MauledAgain

A discussion on the taxprof listserve has been underway for a few days, giving participants an opportunity to opine on the advantages, disadvantages, likelihood, and wisdom of replacing or supplementing the income tax with a value added tax (VAT). The discussion was triggered by reports that if the President is re-elected the Treasury will seek to abolish the IRS and replace the income tax with a VAT (or some similar sort of consumption or sales tax).

There are people who prefer that the income tax (or perhaps its alternative minimum tax alter ego) be retained with respect to higher income taxpayers (whoever they may be), and that the enactment of a VAT be coupled with elimination of the income tax for lower income individuals. Of course, unless something is changed with respect to employment taxes, lower income wage earners will continue to bear a disproportionate tax burden.

What troubles me about such arrangements is what I call the “renege effect.” Two examples come to mind.

The first was the “deal” reached in 1986 with respect to the federal income tax. Rates were lowered in exchange for surrender of some exclusions and deductions. What happened? The exclusions and deductions having been surrendered, the rates were increased, both directly and through the sneaky phase-out mechanism. And Congress wonders why on trust surveys it ranks so low. Simple. Congress cannot be trusted.

The second is the so-called reform of local taxation in Pennsylvania, enacted in an attempt to deal with public school financing issues. I’ll leave aside the concern that the question addressed revenue sources rather than the tougher issue of why so little is produced relative to how much is funneled to the schools, as evidenced by the fact that some under-funded non-public schools often out-perform the public schools. Some other day perhaps I’ll discuss why money cannot purchase discipline and values.

The situation in Pennsylvania is a classic case of the bamboozle used to such great advantage by Barnum. Yes, folks, it is a circus.

Ostensibly, the reform addresses the major concern that the use of the property tax by school districts imposes a burden on individuals (mostly retirees) whose income does not increase as quickly as the values of their homes and the property tax rate increases. Combined, these phenomena put a lot of pressure on these people.

So the reform was sold as follows: school districts would cut property taxes, and in exchange would be permitted to enact or increase local income taxes. But what was enacted is much more complex and puts taxpayers at risk of another renege effect. And even if what was enacted was what was described, it surely would put the squeeze on people who rent. Most renters fall into two categories: lower-income people unable to afford homes, and retirees who choose to surrender the joys and agonies of maintaining a home. Isn’t there some sort of counter-productivity in this?

No, not if one realizes, as one does after an analysis, that this entire “trade-off in taxes” is nothing more than a disguised tax increase. Some clever people snookered some not so clever people. And, as usual, the citizenry, misled and uninformed, gets the short end of the stick.

Point 1. The law gives local governments and school districts the option to enact an earned income tax OR an all-inclusive income tax that exempts pensions and the first $13,000 of interest and dividends from the tax. Why isn’t the first $13,000 of earned income also exempt? Anyhow, because of prior law restrictions, the existing local income taxes are of the earned income tax variety. That means that wage earners bear the burden and millionaires living off investment income go tax-free. Can we guess who supported and caused this sort of tax policy to infect Pennsylvania? Surely not the labor unions. It will be interesting to see how many localities go for the more equitable almost-all-inclusive income tax. One legislator predicts that the almost-all-inclusive income tax will carry the day because it raises more revenue. He could be right. But he could be underestimating the power of the folks that limited local income taxes to earned income taxes in the first place.

Point 2. Pennsylvania residents who work in Delaware and New York face another squeeze. These people are permitted to claim a credit against Pennsylvania STATE income tax for income taxes paid to Delaware or New York. Because income taxes in those states are higher than the Pennsylvania income tax, the effect is to reduce the Pennsylvania income tax burden of these workers to zero, even though they end up paying more state and local income taxes than had they worked in Pennsylvania. The reason there’s no problem with other states is that the other states, such as New Jersey, Ohio, and West Virginia, have entered into reciprocity agreements with Pennsylvania. Under these agreements, those states agree NOT to tax Pennsylvania residents working there and Pennsylvania agrees NOT to tax residents of those states working in Pennsylvania. My guess is that New York and Delaware have concluded they’re better off in terms of revenue by declining Pennsylvania’s reciprocity offer.

Here’s the problem: these people will NOT be permitted to claim as a credit against the new local income tax the income taxes paid to other states and localities in other states. Why not? Because the school districts lobbied for the omission of a credit. If a credit is provided, the worker pays tax to the other state and not to the school district. School district officials think it is a “good thing” because they reject the idea of Pennsylvania residents working in another state paying for the education of students in that other state rather than Pennsylvania students.

Well, let’s consider this. When the Pennsylvania resident works in another state, he or she imposes a burden on that other state, in terms of highway use, police and fire protection, emergency health care, etc. That other state needs educated people to work in those industries. So it makes sense to impose a tax on the Pennsylvania resident working there.

What about the Pennsylvania side? The Pennsylvania resident also imposes a burden on the locality in which she or he lives. But is it as much of a burden as it would be if the resident worked in Pennsylvania? No. In fact, if the Pennsylvania tax were high enough, the credit would reduce but not eliminate it. So the problem is with the structure of the Pennsylvania tax, not the providing of a credit.

The same situation exists when Pennsylvania residents (such as those working in New York) pay sales tax to other states rather than to Pennsylvania because they are eating lunch and doing shopping while in the other state. (Note that Delaware does not have a sales tax, so the analysis with respect to that particular state is different but doesn’t change the basic point.)

The answer, of course, is a user fee. It can be set at one level for residents who work in other states and at a higher level for residents who work in the state. Residents whose income is not from wages would pay the higher level user fee. This would reflect the burden that is imposed on the Pennsylvania locality by the various categories of residents. Of course, this isn’t going to happen, not when the localities have been admitted to the regressive income tax feeding trough.

Point 3. Within Pennsylvania, a similar problem exists with respect to people who live outside Philadelphia and who work in Philadelphia. Philadelphia’s wage tax is set at two levels, a higher one for Philadelphia residents and a lower one for Philadelphia non-residents, an interesting model for the multi-tier user fee I proposed. The non-resident wage tax is sufficiently high that the credit for it that is allowed against the home locality’s earned income tax totally wipes out income tax liability to the home locality. Under the new legislation, a locality that enacts either type of local income tax will be reimbursed by the state for the revenue it loses on account of the credit.

Where does the state get the money for the reimbursement? From taxpayers, of course, although it isn’t clear in terms of the accounting whether the money comes from specific tax sources or from the general fund. No matter, why can’t this be done for Pennsylvania residents working in New York or Delaware? The answer, of course, is that the Philadelphia politician-lobbyists extracted this deal as part of the legislative process.

Point 4. Guaranteed, within ten years, the new local income taxes will exist. And property taxes will return to, or exceed, what they are now. Oh, I know the enacted law has provisions designed to prevent this outcome, but the Pennsylvania legislature cannot be expected to hold to this arrangement any more than the Congress held to the 1986 income tax legislation arrangement. Legislators dealing with taxes are very much like sugar-addicted folks walking past the bakery or donut shop. They just cannot help themselves.

