MauledAgain

My commentary on the failure of Congress to deal with partnership basis adjustments by making them mandatory rather than adding two more layers of complexity to the existing morass generated a lively discussion among tax law professors. They raised some concerns worth consideration, as they shed some light on the sorry state into which American tax law has sunk. Note my questions that are in bold.

One participant suggested that because basis adjustments can be burdensome, it is a "nice compromise" to limit mandatory adjustments to instance where failure to make the adjustment provides an opportunity to duplicate or assign losses, pointing out that "theory is oftentimes sacrificed for good administrative reasons."

I replied that the existence of section 732(d) (giving the partner the right to elect to make adjustments even if the partnership did not do so, although only with respect to distributions)made partnership avoidance of its own election worthless, because section 732(d) requires the partnership to go back in time to when it could have made its own election and then redo computations from that point up until the time that the partner makes his or her 732(d0 election. Thus, it is more burdensome to wait for section 732(d), and this is what causes most partnerships formed with professional advice to have agreements specifying that section 754 will be elected. Those not electing fall into two groups, those unaware that they're not really saving themselves from burden, and those who want to play the system. Thus, I argue, a mandatory election is not only theoretically correct, it would simplify the administration of subchapter K and reduce the burden of compliance.

I was then asked how does the 732(d) election allow a partner to "force" the partnership to do what it sought to avoid. It was argued that 732(d) puts the burden on the individual partner, not the partnership. Presumably, the argument continues, the buying partner would have calculated the basis adjustment before making the purchase, as part of evaluating the deal.

I replied as follows: The section 732(d) election requires the same computation as would be made under section 743(b). Partnership law and partnership agreements give the partners access rights to partnership books and records. Thus, the partnership, at the very least, the partnership is burdened by having to permit that access. In addition, the application of the adjustments requires the partnership to provide the information that would have been different had the adjustments been in effect. Depreciation is one significant example of an adjustment that has this spillover effect. As I noted, it is the "threat" of the section 732(d) election that contributes heavily to the decision by most partnerships (and almost all counselled by a tax advisor) to put into the agreement a requirement that section 754 be elected the first taxable year in which an event occurs that makes the election available. The "threat" simply is the unilateral nature of section 732(d) and the obligation of the partnership to generate the information that it, the partnership,
must report on its return and on the Schedules K-1.

Continuing, I explained: If the buying partner has the opportunity to access the information before the deal settles, it is more likely that the buying partner will seek partnership agreement to make the section 754 election as a condition of the deal going through. If the transfer is by reason of death, there is no examination by the estate prior to the transaction, so the estate isn't in the situation you describe. That may be the reason that the proposed legislation making the election mandatory had an "out" for death transfers (while, at the same time, repealing 732(d) for all partners, including estates that opted out of an otherwise mandatory section 743(b)). As a practical matter, one way or another most partnerships will end up having to do the computations. (Whether a partnership can charge to the partner electing 732(d) the cost of doing the computations is an interesting question, but I've never seen it done.).

In response, it was suggested that there was no point in lobbying for the exceptions that apply to investment and securitization partnerships. These partnerships rarely make the election, so if section 732(d) was forcing them to do the computations, what's the benefit of the exception and why lobby for it?

I replied: Investment and securitization partnerships benefit from avoiding the election when there are losses. So they don't want the mandatory rule. These partnerships are a small portion of total partnerships. Rather than asking for an exception to an overall mandatory rule, they convinced Congress to create a limited mandatory rule and then obtained exceptions to it, giving the impression that they weren't getting as big a break as it would otherwise appear. In other words, "it's a break from a little thing" isn't quite as offensive to those who want equitable taxation as "it's a break to a rule that applies in all other instances." I suspect that these partnerships require investors to waive their section 732(d) rights, or arrange transactions so that there are no property distributions that would trigger section 732(d). Is that so?

Another reader jumped in and agreed that it would be simpler and cleaner to make the adjustments mandatory. He expressed doubt about the impact of section 732(d). He also informed me that the proposed optins regulations would have made section 754 elections, and thus the adjustments, mandatory. He asked if the legislation will cause the IRS to rethink the proposed regulations and guessed not. My question, raised here for the first time, is this: Can the IRS make mandatory something that the Congress permits taxpayers to choose or ignore?

Another participant suggested that the basis adjustments were not desired by those who acquire partnership interests through discount purchases, such as those that arise when there are aggressive valuation discounts in family partnerships. I suppose, though, that the problems for these partnerships will start with the valuation egg and not the basis adjustment chicken. And the previous reader questioned if such a purchaser should even have the option of ignoring the adjustments.

The first respondent then explained that he would prefer the mandatory adjustment, but didn't agree with my position that the legislative solution is inappropriate. The complexity of the exceptions are a problem, he proposes, for those who qualify for the exception, and since they lobbied for it, it's their burden. He did, however, note that it makes the Code heavier for those who carry it around. Responding to another participant's comment, he noted that clean and simple can be just as bad as messy and complex. He then pointed out an issue not raised in my blog commentary, namely, that the selection of $250,000 without any finding connecting that amount to the scope of the administrative burden creates a distortion, perpetuates complexity, and appears to be the product of lobbying. He's right. I did not focus on that question, and he's right, it does have the flaws he points out. What is so bad about $251,000 that isn't so bad about $249,000? To me, of course, it's further "proof" that a clean and simple mandatory adjustment rule would provide far fewer opportunities for distortion, complexity, and favoritism.

I pointed out that the computations were more of a burden in the past, before computer software made the computations much less of a burden (other than the information retrieval issue). I know that the big accounting firms have proprietary software, so, again, it's the unadvised tiny partnerships that get into the mess of computation burden just as they might fail to make the election because of the lack of guidance.

Another professor asked how many "unadvised tiny partnerships" or even "minimally advised small partnerships" or "basically advised medium-sized partnerships" actually deal with this or any of the other complex stuff in subchapter K? 754, 734(b), 743(b), or, indeed, 751 or 755. He then posed this marvelous challenge: "If you have an idea what percentage of your law school's graduates can explain how section 751 works, take a guess as to how the percentages run in accounting programs, and then figure out who is likely to advise any but the largest partnerships and partners, my guess is that an overwhelming majority of sales of partnership interests are recorded as pure capital transactions, with no adjustments to partnership bases. (I'm not even asking whether section 752 was applied correctly to get the right amount of gain or loss.) It will be interesting to see how a mandatory section 754 election is applied in practice." He noted that figuring out compliance rates is challenging, but that anecdote suggests it is not high. I agree, and I've had the same anecdotal experience. As he pointed out, it's not bad faith but inability to understand very complicated rules that affect many people because many people are in partnerships. Almost all multimember LLCs, recall, are partnerships for this purpose.

