MauledAgain

My description and analysis of the "janitor for a day" plan brought some informative and thought-provoking comments. Here are three of them.

1. Prof. H. Beau Baez of Liberty University School of Law wrote:

"Having recently retired from state government and having served on my agency's retirement committee I am fairly well versed on this issue. First,
the states do believe that it would violate the Constitution to impose the employer portion of the tax on the State (the inter-governmental tax immunity doctrine). Second, the States do not opt-out of Social Security but rather they opt-in by contract with the federal government.

"I found the discussion of the Texas teacher's one-sided. Clearly they are abusing the system but the federal government has been abusing state &
local employees for years because of WEP (Windfall Elimination Penalty). If a person works for a state agency that is not subject to Social Security
then that person's record becomes tainted forever. WEP acts as a penalty for state employees that also have earnings subject to Social Security. This penalty reduces Social Security benefits.

"Here is an example: I spend 20 years with a state agency and receive a state pension. I then spend 20 years teaching for a non-state owned law
school. When I retire my Social Security benefits are calculated for the 20 years I contributed into the system. However, my benefits are then reduced (i.e., penalized) because I worked for a state government. I know of no rationale for the claw-back provision except as a mechanism to pressure state governments to opt-in to the Social Security system.

"So, what the Texas teachers took from the federal government, the federal government took back from many other state government employees that did not make state government their lifelong careers. I do not see articles in the press discussing the injustice of reducing a person's Social Security benefits merely because he worked for state government. As best as I can tell, even one year's service (maybe less) with a state government is enough to trigger WEP.

"States have been trying to eliminate WEP for years, but the loss to the treasury would be significant. Thus we have a Congress that believes in
heads I win (no WEP relief) and tails you lose (Texas teacher loophole closed)."

2. Another commentator pointed out that the legislation to stop state and local governments from opting out of Social Security was a political compromise. That legislation was the same legislation that brought Federal employees within the social security system. The recollection of this commentator was that although some concern was expressed about the ability of the federal government to impose the employer portion of the FICA tax on the states it wasn't a major factor in the determination.

3. Yet another commentator pointed out that employees participating in private retirement plans pay FICA taxes and pay into the private plan (directly or through employer contributions that are made in lieu of higher salary), making it reasonable that they would collect under both when they retire. In contrast, the state and local employees using the "janitor for a day" plan pay into the state retirement plan but do not pay FICA taxes. Persons who, like Prof. Baez, have been employed by a state or local government and then become employed in the private sector, are for some reason treated differently. Or, as this commentator put it: "The issue might be framed as why former state Social Security exempt employees accrue Social Security benefits at a lower rate than workers generally."

* * * * * * * * *

These comments reinforce the need for the social security system to be fixed. There are all sorts of ideas floating about as to what needs to be fixed and how it should be done. Wednesday's posting about the "janitor for a day" plan focused on a very narrow, technical question, namely, whether a surviving spouse should be treated as having been a participant in the social security system, and the now-eliminated law that said in effect "yes, if they work as little as one day" was a classic example of something not thought through or perhaps the result of political compromise.

As for the larger question of how state and local employees are and should be treated, there are several points to consider.

1. So long as state and local employees have a pension plan and are exempt from social security, there is some sense in treating the state retirement plan as a substitute for social security. Thus, when a state or local employee leaves government service and enters the private sector, becoming subject to social security, the social security participation ought to be treated as a continuation of the state retirement plan, and the benefits ought to reflect the accumulated years of service. Then a mechanism is needed to figure out which plan pays how much of the benefit, but that is secondary to making certain that the retiree is in the same position as he or she would have been in had the retiree been subject to social security for the entire time or to the state retirement plan for the entire time.

2. The complexity arises when the state retirement plan is considered to be an analog to the private retirement plan, which, for all intents and purposes, it very much resembles. Certainly employees in the private sector can move from job to job and "tack" the benefits from each of the private plans in which they participate. It gets arithmentically complicated, but it gets done. And the private sector employee, when retired, collects from those plans AND from social security, which is computed without regard to the private retirement plan benefits. If the state retirement plan is treated as another private retirement plan, then the employee ought not to suffer a reduction in social security benefits on account of the state retirement plan.

3. The answer, of course, is to require ALL employees to participate in the social security system (railroad employees have their own, analogous system but for purposes of this discussion we'll sweep that into the phrase "social security system"). If the reason for allowing state and local employees to stay out of the social security system is some sense that the federal government cannot tax state and local governments, then stop using the word "tax" to describe payments into the social security system, and call them what they are: insurance premiums or retirement plan contributions, depending on one's view of what social security is and should be.

4. The fact that, at least in Texas, some employees were in the social security system and some were not suggests that something more was at work and it surely wasn't Texas objecting to the "taxation" of its employees. Perhaps the unions representing the teachers had something to do with it?

5. I take the position that social security was originally intended to be insurance, and in any event, ought to be insurance. Just as society, through government, medial, churches, and many other (but not all) groups send the message that it is better to be employed than to be on welfare, so too the message ought to be "it is better to have a retirement plan, even if it is your own IRA, than to be on retirement welfare." If, in fact, social security is a retirement plan, albeit mandatory, as some say it is, then it should be operated and funded as one, such that the benefits ought to match the contributions and plan earnings and the Ponzi-scheme arrangement currently in use ought to be jettisoned. It is "political compromise," the bane of all efficiencies, that generates this "both entitlement retirement plan (yet unfunded) and retirement welfare" arrangement that is much like an animal trying to be a dog and a cat at the same time.

Not only do I think (and feel) that this topic will generate material for this blog in the months and years to come, I also predict that it will become a crisis by the end of the decade. The result, some combination of higher "taxes" and reduced benefits, is going to pose challenges that "political compromises" will not solve. The longer reform is postponed, the more expensive it will be. That's assuming, of course, that reform at that late stage will rescue the system.

I don’t know how I missed this one. Perhaps because it involves social security benefit computations rather than the social security tax itself my attention wasn’t caught when the issue first made the news. This is the sort of news, though, that was buried in the back pages and which most people probably thought had nothing to do with them. I first noticed it today in a Philadelphia Inquirer article (yes, in the back pages), and a little research filled in the story, particularly this informative article in the Washington Post a few months ago.

This is a complicated story. It raises some difficult questions. So bear with me as I try to explain this correctly and yet without getting too technical.

As a general proposition, a person who does not pay social security taxes is not eligible for social security benefits, other than as a child or spouse (under certain circumstances) of a person who does participate. There are two groups of people who do not pay social security taxes: those who aren’t employed or self-employed, and those who are employed in positions that are exempted from the social security system. One group that is exempted are state and local employees who are participants in state pension plans. Question number one: why does this exemption exist? Why should someone participating in a state pension plan escape social security taxes (and give up the benefits) while someone participating in a private pension plan is subject to social security taxes (and eligible for benefits)?

If that were all, it would be relatively simple even if the underlying policy question baffles us. But, of course, it gets complicated. If a person not participating in the social security system because they are covered by a state or local government pension is married to a person who does participate, and the social security participant dies, the surviving spouse, whose benefits would otherwise reflect their status as the surviving spouse of a social security participant, takes a cut in surviving spouse social security benefits because the surviving spouse participates in the state or local government pension plan. If, however, both spouses are social security plan participants, when one dies, the other receives the higher of the benefits to which each was entitled. Question number two: why are spouses treated as a unit rather than as individuals? Why, again, does marital status have an impact on the computation of social security benefits (as it does for some married couples under the income tax) considering that payment of social security taxes is not affected by marital status?

Thus, it is better for both spouses to be social security participants. One might think that the public employee, such as the school teacher, can’t be a social security participant because they haven’t paid social security taxes. Wrong. The social security law treated a person as a social security participant if they retire from a job not exempt from social security, even if they work for a day. Of course, one day’s coverage won’t get the person social security benefits on their own (because 40 calendar quarters are required), but it gets them status as a social security participant spouse. The difference can be as much as $2,000 a month of social security benefits to a person who has not paid into the social security system. Question number three: why did the social security law treat a person as a participant if they worked for as little as one day in a covered job?

Not surprisingly, some public employees, mostly school teachers, decided that they would get themselves hired for a day and retire from a covered job. Where can such a job be found? The school district. Yes, the school district, whose janitorial, cafeteria and similar employees are within the social security system. Question number four: why are school district janitorial and similar employees within the social security system while school district teacher employees not? Question number five: why would the school district hire a retiring teacher as a janitor for a day, that is, what is the benefit to the school district? Hint: the teachers PAID THE SCHOOL DISTRICT A FEE for the right to be hired for a day.

In 2002, the General Accounting Office brought this abuse to light. The practice of signing on as “janitor for a day” seems to be prevalent in Texas. The GAO reported that in 2002, there were 3,521 Texas public employees, mostly school teachers, who switched to a covered job, most on the last day of their career. That’s 25% of all public education retirees in Texas. Although the use of the loophole received most attention in Texas, there are at least 2,300 other state and local pension plans. The GAO suggests that employees under those plans may be using the loophole. The cost to the social security system was estimated at $450 million. It has been estimated that if everyone is permitted to do what these public employees are doing that the Social Security deficit would triple.