None of the localities can enact the new income taxes until the proposal goes before a referendum of local voters. The referendum must be held before November 2007. The timing is good. After the 2004 national election, the spinmeisters can turn their attention to writing ads for and against the many proposals that are certain to pop up. Separating truth from fiction will be no easier, and considering the subject will be taxation, probably will be even more difficult.

In a Philadelphia Inquirer article, a person who lives in Pennsylvania and works in Delaware stated, “I think a lot of people will be surprised to find out that the impact will be different from what they expect, and many people will wind up payingmore.” I think MOST people will end up paying more. It ALWAYS works out that way. And the people paying less? Guess.

While I was away one of the ABA-TAX listserv subscribers posted a question asking if there were any studies on the impact of a child getting a chunk of money from a trust when the child attains age 18 or 21. It’s a good question, though I think it’s just as interesting and necessary to understand the impact when the money is received at age 25, 30, or thereafter.

In my Decedents’ Estates and Trusts class I point out to the students that although the client makes the decisions with respect to how a trust will be structured, the attorney has an important role in helping the client learn the options. There are, of course, all sorts of trust wealth disposition plans, many involving the discretion of a trustee. I’ve noticed that the once-typical “one-third at age 25, one-half the balance at age 30, and the balance at age 35" plan morphs as the trust settlor ages. The 25-30-35 plan that seemed appropriate becomes 30-35-40 and even 35-40-45. I suppose as clients get older, the qualities that they want their children to have, or think that their children should have, to manage money are less likely to exist at age 25.

I’ve seen very few trusts that drop bundles of wealth on 18-year-olds or 21-year-olds. Of course, discretionary education spending by a trustee can be quite a bundle of wealth, but that’s not the sort of thing the subscriber was considering.

The subscriber posted a follow-up that was news to me. Some of the laws providing for Indian gaming also provide that members of the tribe receive money from the proceeds of the gaming enterprises. One law, for example, requires that each member of the tribe receive $9,000 a month. If the recipient is under age 18, the money goes into an account that is turned over to the child when he or she attains age 18. That’s $1,944,000 plus interest. There are all sorts of questions (and the subscriber posted some) that can be asked about the impact of teenagers finding themselves with $2 million or more.

Another subscriber made the point that a similar set of issues can arise when a person wins a lottery. He noted that lives are changed, “but not always for the better.” How true. His anecdotal account fuels the stereotype that most people, when finding themselves with more money than what they’ve been accustomed to receiving, go on spending sprees, splurge, and have little or nothing after a short period of time.

Yet another subscriber provided a link to the Gallo Institute, which offers seminars and workshops dealing with the psychology of money and issues surrounding family wealth. A lawyer-psychotherapist team established the Institute, and it seems they are providing a service that surely would be of value not only to the folks making the decisions about family wealth, but the lawyers and other professionals advising them.

For those who are advising the trust settlors, it is important to remember that in most cases that person knows more about their intended beneficiaries than do the advisors. Sometimes, though, there is more to the situation than meets the eye or is apparent from an interview with the trust settlor. With the settlor’s permission, it makes sense to get a better picture by talking with others or having someone with credentials or programs such as those of the Gallo Institute to become involved. After all, the notion of team advising, with lawyers, accountants, financial planners, and appraisers working together to help the client, suggests that adding a financial psychologist makes a lot of sense.

Let’s face it. Some people at age 18 are very ready to handle money responsibly. I know one college student whose nickname is the “old man” and for a reason. And all of us know people in their 20s, 30s, and 40s who cannot handle money. I’m not talking about checkbook balancing. I’m talking about responsible decision-making, budgeting, saving, and establishing financial priorities.

Most 18-year-olds have some roads to travel before they are at the point where the trust settlor is willing to drop 1/3 of the trust principal into their laps. Once upon a time it probably happened by age 25 for most people, because life demanded that people grow up. In the post-modern world (or whatever it’s called), there are many children who are pampered and coddled, protected and sheltered, to the point where they don’t acquire financial maturity by age 25. That’s probably why I see more and more “30-35-40" and “35-40-45" plans (as well as a few 30-35-40-45 plans).

Sometimes the principal disbursements can be put into the hands of the trustee with the use of discretionary clauses. That, however, invites litigation, and if not done properly, can generate tax problems. And surely, considering all the talents that a trustee needs to have, judging the character of a beneficiary is at least as important as the ability to juggle investments. Trustees who can make the judgments to distribute income under a discretionary clause can make the judgments to distribute principal under discretionary clauses.

None of that, of course, deals with the listserv subscriber’s question. The law providing for full distribution at age 18 trumps any planning that the 18-year-olds parents or legal guardians might wish to put into place. Unfortunately, it will take a few years of financial catastrophes before the legislature that enacted the law even begins to think about amending it. After all, if a legislature can conclude that 18-year-olds cannot purchase or use alcohol (even though some 18-year-olds might demonstrate moderation when it comes to alcohol), it surely can make a similar decision with respect to the acquisition of significant amounts of money. Then again, if an 18-year-old can purchase a lottery ticket and win millions, why should 18-year-olds receiving money from gaming enterprises be subjected to greater constraints? Is it simply a matter of numbers, that there are only a few 18-year-old lottery winners but significant numbers of 18-year-olds receiving gaming enterprise money?

Well, now I’m simply posing even more questions so I’ll leave it at that. I don’t profess to have “the answer.” I’m not sure if there is “the” answer. But there’s a lot to think about, and I’m not so sure that the legislatures did much thinking on this one. I’m not sure that they do much thinking on much else, either.

First, a brief note as to the absence of a posting since Wednesday. I went to New Hampshire, invited by a fifth cousin twice removed with whom I’ve corresponded for the past two decades but whom I had not met. She and her husband had moved there, from California, a while ago, and decided to have a reunion of their branch of the family, most of whom are in California.

It was a wonderful gathering and I had a great time. I’m amazed at how much this group of Maules resemble my more immediate family and cousins. And, of course, personality and other traits were so similar that when someone asked me if I was having a good time I honestly replied that I felt as though I were at a gathering of my cousins.

So sometimes the blog takes second seat. Or even third.

I will note, though, that the roads I used for the trip varied in quality in direct proportion to the funding systems used to maintain them. My vote for highway most in need of redesign (even though it is in fairly decent shape) is I-84 as it goes through Hartford. It is impossible to stay in one lane if traveling through. A bypass or ring road is in order.