One of the previous participants noted he had also had the same anecdotal experience. He then related his own experiences with a partnership that just didn't get the allocations right.

I then shared one of my favorite "teaching Partnership Taxation" stories that illustrates how out-of-control the tax system has become. Tonight I taught section 751. About seven years ago, as we worked through section 751 (in the LL.M. (Taxation) Partnership Tax course), a woman raised her hand and asked if I was sure that there was ordinary income. I replied I was as sure as ever, why was she asking? She replied that she had been doing partnership interest sales in her firm for 5 or 6 years (I cannot remember whether it was 5 or 6) and that no one had EVER done section 751. The following week she returned to tell me her partners were so interested that several were going to enroll in the program (I don't know if they did). I've had similar experiences at CLEs. I noted that even on the ABA-TAX list there is a lot of misinterpretation and lack of knowledge about partnership taxation, and sometimes even resistance to the rules when they get explained (usually by yours truly) as in "that just can't be because I've never done it that way." OK. :-) People who can rumble through subchapter K are in demand.

To which yet another tax law professor said, "And that's just 751(a). With 751(b), it's probably worse." Oh, how true. To which someone else replied that the consensus among many tax practitioners is that absolutely no one pays attention to sec. 751(b) even if they know about it. To me, that is scary, and very indicative of a tax system beginning to melt down. I inquired if the situation as "sort of like speed limits? Until there is an accident......." and pointed out that "The difference is that whereas most highway patrol officers understand speed limits there are very few IRS auditors and agents who understand subchapter K."

One of the participants noted he, too, had always "wondered when the tax system would implode from all of the complexity." Rumors that subchapter K compliance is a mirage seem to be true for section 751(b) as well. He commented "If this keeps up,  the only persons who will care about understanding subchapter K will be the professors who have to teach it!" I doubt it would be the first time something taught in a law school found no home in the practice world. The difference, though, is that subchapter K is not the creation of the academic world but a law enacted and imposed by the Congress. Yet it could become as respected as speed limit laws (which I've never seen or heard discussed or analyzed in law school, even though I've heard stories of engineers representing themselves and getting out of tickets by proving the worthlessness of certain radar and other speed measurement devices, causing me to think that every lawyer should have at least one engineer friend).

One of the participants then suggested that other than sales of interests, most partnerships comply with subchapter K without really trying to do so. He noted that partnerships that don't set up special allocations and keep everything proportional don't have compliance problems. He asked why partners would make disproportionate distributions (which is what triggers 751(b)). The complexity, he noted, is directed toward tax shelter partnerships. He asserted that subchapter K is "pretty recent" and that this suggests things worked well for some period of time without it.

Yet another participant noted that none of us has actual data, but that proportionate distributions on liquidation are rare. Another person made the same point. Where IS the data on subchapter K compliance? Anyone know?

I then contributed this analysis of why all partnerships get caught up in the complexity: I think it's correct that small partnerships in which each partner contributes cash, has an equal or proportionate interest, takes draws and distributions in accordance with those interests, etc, doesn't have much of a problem complying with subchapter K. I've long proposed two subchapter Ks... one for tax shelter partnerships (as already defined) and one for all others.

Yet, even the small partnership has these issues, at least one of which is likely to be the case:

1. Contribution of property (704(c))

2. Liabilities with guarantees or other shifting (752)

3. Death of a partner or sale in the middle of a year (706(d))

4. Liquidation of an interest (need to draft for and comply with 736)

5. Close down when not all assets can be distributed proportionately, so one partner takes more of the inventory/receivables and less of other stuff, and other partners take less of the inventory/receivables (sec 751(b)) Disproportionate distributions are common, because it is rare (and very difficult) to slice up the assets 10% or 25% each. Only if they do a careful trade-off within the inventory/receivables category (remembering that deprn recapture but not the rest of the depreciable property is a receivable) can they avoid a disproportionate distribution. (disproportionate does not mean the 70% partner getting other than 70% of the assets, it means getting other than 70% of each asset).

I added: Subchapter K has been around for 54 years. The tax law, before that, was around for 41 years. And for the last 15 years of that 41 years there were all sorts of problems, as evidenced by cases we no longer read, cite, or teach (with Culbertson being one of the few that survived in terms of relevance to post 1954 partnership taxation). Much of the tax law distorts what would happen in a no-tax world. True for partnerships. True for corporations, trusts, etc etc. True even for the entities that would not even exist but for a tax world (IRAs, SEPs, 403(b) plans, etc etc)

If you've made it this far, I hope you've acquired an appreciation for how the tax law becomes complex, and for how that complexity triggers noncompliance. Applied beyond this one instance where Congress, in my mind, forfeited its opportunity to simpify the Code, one wonders whether a simplified tax law would increase compliance so that the hundreds of millions of dollars in taxes not paid by those who fail to comply, wilfully or accidentally, would find their way into the Treasury, permitting the reduction of budget deficits and another round of tax cuts. After all, the accumulated unpaid taxes, which represent burdens borne by those totally or substantially complying with the tax law and by the creditors financing the deficit, also represent benefits taken against public will by those who fail to comply. And at this point, though much is uncollectible, they total at least 2 trillion when interest is taken into account. I guess that's why Congress keeps cutting the IRS budget and complaining about things the IRS does to collect taxes.

Many thanks to those who contributed to the discussion, raised good points, asked good questions, supplied me with new information, and shared their views and experiences. I didn't attach names to the descriptions because I don't have the right to do that to anyone, but I think I can identify them without tagging anyone with any specific comment so that everyone can recognize this particular group (of many) who contribute to my intellectual sanity: Jack Bogdanski of Lewis and Clark Law School, Mark Cochran of St. Mary's University, Alan Gunn of Notre Dame Law School, Darryll Jones of the University of Pittsburgh Elliott Manning of the University of Miami, Marty McMahon of the University of Florida College of Law, Walter Schwidetzky of the University of Baltimore, and David Shakow of the University of Pennsylvania Law School.

The most recent legislation started its journey as an attempt by the Congress to bring U.S. tax law into compliance with WTO directives so that the EU would stop leving penalties on the sale of U.S. goods in the EU. Then it was decided to add provisions to curtail tax shelters, including not only those that had become prevalent during the past decade but others that were in development.

If that is all the legislation did, the debate would be limited to two major issues. First, was the outcome with respect to the international tax rules appropriate, necessary, sufficient, and worthwhile? Second, will the tax shelter prevention rules work and are they the best that could be designed? I have insufficient expertise to comment on the first, and I will leave the second for a later day.