The fun begins. When the GAO report broke, several Republican members of Congress introduced legislation to close the loophole that treats a person as a social security participant if they work in a covered job for just one day. The legislation requires 60 months of covered employment to so qualify. The legislation also contained numerous provisions designed to curtail all sorts of Social Security Program fraud and abuse.

The legislation was brought to the House floor under suspension rules, which require a 2/3 majority for passage. The bill was killed, because only 249 members voted yes. That’s not enough even though the yeas outnumbered the 180 nays, of which 166 were provided by Democrats. Though I usually cast blame on both sides of the aisle, this story is one that is steeped in partisanship.

Shortly before the vote, Lloyd Doggett, a Democrat member of Congress from Texas, called some Texas teachers. They contacted the two largest teachers unions (the National Education Association and the American Federation of Teachers). The unions swamped Congress with letters claiming that the proposed legislation would “cost their members dearly.” Those voting no claim that the teachers are fighting “discrimination.” Under this logic, if the teachers had not held jobs, they would qualify for their deceased spouse's entire Social Security benefit. The unions, of course, neglect to mention that had the teachers not worked they wouldn’t be getting the public pension. Doggett points out that what the teachers were doing was “perfectly legal” and he’s right. Question number six: Is it enough that something is “perfectly legal” to go ahead and do it? Or should other constraints, moral and ethical, bear on the decision? Question number seven: Should the analysis reflect the “relative injustice” of the situation, and if so, is there an injustice when someone who pays into a pension system and not social security is restricted to the pension when they retire?

The unions and those supporting them claim that the legislation would cause the teachers to be treated “not as fairly” as most American workers covered by social security. Huh? Question number eight: How is it unfair to be covered by a pension plan that is far more generous than social security? Would a person trying to get by on social security consider herself to have an unfair advantage over a pension-getting retired school teacher?

The unions also argue that the teachers were using a legal loophole, and that “wealthier Americans” use tax loopholes “all the time.” Let’s ignore the hyperbole. “All the time” is a bit extreme and is overloaded rhetoric. Question number nine: is the “everyone else is doing it” defense acceptable? Even if it is, is the “everyone else is doing something else that’s sort of like what I’m doing” just as acceptable?

Teachers are a key component of the Democratic Party’s core base. Teachers and their unions are substantial financial supporters of the Democratic Party. Question number ten: should the political allegiance and financial support of a group of people demand that politicians support their position even if it flies in the face of what is right for the nation? Question number eleven: did it occur to the teachers, the unions, and the politicians supporting them that if the “janitor for a day” ploy continues it will cost someone else, either in the form of reduced benefits or higher social security taxes? Question number twelve: did it occur to these politicians that if benefits for others are not reduced and social security taxes are not increased that this “janitor for a day” ploy would increase the federal budget deficit? Question number thirteen: did any of the politicians see anything inconsistent in their thinking?

So, the Republicans re-introduced the bill, and let it take the slower track that does not require a 2/3 majority for passage. It was enacted, and signed into law as the Social Security Protection Act. If you want to read it (good luck), you can find it here. The effective date is July 1, 2004. That caused a flurry in retirements among Texas public school teachers. From September of 2003 through May of 2004 the Texas Teacher Retirement System processed 35% more retirement applications. One school district alone temporarily hired 3,500 workers. Question number fifteen: why was the effective date set at July 1 rather than, as usually is the case, the date that the provision is first read out of the Congressional committee reporting the bill? Question number sixteen: why are the voters living in these school districts tolerating this abuse of the system?

One teacher was hired to move furniture. Question number seventeen: what happens if that teacher throws out her back or otherwise is injured while engaged in employment for which she has not been trained?

This story, unfortunately, is so typical of how things are done today. It begins with a badly drafted legislation containing an indefensible provision, it is tainted with the “married people are special (sometimes)” discrepancy, it encourages greed, it generates reform attempts that are blocked by unions and politicians who cannot put the public good above individual and group gain, and it is reformed with a prospective effective date that triggers a flurry of superficial employment. It pits those who think “just because it’s not illegal doesn’t mean you ought to do it” against those who think “life is fine as long as you simply stay within legal boundaries.” It gives sustenance to those who think government needs to regulate every little bit of life because people, left to their own devices, lack the judgment to take a wider view of things. It also gives “I told you so” energy to those who predicted that every attempt to make life easier for those truly in need will generate abuse by those who aren’t in need but want to appear as though they are.

None of this would have happened had Social Security been left as an insurance program designed to assist those whose pensions and other income were insufficient to support them after retirement. Social Security was enacted, after all, as the Federal INSURANCE Contributions Act. Yep, the I in FICA means INSURANCE, not entitlement.

So not only are there millionaires pulling down huge pensions and raking in investment returns (taxed at very low rates) grabbing Social Security because they paid into the system, there were people who wanted in on Social Security benefits even though they hadn’t paid into the system and already were covered by a very generous pension plan. OK, every once in a while a wealthy person declines social security, and there were some teachers who didn’t succumb to the “janitor for a day” ploy. And perhaps a reporter will feature them so that people can see that there are good decisions being made and role models worth noting.

But, for the most part, the story inspired me to re-use the blog headline I used the other day. It was either that or “Twenty Questions” but I ran out at seventeen.

The headline in yesterday's Philadelphia Inquirer may be a bit overdone but still carries a big oomph to most of those who saw it: Executive pay rose 33 percent in 2003.

For people dealing with increases in gasoline prices, other energy costs, and even the price of food, and trying to make things balance when getting raises of 1.5 or 2.5 percent, it must be at best, bewildering, and at worst, infuriating, to see that the "executives" are getting 33 percent pay raises. For folks not getting raises, or without jobs, it surely is both bewildering and infuriating.

Headlines, though, can be a bit two sweeping. The linked story reports five results from the Inquirer's 11th annual review of executive pay, which was limited to CEOs of 200 plus local companies:

1. Topping the list were Ralph Roberts, CEO of Comcast, who earned $35.9 million in 2003, and Charles M. Cawley, recently retired CEO of MBNA Corp. who earned $34.8 million in 2003.

2. For these two men, their 2003 pay were DECREASES. Both had higher salaries in 2002.

3. The average increase for all the CEOs in the survey was 33 percent more.

4. The MEDIAN earnings of these CEOs in 2003 was $700,000.

5. Of the 950 executives on the list, only 45 are women.

From this information, one can infer that some executives received increases far exceeding 33%, because the two most highly compensated executives had earnings decreases. Statistics, though, are misleading, because one can also infer that many of the CEOs went home with salaries much lower than $700,000. And if someone's salary went from $100,000 to $300,000 (extremely modest by the standards of those at the top of the list), that's a 200% increase. That sounds like a lot, but is a 200% increase on a $100,000 salary as good as a "mere" 5% increase on a $10,000,000 salary? NO. Not at all.

In another story run by the same paper, the headline, "Just how special are CEOs?" doesn't really give a clue as to the information that the Department of Labor shared:

1. There are roughly 9,500 CEOs in the Philadelphia area.

2. There are fewer than 9,500 bank tellers in the area. There are fewer than 9,500 bartenders in the area. Same for telemarketers, plumbers, and dishwashers. [So it's true, everyone wants to be the boss. Big surprise.]

3. There are fewer than 9,500 employees at the area's major employers, including Comcast, Vanguard, Merck and Cigna.

4. There are three times as many CEOs as there are dental hygienists.

5. The median per-hour pay of local CEOs is $63 ($132,000 a year).

6. The typical dentist in the area earns more than $132,000 a year.

7. There are far more small businesses run by board-hired CEOs.

8. The Labor Department definition of CEO probably includes people that most of us would not think of as CEOs, and includes owners of small family businesses.

9. There are about 400,000 CEOs nationwide.

10. About 5% of the 400,000 CEOs run government agencies, roughly 8,000 run educational institutions, and roughly 8,000 run engineering and architectural firms. Fewer than 40,000 run companies, enterprises, and financial institutions.

11. Company CEOs average $170,000 a year, bank chiefs $140,000, and local government agency CEOs $81,000.

It's always worthwhile checking out the facts. Despite the tendency of many critics (including myself at times) to lump business executives into one big pile, the situation in the business world isn't that much different than it is in other professions.

For example, it's common to hear complaints about "grown men making tens of millions a year to play a boys' game" whenever a high profile professional athlete signs a mega-bucks contract, but littel attention is paid to the guys scraping by on the rookie minimum or the journeyman's $120,000. And, female professional athletes, if the few in the big bucks media spotlight are ignored, earn very modest sums.

Lawyers are perceived as hauling in huge salaries, but for every "Wall Street partner" taking in $500,000 a year or every big-time plaintiffs' injury counsel getting fees in the tens of millions, there are lawyers scraping by on $25,000 or $30,000 doing public defense or other pro bono work, or trying to establish a general practice in a small town.

Any good statistician will agree that a few very high salaries will boost the average to an amount not seen by most of the people in the category being measured. That's why the surveys use median, that is, the point at which half are above and half are below. A median of $700,000 means that half of the CEOs earn less than that amount. Although $500,000 or $600,000 may seem like a fortune to someone without a job or earning $60,000, it, too, pales when compared with a salary of $5,000,000, $15,000,000 or $30,000,000.

