the tow truck driver that the best way to clean up the accident site is to let the drunk driver get back behind the wheel to take the wrecked car home. Some people, it seems, are incapable of learning from their tax policy mistakes. Unfortunately, some of them remain in a position to wreak more havoc.

The current Administration emphasized "change" as a core component of its intended philosophy in governing the nation. A message and spirit of can-do permeated the campaign and the speeches that have been given. So what's going on with the quick and early dismissal of mileage-based road fees as the future of federal highway funding?

According to this CNN report, the Transportation Departement has announced that "The policy of taxing motorists based on how many miles they have traveled is not and will not be Obama administration policy" This announcement came shortly after an interview with Ray LaHood, Secretary of Transportation, in which he said "We should look at the vehicular miles program where people are actually clocked on the number of miles that they traveled."

I am a fan of mileage-based road fees. As explained in Whatever a Tax Increase is Called, Someone Needs to Sell It, the National Commission on Surface Transportation Infrastructure Financing (NCSTIF), though recommending a 50% increase in the federal gasoline tax to provide funding for road construction and repair, selected the mileage-based road fee system as its choice for a long-term revenue mechanism to deal with the maintenance of highways. I first explored this concept in Tax Meets Technology on the Road, examined the concept further in Mileage-Based Road Fees, Again, and early this year took an even closer look in Mileage-Based Road Fees, Yet Again. A few months ago, as reported in Introducing Mileage-Based Road Fees to the Pennsylvania Legislature, I wrote to Dwight Evans, Chairman of the Pennsylvania House Appropriations Committee, pointing out to him the existence of these fee concept and suggesting that it provided a way out of the road maintenance funding challenges facing the state. Reports out of Oregon, whose experimentation with the fee triggered my attention to the issue, are that the experiment was a success. It works. That may be why Massachusetts has joined the list of states looking at this approach, which concedes that modest increases in the state gasoline tax will not provide the necessary funds.

The system permits increasing rates for drivers who enter congested areas during peak travel times. It also can be adjusted for the fuel efficiency of the vehicle, a point missed by one critic, a columnist for Popular Mechanics, who claims that "A mileage tax, presumably, doesn't care whether you're driving a Prius or a Hummer, giving no incentive to save." That "presumably" is an invitation to dig into the Oregon experience, which, incidentally, also found that the other claimed flaw in the system, invasion of privacy, is overstated.

When CNN tried to contact the Secretary of the Treasury after the Department issued its announcement, it was told he was unavailable. The spokesperson for the Department, when asked about the announcement, claimed to be unable to elaborate.

So what's going on? Why are we not being told the reasoning that led to the Transportation Department's announcement? Why are citizens not being asked for input? Why have there not been hearings on the matter? Why has a decision been made so summarily and abruptly? What's the secret?

My guess is that someone in the Administration doesn't like the idea of mileage-based road fees. Somehow, that person has exiled the proposal into a black hole, perhaps afraid of what might happen if the idea were to get a full public examination. Does the person, or persons, lack confidence their position would triumph? Are they more secure in their power to issue back-room commands than in their power to persuade in a public forum? Considering that the report of the NCSTIF has not yet been formally presented, is it sensible to reject its recommendations before people have a chance to educate themselves with respect to mileage-based road fees? I also will guess that opposition to the concept comes not from those genuinely interested in privacy, because that concern has been declawed by the Oregon experiment, but from whomever would stand to lose if the system were put in place. Who might that be? Certainly not the manufacturers of the units that track mileage or the folks who would obtain jobs installing them in existing vehicles. Certainly not the people who would be programming the units and operating the equivalent of a networked EZ-Pass. Honestly, I see a win-win proposition that benefits everyone involved in highway use, and I cannot determine what would be fueling (sorry) opposition. This is why it is essential to find out what underlies the announcement by the Transporation Department.

It was one of those tax questions that doesn't require much more than a paragraph to put forth. It was posted recently on the ABA-TAX listserve:

Client moved to Colorado from Maryland in 2007. They were not able to sell their home in Maryland, so turned it into a rental. They receive rent, but it doesn't even come close to mortgage interest and taxes expenses. Instructions for Maryland income tax returns specify that gross rents from property situated in Maryland must be reported. Gross rents exceed the level of income required for filing, but, of course, there's a large loss, so no tax will be due.

Right now I have classified the rental property as MD sourced. My clients don't want to file a MD return for just that.