The bill could have been, and should have been, enacted in the spring. It wasn't, for reasons that can be described in one word: politics. When Congress finally turned its attention back to the legislation, election day was in the near future. The temptation to add in provisions that would entice voters to reward incumbents, especially those in tight races, for reducing their taxes was too strong to resist.

The temptation always is too strong to resist. I'm amused when commentators unfamiliar with tax history discover these "giveaway goodies" and think they've stumbled onto a new abuse. This behavior by Congress has been around for a long time. True, it has grown in frequency, intensity, and revenue cost during the past decade, but it isn't new. After all, it's been many, many years since Congres enacted the provision that benefitted one particular radio station, memorialized in statutory language cleverly drafted (by staff) so that the station's call letters appeared as the first letter in the first word in each of four paragraphs of the provision. The next time the staff tried something like this, involving a break for a labor union, I'm told that an interested member of Congress had been tipped off, and made the staff take it out. Perhaps instead of naming tax provisions after themselves, Congress ought to name them after the clients of the lobbyist who extracted the provision. Truth-in-legislating. It might even have a beneficial effect on the American political system.

Well, putting history aside, here are some of the giveaway goodies in this legislation. These are some, because Taxpayers for Common Sense asserts there are more than 150 giveaways and payoffs unrelated to the principal purpose of the legislation, the replacement of the export tax breaks violating WTO rules. Some of the provisions that are listed, though, aren't giveaways and payoffs, and a few actually benefit things that will improve the environment or reduce reliance on foreign energy sources.

I urge each reader to ask, "Is it worth it?" That is, is it worth having a larger federal deficit in order to create this benefit for a small group or individual? Is it worth paying more taxes, or having less of a tax cut, so that this benefit can exist for the small group or individual who benefits?

1. A change permitting more rapid depreciation deductions for certain restaurant property. Why restaurant property and not other property?

2. A extension of the date by which certain aircraft must be put into service in order to qualify for special depreciation allowances. The Report of the Managers of the Conference states this is "due to the extended production period," but why not extend this break to all property for which there is an "extended production period"?

3. An extension from two to four years for replacement of livestock involuntarily converted on account of weather conditions such as flood or drought. Why not a similar extension for replacement of ANY property involuntarily converted on account of weather conditions?

4. Capital gains treatment (i.e., lower taxes on the gain) for timber sold outright by the landowner on whose land the timber was cut. Why not a similar provision for the sale of anything removed from land, such as crops or minerals?

5. A reduction in the excise tax on certain bows and arrows. Why? Is this to encourage us to buy bows and arrows to use in homeland defense? Actually, it is a reaction to the lack of a tax on imported bows and arrows. Why not tax the imports? Would that not save American jobs?

6. A reduction in the excise tax on fishing tackle boxes. Is there a shortage of fishing tackling boxes? Was the excise tax eliminating jobs in the fishing tackle box manufacturing industry the way the luxury tax on yachts devastated employment at shipyards? The latter was well publicized. I've seen nothing about the loss of thousands of jobs in the fishing tackle box industry.

7. Repeal of the excise tax on sonar devices used to find fish. OK, to be fair, maybe this tax is preventing commercial fishers from buying the device needed to increase the yield of commercial fishing so as to make up for the shortfall in fish supply. Wait, no, the shortfall in fish supply comes from over-fishing. So is more fishing what is desired?

8. Suspension of occupational taxes relating to distilled spirits, wine, and beer. Don't even get me started on this one.

9. A provision permitting certain film and television production companies to elect an up-front deduction for certain production expenditures rather than capitalizing the costs and recovering the costs through depreciation deductions over a period of time. In all fairness, the bill also reduces some benefits that would otherwise have been available to the film industry, purportedly because it hired as a lobbyist a former Clinton Administration official, as reported here. Perhaps the Congress should have been MOORE punitive?

10. An exclusion from gross income for winnings paid to nonresident aliens from legal wagers initiated outside the United States in pari-mutuel pools on live horse or dog races in the United States. Why not a similar exclusion for residents? Is this provision designed to get all those aliens holding U.S. debt to return it by gambling in the U.S. and losing most of it? If so, why only horses and dogs? Why not an exclusion on ALL gambling winnings by foreigners in the U.S.? If it has something to do with animals, why just horses and dogs?

11. A shorter depreciation period for permanent motorsports racetrack complexes. Are you kidding me? Is this an industry that has fallen on hard times? Joe Gibbs is back as the Redskins coach for only a few games and he is THIS influential? Gee, I guess they do worship him in D.C. Seriously, I doubt he had time to be involved in the lobbying for this one. Maybe the next one was of more interest to him.

12. Making available to owners of sports team a tax write-off for the cost of the franchise, rather than just the cost of player contracts. Recall that player contracts lose value as the player ages and is no longer under contract, but why a deduction for something like a sports team franchise that goes up in value? Well, it's an imitation of the depreciation deduction for buildings that do not depreciate. Investment bankers explain that this change will add up to $2 billion to the value of professional sports franchises, as reported in this article.

13. A tax credit (rather than depreciation deductions) for maintenance of railroad track. Aren't railroad companies supposed to do this without needing a tax incentive? Are we to believe that without this credit they would let the tracks fall into disrepair and pay damages in all the ensuing lawsuits? Can I have a credit for doing my job?

14. A provision that lets the cruise industry postpne taxes on excursions it sells to its passengers. Why?

15. A tax break for the Oldsmobile dealers who are getting payments from General Motors for their discontinued franchises. So the GM payment isn't enough? [Oct 15 2004 update: Apparently it is, because this provision WAS removed from the legislation by House conferees. Many news services are reporting the provision as having survived the Conference, a not unexpected outcome of the confusions of last-minute legislative activity and a lag in reporting or technical problems on several official web sites.]

16. Deferral of gain from the sale of certain electric transmission property. Why?

17. The tightening of the rules applicable to nonqualified deferred compensation plans "do not apply to a plan meeting the requirements of section 457(e)(12) if the plan was in existence as of May 1, 2004, was providing nonelective deferred compensation described in section 457(e)(12) on such date, and is established or maintained by an organization incorporated on July 2, 1974." The Wall Street Journal, in an article that turns the spotlight on how this provision found its way into the legislation (think campaign contributions and other benefits) reports that this is designed to benefit the Professional Golfers Association.

18. Suspension of the customs duty applicable to ceiling fans. Why encourage the purchase of foreign-manufactured products? And if John Kerry is correct that it's mostly ceiling fans from China, and I think he is, then why encourage purchases from a country whose monetary policies are part of the reason the U.S. economy is weaker than it ought to be and that has contributed to the trade deficit?