And a suggestion to the Pennsylvania Turnpike Commission and the folks running the toll booth on I-78 at the Pennsylvania-New Jersey border: Take a page from the folks who set up the E-Z Pass bypass lanes at the Tappan Zee Bridge. Sitting in backed up traffic trying to get to the E-Z Pass lanes makes no sense when most of that traffic consists of vehicles not using E-Z Pass. Once I “broke through” the 3/8-mile jams, the E-Z Pass booths were almost empty. My guess is that for every vehicle with E-Z Pass there were 100 or 150 without it. C’mon, folks, get E-Z Pass: it’s in use in more and more places, there’s a wee bit of discount on the tolls, there’s no need to fumble for cash tolls, and once the Tappan Zee plan is in place there’s no need to waste time (and gasoline) cooling one’s heels in the backup. In fact, there would be no backup.

Oh, by the way, Turnpike Commission: put up signs indicating where the E-Z Pass lanes are so that the vehicles with E-Z Pass can get into position long before they get into the thickest jams in front of the cash toll booths. Easily done and worth the effort.

Though the news about the huge Microsoft dividend appeared several weeks ago while I was away, there’s still time, I hope, to share some observations that I haven’t seen in any of the material that passed through my email, listservs, and news subscriptions. Microsoft’s announcement of a $32 billion dividend, the largest ever, got attention.

Some folks focused on the inevitability of a huge dividend from a corporation that had accumulated huge amounts of cash. Others pointed out that the dividend creates an incentive for foreign owners of Microsoft stock to sell their stock, to avoid a 30% withholding tax on dividends paid to residents of countries other than those that have tax treaties with the U.S. providing for a lower rate (usually 15%).

The announcement also brought speculation about the impact of the presidential campaign. If John Kerry is elected and manages to abolish the special low tax rate for dividend income (something that is far from certain even if he does win), corporate officers and directors that waited until 2005 to cause increased dividend payouts to be made will face adverse shareholder reaction.

No one has said much about the accumulated earnings tax. Generally treated as meaningless by most commentators because almost every corporation can get into the “accumulated to meet the reasonable needs of the business” exception, it surely must come into play under these circumstances. Though it is possible that Microsoft has figured out ways to make its taxable income less than its cash flow, it surely has not reduced it to the point where there are no or little accumulated earnings in the company. Now, the declaration of this dividend is PROOF that the accumulation were not for the reasonable needs of the business because Microsoft is saying, in effect, that the business didn’t need the earnings. It will be interesting to see if the IRS picks up on this (especially if no one there reads this blog). Perhaps it will be more successful than was the Department of Justice.

Accumulated earnings taxes aside, the Microsoft dividend, and its taxation at low rates, highlights some of the failings of present-day corporate business culture. Let’s try this scenario:

A company invents an operating system unlike anything ever seen. It is almost perfect. It rarely crashes. It is secure against hacking, worms, and other intrusions. It is fast. It is easy to use. The company advertises this operating system, users speak of it highly, sales skyrocket, and the industry begins to suggest that the company branch into applications software. The company brings its expertise to bear on word processing, databases, spreadsheets, email, networking, and a long list of other applications. The programs are a hit. Competitors simply cannot deliver similar quality. Company revenues soar. The applications and the operating system are sold for a fair amount representing value. The company eventually pays out a huge dividend to its shareholders, who are taxed at low rates. After all, the company’s products energized the economy.

If that were the story, perhaps there would be some sympathy for the temporary stashing of cash in the company as it pondered other areas of technology in which it could make a similar high quality contribution, making talk of an accumulated earnings tax a bit silly. And if that were the story, perhaps there would be an array of arguments advanced to support the idea of taxing dividends at rates lower than other income.

Of course, that is not the story. Even if it were, we know that no one, back in the 80s, would have banked on dividends being taxed at absurdly low rates in the 2000s. Not only could no one have counted on such a thing, it would have been risky even to predict it other than as something in the “anything can happen” category of items ignored as silly.

No, the story goes as follows. A company takes an existing operating system and rushes it to market in order to get an advantage over another enterprise also fashioning a new operating system from the existing operating system. The company’s operating system is a kludge. It crashes incessantly. It is insecure. Later versions, spawned almost yearly if one counts service pack upgrades as new versions, add all sorts of needless complexity while opening up even more security holes. The systems are slow, and users complain. Attempts by users or other businesses to bring other operating systems to market are met with obstructions, some legal and some on or past the borderline. Manufacturers are arm-twisted into accepting the operating system because the company knows most end users lack the ability to replace it. Free copies are given to schools in the same manner as the soft drink sugar merchants put discounted vending machines in the school, both having learned lessons from the guy down the street from the school just past the “Drug-Free Zone Starts Here” sign. The company, bored with fixing the operating system, jumps into developing applications to compete with any other venture that manages to bring out something useful. The perfect word processing program is pushed aside with a lesser-quality pale imitation that is filled with security holes, a mind-boggling concept. Someone invents a great web browser and a campaign to drive it into oblivion succeeds even though the replacement is buggy and needs upgrade and revision almost every month. Someone else develops instant messaging and the company is on their backs the minute it seems there is money to be made. Others develop web search engine technology that works marvelously and the company announces it’s going into that area as well. In the meantime, its latest operating system, rid of some of the earlier flaws, generously advances new defects that defy explanation and that are passed off by the company as the fault of the users or others. As the money flows in from what clearly is a compelled monopoly, the efforts of the federal government and most of the state governments to bring the company into compliance with antitrust laws is thwarted.

Now, awash in cash from having shoved its less than adequate products into most of the nation’s homes and businesses, and a good portion of those elsewhere in the world, the company decides to funnel a huge amount of the cash to its shareholders. Yes, that’s us, if we own Microsoft stock (I don’t) or are in retirement plans that own the stock. But is that what we really want?

There are two things that Microsoft SHOULD do with its cash. Both rest on the principle that until a job is finished, and finished correctly, the anticipated profits ought not be spent.

First, all users of Microsoft products should be compensated for the time, distress, and lost profits caused by the numerous crashes, virus and other invasions, sluggish performance, and other damage generated by the flaws in Microsoft products over the years. I’m picking on Microsoft because it is awash in cash that reflects the burdens and costs it surreptitiously shifted to the consumer. Other companies do the same thing but they’re not awash in cash because if they didn’t shift costs to the consumers in terms of bad products, poor service, incompetent help line employees and other failings, they’d be out of business. Microsoft, it will claim, simply learned the lesson taught by the developers who made and make money building projects that leave infrastructure burdens in the form of traffic, congestion, demand for fire and police services and other costs on the taxpayers of the region. With all the economists in this country, you’d think somehow they’d get the point across that hidden and shifted costs ought to be taken into account. More, in a moment, on how.

Second, Microsoft should take this cash, for which it appears to have no use, and plow it into a total and complete redesign of its operating system. Microsoft claims it doesn’t do that because it would cost too much. Well, guess what? Microsoft has the wherewithal to pay those costs.