The responses were almost unanimous in concluding that the Maryland return should be filed. One response put it succinctly: "Of course, your client must file a MD ret. the fact that he doesn't like it doesn't change the law, not [sic] does [the] fact that he has offsetting expenses." Another respondent gave a good reason for complying with the law: "If for no other reason than to establish the existence of the rental loss, which presumably would end up in some sort of carry over status, thus available for offset some day down the line when the property may be sold at a gain." This reasoning was echoed by yet another list participant. Three more reasons came from different participant: "… software makes it easy to do so. Besides the fact that most states require that you file such a return it also had the advantage of starting the running of the statute of limitations. Also the preparing of the return may be cheaper than having to respond to the state later when Maryland sends a letter asking why no return was filed." As for the client's unwillingness to file, this advice makes sense: "I'd prepare the return according to the rules. If they don't mail it in, it's their issue."

The implications of a the requirement that a nonresident who transacts business or engages in an activity in the state must file a return with that state become quite complicated when the nonresident's business or other activities touch multiple states. The cope of the complexity is illustrated by this inquiry which followed up the original question:

Related to this situation, what happens when K-1 activities are allocated to multiple states? I have one client that is invested in a private equity fund that allocates income across 32 states. In some states the income is as low as $5 and some of the states show losses.

I know that technically we should be filing in all of the states, but I don't think that is practical at all. And while I understand that technicalities should trump practicalities, there must be a feasible way to do this.

The first response to this question tried to soften the impact of multi-jurisdictional activity on tax compliance:

Just because income was allocated across 32 states does not mean that the client has a filing requirement in each of those states. It is likely that in many of those states the income threshold was not met and thus no return need be filed.

As someone else pointed out a while ago ( I'm not sure if it was here or elsewhere) the client is the one that made the investment decision. All we can do is advise them of the law.

If I know a return is required, it is my current practice to prepare one ( of course a client can instruct me not to prepare a particular
return). Once prepared it is up to them whether or not to file it.

That is when I jumped in with this observation:

This is a reason that some states permit the entity to withhold and pay taxes on behalf of the shareholder/partner/member. When I worked on the Model S Corporation State Income Tax Act, the drafters adopted this concept.

Unfortunately, many states do not provide for this mechanism, some make it optional, and some make it available for certain types of entities and not others.

As states begin to figure out what some of us already know, that mandatory withholding of income taxes by the entity on behalf of nonresident shareholders/partners/members will increase state revenue, we'll begin seeing this approach take hold across the country.

In the meantime, different states pursue nonresident shareholders/partners/members with varying degrees of intensity. New York is quite aggressive. Other states lack enforcement resources.

Withholding on behalf of nonresident shareholders and partners is a sensible solution but it also provides challenges.

The concept of withholding on behalf of nonresident shareholders and partners is simple. An entity that engages in activities in a particular state applies a specified rate to each of its nonresident owners' distributive shares of its income, and pays that amount to the state on behalf of the nonresident owners. At this point, application of the concept becomes more complicated. Some states provide for withholding on behalf of resident owners, even though the resident owner must file an income tax return with the state in any event. Other states do not. Some states make withholding on behalf of nonresident owners mandatory, while others make it an option. Some states do not provide for withholding on behalf of nonresident owners.

In an extended form, the concept evolved into the composite return. The amount paid by the entity to the state, rather than being treated as withholding claimed by the nonresident owner on the owner's state income tax return, is treated as payment of the state income tax on behalf of the nonresident owner, who is then absolved of any requirement to file an income tax return with the state. Even this concept can become more complicated, because some states permit the nonresident shareholder to file a return, report the income, and treat the payment as a credit, if the nonresident chooses to do so. Why would the nonresident choose to do so? If the nonresident also owns an interest in another entity with activities in the state but that incurs a loss, the nonresident would prefer to file a return on which both the income and loss are reported, with the loss offsetting the income and thus eliminating the tax liability. Whether a refund could be obtained depends on the precise language of the state's statute.

The drafters of the Model S Corporation Income Tax Act, and I must disclose that I was among them, agreed on the use of composite returns rather than simple withholding. Although not every state has adopted this model act, some have, even though some of the states that have adopted it did not include the composite return provision or modified it to some extent. On the positive side, the endorsement of the Model Act by the Multistate Tax Commission gave impetus to many states to focus on this issue, not simply for S corporations but also for partnerships and other pass-through entities. Progress, it seems, often is made one step, or one state, at a time.

One of the reasons for choosing the composite return approach is to avoid a federal income tax issue that arises for S corporations under the withholding approach. Many S corporation shareholders focus on after-tax returns, and seek to guarantee that each share of stock ends up with the same after-tax income. The problem with this approach is that under a withholding system as in place in some states, a nonresident and a resident shareholder are treated differently. Thus, if the corporation pays state income tax on behalf of one shareholder and does not pay it on behalf of another, the effect could be a difference in deemed distributions, causing there to be more than one class of stock. If the corporation complies with Regs. section 1.1361-1(l)(2)(ii), it can avoid being disqualified as an S corporation for having a second class of stock. But if it doesn't comply with that provision, the consequences could be quite disadvantageous.