19. My favorite. Tax incentives to build more shopping malls, in places such as Syracuse, N.Y., Shreveport, La., and Lakewood, Co. I want to ask, "Don't we have enough malls already?" but I know some clever wit will re-write that one and change the spelling of one word, ha ha. Seriously, why encourage what already is happening? We are drowning in shopping malls while other retail space goes unrented.

However, given the opportunity to combination and simplify the work opportunity tax credit and the welfare-to-work tax credit, the Congress chose to delete the provision doing this from the legislation. It also chose not to approve the appointment of a commission to study tax reform. That's like asking middle school students to vote on the appointment of a disciplinarian.

To its credit, the House-Senate conference axed a long list of additional giveaway goodies that were in the Senate or the House bill. I'm not going to list them here, but it's worth remembering that proposals that don't get through the first time usually show up again. And again. And again. Sometimes the second time's the charm. Or the third. So there's more of this in the pipeline. And some of it is so outrageous it floors me that legislators had the "courage" to introduce the tax break and then put them into the bills that went to Conference.

We are so well represented. Have I used the word disgrace yet?

The Congress had an opportunity to simplify the tax law. It failed to do so. It did worse. It made the tax law more complicated.

One particular set of provisions, dealing with partnership taxation, especially demonstrates the mess that Congress has made of the tax legislative process. Of course, Congress has had help from lobbyists, but Congress should be capable of "just saying no" to lobbyists whose proposals conflict with what is best for Americans as a nation. Groupthink and groupselfcenteredness is slowly polarizing and destroying the nation.

The provisions in question are complex, but I will attempt to describe them in comprehensible terms. For some purposes, the federal tax law treats partnerships as entities separate and apart from the partners. For other purposes, the federal tax law treats partnerships as nothing more than the aggregation of the partners (which is how state law treats them, aside from certain limited partnerships).

Because of this duality of treatment, which arose from a compromise in 1954 between the "treat as entity for all purposes" advocates and the "treat as aggregate for all purposes" advocates, technical glitches arise when a transaction treated in one manner meets a transaction treated in another manner. One example of this is the basis discrepancy that arises when a partner sells a partnership interest to another person (or when death causes the interest to shift from the decedent partner to the successor in interest, such as the estate of the decedent partner). The problem is that the partnership's adjusted basis in its assets reflects historical cost, reduced by depreciation (and in some instances adjusted for other things), but the "new" partner has an adjusted basis in the partnership interest that reflects fair market value at the time of the acquisition of the interest. The former, called "inside basis," will be less than the latter, called "outside basis" if the partnership has increased in value, and outside basis will be less than inside basis ifthe partnership has decreased in value.

A similar problem arises when there is a distribution by the partnership. If the amount of cash is distributed to a partner exceeds the partner's outside basis, the partner recognizes gain, and inside basis will be less than outside basis. If property is distributed, and the partner's outside basis is less than the partnership's inside basis in the property, the partner's basis in the distributed property will be the partner's outside basis, and the rest of the inside basis disappears. It's called "disappearing basis." Conversely, on liquidating distributions, under certain circumstances, the partner recognizes loss or basis is created in a distributed asset. In all of these situations, inside and outside basis fall out of balance.

The solution, enacted in 1954, was an election that permits the partnership to make basis adjustments to account for the difference between inside and outside basis. Take my word for it, the computation and the allocation of the adjustment among the partnership assets is a complex maze of arithmetic that most tax lawyers prefer to leave to those of us who somehow manage to understand it. So what's the problem other than the arithmetic?

The problem is that an election is required. Some partnerships fail to make the election. If the election is not in effect, then a partner who acquired a partnership interest by purchase or through death can elect to make the adjustment, but only for that partner and only under certain circumstances when a distribution is received. This election generate a SPECIAL basis adjustment, to distinguish it from the OPTIONAL basis adjustments that are made if the PARTNERSHIP made the partnership election.

As a practical matter, because a partner electing special basis adjustments can compel the partnership to do all the computations required when there are optional basis adjustments, most partnerships, at least those who have the benefit of knowledgeable tax advisors, provide in their agreement that the partnership election will be made the first time it is possible to do so. This eliminates the chance that individual partners would seek or object to the election at the time it presents itself based on how the numbers would turn out for their own individual tax situation.

On top of all this, the adjustments that are made to partner capital accounts, maintained to regulate how partnership items are allocated among partners for purposes of reporting them on partners' individual returns, are made as though the basis adjustments are not in effect. Thus, the amount of record keeping and computations is multiplied.

Needless to say, teaching this is a challenge. Students consider Partnership Taxation to be the nuclear physics of tax. That's amusing, because lawyers consider tax to be the nuclear physics of the law. I'm not even going to try to characterize a person who teaches the nuclear physics part of nuclear physics. You can.

In recent years, tax shelter merchants began to develop ways to take advantage of the elective nature of partnership basis adjustments. Without going into all the details, it was possible to shift losses from persons or entities not needing them (because, for example, their taxable income was at or below zero) to persons or entities who could use the losses as deductions. This ploy took advantage of the benefits that could be obtained when the basis adjustment election was not in effect with respect to loss property (because in that situation, the adjustment that would reduce basis was not in play; keep in mind that basis generally is "good" for reducing tax liability because it increases loss deductions or reduces gain, and so the avoidance of a basis adjustment that reduces basis is the key to these sorts of tax shelter arrangements).

When Congress began to consider seriously legislative provisions that would de-energize the tax shelter market, it considered a proposal that would make the optional partnership basis adjustments mandatory. This would not only solve the tax shelter problem, it would simplify partnership taxation. As a measure of that, it would shave at least one to two hours from a 28-hour Graduate Tax Program partnership taxation course. It would permit repeal of all the procedural rules with respect to the election, and thus remove traps for the unwary. It would bring to all partnerships the planning benefit enjoyed by partnerships with savvy tax advisers. It would permit repeal of the special basis adjustment, because that adjustment would no longer be necessary. It would remove one code section, one code subsection, and some other language.

What happened?

Someone decided that they didn't want this to be enacted. Why? I honestly don't know. I could speculate, but that doesn't tell us much. After describing what did get enacted, it might be possible to venture a guess or two.

What did get enacted were provisions that require basis adjustments if there is a substantial loss in the partnership at the time of the sale or death transfer or at the time of the distribution that generates gain, loss, disappearing basis, or created basis. So Congress adds two subsections, one to each optional basis code section, to set forth this rule. Then Congress had to add language defining substantial loss.