Before getting to the how, one more facet of this prism needs examination. Bill Gates announced that his $3 billion dividend (subject to $600 million less tax than it would have been in the absence of the “dividends are really special” low tax rate) will be contributed to the Bill and Melinda Gates Foundation, which already is the largest charitable foundation in the world. Sounds nice? Well, let’s face it. When foundations give money, they can attach conditions. Foundations CONTROL the use of their money. So while we hear about elections and voting, we don’t hear much about how corporations and their foundations are shaping policy and decisions while the Congress wanders aimlessly searching for ways to deal with the EU tax crisis, homeland security, intelligence oversight and many other serious issues.

The tax law, of course, exempts the foundations from tax if they jump through certain hoops. A tax-free institution, therefore, has even more economic muscle when it’s not Alex’s Lemonade Stand trying to eke by on the generosity of individuals, but is simply an extension of someone who has a lot of wealth acquired not through the free marketplace rewarding high quality products but gathered through intimidation, questionable business practices, and corporate behavior still being investigated by some brave state attorneys general.

The tax law has failed us. Not only has it prompted Microsoft to move its profits into charitable foundations and to shareholders taxed at rates more appropriate for the working poor, it has also failed to penalize Microsoft for having accumulated these profits in the manner in which it did. It also lacks any mechanism to reward quality and tax that which hurts society. If there can be taxes on environmental polluters, why not taxes on technological destroyers? Why not a system that records every Microsoft operating system crash, every security hole opportunity used by a hacker, and every productivity slow-down caused by bad programming, followed by a user fee imposed on Microsoft for the outrage of high priced products that deliver far less reliability than the $29 genealogy program or $19 html editor (which, by the way, is far superior to the junk churned out converting a Word document to html)?

Here’s why not. The typical person does not understand computers and think crashes are as normal as are automobile accidents (even though both are preventable and need not be accepted as unavoidable). Most people know little or nothing about programming, and thus are in no position to judge the defenses raised by those whose programming falls short because the dollar is considered more important than any other value. Most people know little or nothing about the tax law, how it affects dividend payment decisions, or how it is used to regulate (or not regulate) charitable foundations. So they don't know what to demand of their elected representatives (who themselves struggle to understand what's really going on), and thus suffer because "that's the way it is" and "what are you going to do?"

I have a nephew who is a certified Microsoft network engineer. He defends Microsoft with the same vigor with which I criticize it. He argues that Microsoft is doing a better job than anyone else. I respond that no one else is given much of a chance to do the job, and when they do find a niche and make it successful, Microsoft moves in quickly and rapaciously. Our debates could be endless, except that we’ve given up trying to change each others’ minds. I am resigned to the notion that someday Microsoft will pay yet another huge dividend, say, $50 billion, because it has accumulated yet another hoard of cash, from selling and monopolizing the sale not only of operating systems, word processing applications, networking software, email clients, and internet searches, but also robotics software, music downloads, cable television services, cell phone services, computer hardware, homeland security software, defense department databases, RFIDs, highway toll collection systems, GPS navigation services, and just about every other digital product or service on the market. Considering the extent to which technology has penetrated and will dictate even more decisions in education, health care, safety, entertainment, transportation, and manufacturing, it may be time to start collecting corporate logos for the collectors’ items they are bound to become.

And I will always wonder what the world would have been like had Microsoft waited to market its products until the products were essentially as fault-free as intensive cardiac care software systems. I wonder what would have been the impact on society, politics, and life had the increased productivity, the hack-free databases, the increased speed in delivery of goods and services, and the other benefits that should come from paying top dollar for software, been delivered. At least a $32 billion dividend would have been seen in the same light as a similar payout to the folks who cured cancer or developed an earthquake preclusion system.

Forgive the tardiness of this update, but I've been digging through some emails and other items that "accumulated" while I was away. In early July I had shared my thoughts about the IRS proposal to extend the telephone tax to VOIP (Voice Over Internet Phone) calls, and the subsequent introduction of legislation on the topic .

Late in July I received a copy of a letter sent to the President by Rep. Christopher Cox, urging him to direct the IRS "immediately to affirm that this 100-year-old tax does not apply to the Internet, but only to traditional voice analog services." Rep. Cox argues that if restricting the tax in this manner causes revenue to drop (I suppose, because over time fewer calls will be made via analog devices), then a 100-year overdue ending of the tax in question would be "very good news."

Rep. Cox makes some very good arguments against the telephone tax in question. It is regressive, it imposes a higher tax burden on phone calls than on any other activity except alcohol and tobacco, and it compounds state and local telephone taxes.

All user fees tend to be regressive. The cost of most products and services, such as food and automobiles also are regressive. That's one extreme of the tax spectrum. The other is "from each according to his or her means, to each according to his or her needs." The latter, which also is found in some theologies and in other ideologies, works well if the folks involved are honest, industrious, and caring. In other words, it doesn't work very well in the real world. What works best is a system of user fees coupled with an income transfer program (such as an income, estate, or wealth transfer tax) that provides for those who are unable to cope with the cost of life (including user fees, food, medical care, housing, etc.)

The problem I have with Rep. Cox' position (at least as he sets it forth in the letter to the President) is that he saves his best efforts for finding an "Internet is special" approach rather than a tackling of the issue on two more basic points. First, as I pointed out in one of the earlier posts, SHOULD there be a tax (or user fee) on communications? Second, if so, on what aspect of communication? Clearly, taxing words raises First Amendment concerns (and would bankrupt me, ha ha). To the extent society (through government) is providing something of value to communication, then a tax or user fee is in order. If that something of value can be demonstrated, then the tax or user fee ought to be applied to all that receives value, whether it is on the Internet or not, whether it is voice or data, whether it is in color or black and white. There probably is some government benefit to communication, whether it is defense of facilities against attack, regulation of the bandwidth to prevent confusion and communication chaos, the launching of communications satellites, etc. My point is that singling out analog phone calls is just as bad as singling out analog and VOIP calls.

While in England I was reminded that the U.K. imposes a fee for the privilege of owning a television (and learned that it is waived for persons who reach retirement age). That fee rests on the long-eroded practice of government providing television content (and so when we are tempted to think that it's bad, yes, it could be worse, except that the BBC did, and does, produce some programs of exceptional quality that ought to make the "we know all about who should be President" folks in Hollywood re-think the reasons that their brains churn out so much low-grade junk for the networks (which, of course, watch their ratings plummet)). So perhaps there could be a fee imposed on the original purchase of a communication device of any sort, with the proceeds invested in repaying government (i.e., we taxpayers) for the costs of communications facilities, protection of those facilities, etc.

My proposal goes beyond the simplistic (though artful) attempt to render the telephone tax obsolete by letting its subject go extinct while protecting its successors from the reach of the tax. (It is, after all, artful, to denounce a regressive telephone tax while the Congress continues to make the income tax more regressive!) My proposal involves a down-to-the-ground examination of the relationship between communication and society (government) and the crafting of a user fee system that does not disfavor any sort of telephone usage to the benefit of other communications devices.