That's why the tax reform focus and the social reform focus needs to be on dollars and not occupations. And that's why the practice of the Congress of using $100,000 or $150,000 or $80,000 as a cut-off, above which tax deductions or other benefits are denied or phased out, is so unrealistic. The highest income tax rate applies to taxable incomes over (roughly) $319,000. Even though taxable income isn't the same as gross income (such as salary), putting a person with taxable income of $325,000 in the same marginal tax bracket as someone taking in $30,000,000 skews the progressivity of the federal income tax.

There are three issues here. One is how high the highest rate ought to be. The second is defining the point at which it applies. The third is the proportion by which the rate climbs from zero to the point at which the highest rate kicks in, including the question of how many different rates should exist. Much has been written about these issues, because they've been around to be discussed since long before the income tax was first enacted.

The stories about CEO pay, and the eye-grabbing, eye-popping effect of learning that there are salaries of $30,000,000 or more compel me to share a few thoughts about the question of defining the point at which the highest rate should apply. There is a point at which additional income no longer has value to purchase food, clothing, housing, and vacations. A person can only eat so much, even if they're intent on "supersizing" at the five-star version of McDonalds. I understand that some people "need" 6,000 pairs of shoes, or 10,000 pieces of jewelry, or a home with garage space for 30 vehicles, but there is a limit. It may vary, but no one has TIME to consume $100,000,000 in a year.

The facts bear that out. Most individuals with mega-salaries invest a substantial portion of their incomes. That permits them to acquire control over other companies, charitable foundations, and political offices. Although some grass-roots candidates seem to demonstrate that a huge flood of individuals each contributing $10 or $20 can generate enough money to offset the big-time contributions (funneled through multiple "independent" organizations), the gist of the matter is that control of business, government, and charity (read: control of society) is in the hands of those with huge amounts of "excess" money.

So the question comes down to this: Should the control be in the hands of the few who have huge amounts of money or in the hands of government, through imposition of higher taxes? That is a way of characterizing the debate between those who advocate tax cuts and those who advocate tax increases. The wrinkle, imposing very low taxes on capital gains earned on the investments themselves, simply intensifies the contrast.

Both sides ultimately argue in futility. What good is it to have government taking in more money if the decisions as to its use are made by the same people who make the decisions if they had held the money in their own hands? Is the question really a matter of WHICH GROUP of moneyed interests will get to make the decisions? Is there any place for the "typical" American citizen who has neither the time nor the resources to engage in power brokering?

The argument that salaries should be limited by the government misses the point. Government control of salaries would be yet another step away from a free-market system. But doesn't that last sentence require support of minimal taxation? No. It is one thing for the government to control the market (which it has done many times, through war-time rationing, war-time and peace-time price controls, setting of the federal funds rate, etc.) and it is another for government to charge for its services in providing security, opportunity, and fairness in the operation of the free market. A stock or other financial exchange isn't free if its electronic data is being hacked, its buildings bombed, and its personnel kidnapped, and what other way than government-provided defense to protect that freedom?

It may be useful to inquire how or why those with mega salaries obtain them? Is it hard work? Cleverness? God-given (or nature-provided) talent? Fraud? Luck? Fortune of birth? Some combination? Ought it matter? It does, to the extent that there are penalties other than taxes on the fraudulent acquisition of income. Is there a difference between $30,000,000 a year earned by someone who designs the perfect anti-spam software and sells a lot of it and the $30,000,000 a year earned by someone who can hit, throw, or catch a ball in ways that few others can and whose skills are in high demand? Is the first $30,000,000 a reflection that the software is priced too high? Is the second $30,000,000 a reflection that the cost of advertising (built into product prices) is too high and thus generates too much spendable revenue for team owners? Add into the comparisons $30,000,000 earned by someone who is hired as CEO by a company with huge revenues with low profits who turns those revenues into higher profits by reducing the company's workforce. Does this represent the cost of the skills demanded by the shareholders of that company (who, by the way, are most of us through our retirement and mutual funds)? Or does this represent the failure of the company to reduce the prices of its products and services?

Somehow, even though some holding radical views disagree, it isn't difficult to see that the person on whose desk the decision ultimately rests incurs risks, and attendant stress, that permits a reasonable conclusion setting compensation at some multiple (say, 2 or 3) of someone employed to provide services without taking similar risks. But how does one justify salaries that are 300 times or 400 times the average salary of all employees, and 500 to 1,000 times the salaries of the lowest paying employees? How does one justify extremely high salaries in industries that continue to generate barely acceptable quality of product or service, that shift the burden of testing, repair, and risk to the consumer, and that move jobs overseas for reasons of money acquisition rather than quality improvement? Yet would any of us really begrudge a $30,000,000 salary to the person who invents the fool-proof anti-spam software (or the perfect cancer drug, or the perfect diet)?

Everyone has a different perspective on the issue. Should we vote on it? At a ballot box? At the store? By changing channels? By turning off all the electricity-driven things in the house? By cutting driving in half?

Or perhaps does the eternal quest for the get-rich-quick-with-little-effort answer continue to inspire the spammers and the flim-flammers? Could it be that the effort to stand alone at the top condemns the interaction on the corporate mountainside to be counterproductive, because individual goal trumps (ha, ha) the collective good?

There are some major warning signs lurking in the information published in the two Philadelphia Inquirer articles (and in a variety of other sources). Without a careful study before the crises erupts, the reactions may be instinctive, limbic, and dangerous. Now is the time to ponder the larger question of which megadollar salaries (executive or otherwise) are a mere symptom.

During the past few years the dire financial situation faced by most of the states has frequently been in the headlines. Attention has focused on two major alleged causes, namely, an increase in mandatory program funding required by federal legislation and a decrease in tax revenue on account of the slowly ending economic downturn.

There is a third cause, and one that is much more difficult to understand, much more difficult to resolve, and much more difficult to explain. But considering it costs the states about seven BILLION dollars a year, it’s worth examining.

Two major sources of state revenue are the income tax and the sales tax. The sales tax is backed up by a use tax. Taxable items purchased in a state are subject to the sales tax, and taxable items purchased elsewhere and brought into the state are subject to the use tax. The purchaser is obligated to pay the use tax, but few do (unless the purchase is a big-ticket registered item such as a vehicle). So states try to get the out-of-state seller to collect the use tax from the purchaser and send it to the state. The Supreme Court, in a case called Quill, has held that a state cannot compel an out-of-state seller to do its collection for it unless the seller has a physical presence in the state. This case is why states are trying all sorts of things to deal with sales made over the Internet by out-of-state sellers. That’s another issue which I’ve blogged previously.

When it comes to the income tax, a state can tax an out-of-state individual or corporation only on income that is properly allocated or apportioned to the state. Generally, this means income from services rendered in the state, income from property used in the state, and income from products sold in the state. The income tax is imposed on gross income minus deductions, and it’s with respect to the deductions that the fun begins. Keep in mind that this is an issue involving corporate income taxes, because there’s no effective way for individuals earning salaries to take this approach.

Suppose a company in State A sells kitchen appliances in State B under a well-known brand name. Suppose that the company has $300,000,000 in sales, pays $100,000,000 to manufacture the appliances, and has $100,000,000 of other expenses such as advertising, sales support, shipping, and similar outlays. Assume that State B has a simple tax rate of 10% on corporate income. So the company’s State B taxable income would be $100,000,000 and it would own $10,000,000 in taxes to State B.

Someone figures out that part of the cost of manufacturing and selling the appliances is exploitation of the brand name, an asset that has value. So the company creates a subsidiary in a state other than State B, puts the brand name asset in it, and has that subsidiary charge the parent company a royalty for use of the brand name. There are, of course, variations on the theme, as the subsidiary could be set up at the outset, or a brother-sister corporation could be used. The point, though is that the State B taxable income is reduced. Suppose the royalty is $50,000,000. The company’s State B taxable income is $50,000,000 and the tax liability is $5,000,000, not $10,000,000. State B has “lost” $5,000,000 of tax revenue.

But, one asks, isn’t the subsidiary taxed? The subsidiary is set up in a state with no income tax, usually Delaware.

This is the sort of tax planning which some tax practitioners love to do, which revenue departments detest, and which boggle the state legislatures. Some states (16 at last count) have taken a “unitary” approach, and treat the income of the subsidiary as part of the income of the company doing business in the state. Other states prohibit deductions for payments to related corporations.

The technique is named the Geoffrey technique, because the first case in which it was considered involved Geoffrey Inc, a subsidiary of Toys R Us and the South Carolina Department of Revenue. The South Carolina Supreme Court upheld the revenue department’s inclusion of Geoffrey’s royalty income in the tax base. The United States Supreme Court has not yet addressed the issue; it declined to grant certiorari in the Geoffrey case.