Was Congress done? No. Of course not. Congress then enacted exceptions to this anti-abuse rule. It provided an exception for so-called electing investment partnerships. It provided an exception for so-called securitization partnerships. This required the addition of language to the Code defining these entities. Then Congress added rules that applied to electing investment partnerships that deferred the benefit of certain loss allocations.

So by the time Congress was done with this, what was a simple proposal that would have shrunk the Code (making basis adjustments mandatory) became a complex addition to the Code. Why?

Who benefits from the ability to ignore basis adjustments when there is no substantial loss? Surely electing investment partnerships and securitization partnerships. Is that what this is about? Has the world of high finance once again insisted on tax rules that permit them to escape what good tax policy would not permit them to escape? Or is it some partnership that concludes that the making of the election generates too much of an expense for accounting fees? If so, that's short-sightedness, because avoiding the optional basis adjustments means nothing when a partner can unilaterally make the election for special basis adjustments.

It is clear that a good idea was sidetracked. It's not as though the good idea had not settled in someone's brain. The good idea found its way into legislation. The bill, as originally passed by the Senate, contained the simple repeal of the election. Someone with a vested interest that requires complexity was able to convince the Congress that their special interest was worth more to America than the simplification of the tax law.

It is no surprise that this election-year tax legislation, which I will continue to discuss in the next post, contains things that are important to certain taxpayers. Members of the Congress are going home for elections, patting themselves on the back in public for having done these wonderful things. It is annoying to watch the Senators and Representatives who decried the increase in federal deficits congratulate themselves for having enacted legislation that makes the deficit bigger. It's called vote-buying. It panders to the selfish citizen whose "what's in it for me" perspective lacks the vision of what's good for society as a society. It demonstrates keenly the hypocrisy of politicians. It is a bipartisan effort, and the overwhelming votes in favor of the bill make that very, very clear.

It might be difficult to envision a voter casting a ballot for someone because this complex stuff was added to the Code. It's not as easy to see as the corn farmers in South Dakota rushing to the polls to thank the biggest critic of the deficit for enacting a tax giveaway for those farmers that increases the deficit. But surely, there are folks who are pleased with this new complexity, and my guess is that they are part of, connected to, or beneficiaries of the tax shelter industry.

Once again, Congress has failed the American people. Once again, almost all of the Congressional incumbents up for election in a few weeks will be re-elected. At least that's what the polls say, and though there may be a few upsets, history supports the outcome that the polls suggest. It boggles my mind how so many of the American electorate will vote for people who will cause the very problems that the electorate wants fixed. It's like hiring the burglar to wire the home alarm system.

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Here is the stuff that got enacted. Take some quantum leaps through some split atoms, quarks, and muons.

SEC. 833. DISALLOWANCE OF CERTAIN PARTNERSHIP LOSS TRANSFERS.

(a) TREATMENT OF CONTRIBUTED PROPERTY WITH BUILT-IN LOSS.--Paragraph (1) of section 704(c) is amended by striking ‘‘and’’ at the end of subparagraph (A), by striking the period at the end of subparagraph (B) and inserting ‘‘, and’’, and by adding at the end the following:

‘‘(C) if any property so contributed has a built-in loss--
   ‘‘(i) such built-in loss shall be taken into account only in determining the amount of items allocated to the contributing partner, and
   ‘‘(ii) except as provided in regulations, in determining the amount of items allocated to other partners, the basis of the contributed property in the hands of the partnership shall be treated as being equal to its fair market value at the time of contribution.
For purposes of subparagraph (C), the term ‘built-in loss’ means the excess of the adjusted basis of the property (determined without regard to subparagraph (C)(ii)) over its fair market value at the time of contribution.’’.

(b) SPECIAL RULES FOR TRANSFERS OF PARTNERSHIP INTEREST IF THERE IS SUBSTANTIAL BUILT-IN LOSS.--

(1) ADJUSTMENT OF PARTNERSHIP BASIS REQUIRED.--Subsection (a) of section 743 (relating to optional adjustment to basis of partnership property) is amended by inserting before the period ‘‘or unless the partnership has a substantial built-in loss immediately after such transfer’’.

(2) ADJUSTMENT.--Subsection (b) of section 743 is amended by inserting ‘‘or which has a substantial built-in loss immediately after such transfer’’ after ‘‘section 754 is in effect’’.

(3) SUBSTANTIAL BUILT-IN LOSS.--Section 743 is amended by adding at the end the following new subsection:

‘‘(d) SUBSTANTIAL BUILT-IN LOSS.--
   ‘‘(1) IN GENERAL.--For purposes of this section, a partnership has a substantial built-in loss with respect to a transfer of an interest in a partnership if the partnership’s adjusted basis in the partnership property exceeds by more than $250,000 the fair market value of such property.
   ‘‘(2) REGULATIONS.--The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of paragraph (1) and section 734(d), including regulations aggregating related partnerships and disregarding property acquired by the partnership in an attempt to avoid such purposes.’’.

(4) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.--

(A) IN GENERAL.--Section 743 is amended by adding after subsection (d) the following new subsection:

‘‘(e) ALTERNATIVE RULES FOR ELECTING INVESTMENT PARTNERSHIPS.--
   ‘‘(1) NO ADJUSTMENT OF PARTNERSHIP BASIS.--For purposes of this section, an electing investment partnership shall not be treated as having a substantial built-in loss with respect to any transfer occurring while the election under paragraph (6)(A) is in effect.
‘   ‘(2) LOSS DEFERRAL FOR TRANSFEREE PARTNER.--In the case of a transfer of an interest in an electing investment partnership, the transferee partner’s distributive share of losses
(without regard to gains) from the sale or exchange of partnership property shall not be allowed except to the extent that it is established that such losses exceed the loss (if any) recognized by the transferor (or any prior transferor to the extent not fully offset by a prior disallowance under this paragraph) on the transfer of the partnership interest.
   ‘‘(3) NO REDUCTION IN PARTNERSHIP BASIS.--Losses disallowed under paragraph (2) shall not decrease the transferee partner’s basis in the partnership interest.
   ‘‘(4) EFFECT OF TERMINATION OF PARTNERSHIP.--This subsection shall be applied without regard to any termination of a partnership under section 708(b)(1)(B).
   ‘‘(5) CERTAIN BASIS REDUCTIONS TREATED AS LOSSES.--In the case of a transferee partner whose basis in property distributed by the partnership is reduced under section 732(a)(2), the amount of the loss recognized by the transferor on the transfer of the partnership interest which is taken into account under paragraph (2) shall be reduced by the amount of such basis reduction.
   ‘‘(6) ELECTING INVESTMENT PARTNERSHIP.--For purposes of this subsection, the term ‘electing investment partnership’ means any partnership if--
      ‘‘(A) the partnership makes an election to have this subsection apply,
      ‘‘(B) the partnership would be an investment company under section 3(a)(1)(A) of the Investment Company Act of 1940 but for an exemption under paragraph (1) or (7) of section 3(c) of such Act,
      ‘‘(C) such partnership has never been engaged in a trade or business,
      ‘‘(D) substantially all of the assets of such partnership are held for investment,
      ‘‘(E) at least 95 percent of the assets contributed to such partnership consist of money,
      ‘‘(F) no assets contributed to such partnership had an adjusted basis in excess of fair market value at the time of contribution,
      ‘‘(G) all partnership interests of such partnership are issued by such partnership pursuant to a private offering before the date which is 24 months after the date of the first capital contribution to such partnership,
      ‘‘(H) the partnership agreement of such partnership has substantive restrictions on each partner’s ability to cause a redemption of the partner’s interest, and
      ‘‘(I) the partnership agreement of such partnership provides for a term that is not in excess of 15 years.
The election described in subparagraph (A), once made, shall be irrevocable except with the consent of the Secretary.
   ‘‘(7) REGULATIONS.--The Secretary shall prescribe such regulations as may be appropriate to carry out the purposes of this subsection, including regulations for applying this subsection to tiered partnerships.’’.