I mute my criticism of Rep. Cox (much of whose efforts in support of the development of the Internet and the fending off of government interference I respect) because all I have, of course, is his letter to the President. It might be a bit much to ask Rep. Cox to get too technical, precise, or detailed when writing to the White House (no matter who resides there). Perhaps all Rep. Cox was doing was trying to buy some time by holding off the IRS until Congress can do something. If that's the plan, he needs to ask for a HUGE amount of time, considering the molasses into which the Congress has sunk on its recent tax legislation efforts.

Well, users of the Pennsylvania Turnpike, according to this article, tolls are going to increase by as much as 43% on Sunday.

This news came as a shock and more than an annoyance to some users. Business travellers aren't necessarily reimbursed by their employers, especially if they are on a monthly allowance. One person was quoted as figuring a typical increase was 5%, "like everything else in life."

The turnpike has not raised tolls since 1991. That's 13 years ago. At 5% per year, compounded annually, we're looking at 70%. So 43% isn't that bad of a deal. It's roughly 3% annually.

What happens to the projected $1.1 billion increase in toll revenue? All of it will be spent on a $3.4 billion construction plan. The list of projects can make a driver smile (and will benefit the environment and the economy by easing fuel-consuming and air-polluting traffic tie-ups, bring traffic trying to get to I-95 off the local roads, and save lives by improving road safety): widening the turnpike between Valley Forge and Norristown, widening the Northeast Extension between the East-West turnpike and Lansdale (something that I proposed doing in the mid 80s to the usual responses of "never" and laughter), and then widening it from Valley Forge to Downingtown. The much needed interchange between the turnpike and I-95 will be constructed. Toll plazas will be rebuilt and slip ramps will be added in several places.

The best responses came from those who are willing to pay for better roads. That makes sense. Better roads are desired, and necessary. They cost money. The users are the logical sources of that money.

As readers of this blog know, I am a fan of user fees. User fees come as shocks to folks who grow up thinking money grows on trees, that there is such a thing as a free lunch, and that resources are infinite. I would like to see more user fees that cause people to think, "Well, if doing this (whatever it might be) costs $x then perhaps I will re-think my intention to do this." In other words, let's unhide the hidden costs.

Happy motoring.

Beau Baez, a member of the law faculty at Liberty University, shared with me some thoughts about the outsourcing of legal research services to India. Specifically, though agreeing with my points and expressing concern about outsourcing in general, he wrote:

...lawyers in India are trained in the common law tradition and they speak English. While I don't see Big Law turning to outsourcing I can imagine many solo practitioners and small firms doing so. At aminimum I can envision a competent attorney using this kind of servicefor getting a first draft- is that really any different from what a partner does when he asks a first year associate to prepare a draft? Over time these Indian lawyers - where there is a huge glut of attorneys - will become experts in American law. I suppose that a person could be trained in India via theInternet. For four years I worked for Concord Law School, the nation's first Internet based law school. At $8,000 a year an Indian could be fully trained in U.S. law without ever leaving India (there are a numberof foreign nationals in the school right now from countries all over the world who don't have to deal with U.S. travel restrictions) and theywould have the basic skills to conduct legal research from India forAmerican law firms.

I share my reply:

You make several good points. . . . . The key consideration is "Over time these Indian lawyers -- will become experts in American law." If it's at the expense of beginner's workproduct, the issue is whether the solo practitioner or small firm can do the mentoring that the traditional first year associate gets. There's something about having the associate in a position for a face to face meeting. And if the solo is going to do that via teleconferencing, the time investment makes the outsourcing far less attractive economically. I do think, though, that the idea of training lawyers via the Internet may have an impact on what I'd call "globalized international law"....eventually, just as the existence of 50 different state laws led to the Uniform Laws movement (with varying degrees of success), so, too, a similar phenomenon could occur internationally. But I'm not so certain that it will be driven by outsourcing or outsourcing alone. I suppose the researcher in India isn't practicing law? Else there'd be all sorts of practice of law issues. Yet the first year associate must pass at least one bar exam. That provides a screening level in addition to that provided by the law school. (Nothing against Concord or any other school, but the existence of bar exams does tend to set a standard for curricular design and for weeding out students who got through on"mercy"....)

Beau then replied:

I certainly am not promoting the use of overseas outsourcing but I recognize that it may occur. In part, our state unauthorized practice of law ("UPL") rules are to blame. The UPL rules use a
physical presence standard thus a person overseas would not run afoul of them. As long as we insist on 50 distinct state bars the physical presence rules will remain because the standard is very easy to administer, and attorneys do not want to be subject to another state's disciplinary system when they provide multistate advice. A unified national bar would solve our internal problems and possibly the outsourcing possibility. However, I am not an advocate of a unified
national bar.

There are indeed some serious issues here. It is unlikely that the Indian researchers are practicing law. If the lawyer meets his or her professional responsibility requirements in the matter, he or she will be doing far more than what would be done if an associate down the hall were doing the research. Will the outsourcing tempt the lawyer to perform the same sort of review as if the work were being done in the same office? Who's at risk? Ultimately, the client. Though I dislike regulation, state disciplinary boards may find it prudent to address this question before it becomes (as have so many other practices nurtured by the Internet and its technology) a fait accompli. Perhaps bar associations can take the lead and thus steer the debate? Would it be more efficient to have a national bar rather than 50 state bars? Maybe. But addressing that issue is not an absolute prerequisite to dealing with the problems generated by the outsourcing of legal research and analysis tasks.

While I was away a friend and colleague forwarded an email that he had received from an outsourcing company in India, offering to do legal research and information. The company claims to produce high quality, low cost work, with excellent delivery schedules. On the side, I think they do atomic fusion, too.

Sorry about the sarcasm, but despite the company's guarantee of highest quality and accuracy available anywher, I just don't follow the logic. I'll skip over the claim of highest quality because I don't have time to pit my research skills, the research skills of people I know, and the research skills of the best lawyer-librarians with the employees of this company.

But I do want to share why I have more than just a few doubts. Doing research, in terms of gathering information, isn't very difficult. Of course, compiling legal information (not unlike what uninitiated law students think law school teachers) doesn't do much most of the time for most clients.

What matters is analysis. And it is in the analysis that a researcher finds the clues to develop the second and third layer of research. It's the reason that those teaching "legal research" in law schools end up teaching a fair bit of legal analysis.

Now, to do American law research and legal analysis, one needs to be educated in American law. Oh, a few Einsteins might teach it to themselves, but they won't be hiring themselves out to a company that is going to make the money from their efforts.