Until all of the states and localities with income taxes adopt a uniform composite return approach to the issue, the aggravation of having to file multiple state income tax returns, perhaps several dozen of them, will continue to exist for persons who own interests in entities that engage in multistate operations. The independent taxing authority of each state, and if one wants to be precise, each locality within a state, is a political feature of the nation's governance system that imposes a transaction cost on doing business. Only the most local of businesses can avoid multistate taxation. And only a few can afford to ignore the increasing globalization of most types of businesses.

None of this, of course, addresses the further complications arising from differences in how each state or locality defines taxable income. Amounts deductible in one state may be disallowed in another. Even if the state or locality uses federal taxable income as a starting point in computing state taxable income, as most do, all sorts of adjustments are required, and those vary from state to state. Worse, something that may not need to be separately stated for purposes of one state's income tax may need to be separately stated for purposes of another state's income tax because the latter state may have a credit related to certain types of expenditures for which the first state makes no provision.

When I tell students in the Partnership Taxation course that we are ignoring more of the issues than we are addressing, they nonetheless conclude that the topic is brutally complex. It is. Though the course focuses on federal income taxation, from time to time I ask them to envision the issues that the transaction presents for state income tax purposes. And if that's not sufficient to help them understand the extent to which the course is "watered down," I remind them that many partnerships and S corporations engage not only in multistate activities but in multinational activities. Recession or no recession, someone needs to figure out how the partnership or entity fills out the many returns it must file. And going back to the original question, the folks who own rental properties in multiple states either need to sit down and do a handful or more of returns on their own, or stimulate the economy by paying tax return preparers to do so for them. It's no wonder that one preparer's client balked at the expense. But as the participants in the discussion demonstrated, that client has no realistic choice. The option of not filing the state income tax return isn't a viable one in the long term.

Last Friday, in Don't They Ever Learn? They're At It Again, I lamented the continued persistence of the Delaware River Port Authority (DRPA) in its plans to use toll revenue for purposes other than repair, maintenance, and protection of the bridges and rail line that generate the tolls. On Thursday, in Legislators eye limits on DRPA spending, Paul Nussbaum examined the issue, explaining what would be required to amend the DRPA charter so that its use of toll revenues for unrelated projects would come to an end. He interviewed Pennsylvania State Representative Paul Clymer, who noted that while costs for motorists were "ballooning," the DRPA was using toll revenues for "special pet projects" of politicians. He's in favor of amending the charter. A member of the New Jersey Assembly noted that there was interest in doing this but that it wasn't a priority. The American Automobile Association Mid-Atlantic club has come out in favor of a change. The people who emailed me, called me, and spoke with me after having seen my comments quoted by Paul in the article unanimously agree.

Paul's exploration of the issue revealed that when the DRPA charter was changed in 1992, it was resisted by some New Jersey members of the DRPA because "they feared that toll revenues would be diverted from bridge maintenance." It's unfortunate how the warnings of the prescient too often are ignored. Since the DRPA's foray into projects other than bridge and rail line stewardship began, its debt increased from roughly $250 million to $1.2 billion, with an further increase to $1.5 billion expected. Bridge tolls have soared from $1.80 to $4, and will increase to $5 in 2010.

The DRPA defends its largesse to stadiums and other projects by claiming "We are confident that the authority's investment in these projects will generate increased toll and transit revenues for years to come." C'mon. Money has been poured into these projects by the DRPA for more than a decade and if toll revenues had grown as predicted there wouldn't be a need to throw two consecutive annual increases of 33% and 25% at motorists. The DRPA also claims that "even if every penny of the remaining $35 million in bond proceeds were diverted to the capital program [for bridge repairs and other improvements], it would not reduce the size of the bond issue needed to fund the program, nor would it reduce or eliminate the need for the toll increases that are being implemented to fund it." Simple accounting tells us that if the $35 million is used for repairs and improvements to the bridges and rail line, that's $35 million fewer dollars that need to be borrowed or $35 million fewer dollars that need to be collected in tolls.