(B) INFORMATION REPORTING.--Section 6031 is amended by adding at the end the following new subsection:

‘‘(f) ELECTING INVESTMENT PARTNERSHIPS.--In the case of any electing investment partnership (as defined in section 743(e)(6)), the information required under subsection (b) to be furnished to any partner to whom section 743(e)(2) applies shall include such information as is necessary to enable the partner to compute the amount of losses disallowed under section 743(e).’’.

(5) SPECIAL RULE FOR SECURITIZATION PARTNERSHIPS.--Section 743 is amended by adding after subsection (e) the following new subsection:

‘‘(f) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.--
   ‘‘(1) NO ADJUSTMENT OF PARTNERSHIP BASIS.--For purposes of this section, a securitization partnership shall not be treated as having a substantial built-in loss with respect to any transfer.
   ‘‘(2) SECURITIZATION PARTNERSHIP.--For purposes of paragraph (1), the term ‘securitization partnership’ means any partnership the sole business activity of which is to issue securities which provide for a fixed principal (or similar) amount and which are primarily serviced by the cash flows of a discrete pool (either fixed or revolving) of receivables or other financial assets that by their terms convert into cash in a finite period, but only if the sponsor of the pool reasonably believes that the receivables and other financial assets comprising the pool are not acquired to as to be disposed of.’’

(6) CLERICAL AMENDMENTS.--

(A) The section heading for section 743 is amended to read as follows:

‘‘SEC. 743. SPECIAL RULES WHERE SECTION 754 ELECTION OR SUBSTANTIAL BUILT-IN LOSS.’’

(B) The table of sections for subpart C of part II of subchapter K of chapter 1 is amended by striking the item relating to section 743 and inserting the following new item:

‘‘Sec. 743. Special rules where section 754 election or substantial built-in loss.’’.

(c) ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY IF THERE IS SUBSTANTIAL BASIS REDUCTION.--

(1) ADJUSTMENT REQUIRED.--Subsection (a) of section 734 (relating to optional adjustment to basis of undistributed partnership property) is amended by inserting before the period ‘‘or unless there is a substantial basis reduction’’.

(2) ADJUSTMENT.--Subsection (b) of section 734 is amended by inserting ‘‘or unless there is a substantial basis reduction’’ after ‘‘section 754 is in effect’’.

(3) SUBSTANTIAL BASIS REDUCTION.--Section 734 is amended by adding at the end the following new subsection: 21

‘‘(d) SUBSTANTIAL BASIS REDUCTION.--
   ‘‘(1) IN GENERAL.--For purposes of this section, there is a substantial basis reduction with respect to a distribution if the sum of the amounts described in subparagraphs (A) and (B) of subsection (b)(2) exceeds $250,000.
   ‘‘(2) REGULATIONS.--‘‘For regulations to carry out this subsection, see section 743(d)(2).’’.

(4) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.--Section 734 is amended by inserting after subsection (d) the following new subsection:

‘‘(e) EXCEPTION FOR SECURITIZATION PARTNERSHIPS.--For purposes of this section, a securitization partnership (as defined in section 743(f)) shall not be treated as having a substantial basis reduction with respect to any distribution of property to a partner.’’.

(5) CLERICAL AMENDMENTS.--

(A) The section heading for section 734 is amended to read as follows:

‘‘SEC. 734. ADJUSTMENT TO BASIS OF UNDISTRIBUTED PARTNERSHIP PROPERTY WHERE SECTION 754 ELECTION OR SUBSTANTIAL BASIS REDUCTION.’’

(B) The table of sections for subpart B of part II of subchapter K of chapter 1 is amended by striking the item relating to section 734 and inserting the following new item:

‘‘Sec. 734. Adjustment to basis of undistributed partnership property where section 754 election or substantial basis reduction.’’.

(d) EFFECTIVE DATES.--

(1) SUBSECTION (a).--The amendment made by subsection (a) shall apply to contributions made after the date of the enactment of this Act.

(2) SUBSECTION (b).--

(A) IN GENERAL.--Except as provided in subparagraph (B), the amendments made by subsection (b) shall apply to transfers after the date of the enactment of this Act.

(B) TRANSITION RULE.--In the case of an electing investment partnership which is in existence on June 4, 2004, section 743(e)(6)(H) of the Internal Revenue Code of 1986, as added by this section, shall not apply to such partnership and section 743(e)(6)(I) of such Code, as so added, shall be applied by substituting ‘‘20 years’’ for ‘‘15 years’’.

(3) SUBSECTION (c).--The amendments made by subsection (c) shall apply to distributions after the date of the enactment of this Act.

********************************************************

Yesterday's post on the proposed gross receipts tax in Pennsylvania brought some comments from Prof. Beau Baez, of Liberty University School of Law, who makes some good points, particularly about jurisdiction and the resilience of gross receipts taxes in the face of economic downturns. Here's our dialogue:

Beau wrote:

Jim,

I have been following your attack on the proposed Pennsylvania gross receipts tax and I think you are missing the big problem-jurisdiction to tax. In 1959, in response to a U.S. Supreme Court opinion (Northwestern Portland Cement), Congress for the first time in history pre-empted a state & local tax. P.L. 86-272 limits the ability of a state to impose a corporate net income tax. A company can
avoid corporate net income tax jurisdiction if it limits its in-state activities to solicitations of orders for the sale of tangible personal property. Washington State enacted a gross receipts tax a few years ago that is not limited by P.L. 86-272 because the pre-emption only applies to net income taxes. Washington State has been extremely successful with this tax, which is imposed at fairly low rates.