So who has that education? People who have graduated from American law schools. Now, will those graduates ship themselves off to India to work for "low cost" wages so that the owners of the company can gather profits on their efforts? NO!! They will ship themselves off to law firms that will pay them commensurate with their education and accomplishments (though perhaps not as much as the graduates would like to receive), and though their employer law firm will gather profits on their efforts, those law firms will provide guidance, mentoring, and client experience (even if not as intensely as in years past) that will refine the research and analytical skills of these newly hired attorneys.

Could it be that this company is sending its Indian employees to American law schools to learn American legal research and analysis to bring back to the company? I doubt it. The company would need to shell out at least $120,000 per employee (which makes "low cost" a bit more difficult to achieve). And once someone comes to America, as much as it is held in disdain by so many of the world's people, they tend to want to stay. Why? BECAUSE INCOME IS HIGHER, the quality of life is better, and opportunity abounds far beyond the confines of a partitioned cubicle grinding through the compilation of legal information.

I was tempted to waste a few dollars and send along an "interesting" American income tax question. But once I re-read the advertisement email, and noticed that legal research and information is one of "a number of services" that are provided, I decided to use the few dollars for something more fun than playing tax research and analysis games. After all, that happens every semester in the normal course of teaching.

All of that aside, I can't imagine a legal professional putting the fate of a client in the hands of an unknown, unseen, and unmet researcher thousands of miles away, who lacks American legal education, who lacks access to the state and local materials that are the more difficult even for domestic researchers to find, and who surely have a minimal command of the necessary language. Oh, I know that professionals in other fields are doing this, but will it make sense for the lawyer who is representing the patient, client, customer, or associate who is harmed by the use of off-shore resources to be exposed as doing the very thing of which the plaintiff is critical?

No, it would not.

Nor does it make sense to pay someone else to do one's thinking. That's what gets politicians in trouble. And we know that lawyers don't want to come across in the same light as do politicians. Ha.

Though I tried to keep the blog current while I sailed across the Atlantic, toured Europe and sailed home, it wasn't the easiest thing to do. Even though it is 2004, Internet access isn't easy in the small towns of Europe (other than through expensive and slow old-style dial-up modem). And on the ocean, even with newer satellites covering most of the world, the ship charged as much as $30 per hour for access.

I kept a list of the topics on which I want to discourse. I'll start with one very soon and allocate the others across the next week or two.

Oh, while I was away the Philadelphia area was drenched, literally, with rain. On one day 12 inches fell on parts of New Jersey. Dams broke. A lot of people lost a lot. And then a tornado hit. And in Europe? It rained far more than usual, and has been raining. It has been colder. Several pictures comparing 2003 (remember the heat wave) and 2004 were striking, especially one of the beaches in southern England. Jammed in 2003, they were populated by a few brave souls bundled up in December clothing. It had warmed up a bit by mid-July. So where was the sun and fair weather? In the middle of the ocean. On a sea that was like a pond for much of the time. I suppose a few folks will cry, "Oh that is so different from last year, the world is ending, the glaciers are melting, the sky is falling" but the experts tell us that some decades ago there were summers just like this one. Weather: what goes around comes around. Literally.

The Democrats are trying to make tax simplification a highlight of their campaign promises. This is an amusing thought, but it’s also frightening because there are people who will believe it.

The Democrats, after all, were the pioneers in modern tax hypercomplexity. Beginning with Kennedy’s investment tax credit and magnified by a huge array of other credits, deductions, and exclusions, the tax law was made even more complicated through the enactment of phaseouts, scalebacks, and other hidden tax increases.

Not to be outdone, it didn’t take the Republicans long to get on the special interest complexity tax train. Absurd capital gain rate structures, a new cluster of credits, and all other sorts of finely
tailored specially-directed provisions were crammed into an already bloated code. To use an analog from an astrophysics lecture I attended yesterday, the tax universe is expanding at a constant rate and is moving toward increasing disorder. Just like the cosmos.

John Kerry’s tax proposals are inconsistent with the notion of tax simplification, so it will be interesting to see how the Democrats reconcile the party’s “tax simplification” message and Kerry’s proposals. To be fair, Kerry cannot be blamed for all of the tax complexity in the Code or even all of the complexity bestowed on us by the Democrats in Congress. He isn’t even to blame for some of the stuff enacted while he was in the Congress.

Nonetheless, why is Kerry willing to make his proposals within the confines of a Republican tax design? The tax on dividends is a fine example. The Republicans create complexity by making most dividends (a selection process that is itself complex) subject to lower tax rates essentially the same as the bizarre rate structure applicable to capital gains. As readers of my blog and listserv posts know, this is an approach wholly inconsistent with fairness, implification, and common sense. Kerry proposes to eliminate this rate twist by restricting it to taxpayers with incomes under $200,000. This creates yet another layer of complexity onto the already complex dividend taxation structure.

I’d be far more impressed if Kerry took the following position: “Look, folks, dividends are just one form of income. A person with a lot of income, no matter its source, ought to pay tax at a higher rate than someone with much less income. A person with interest income from certificates of deposit is no less entitled to a low rate than is a person with dividend income. In other words, the basic tax rate structures ought to reflect this principle, and favoritism of one sort of income over another is wrong, no matter the income level. To tax a retired person who has no pension and lives on social security and $30,000 of dividend income at a lower rate than her neighbor who has no pension income and lives on social security and $30,000 of interest income is flat out wrong and contrary to all principles of fairness.”

What stops Kerry (or his advisors) from tackling this head on? Surely it has something to do with trying to make everyone think he or she is better off under Kerry’s proposals (which in fact is not the case). In an election campaign directed pretty much at the 10% of the voters who are “swing votes” where’s the advantage in Kerry’s existing proposals? It doesn’t make much sense politically. So I’m wondering if in fact the Kerry tax advisors don’t quite know how to cut the Gordian knot of taxation.

So as far as I’m concerned, with the exception of a few individual members of Congress whose voices of common sense are drowned out in a sea of special interest tax pandering, both major parties and both major Presidential candidates don’t earn any points on the tax uestion.

So no matter who wins, the tax law will become even more disordered. Will it end as the astrophysicists predict the cosmos will “end”? Will the system collapse of its own weight, becoming a black hole that swallows all? Does anyone other than a few “tax mavens” even
understand the seriousness of the problem?

Right now, I’m going to go back to looking in 360 degrees at two shades of blue. I’ll let my brain process tax stuff later.

The UK government is considering a proposal to impose a road congestion fee, and this has generated all sorts of opposition. The concept is that every vehicle would be equipped with a GPS system that tracked road usage (miles, location). The car (not the driver, apparently) would be subject to a fee based on usage. I’m not certain if an adjustment is made to “reward” owners of vehicles that are fuel efficient, use alternative fuels, etc. And I’m sure the “I’m special, I don’t pay the fee” queue will form shortly.