But many states have not done anything, because their state income tax laws were enacted before the Geoffrey technique took hold. Now, with revenue decreases threatening state programs, more legislatures are examining the problem. Maryland, for example, recently amended its law to follow the South Carolina approach. The Missouri legislature, however, failed to enact legislation because it tried to limit the South Carolina approach to situations in which the subsidiary was created for the primary purpose of avoiding state income tax. As soon as “primary purpose” or “principal purpose” comes into a tax statute, the door is open for subjective debate between the taxpayer and revenue department that leaves too much uncertainty in terms of tax planning on the taxpayer side and revenue estimation on the state or federal side. In Missouri, the concern was that such a limiting phrase would provide a map for companies to continue shifting the income to a state without an income tax.

Before jumping all over Missouri, keep in mind that attempts to deal with the Geoffrey technique have been considered and rejected in at least six other states. Louisiana is litigating with several big companies, in cases involving millions of dollars.

What’s to litigate, given the outcome in Geoffrey? The companies claim that the out-of-state subsidiary has no physical presence in the taxing state and thus Quill blocks the state from doing what South Carolina did. That the South Carolina Supreme Court held for the state doesn’t mean that its decision would have been affirmed by the United States Supreme Court. The states argue that Quill is a sales tax case irrelevant for income tax purposes. The states also argue that when the subsidiary’s brand name or other intangible asset is used in the taxing state that creates the requisite connection for taxation.

There is an easier way to deal with this than finding a way to tax the out-of-state subsidiary. The federal tax law, and many state tax laws, deny deductions for payments to related parties. Treating related party transactions differently is common, not just for deduction denial, but also in terms of capital gain characterization denial, installment sale gain acceleration, and as an element in definitions affecting qualification for credits, deductions, or exclusions.

If the taxing state denies a deduction for payments made to related parties, then in the example, taxable income remains $100,000,000 and the tax obligation remains $10,000,000. So why not just amend the tax law? Why have efforts to deal with this matter failed in so many legislatures?

Certainly, the lobbyists for the corporations who use the Geoffrey technique have been effective. But there’s also a valid argument that payments to related parties ought NOT be denied simply because they are made to related parties. After all, it is a basic principle of taxation that a person is entitled to arrange their business and other entities however they wish, provided that no other law is broken and provided there is no fraud.

Those with a theoretical bent suggest that if every state had an income tax of roughly equal impact there would be less incentive for this sort of planning. That’s very true. It’s that approach that motivates the uniform sales tax project, which, if it reaches full adoption, will make state sales taxes national in effect. Watch the federal government jump on THAT bandwagon. And so it isn’t that far-fetched to predict a similar evolution in terms of the income tax. But with the sales tax effort in its very early states, don’t expect to see much happen in the income tax area for years.

And what about the Supreme Court? After all, IT decided Quill and IT can tell us whether Quill applies to the income tax. Some observers think that the Supreme Court chose not to hear the Geoffrey case (and others subsequently coming along) because it wants Congress to deal with the matter. I agree. With the observation about the Supreme Court. I’m not convinced Congress is the appropriate place to deal with the issue, nor am I convinced that Congress would deal with it sensibly. Letting Congress jump from the mess it makes with the federal income tax to involvement with state income taxes would be as unpleasant as watching Bill Gates jump from insecure, inefficient operating systems into a Microsoft imitation of Google.

What has to happen is a conference of all 50 states at which the matter is discussed, and then resolved through the use of interstate compacts. That has happened with respect to taxation of salaries earned by residents of one state working in another state. It COULD happen here. Will it? Don’t hold your breath.

So, next time you take your son or daughter, grandchild, niece, nephew or friend’s child to Toys R Us, pause for a moment and remember that Geoffrey is more than a giraffe. Don’t try to explain to the youngsters, though. That wouldn’t be very nice at all.

United States District Court Judge Stewart Dalzell issued a decision yesterday that raises the question of how the Religious Freedom Restoration Act (RFRA) impacts IRS attempts to collect taxes. The question, labelled by the judge as an issue of first impression, is best understood after learning the facts and exploring a bit of the relevant law.

The federal income tax applies to all sorts of income, including wages and salaries. During the Second World War, when tax rates were raised, Congress decided that the practice of letting taxpayers wait until their returns were filed before paying the tax had to be replaced. That's when wage withholding began, and it's been with us ever since. Wage withholding requires the employer to withhold federal income taxes, using charts provided by the IRS that estimate the employee's federal taxes based on information provided to the employer by the employee on a W-4 form.

To ensure that employers withhold and pay over the withheld taxes, Congress over the years has enacted various provisions that collectively impose liens on the employer for taxes that are not withheld and taxes that are withheld but not paid. If an employee does not provide a W-4 form or provides an erroneous or fraudulent W-4, the IRS can impose a levy on the employee's wages. The IRS can require the employer to pay that levy. Employers are subject to an array of penalities for failure to withhold, failure to pay over tax, and failure to pay a levy. The levy failure penalty equals 50% of the levy amount.

Priscilla Adams, a Quaker peace activist and an employee of the Philadelphia Yearly Meeting of the Religious Society of Friends, has refused to pay federal income taxes since 1974 because she wants the right to designate that her taxes be used for expenditures other than those supporting or funding war and other activities inconsistent with her peace testimony. So she asked her employer, the Friends Yearly Meeting, to refrain from withholding taxes. Instead, the Meeting withheld some taxes, though not enough to cover her tax liability. It then placed the withheld amounts in a bank account and did not pay them over to the United States Treasury.

The IRS sought payment for taxes owed by Adams for the period 1986 through 1996. Ultimately, Judge Dalzell concluded that the taxes were owed. He simply relied on the position taken by the United States Court of Appeals for the Third Circuit (which hears appeals from Judge Dalzell's district court) in previous litigation, that the "routine administration of the federal income tax system requires uniform assessments and mandatory participation." Adams not only must pay the back taxes but interest and penalties on HER, and so her tax bill of $20,152 became $49,188 as of last December 22. It's still growing.

Because the IRS had previously prevailed in litigation with the Yearly Meeting over the question of its obligation to garnish the wages of employees who fail to pay back taxes, it imposed the 50% penalty on the organization. The IRS took the position that the Meeting was "on notice" that its position was unreasonable.

This is where the First Amendment comes into play. Eleven years ago Congress passed the RFRA as a reaction to a United States Supreme Court decision (Employment Division v. Smith) that neutral, generally applicable laws do not violate the Free Exercise Clause, even if they incidentally burden religious practice. The RFRA provides:

Government shall not substantially burden a person's exercise of religion even if the burden results from a rule of general applicability, except as provided in subsection (b) of this section."

Subsection (b) provides that government action may substantially burden a person's exercise of religion if such action (1) furthers "a compelling governmental interest" and (2) is "the least restrictive means" of furthering that interest. RFRA "applies to all Federal and State law and the implementation of that law, whether statutory or otherwise, and whether adopted before or after [the statute's] effective date."

The Meeting took the position that requiring it to garnish Adams' wages substantially burdened its exericise of religion and thus violated the RFRA. Judge Dalzell agreed that the penalty might violate the RFRA. If the IRS has alternative means of satisfying a taxpayer's delinquent account, and one of those means substantially burdens the First Amendment right to free exercise of religion, ought it not be restricted to the means that does not burden freedom of religion?

Because the text of the opinion is not yet on the Eastern District's web site, it isn't clear where the case is in procedural terms. Suffice it to say that the case isn't over. Surely the IRS will appeal if it cannot collect the penalty. From its perspective, there is a lot at stake.

There is no question that the Quaker peace testimony is a principal tenet of Friends beliefs, and the issue has arisen during every period of military activity in the nation's history. Adams' refusal to pay taxes dates back to the years of the Vietnam Conflict. Similar cases arose during the Civil War, the First World War, the Second World War, and an array of other wars and military engagements, declared or not. Cases have arisen during the current military operations in Afghanistan and Iraq.

Considering that Quakers constitute a very small fraction of the population, and considering that the IRS hasn't been blocked from collecting the taxes (but is being challenged with respect to a penalty), why would there be a lot at stake?

First, if the IRS cannot impose the penalty, it loses leverage in its attempts to get employers to comply with their withholding obligations. Employers fail to withhold, or withhold and fail to pay over taxes, for all sorts of reasons, most nowhere as noble and appealing as Adams' peace testimony. Personally, I have far more sympathy for Adams than I do for someone who fails to pay over withheld taxes because they need to pay gambling debts or purchase illegal substances. I doubt the IRS sees it quite the way I do.

Second, because the employer often is a "deeper pocket" than is the taxpayer who has failed to pay the income taxes, inability to collect the 50% penalty raises in the IRS a concern that other employers will yield to the requests of employees who do not want to have taxes withheld because of other reasons grounded in religious beliefs. There are enough theologies and issues in this nation to make just about every federal expenditure a violation of someone's dogma, creed, or belief system. What happens if the number of people taking Adams' approach grows in numbers to levels that threaten the revenue, as the IRS would put it?

Put these considerations together, add in those protesting taxes for reasons having nothing to do with religion, and one can see why the IRS could be alarmed. Surely, it suggests that this case isn't over.