It is not much better for sales and use taxes. An out-of-state company can only be required to collect a state's sales and use taxes if that company has a physical presence in the state. See Quill v. North Dakota. That is why your large mail-order companies, such as Dell computers, do not collect the sales tax-this leads to tax base erosion since there is no efficient way to get the individual citizens to self assess.

Business is not interested in fixing either of these two jurisdictional problems, thus leaving the gross receipts tax as the only tax that allows for horizontal equity. Is a progressive income tax really a better alternative given that out-of-state competitors are exempt? Fortune 100 companies can have thousands of employees in a state soliciting orders, doing huge amounts of business, and not paying a penny of tax. California fixes this problem years ago by requiring forced combined reporting, but there has not been sufficient political will in the eastern half of the U.S. to adopt the system. When it has been suggested at the state level business lobbyists sweep in and argue that business will flee the state-that is enough to kill reform efforts.

Though I am not an advocate for gross receipt taxes, it does provide a stable tax base with horizontal equity. States need stable revenue sources since most states do not have the ability to borrow money in years with economic downturns-depression era laws prevent most states from borrowing money. Therefore, heavy reliance on income taxes means rollercoaster rides tied to the economic condition of the country.

Hope all is well.

Beau

I then replied:

Hi Beau,

You know I'll end this by asking permission to share your comments, and my thoughts, on the blog. You make some interesting points and shed some light on a wider perspective.

The irony is that you're making a better argument for a gross receipts tax than are the folks advocating it here! Their approach is simply a mechanism by which to expand the sales tax without saying so. There is a sense that consumers would think they have been relieved of a tax that has been shifted to business. Of course, that's not what will happen.

I have my doubts about the horizontal equity issue, and I don't quite follow the jurisdiction question. Assume a company without nexus in Pennsylvania for income or sales tax purposes (or use tax collection purposes) is "doing business in Penna." If it doesn't have enough nexus for use tax collection, how does it have enough nexus for gross receipts tax imposition? I'm not disagreeing, but there must be some fine line distinction other than the one between net income and gross receipts taxation, because the gross receipts tax isn't much different from a use tax with collection responsibilities imposed on the business.

As for equity, this sort of tax can drive companies out, and it can cause increases in the price of products. I don't think for an instant that there will be a full offsetting decrease in other taxes. The upshot is that Penna wants more revenue, not a "no change" in the revenue amount. If Washington State managed to get rid of other taxes, that's great, but that's not Penna tradition. Penna already has a capital stock tax, measured in part by a weird sort of net/gross income, that many consider the reason businesses and jobs have left Penna.

Of course, there are all sorts of vertical equity problems with a gross receipts tax. They surely ignore ability to pay because they are passed on to consumers.

It is puzzling why the unitary approach doesn't find takers outside of California and a few other states (including North Carolina). It's also unclear why Pennsylvania still has local earned income taxes rather than local broad income taxes. Nothing in the gross receipts proposal fixes that problem.

Why would gross receipts taxes be less volatile than an income tax? In downturns, business activity also slips (and in fact, in Penna, it has slipped, at least according to the publicly traded retail firms).

I think we're in agreement that there are better ways to raise revenue than gross receipts taxes. And I'd guess you'd favor a broad income tax over an earned income tax.

So do we differ in my not thinking that a gross receipts tax should be enacted until all efforts at fixing the other revenue sources fail?

And, here goes... I'd like to share your comments on the blog. I'd prefer to wait until you educate me a bit on my questions and then I can be more sensible in reacting. Plus I think blog readers may have the same jurisdiction question I have (which is not to say you're incorrect, just that tax jurisdiction isn't easy to explain).

Thanks
Jim

And Beau then provided some very useful insights, including why the backers of the gross receipts tax aren't arguing its superiority to net income taxes and why gross receipts taxes aren't as volatile as income taxes:

Jim,

You may share my comments in my prior email and in this one. I am unfamiliar with the arguments being made in Pennsylvania, but if they are clever they would avoid all public discussion concerning P.L. 86-272. In Hublein v. South Carolina the Supreme Court held that a state may not enact legislation for the sole purpose of bypassing P.L. 86-272 as that would defeat the purposes of the legislation. However, if the legislation has the indirect effect of bypassing P.L. 86-272 then the legislation passes muster under the Commerce Clause. A gross
receipts tax is, arguably, a gross income tax. If a state creates a gross receipts tax with a few basic exemptions it arguably has a net income tax clothed in gross receipts language. Interestingly, Supreme Court jurisprudence seems to classify gross receipts taxes as a distinct category--neither a sales tax nor an income tax.

In Quill v. North Dakota the Supreme Court mandated a physical presence standard for use taxes under the negative commerce clause. In 1959 the Congress mandated in P.L. 86-272 a modified physical presence standard for corporate net income taxes. That leaves gross receipt taxes as the only tax with no jurisdictional limitations, at least in theory.

State taxation jurisprudence is a quagmire but an argument can be made that gross receipt taxes and some corporate net income tax activity is governed by an economic nexus standard. Keep in mind that P.L. 86-272 only addresses the sale of tangible personal property so businesses that sells intangibles or services cannot receive its protection. Minnesota for example has legislation for financial institutions that is not based on physical presence in the state.

Gross receipts taxes are better from a revenue stream perspective for numerous reasons. First is the stability of the tax. For example, Manufacturing Co. has a great year in 2002 with a PA income tax liability of $500,000. In 2003 the economy sours and they have a net loss, thus no income tax liability for that year. While it is true that in an economic downturn this company will likely have lower gross receipts, from the state's perspective they will still get some revenue--this is why states adopted broad-based sales taxes at low rates during the depression.

The second advantage of the gross receipts tax is the reduction of tax planning techniques to avoid paying the tax. The third advantage is the simplified reporting of the tax and on the state side in administering the tax.

While your vertical equity problem makes sense at the federal level I am not sure it makes as much sense at the state level. Under the corporate net income tax a company losing money doesn't really care where it establishes nexus since its liability is zero. However, if it is entering a cycle of profitability it may be able to quickly alter its activities to avoid nexus in Pennsylvania. This means that in the lean years PA gets no revenue from this company and now that it has profits
it gets nothing as well because jurisdiction is measured on a year-to-year basis. The federal government also has this problem but it is not nearly as acute as it is at the state level. The current tax jurisdiction standards skews sound tax policy.