Privacy advocates are all in a furor. Imagine, the government knowing where you are, where you drive, and when you go. Of course, there are speed cameras all over the place (including streets
where the only impact of speeding would be the impact into the vehicle stopped in front of the speeder waiting for the traffic to move).

Those who detest government involvement in citizens’ lives, or who want it to be minimized, also oppose the concept of a road fee. The “reduce tax” crowd, of course, is opposed, even though a user fee is no more a tax than is the charge for admission to the theater. Use it, pay for it.

The UK does have a problem. Even in the countryside traffic volume is up. I’ve visited the UK six times during the past eight years, and even in that short span of time I notice a difference (not
only in traffic but in manners, culture and attitude). As trucking replaced much of railroad shipping in the US, lorries are now all over UK roads, including those narrow, twisty one-laners that can require one vehicle to back up (and it’s not the lorry that backs up).

Traffic volume is up for the same reasons as in the US: more drivers, more trips, higher miles per trip. Public transportation in the outlying regions is a bit more available than in the US, but it’s
an inconvenient and expensive way to get around. Passenger rail has had its problems (just as in the US).

The government plans to use the billions raised by the fee to improve roads. And, yes, they need it. Their national “A” roads at times look like American back roads, and the “B” roads are often
paved over donkey tracks. Don’t even ask about the “unclassified” roads.

I’m a fan of user fees. Whether the GPS system is the best, or toll charging (as in the American east) should be considered, deserves debate. But if the days of free roads, like free lunches, are
going to end, then the person who eats more should pay more.

COMING ATTRACTIONS: I will be sharing my reactions to a tax-related TV spot I saw the other night. Stay tuned.

Tax is complicated. But it's not the most complicated thing.

Friends who have studied nuclear physics claim tax is more complicated. Einstein said something to that effect, too. Puts my friends in good company.

Yesterday I watched a cricket match, and my cousin (many times removed) explained the basics and some of the more advanced rules. Baseball it isn't (though some of the terminology is the same).

Whoever invented cricket died, and then reincarnated as the inventor of income tax.

Perhaps if I begin the basic tax class with a cricket rules lesson, the students will be thrilled to ease up with a study of the Internal Revenue Code, its regulations, and all the law associated with it.

The good news: I'm not going to try explaining it here. At least not yet.

Well, the Department of Revenue of New Hampshire, after proposing a 7% tax on internet (browser, chat, etc) and other communications, has backed off in deference to a legislative study on the matter.

Well, let's salute the N.H. Department of Revenue for recognizing its initial bad call. At least there was a willingness to appreciate that taxes are a matter for the legislature to initiate.

Of course, the notion that the legislature might decide to impose a tax suggests that legislators still don't quite get it. Oh, of course, they do, to the extent that they see cash cows. But a tax ought to represent either a charge for a government service or a redistribution of wealth. What service does the government providein this instance? The actual costs are incurred by the ISPs and other communication enterprises, which pay taxes, and which pass costs and taxes on to their customers. As for wealth redistribution, a 7% tax hits the poor as much as the rich (or more, in fact, as it is regressive). At a time when 21st century communication ought to be encouraged, and brought into the homes of poor and not so poor alike, the application of a 19th century revenue approach is just plain disappointing.

That's all for now.

About the time that I was posting Wednesday's item about taxation of internet phone calls, two members of Congress introduced legislation extending (or perhaps affirming) the application of the taxes on analog phone calls to VOIP phone calls. VOIP is voice over internet protocol... fancy words for "phone calls over the internet."

The proposed legislation deals with more than just taxes, and I'll leave that to others more expert to describe and critique. I don't have a link for the legislation because my Internet access is time limited at the moment, and I haven't had the opportunity to dig it up.

That's all for now....

The IRS has invited comments on the applicability of the section 4251 excise tax to telephone calls made with technology more recent than what existed when Congress enacted section 4251. In its notice, the IRS describes a way of analyzing the statute that suggests it is preparing to rule that the excise tax applies to Internet phone calls.

There are three major questions:

1. Does section 4251 apply? Solid statutory analysis suggests that it does.

2. Assuming that telephone calls should be taxes, Internet telphone calls be taxed? Of course. The fact that a call is made over the Internet rather than through wires, cables, radio waves, or some other medium ought not matter if the tax is intended to tax communications made by voice transmission, as defined.

3. Should voice transmissions made by phone, as defined, be taxed? From my user-fee approach, the answer is, yes, to the extent that telephone calls, however made, impose a burden or cost that should be borne by the user. Does Internet telephony impose a burden? Yes, it consumes bandwidth.

Arguably, if question 3 is answered in the affirmative, the next question is why not, then, tax text transmissions, audio or video imbedded in text, and other forms of communication?

Does text messaging (e.g., email) impose the same level of burden? Perhaps. Perhaps not. A delay in the receipt of email can be inconvenient, but email moves as the bandwidth allows. Voice and real-time video streaming need priority access to the bandwidth, and if the technology being employed acquires that priority, it bumps other transmissions (e.g., text) down in priority. Perhaps an analog to first-class and third-class postal mail would be helpful.

Well, my views are my views, and so what? What matters are the view of others. If this issue matters, take the IRS up on its offer and comment. That, however, may not be as important as also contacting Congress. After all, IT, and NOT the IRS, enacted the statute in question and IT, not the IRS, can revoke it, and amend it. The IRS is stuck with what's there now, as are we, and can only do its best in trying to interpret a provision that Congress ought to revisit, and clarify one way or another.

If you're a regular reader, you've probably noticed that I usually post on Monday, Wednesday, and Friday, with an occasional fourth or fifth weekly post tossed in. Today is a Sunday, and I posted. What's up? Well, life over the next three and a half weeks will be such that my posting will be erratic. The posts may even be shorter.

Don't go away. Keep checking, and just be thankful I'm not planning any summer reruns in the style of network television. Remauledagain or Mauledyetagain is just too scary.

Racinos?

Early on the morning of Independence Day, the Pennsylvania legislature struck a blow for freedom. Or so it would like to think. The early morning thing was the result of a deadline, but it too easily appears to be an imitation of the Phillies’ 16-inning game that ended early on Saturday morning. Let’s not make this a habit. And let’s hope that the legislature’s move turns out to be the winner it claims it is, unlike the yet one more extra-inning loss that the Orioles pinned on the Phils.

What did the legislature do? It legalized slot machine gambling in Pennsylvania. The stated goal is the generation of billions of dollars of revenue that would be used to reduce property taxes and encourage economic development.

To be fair, it was a majority of the legislature that approved the legislation. Specifically, 113 of the House’s 201 members and 30 of the Senate’s 50 members voted in favor of the gambling. The tax bill passed the Senate by 50-0. I haven’t researched it, but I don’t think 50-0 votes are common in the Pennsylvania Senate.