Aside from this case, though, how does one reconcile the First Amendment with the federal income tax? There is something offensive about requiring a person who opposes war to pay taxes that fund war. Of course, one might respond that the person is paying not for war but for protection. There's a underlying issue that I find difficult to resolve and is demonstrated by this question: "What if every citizen of the United States on December 6, 1941 had been a member of the Religious Society of Friends and held to its peace testimony?" One, of course, could argue that literal interpretations of the foundational documents of many religions, denominations, and sects require a behavior not unlike the Quaker peace testimony. In practice, of course, most people find ways to find interpretations that justify war (such as the oft-debated notion of a "just war") and not a few Quakers have served in the military and then found their way back to meeting.

War and peace are matters of great concern. For a person holding to a peace testimony, the payment of taxes that fund war must surely be painful and more than troubling. It is easy for some to brush aside this concern, in part because there are so few who take the route Adams took and in part because it is not a popular position.

But there are other issues in which those with deeply held theological principles are dismayed by the use to which taxes are put. Those who believe that abortion is theologically wrong can make a similar argument (and be tempted to take a similar tax payment refusal course) if the government to which they owe taxes funds, in one way or another, anything that is considered abortion. (Outside of the realm of taxes, parallel arguments are being made in cases in which religious organizations object to requirements that they fund medical insurance premiums for policies that provide services that violate the organizations' beliefs.)

The list is long: what about those who are theologically oppposed to capital punishment? To the use of electricity? To the use of fossil fuels? To nuclear power? To homosexuality? To the use of alcohol? To the eating of pork? To working on the Sabbath?

The legal analysis is that the income tax law is of general applicability, that there is no tracing of the dollars paid by a taxpayer and thus no connection demonstrating that any of the dollars paid by Adams, for example, actually ended up at the Pentagon. If imposition of the 50% penalty on the Meeting violates RFRA, the obligation of withholding should similarly violate RFRA. The only reason there is withholding on wages is to up the compliance rate, and without withholding the IRS would deal directly with, and only with, the taxpayer who fails to pay taxes.

The political analysis is that Congress won't stand for the impact of withholding repeal. Without withholding, the collection of taxes on wages would fall to match the compliance rates on dividend, interest, and business income. It's low. Because wages constitute a huge chunk of the income that is taxed, a fall in the compliance rate of that order of magnitude would indeed pose serious financial and economic threats to the nation and its economy.

From a wider political perspective, is there a solution in the expansion of the "check a box to fund your favorite program" opportunities that appear on almost every federal and state income tax return? The federal return provides opportunities to fund or not fund the election campaign fund. State returns provide opportunities to rescue wildlife, contribute funds to this or that charity or cause, and to designate amounts for a long litany of purposes. Why not take it to the next step? Putting aside the fact that the list of programs in the federal government would itself be a 500-page booklet attached to the tax return, and putting aside the time and effort needed to cull through the list to find designees, the concern is that unknown but critically important programs could end up with little or no funding and that programs suddenly rendered unpopular through media misinformation would be "de-funded" at inopportune times.

There is something to be said, though, for letting taxpayers communicate directly, rather than indirectly, with lawmakers when it comes to the spending of money. It isn't going to happen.

But perhaps some sort of accommodation can be made for those whose religious beliefs compel them to resist the funding of activities that they consider wrong. To prevent fraud, it would be necessarily, unfortunately, to have some way of knowing that the belief was sincere and not a mere convenience. Moreover, the tax bill would not be reduced, but simply redirected.

As for the employer, it would "clear the conscience" so to speak. Knowing that the employee could direct tax payments away from military uses, for example, would leave the Friends Yearly Meeting with no concern about complying with a wage levy order.

Whether that is the answer is debatable. But this is surely an issue that isn't going to go away anytime soon.

It's imitation time. On Friday I described the tax legislation grinding through the sausage stuffer called Congress. Today Philadelphia City Council got in on the act. It's a split decision. Why? There were two major tax-related actions.

In the first, Council approved its second try at a budget coupled with the tax reductions I've mentioned from time to time. The Mayor opposes what the Council has done. The Mayor has a veto. Council can override mayoral vetoes if 12 or more members vote to override the veto. The mayor vetoed the first budget/tax reduction package passed by the Council and it failed to override his vetoes.

What happens now? First, will the mayor veto the latest Council actions? Probably. Second, if he does, will Council override? Math time. The budget passed Council by a 12-5 vote in favor. But the tax reductions passed by an 11-6 vote, which is not enough to survive a veto.

So it's possible Philadelphia gets a budget with no tax reform and no tax reductions. Guaranteed, by this time next year the revenues will be even lower (as more residents and businesses flee) and expenses surely aren't going to go down on their own. With inflation winking at the economy and energy prices soaring, the cost of funding the same level of activity next year goes UP.

There are long-term thinkers and short-term thinkers in the Council. Here are two quotes. Try to figure out who's who:

Quote number one: "If these [city funded] programs are gutted, it will severely impact the quality of life in this city."

Quote number two: "Jobs will continue to go, and this city will become smaller and poorer, unless we have a stronger private sector to contribute to the taxes."

While that percolates, and Council members opposing the tax reform tax reductions stew about how to fund programs, the very same Council, in Act Two, voted almost unanimously to approve tax breaks for a proposed skyscraper in the city, which would be occupied by Comcast. The same Comcast that hasn't come through on its promises to provide high quality public access cable for the city that it gave when it grabbed the monopoly. (By the way, considering modern technology, why is cable service a monopoly? Is Bill Gates involved?)

Comcast claims that it will add 2,000 new jobs if it gets the tax breaks. Should that promise be rated as bankable as the public access promise? Anyhow, adding jobs should raise the tax base, but the special tax breaks offset those benefits. Why not take the tax breaks for Comcast, and spread them out among ALL taxpayers? Comcast would still get a break, but so too would all the other taxpayers. Is there something unfair about having Comcast share the benefits of a tax reduction? (The Comcast deal must also be approved by the Pennsylvania legislature. Now there's another story on the "blog it someday" list that I have in my head.)

Stay tuned.

If they still teach Civics or Government Process in the middle and high schools of this country, and perhaps they do in some places despite allegations that they don't teach this anywhere anymore, I wonder how they describe the process by which tax (and other) laws are enacted. It's so easy and charming to wrap the description in a presentation populated by elected representatives acting in the best interest of the nation.

It wouldn’t surprise me that if the schools taught the reality, parents and others would complain that the students were being traumatized. Imagine finding out, at a young age, that as I blogged yesterday, money talks and, worse, special interests dominate to the point that the best interest of the nation is cast into the dark shadow of the self-anointed bearers of the tag “special.”

Yesterday the House of Representatives passed its version of the 2004 tax legislation. The Senate has already passed its version. Don’t we teach (when we teach the subject) that revenue bills originate in the House and then are sent to the Senate? Well, that’s the theory. Tack on another reason why I reject teaching theory to the detriment of practice. In practice, revenue bills have originated in the Senate, and have passed Constitutional muster through a variety of procedural zig-zags that make lawyers proud and advocates of following the rules shudder. This time around, despite the strange sequence of passage, there exist two very different versions of the legislation. Accordingly, the House and Senate each appoint representatives to a Conference that will “reconcile” the two bills.

The House bill contains $140 billion in tax cuts, $98 billion in revenue raisers, for a net increase in the federal budget deficit of $34 billion over 10 years. The Senate bill is revenue neutral, that is, the budget deficit is unaffected. So there must be some big differences between the two bills. There are. So many, in fact, that reconciliation will be difficult. It’s one thing to reconcile a bill that reduces a tax rate to 23% with one that reduces it to 25% (does 24% sound right?) or a bill that sets a credit to expire at the end of 2007 with one that sets the credit to expire at the end of 2005. (Figure that one out and you’re ready for a career either as a tax lawyer or a politician.) But what if one bill creates a deduction for the cost of diapers and the other bill creates a deduction for the cost of toilet paper? The end result could be a deduction for neither, a deduction for both, or some typically complex provision permitting deductions for diapers and toilet paper manufactured in factories north of the 75th latitude on days when the temperature at 3 p.m. Eastern Standard Time exceeded 80 degrees Fahrenheit. Wait, that’s too simple. But you get the point.

So why is this Conference going to face tough challenges? Because it is being hijacked. Knowing that the core of the legislation MUST be enacted to prevent increasingly higher duties imposed by the European Union on exported American products, legislators from both sides of the aisle jumped in with this sort of blackmail: “I won’t vote for it unless there is a provision that.....” And the provisions that were included in the legislation are hand-outs to an interesting array of people. Let’s take a look:

* Reduced tax rates for corporations. Let’s see, do you think corporations will use their tax reductions to create more domestic jobs? Or do you think the folks in the executive offices earning $20,000,000 a year will get a nice cost-of-living raise so that they can maintain their lifestyles?

* Tobacco farmers get $10 billion in exchange for a repeal of the federal quota program that has financed tobacco growing. The quota should not have been there in the first place. So now taxpayers must pay to remove it.

* More favorable depreciation deductions for small jets and planes. Why? First of all, depreciation and related expensing deductions are already so favorable that it’s difficult to imagine that they could be made much more favorable. Second, the state of public air and other transportation encourages the purchase of small jets and planes by businesses and individuals who can afford them, so why encourage what already is and will be taking place? Third, what’s so special about small jets and planes? What about small boats? Or small cars? Or small flat-screen televisions? Or diapers? Or toilet paper?