On Wednesday, the Philadelphia Inquirer invited two public officials to opine on the question. In Should DRPA fund President’s House? No. Agency should stay on mission, Jack Wagner, Pennsylvania's auditor general, presented arguments similar to those set out by those opposed to the diversion of toll revenues. He explained that as a member of the DRPA he had voted against its contribution of $10 million to construction of a soccer stadium and intended to vote against the latest round of projects that brought the issue to the forefront once again during the past two weeks. In all fairness, I ought to stop painting the DRPA with a broad brush, as the decision to spend toll money on unrelated matters hasn't been a unanimous one. He points out that the projects to which tolls have been diverted won't fall apart without the DRPA money. That makes good sense. The analysis ought to be "we build and maintain bridges so that people can get to where they want to go" and not "we use toll money to fund projects so that people will want to use our bridges."

Taking the other position was Pennsylvania's Governor. In Should DRPA fund President’s House? Yes. Growth is a key part of the agency's role, Ed Rendell argued that the DRPA must make strategic investments as part of its "critical role in fostering growth throughout the greater Philadelphia region." Since when does an agency created to care for bridges and a rail line become the engine of economic growth for the region? What's next, the DRPA building public housing, collecting trash, and plowing Philadelphia's streets? Rendell makes a strong case for the quality of the projects, a conclusion with which I do not disagree and a conclusion with which few others disagree. Instead, as I pointed out in my comments quoted in Legislators eye limits on DRPA spending, "public anger with DRPA had less to do with the projects that are being funded than with the way the agency does it. These aren't bad projects. They're not funding the importation of illegal drugs or something [like that]. But the user fees are being used for purposes totally unrelated to what users are paying for." Something more than the project being worthwhile is required for the funding to come out of bridge tolls rather than from some other source. Otherwise, there would be no limit to what the DRPA would fund. That would be wrong, because the DRPA is not a general fund government but an agency charged with bridge and rail line stewardship.

Rendell's justification rests on this rather revealing argument: "Seventeen years ago, elected leaders in New Jersey and Pennsylvania recognized that the DRPA was uniquely situated to support economic development." Uniquely situated? The DRPA is as uniquely situated as is any unregulated monopoly. It's in a position to collect tolls from motorists who, as I pointed out in Legislators eye limits on DRPA spending, "don't have another way to cross the river, and … don't have a way to vote against DRPA board members." Rendell's argument is not unlike the "we're in a position to take the money, so we will" approach that was embraced by certain business entrepreneurs, investment bankers, brokers dealing in toxic derivatives, boiler room sales forces, and others who abused the so-called "free" market to the point this disregard for the obligations of holding a position of stewardship significantly contributed to the current economic downturn. Just because it's possible to gouge the motorist or the customer or the client doesn't mean it ought to be done.

Rendell points out that "They amended the agency's charter to make that one of its essential functions. The amendments were reviewed and approved by the Pennsylvania and New Jersey legislatures, Congress, and the president." That might make the DRPA's actions legal, but it doesn't make them wise or responsive to the electorate. Did any of these officials tell the voters while they were campaigning for office, "We're going to raise bridge tolls to finance the Army-Navy game, the Kimmel Center, and other projects that the DRPA happens to take a liking to"? Why is it that the DRPA hasn't funneled toll revenues to feeding the region's hungry or financing scholarships for the underprivileged? Expanding the DRPA's mission to include improvements to feeder highways, to improve access to the bridges, though beyond the technical boundaries of the bridges, is defensible, even to the point of probably getting my support.

Rendell does make a good point that the DRPA has painted itself into a corner. Some of the money that it is about to disburse was committed some time ago. According to Rendell, the DRPA "must honor those commitments." I'm sure he's right. I'm sure there are contractual obligations in place such that if the DRPA does not cut the check, it will be sued, successfully, by the designated recipients. That's too bad. It may be too late to back out of those expenditures just as it's too late to back out of hundreds of thousands of ill-advised mortgage loans.

Rendell then asks, "Does anyone seriously dispute that this will generate significantly more trips across our bridges and on our trains?" Yes, Ed, I do. Where are the surveys? How many motorists would answer "No" to the following questions: "Would you have crossed this bridge if the DRPA's refusal to put $250,000 into the Army-Navy game caused it to be moved to some other city or cancelled? Would you have crossed this bridge if the DRPA had not contributed to the funding of the Kimmel Center? Would you have crossed this bridge if the DRPA had not funded some of the cost of the President House project?" How many people in New Jersey are saying to each other, "Hey, Sam, they managed to get the soccer stadium built with help from the DRPA, so let's cross the bridge without eliminating any of our existing bridge crossings"? Yes, there are some motorists who might make a crossing that they otherwise would not have made, without cutting back on existing trips, to see something that arguably would not exist but for DRPA funding, but there's nothing to demonstrate that there's enough of them to "generate significantly more trips across" the bridges. The burden of proof is on the supporters of this spending spree. To date, they haven't generated the evidence.