The supporters of legalized slot machine gambling also claim that its adoption will create jobs and revive the horse-racing industry. Hmm. I thought Smarty Jones had taken care of the downturn at the tracks.

See, the parlors at the race tracks that will have slot machines are called “racinos.” That’s a new word for me. The crossword puzzle designers are probably thrilled that they can use an R or a C in figuring out the intersecting word!

So what will these racinos really do? Estimates are that property taxes will be reduced by several hundred dollars a year. That sounds nice, except that most folks’ property taxes are in the thousands and tens of thousands of dollars a year. Early on, proponents were touting the legalization of gambling as a way to cut property taxes in half. And, property tax relief cannot be funneled to a locality unless that local government agrees not to raise taxes by more than an annual wage-and-employment index unless they obtain approval of their voters.

The legislature rejected an amendment to the legislation that would have prohibited legislators from owning interests in gambling enterprises. Instead, they are restricted to 1 percent interests. Considering how tightly New Jersey regulates gaming, it’s a wonder that Pennsylvania isn’t learning from its next-door neighbor. Perhaps they weren’t on speaking terms, since it’s likely that Pennsylvania racinos will siphon some business away from Atlantic City.

So where will the gambling revenues go if not for the substantial property tax relief that was promised? About $1 billion heads for economic development. Another portion will be used to improve education for young children. $750 million will be used to decrease the Philadelphia wage tax, starting in 2007, if certain slot revenue levels are attained. Another $636 million will be used to pay for the expansion of the Convention Center in Philadelphia, the one that is losing business every day because the union rules compel would-be exhibitors to go elsewhere. Expanding the Convention Center under these circumstances is like enlarging stores that sell 8-track tapes. But, hey, there’s money so let’s spend it.

Where will these racinos be? After all, if they create jobs, it will be in the areas near the new gambling parlors. Two will be in downtown Philadelphia. Next to City Hall, perhaps? I can’t wait for the zoning questions that will pop up when the neon signs are proposed.

Three other slot parlors are permitted, one designated for Pittsburgh, and two that aren’t designated. The Philadelphia Inquirer story suggests that the other two may end up near the Poconos or Allentown. The racinos will be at seven horse-racing tracks. And two small gambling halls are destined for Western Pennsylvania.

The big question, though, is whether slot gambling in Pennsylvania will raise the projected revenue. After all, almost everyone who starts a business expects to do well, but there are no guarantees in life other than, yep, death and taxes.

Is there room in the market for more slot machines, considering that casinos are nearby not only in New Jersey but Connecticut and several other northeastern states? Every time I see a new state lottery enacted or a new game added to an existing lottery I think that the gambling market is saturated. Ha ha, I learned on my cross-country driving adventure last summer that gambling is everywhere, and there don’t seem to be enough opportunities. It seemed that there was a slot machine at every rest stop, restaurant, and store once I got west of the Mississippi. Then I arrived in Las Vegas. In the middle of summer the slot machines were running full bore, with people trying to operate two or three at a time. I don’t want to digress, but it’s the fastest growing city in the country. Hmmmm. Then again, there’s far more going on in Las Vegas than gambling. Oh, and there are casinos on the cruise ships, and don’t get stampeded when the ship crosses into international waters and the tables open!

The Pennsylvania legislation permits 61,000 slot machines. Spread over 14 locations, but with 2 having only 500 each, that’s an average of 5,000 machines per racino or parlor. FIVE THOUSAND. But that’s small compared to the Vegas floors. It’s going to be educational, watching what some consider an “evil” taking root in Pennsylvania. What’s left to legalize? Ah, I should shut my mouth.

There is, though, one aspect of slots that is an improvement on the lottery. The lottery has a very few huge winners, and a handful of moderate winners. Slot machines seem to give better odds for smaller jackpots. Personally, I’d rather have a 20% chance at winning $1,000 than a .00002% chance of winning $10,000,000 (even though the arithmetic tells me that both have the same statistical probability value). But what do I know? I rarely gamble. I’m better at guessing the number of jelly beans in a jar (which I did as a child and I won, though I never figured out how to build a career on that skill other than being a crowd counter, which didn’t interest me).

The irony is that the slot revenue is a temporary fix on spiraling school taxes. Unless slot revenue grows at the rate that local school district expenditures grow, all that has happened is a postponement of the reality: we are paying a lot for public education, and as a graduate school and post-graduate educator, I’m not convinced we’re getting our money’s worth. All we need now are the teacher unions asking for bigger salary hikes since, “after all, there’s all that gambling revenue available.” I predict that property owners won’t see much in the way of property tax decreases. I’ll try to remember to share some thoughts about the underlying problems that cause the big property tax hikes seen in recent years.

The history of the attempt to legalize gambling beyond the state lottery (which came into existence in 1972) would make for an interesting cable channel documentary. People have proposed video poker in bars (people are less inhibited when drinking, so the revenue on those things would be huge, right?), floating casinos, keno, dog racing, blackjack and roulette tables, and legalized sports gambling (talk about the big bucks.... people bet on whether there will be a left-handed pinch hitter in the sixth inning.... but.... people bet on everything. Life, they say, is one big gamble, so why not profit from it?)

But nothing happened. Sometimes it was a governor who considered gambling to pose too many moral questions. After all, there still are many Pennsylvania residents who think the lottery siphons money from those least able to afford such discretionary spending. Another governor wanted a statewide referendum, but for some reason that didn’t get approved. Weird. It is a democracy, isn’t it? And last summer, a gambling proposal was defeated. So this is big news in Pennsylvania.

The politics behind the passage of this legislation will consume half of the documentary time. Take a look at the Philadelphia Inquirer story for the details. I just had lunch and don’t want to spoil my dinner appetite. It’s a typical special interests bill, with deals for airports and gaming lands, and a candid reference by the bill’s chief sponsor (of whom I am a total non-fan) to the making of sausage. Suffice it to say that gambling companies have contributed close to $6 million to political campaigns in the state since 2000. Gambling and elections? Why not? Maybe a coin toss in Florida, simplified gambling that it is, would be better than what was being used four years ago.

EUREKA: I have it. Let’s hook slot machines and video poker to electronic voting. How appropriate, no?

Happy Independence Day. After all, there are a lot of places where gambling (with money) is illegal, though ironically life in most of those places is a much bigger gamble. We are blessed, folks, even if we do goof more than we’d like.

An update on a story to which I've given quite a bit of attention on this blog:

Mayor Street of Philadelphia agreed to the budget and the provision reducing the Philadelphia wage tax.

The planned decreases in the business privilege tax did not make it. So.... we'll check in on the statistics a year or so from now and see what impact this had.

No news of note on the Keystone Opportunity Zone tax break for Comcast and some other taxpayers with offices in that dreadful area in need of the sort of rehabilitation encouraged by Keystone Opportunity Zone tax breaks (center city Philadelphia).

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.