* Aha, it’s more than small airplanes. More favorable depreciation deductions for restaurants. I guess there’s a shortage of restaurants and this will encourage more to open? I don’t get it. The provision is written to preclude carry-out establishments from getting this favorable tax treatment. Is this part of a plot to “make America eat out?” It appears that the fast food places qualify. I don’t get it. Wait, I already said that. But, really, I don’t get it.

* Restoration of the sales tax deduction. I’ve blogged this on several occasions, so I’ll say no more than “watch the 1986 tax reform unravel faster than it took to create it.”

* Letting compensation in the form of most stock options escape social security and unemployment taxation. Excellent. Two people earn $100,000. One is paid in cash, and the other half in cash and half in stock. The first one will pay more taxes than the second. Why?

* Repeal of the basis limitation for player contracts transferred in connection with the sale of a franchise. Let’s guess who benefits from this one. Hmmm. Those bankrupt professional sports clubs?

* Occupational taxes relating to distilled spirits, wine, and beer. I guess with tobacco production getting whacked a substitute is needed? Maybe the alcohol industry is suffering? After all, rumor has it that people have stopped drinking. I don’t get this one, either.

* A temporary waiving of the customs duty on ceiling fans manufactured overseas. Huh? Our exports are being subjected to EU fees and we’re giving up a source of revenue? Will this create jobs at the ceiling fan factory somewhere in the U.S.? Are ceiling fans being kept out of this country because of the customs duty? Is there a run on “foreign” ceiling fans because it’s fashionable to have them? Or is it a matter of “foreign” ceiling fans being of higher quality? Goodness, I wish there had been a $1,000,000 customs duty on those floor tiles I purchased that turned out to be manufactured overseas. Then perhaps that garbage would have been kept out of our country and off the store shelves.

* Reduction of the excise tax on hunting arrows. I’m a tax lawyer, and I wasn’t aware that there was one.

* Repeal of the excise tax on tackle boxes. My students must feel short-changed because they’ve not heard about that one from me, either. Of course, even if I was paying attention to it there wouldn’t have been time to mention it in the classroom.

* Repeal of the excise tax on fish-finding sonar devices. Not only did I not know about this excise tax before this legislation began its crawl through the Congress, I didn’t know that there were such things as fish-finding sonar devices. How about winning lottery ticket prediction devices? Or even mislaid important book finding devices? Well, I do know that my portable phone has a beeper that serves as a “lost portable phone hand unit finding device.” Now if someone could invent a brain finding device......

* Almost two dozen provisions, most of them allowing deductions or credits, will be extended. When originally enacted, they were set to expire so that their negative effect on revenue (and their contribution to the federal deficit) would be limited. I wish I had hired a member of Congress to help me when I was a teenager. If curfew was set at 9 p.m. (yes, I had one that early on the weekends), on the trade-off that it would minimize the negative impact on sleep deprivation and potential unacceptable behavior, I could simply get an extension at 8:55. Better yet, I could get an extension at 10:30 retroactive to 9 p.m. No wonder I would make an unsuccessful politician: if I couldn’t pull off this stunt with my parents, how would I ever pull similar stunts sitting in D.C.? And to top it off, no one has shown that each of these renewed provisions has in fact been a boon to the economy.

Now I turn to a provision that is beyond annoying. The legislation had a provision that repealed the partnership section 754 election (which most partnerships made), making basis adjustments mandatory. This would simplify the tax law (yay!), even to the point of making the Partnership Taxation course a wee bit easier (though it would require an investment of time for me to conform the class notes, problem answers, powerpoint slides, TaxJEM CATLI exercises, etc.). So what did they do to this provision? They leave the section 754 election in place, add a mandatory basis adjustment if there is a basis decrease of more than $250,000 (leaving the details to regulations that will need to be written), and tack on several special rules for basis adjustments. Outcome? Tax law is more complicated, Partnership tax course becomes more difficult, and I still need a huge investment of time, without any worthwhile return in terms of tax law quality.

So that’s why it’s so nice to hear the words of a member of Congress who had the courage to stand up to the blackmailers and hijackers. He called this legislation “an orgy of self-indulgence.” I use another word from the same part of life: legislators are prostituting themselves. A careful link of each provision with its sponsor(s) demonstrates the tie-in to vote acquisition, as described in an article in today’s Philadelphia Inquirer. Yes, those are strong words, but enough is enough. With all the serious and deadly threats facing this nation, with the economy threatening to shift into inflationary mode, with the risk of $100 or more per barrel oil prices, and with the mess that the tax code is, you would think that legislators acting in the best interest of the nation would do what is right rather than what is expedient. The baby-boomer “me generation” mentality is blossoming richly in the world of lobbyist meets legislator.

Notice, for example, that nothing is done to fix the alternative minimum tax trap that will afflict additional tens of millions of taxpayers over the next few years. Oh, wait, they added the vaccine against hepatitis A and the trivalent vaccine against influenza to the list of taxable vaccines. By the way, the tax is generally 75 cents per dose. Can somebody explain this one to me? Goodness, why not just impose a tax on sick people of $2 per day per illness? That might get rid of the budget deficit. Sorry for the sarcasm.

The good news is that knowledgeable observers predict that the Senate will not pass legislation that increases the deficit. But whatever the Conference crafts must get enough votes in each chamber to pass. Supposedly the Democrats supporting the legislation won’t do so without the tobacco farmer payout. Can someone explain why legislation to fix glitches with the taxation of U.S. business abroad to comply with World Trade Organization rulings on our treaties has to be held hostage to tobacco?

So that means legislation with the existing goodies but higher taxes on somebody (guess who?), or legislation with most of the goodies removed, or some combination (probably even more complex). Don’t look for a final vote until the fall (late enough to leave the IRS with 7 days to redo the forms for 2004).

People ask me why I can be so cynical and sarcastic. I’ve shared one reason. Don’t ask for the rest. At least not just yet.

It is said that money is the root of all evil. I disagree. Money simply is a tool. Money can be used to do good, and it can be used to do evil. The desire for money is a desire for the things that money permits a person to have or to do.

People will do almost anything for money. Though one person might rule out some money acquisition plans, others eagerly adopt those plans. Though few individuals would do anything for money, humanity as a group has probably done everything for money that can be done.

Money sends a message. Those with money are in a different position than those who do not have it. The amount of money that a person has tells us nothing about the person: poverty can arise from laziness as easily as it arises from misfortune, and wealth can be acquired through honest labor and through crime.

Many people seem to think that most other people have more money. Many people resent those who have, or appear to have, more money. Some people renounce money, take vows of poverty or their equivalent, and try to live as though money and property mean little. Of course, in the long run, they do mean little. It's the intervening time, though, that gives money a chance to be used for good or evil.

Some folks think that they are entitled to take money at their own whim. It is somewhat easier (though costly in the long run) to rob a bank than to sweat in a factory, coal mine, or construction pit. It also is easier (and again costly in the long run) to take services without paying. And that brings me to the first of today's news items that inspired this monologue about money. The Philadelphia Inquirer reports that the Delaware River Port Authority has caught yet another "toll cheat" allegedly responsible for more than $20,000 in unpaid bridge tolls. This person owns a trucking company whose trucks zoomed through E-ZPass lanes 2,559 times without paying tolls. The truck that was stopped was driven by an employee of the company whose commercial license had been suspended. Wow, doesn't this make us feel so safe and secure?

What's this fellow's mindset (assuming that the allegations are true)? Was it curiosity or a dare to see if it was possible to avoid the toll, that ripened into an addiction? Was it greed? Was it an attempt to avoid financial problems? Was it an attitude of "me first and the rest of the world isn't as important as I am?" My guess is that it is another instance of selfishness and greed, reflecting outlooks on life that are learned somewhere and that somehow escape reformation as a person grows and develops. Under almost every moral code, it simply isn't right.

The second item presents tough questions. Several years ago three McDonalds employees were killed when an emotionally ill driver plowed a car into the restaurant where the employees were working. I'll set aside my questions concerning the state of mental health care in this nation. What's getting attention at the moment is McDonald's refusal to pay a small life insurance benefit to the family of one of the deceased employees. Legally, McDonalds appears to be correct, because the employee had been promoted to manage, was still in the probationary period for that position, and thus did not qualify for the life insurance benefit. But from every other direction, morally, ethically, and even in terms of business common sense, McDonalds is taking a short-sighted position.

Yes, this is about money. The amount involved is so small it probably disappears in the "rounding to the nearest $100,000" that occurs on McDonald's financial statements. If the question is a concern about precedent, the answer is that not very many McDonalds employees die while working during the probationary period.

Part of the problem is what the McDonalds life insurance plan appears to do. Had the employee in question not been promoted, she would not have been in a probationary period and the life insurance would have been paid. But because she was promoted, which suggests she had been doing at least a good job, she is punished because she was pushed back into a probationary state as to the new position. Isn't there a difference between benefits for new employees and benefits for new employees who are promoted to new jobs? Sure, it makes sense to have a probationary period to see if she could handle the new job, but why cause her to forfeit the life insurance benefit that had vested once she finished her initial probationary period? I'm guessing that there was some bad drafting, and perhaps the pending result wasn't what was intended.

Even if McDonalds is perceived as being so focused on money retention (a corollary to money acquisition), the decision not to pay the benefits makes no sense. Making money requires expending money. McDonalds could have stepped up, made the payment, explained that it was doing so it was not under a legal obligation because of technical glitches in the drafting (if that were the case), and picked up some big time goodwill bonus points. Of course, then it could have sued the lawyers who did the drafting, if in fact that is the problem.

Instead, McDonalds faces a boycott, reported by John Grogan in today's Philadelphia Inquirer. Some folks are holding to principles that takes money off the top rung of the nation's ladder. They are speaking the language that corporations speak, namely, profits. Corporations seem unable to speak any other language. Corporations (and limited liability companies) are the ultimate tool of a money-based capitalist society, because they protect the individual wealth of the owners and make investor return the controlling benchmark for decision making. They have their own culture just as they have their own language. It is a culture that fails in many ways.

Here's the "big mosaic" question. If the deceased worker's family is in dire need of the life insurance proceeds, and ultimately fails to get paid, would they be justified in zooming through E-ZPass without paying?

The answer is no.

But that the question exists tells us that much remains to be done in terms of how society, and the nation, and, yes, the world, deals with money, mental health, values, attitudes, and education. It is sad that someone died because another person was unhappy. It is sad that a corporation holds fast to a technicality that makes no sense. It is sad that someone can conclude his trucks ought cross bridges at someone else's expense.

And it is sad that someone decides to participate in a tax evasion plan under which bonus payments were deposited into Swiss bank accounts and not reported to the IRS. The Philadelphia Inquirer also reported today that the employer in question, who had fled to Cuba, was arrested in Berlin. But this post is already long enough, so I'll pass on this story, for now.

I'm not sure now if I should have read the paper this morning. I need to find something to read that reports good deeds and acts of kindness.

The National Law Journal published an article today on Top Law Professors' Star Power. Essentially it is a description of what some law school deans "describe as an ongoing talent raid on academic stars." Examples are presented of law professors lured from one law school to another, generally with inducements other than simply money. Some of the wild rumors are debunked, but it's clear that some very nice perks are being dangled in front of some law professors.

It means that the days of institutional loyalty are fading even in the legal academy. Of course, institutional loyalty generally has been seriously eroded during the past thirty-some years. Professional athletes jump ship, corporations toss out long-time employees, people are known to ditch relationships once they get what they wanted, attorneys move from firm to firm every few years, and consumer brand-name repeat buying has dropped.

Now I’m not pleading for a return to the days of one-institution or one-firm careers, though it would be nice if professional sports teams could cobble together dynasties and be rewarded for good drafting, excellent player development, and superior coaching. Surely there are good reasons to move on, when people do move on, though I don’t think that’s always the case.

At least with respect to law faculty, one of the primary considerations appears to be family issues. Professors who are part of two-person households generally can’t pick up and leave when they want, but also find it necessary to search for a new position if the other member of the duo gets a “too good to refuse” career offer in some other location. Some of the faculty who moved did so when the nest emptied, and the youngest child went off to college. In some instances, the child’s decision to attend school in a particular city made that metropolitan area attractive to the parent. I’m not so sure, though, that I want to follow my children (and with my son in Manchuria for six months where the temperature reaches umpteen below zero I am CONVINCED I do not want to tag along, much as I love the fellow). And there is absolutely no doubt that children do not want their parents dropping by their college dorm room every other day.

The fascinating part of the article isn’t that law professors are beginning to move from school to school with the same frequency as professional athletes change teams or attorney change law firms. It’s that the upper-tier law schools are recruiting law faculty from other institutions. At one time, years ago, most law firms, law schools, and many businesses refrained from tampering. After all, if you did it to someone else, someone might do it to you. Now, of course, other than some anti-tampering rules protecting sports franchises, it’s not uncommon for people to try prying attractive candidates away from their present positions. About the only two places it remains offensive (and I’m not so sure that’s the case) is trying to persuade someone to leave a spouse and trying to persuade the Pope to abandon Catholicism and convert to some other religion.

So where is this heading? Will it be like professional sports, where the top stars make millions and the rest of the roster scrapes by on rookie salaries, veterans’ minimums, and journeyman’s wages? Will it be like corporate America, where the star CEOs pull in tens of millions and the rest of the labor force ekes a living from minimum wages? Will it be like the law firms, where the top partners pull down big bucks, and many of the other lawyers do quite comfortably (financially, that is, for they surely get worked over in terms of hours and stress)?

I fear it is going to go the route of professional sports and corporate America. Already in the undergraduate institutions, schools are cutting costs by shifting teaching loads to adjuncts who do not qualify for most of the non-salary benefits. Many such adjuncts hold four jobs, teaching one course at each of four institutions, racing from one place to another, praying for good weather and no traffic tie-ups, and steaming about the increase in gasoline prices. Colleges and universities are under pressure to reduce the rate of tuition hikes, and if they start shelling out big bucks for the so-called “stars” there will be less for the rest.

I might be sympathetic toward this trend if the incentive was the acquisition of the best teachers. But that’s not what happens. The schools, anxious to better their positions in the rankings game, seek out the “scholars” who write the articles that are read by other scholars. They’re the folks who consider my writings, read by tens of thousands of practitioners, as “not scholarship” because they’re “too focused on doctrine and practice and insufficiently imbued with theory.” Of course, if there were to READ my writings they’d realize they’re wrong, but we can’t let facts get in the way of the logic, can we? Worse, what most educational institutions consider good teaching are performances that minimize student complaints. The irony is that good teaching will increase student complaints because students like to complain, and will complain when pushed and shoved into active rather than passive learning.

I’m not saying that law faculty who need to move for family or other reasons ought not do so. I think THEY should make the first move. And if law schools learn that someone is pondering a move, sure, it should contact the person if its faculty thinks the person would be a valuable addition. But to blanket other law school’s “scholars” with offers and invitations on the “it doesn’t hurt and there’s nothing to lose” justification in the hopes of inching up the ratings ladder is a long-term silliness. In the long-term, those leaving the school will offset the reputation impact of those who depart, and salaries for the upper echelon will skyrocket.

For me, the question is “would this person’s presence on our faculty enhance our mission of preparing people to practice law?” (Yes, I know there are many who see the mission of law schools as preparation of legal theorists to staff the next generation of law faculty, but I beg to differ and I wish law school graduates would share their thoughts on this matter with their alma maters). Yet because teaching (aside from faculty-student ratio and a few other almost meaningless statistics) doesn’t factor as such in the rankings game, it doesn’t get the right attention. (Wouldn’t it be nice if U.S. News asked practicing lawyers to rate the teaching effectiveness of their alma mater after five or more years in the practice world? No, because everyone would claim their school was and is the best. Instead, ask the managing partners to comment on what is brought to the firm by graduates of schools other than the managing partner’s alma mater.) Of particular concern is the “star scholar” who insists on a low teaching load (e.g., no more than 50 students a semester) while others grind through the grading of 300, 400, or even 500 exams a year (aside from all the other tasks that increment as class size increases).

I don’t expect my door to be knocked down (or even knocked) as this phenomenon sweeps the academy. Interestingly, I’ve been invited to seek deanships but perhaps that’s because my tax and business background, my fund-raising experience, my notoriety in the practice world, my immersion in technology, and my enthusiasm for teaching are seen as hallmarks of “deaning” rather than of “starring as a scholar.” Hey, so long as deans are the highest paid members of the faculty (and they are in most law schools), why should that be an issue, hahaha? (Anyhow, good deans are difficult to find and even more difficult to keep... the average tenure of a law school dean is under 2 years, not counting interim deans. Law faculties, they're tough, and university administrations, well, Villanova has had only 5 deans in its 50-year history. That's an average more than 5 times the current national norm. For that alone, Villanova should be in the top 20, he says with a smile.)

Much of the problem reflects the distortions of the LL.B. degree masquerading as a doctorate, of the relatively insignificant size of S.J.D. programs, and of the implantation of doctoral scholarship into what is, for all intents and purposes, a bachelors’ program. But that sequential dysfunction is a topic for another blog posting, and I promise it will be fun (at least for me) and provocative.

Gotta run. Phones’ ringing and it could be a dean at another school asking me if a chauffeured limousine, a private jet, telecommuting from a resort, and release from all faculty committee and administrative work would get me to move. Or perhaps it’s an inquiry into my availability to become dean at a top five law school and straighten out the legal education mess. I’ll let you know. Think I ought to put this blog on my resume? :-)

Though I try to blog on Mondays, Wednesdays, and Fridays at a minimum, there's not going to be much tonight. I've been writing for most of the day, so rather than shift gears and write much more, I figured I'd give my readers an insight into what the other writing involves.

At present I am updating BNA Tax Management Portfolio 560, Income Tax Basis: Overview and Conceptual Aspects. First came the research, much of which is now complete. Because I am updating the portfolio (and not creating it for the first time as was the case in 1997), I must craft ways to find references to events that have taken place since 1997 that affect income tax basis.

Almost everything affects basis. It's the glue that holds the income tax together. Most income inclusions and exclusions, nonrecognition, deductions, and credits have some impact on, or are measured or limited by, basis or one of its variants (such as adjusted basis, recomputed basis, etc.)

Much has changed since 1997 when it comes to research. In 1997 my research was primarily paper oriented. And much of it was done by a student hired by the school to be a research assistant. Now, my research is primarily digital, and I do it myself (principally because I no longer have the luxury of multiple research assistants, who can train their successors, and it takes me less time to do it myself than to bring law students up to speed on tax research).

To find legislative changes, I had to do something other than search the entire Code for the word basis (which I did (myself) in 1996 while working on the feasibility study for the portfolio). So I went to the Thomas Legislative Information site, which is a fine site, identified each act that amended one or more Code provisions, and searched it for the word "basis."

To find regulations changes, I used Lexis, an on-line research source that I've been using (online) since 1976. Yes, 1976. So I'm comfortable with it, have evolved with it, and have nothing against its chief competitor.

To find caselaw changes, I used RIA, the on-line successor to the multi-volume print looseleaf service that I began using while in law school in the mid 70s. I met that looseleaf service while working at an accounting firm during my college days, and when it went online and evolved to a nicely functional service, I told the school to cancel the print subscription. So for those who think that the digital revolution has NOT had a beneficial impact on the environment and office space, I point to the liberation of two full shelves in my office (and to some other space saving changes that prevented me from suffocating in paper).

After doing the research I work my way through the portfolio from start to finish, examining each sentence and each of the almost 3,000 footnotes. I ask myself if there is anything in my research (or in my memory) that would require a change. Then I work through the research results, jumping from place to place in the portfolio to revise the appropriate portions.

That's what I've been doing, and I have some more to do. Then will come some mundane, tedious, and very necessary tasks to check cited authorities to see if they have been affirmed, overruled, reversed, etc. After that, it's time to find articles published since 1997 about basis, to upgrade the Worksheets, update the bibliography, revise (if necessary) the description sheet, and to generate a Table of Contents.

And when this (the last of the tax overview portfolios that are under my care) is finished, there will be some chapters to update for Tax Practice Series, and then it's time to recycle once again through the overview portfolios. Yes, TM 501, Gross Income: Overview and Conceptual Aspects, hasn't been updated since 1998. It seems as though it was yesterday.

And remember: were it not for all this writing I'd be talking. Imagine that.

Sometimes the briefest of comments will not only get my attention but also stir up the distaste that I have for unfairness. Today's Philadelphia Inquirer [need registration to access], carries a story in which David Christensen of Livonia, Michigan, describes why he drove to Washington to pay last respects to President Ronald Reagan. Christensen mentioned "that he once received a D college paper for defending Reagan's view that tax cuts for the wealthy ultimately would benefit Americans at all income levels."

It is appalling to me that a person’s ability would be scored by an educational institution or a member of its faculty on the basis of political, economic, or religious beliefs, unless, of course, the institution was one dedicated to a particular ideology, theory, or theology. The purpose of education is to teach people how to think, not to do the thinking for them. A good teacher knows the difference. Insecure educators, partisans, and narrow-minded zealots do not.

It is easy to believe David Christensen’s story. It happens often, and even once is too often. It happens, if not everywhere, almost everywhere. It happens, so I am told by my students, at the law school where I teach. I believe those students because I have heard one or another colleague make statements totally consistent with the notion that a student should be evaluated in the context of the political, social, or economic theory which they support. Students describe how they learn to write “what the teacher wants to hear” rather than what they would write if they were no so constrained. The result, learning how to cloak the truth and speak for profit, is a lesson that ought not be taught.

Surely a good teacher can ask questions that compel students to defend a position. A student can and should learn how to defend a position with which the student does not agree. In my field, a lawyer who does not believe that capital gains should be taxed at a lower rate than other income surely needs to know how to represent a taxpaying client who has recognized capital gains, or to prepare a tax return on which capital gains are reported and taxed at those low rates.

Thus, the good teacher asks “What are the two best arguments in favor of position x?” or “Which of the following statements would not be consistent with an argument in favor of position y?” A good teacher can ask for a description of the advantages or disadvantages, or both, of position z. The skills that these questions demand a student learn and acquire are of value not only in the law but also in many other disciplines. Though in class I ask students for their opinions on questions as to which there is no right or wrong answer and how they would deal with the matter, I do not put those sorts of questions to them on a graded exercise or exam. For example, I ask them if they think it is a good idea to be an organ donor, to get a sense of their awareness of the issue and to transition to the next question, but I understand that some students might have theological or other objections to organ donation. That sets up asking them how they would put the issue to a client when doing estate planning work for the client, and gets them sensitized to the realities of practice, where clients indeed arrive with a wide variety of perspectives. It would be unconscionable for me to give A grades to organ donors and D grades to those who object.

That is why I think that it is unacceptable to base a grade on a student’s conclusion with respect to a position for which there is no right or wrong answer. In contrast, a professor can evaluate how well a student crafts an argument, the quality of the writing, spelling, and grammar, the scope and quality of the research, the structure and organization of the answer, and the relevance of the issue. Holding a student’s grade hostage to the teacher’s ideology is flat-out wrong.

It’s ironic, isn’t it? Hindsight tells us that David Christensen was correct, and that the instructor was wrong on several points. It’s a bit too late to undo the damage that was caused, though perhaps and hopefully David Christensen got on with his career and found interviewers understanding of how the D on his transcript was a measure of his teacher’s dogmatism rather than Christensen’s ability.

To all those who teach, instruct, and profess: we are stewards. We are guides. We are charged with nurturing and educating those whose minds are entrusted to our care. We must let our students remain persons of reasonable minds so that in life, they can be among those reasonable minds who differ when there is a matter on which reasonable minds can differ. Let us not take that away from them nor punish them for not sharing our view of the world.

An interesting thread on the ABA-TAX listserve gets into a topic that probably interests many more folks than just those who subscribe to the listserve. I think that this would be useful information, even if to use to make a point, for people who aren't tax professionals.

We know that the tax law has become absurdly complicated. We know that tax returns have grown in size for many people. Even those who use tax preparation software and file electronically discover, when they print out their returns, that the amount of paper needed to file a tax return has increased. There are hundreds of IRS forms so surely there will be piles of paper.

The thread started when one subscriber asked for advice concerning the logistics of filing a 500-page federal estate tax return. He described the return as "large" but another subscriber brushed that aside, describing 10,000 to 20,000 page estate tax returns that his firm had prepared, and mentioning 20,000 to 40,000 page partnership tax returns for oil and gas partnerships. One measured three feet in height.

Egads! Of course, someone wanted to know how do you staple a large return. The answer is, you don't. The person describing the gargantuan returns described a process of boxing the return in multiple boxes, labelling them, and going through hoops to make certain the IRS would get the entire return. Others mentioned ACCO fasteners taped down with book binding tape. Makes sense, considering the thing is at least the size of a book. Another suggestion was that an index and cross reference chart be included.

Finally, another subscriber couldn't resist the "here we go with a 'mine's bigger than yours' debate" jab. So, here's an invitation to a contest (no prize awarded other than a moment of fame in my blog): what's the largest tax return (number of pages) ever filed with the Internal Revenue Service? Second category: what's the largest tax return (number of pages) ever filed with a state or local government? [I'm using number of pages because weight will vary according to the paper stock used, and likewise the height could vary a bit depending on paper stock.] Email your entries .... your descriptions, that is, NOT the return, ha ha ha.

And hope that the income tax approach to life doesn't show up at toll booths......

Unquestionably, Ronald Reagan's impact on the tax world was the enactment of the Internal Revenue Code of 1986. Replacing the Internal Revenue Code of 1954, it simplified the tax law by removing a variety of exclusions and deductions in exchange for fewer and lower tax rates. Prof. Mike Waggoner at Colorado Law says, "Many students of taxation consider that act to have been the recent high water mark in the U.S. tax system." I'm among them.

Much of that accomplishment has been trashed during the past decade and a half. Both major political parties share the blame, along with lobbyists who represent individuals, entities and industries that consider themselves special and more worthy than the rest of us, although by the time Congress finishes with the politically correct tax policy of "everything for everybody" we end up with the mess we have today.

The most disappointing aspect of the deterioration of the tax law is that the compromises reached in 1986 are discarded on an inequitable basis. In my description of the effort to restore the sales tax deduction, I point out one example of this problem. If the sales tax deduction is restored, will rates be increased to offset the revenue impact? After all, removal of the sales tax deduction was part of the price paid for lower rates. In all fairness, though, the rates were increased during the 90s without a concomitant restoration of the various deductions and exclusions that had been abandoned. Nonetheless, a legion of other deductions and credits were enacted during the same period. Keeping score isn't easy in the tax game.

Reagan's tax legacy was tarnished long before he reached his grave. No matter how many things are named after him, the trashing of the tax code will remain as a reminder of what once was, replaced by something that cannot, under any circumstance, be called an improvement. The best memorial to Reagan, and the best gift to all citizens, would be for Congress to fix the tax code. Don't hold your breath.