The state corporate net income tax cannot be fixed at the federal level. In fact, business recently introduced legislation that would further erode the tax base. This proposed legislation would expand the number of activities that are immune from taxation and would even allow significant physical presence in a state without subjecting the out-of-state company to that state's income tax. To paraphrase Helmsly: only the small corporations would pay taxes.

There is a simple solution. Congress can affirmatively grant the states the ability to tax all businesses that do business in their states. In fact, on the sales tax side the states have been working for years on a Streamlined Sales Tax Project--Congress will review this next year after the elections.

So, where does this leave me in relation to gross receipt taxes? In a sense, gross receipt taxes are like diesel engines. A product of yesteryear, a bit messy, not the best thing going, but it does get the job done. Always keep in mind the 2004 Dave Barry for President tax platform: the ideal tax is one where everyone would pay less taxes and you individually would pay no taxes. Take care.

Beau

Beau's explanation makes sense, especially if the gross receipts tax were to replace the net income tax and/or the capital stock tax. But it supposedly will fund decreases in local property taxes, and thus the other business taxes would remain. The gross receipts tax will be passed on to the consumer, through price increases equal to the amount of the tax, though consumers would benefit from a reduction in sales taxes. For some items, especially those not subject to the sales tax at present, the total cost will go up. For other items, mostly those subject to the sales tax, the total cost will go down slightly (assuming that the gross receipts tax percentage is what the backers claim it would be). Thus, the gross receipts tax will be as regressive as the regressive local property tax that the legislature claims it wants to eliminate or reduced for the very reason it is progressive. What is the benefit to a local homeowner to see a $300 reduction in local property taxes and an offsetting increase in the price of goods and services purchased by the homeonwer? If the gambling legalization generates revenue, THAT revenue will be the source of tax reduction (although one wonders who will be funneling money into the gambling operations... perhaps homeowners who now have some spare cash?)

The proposal for a gross receipts tax does nothing to shift the state and local tax burden to an "ability to pay" or "user fee" approach. After all, some goods and services impose much higher societal costs than others, and some probably reduce those costs. Isn't toothpaste a far more beneficial product than tobacco?

The truth is that Pennsylvania's tax system is antiquated, ineffective, and inefficient. The gross receipts tax proposal does nothing to solve the problem.

Almost two months ago, I delivered a criticism of how Pennsylvania's legislature is going about state and local tax reform. I especially denounced the use of a gross receipts tax on business, pointing out how it has contributed to the economic decline of Pennsylvania and how it would not solve the problems that its advocates claim it would solve. I questioned why its supporters cannot let go of a bad idea and work with revenue generators that have proven to be effective, even if not fully efficient.

I doubt any of the group advocating this bad idea read my blog. Perhaps one or another did, but did not reply. That's unlikely, because it is tough to imagine a politician passing by an opportunity to respond to criticism and argue for a pet project. So it's time for someone, somehow, to get these folks to do some research and thinking.

Why?

Because the Governor of Pennsylvania, breaking ranks with members of his own party, has decided, according to KYW Radio, to take a serious look at the proposal to change the state sales tax and reduce local property taxes with a 4.5% business receipts tax. A group of Republican state House members (calling itself the "Commonwealth Caucus") has advanced this regressive and economy-damaging idea. I wonder who's selling it to them?

The proposals are not without technical problems, some of which have been described in a writeup of House Finance Committee Hearings. (Scroll down to "Business Tax Receipts Plan Debate Continues") Fortunately, there are others who have identifiedflaws in the proposal. I particularly like the headline for the press release issued by one legislator who thinks the business receipts tax is foolish: Too bad there’s no tax on bad ideas. I must confess that's a line I would have been happy to have authored. A business gross receipts tax just doesn't qualify as a sensible user fee equivalent, and it shifts tax burdens to those least able to bear them while creating a business environment that would chase businesses and people out of the state, as I discussed in that previous blog post.

In all fairness, the Governor admits that the numbers don't add up. That's good, because, knowing him, he'll look more closely and figure out WHY the numbers don't add up. At that point, one hopes he uses his influence to get the facts onto the table, open up meaningful rather than sound-bitten discussion, and push for the local "piggyback" to the state income tax that I advocate.

Thanks to Paul Caron's TaxProfBlog for this tidbit. According to an ABC News report, tax authorities in Sweden rejected an attempt by a child's parents to name him Superman. The question was litigated and a court of appeals upheld the denial.

The question is why are tax authorities involved in approving people's names. The most I could discover is that children, at birth, are given national identification numbers by the tax authorities. The story has appeared on many forums, and the most popular question is the one I just asked. Does anyone know why it's the TAX authorities who get to approve names? And, incidentally, why should a government, no matter the department, have a right to control what parents name their children? Supposedly the tax authorities in Sweden disapproved the name "Superman" because it would subject the child to ridicule, even though it would have been the child's third name. If parents choose stupid names for their children, then they're alerting the world to the fact that the child has parents who do stupid things, which could be useful information.

So this couple in Sweden couldn't get their proposed name by the tax authorities. Does the law in Sweden go so far as to provide that a child can be named by the tax authorities? One hopes that they would not display the same mindset that has given the U.S. tax names such as TRA, ERISA, ETA, COWPTA, ISRA, ERTA, OBRA, TEFRA, DRA, COBRA, TAMRA, TEA, SBJPA, TREA, CORTRA, ITCA, EGATRRA, VOTTRA, JCWAA, CHACA, JAGTRRA, and WFTRA. And they think SUPERMAN is bad?

Perhaps someday I'll investigate any connections between name approval in Sweden and vanity license plates in Sweden.

If they prove nothing else, these presidential candidate debates demonstrate that politicians will trip over each other handing out tax goodies as they troll for votes. During his speech to the Republican National Convention, the President, though admitting the tax law needs to be simplified, proposed the addition of more tax credits. I pointed out this inconsistency in a previous post.

Tonight, John Kerry promised to create a $4,000 tuition tax credit, a manufacturing jobs credit and a new jobs credit. I’m not sure whether to score this by counting the number of credits or the amount of total tax reduction that would be provided. Perhaps, considering the purpose of these promises, the count should be the number of people whose taxes would be reduced by the proposed credits. I’m not certain how to count a person who would benefit from more than one credit, especially because people are supposed to vote only once.

Kerry noted that the most recent tax cut was the first time a tax cut was enacted during a war. He then proceeded to promise another one. “I'm going to give you a tax cut.” He clarified that statement, “I’m giving a tax cut to the people earning less than $200,000 a year.”

When asked if he would “be willing to look directly into the camera and, using simple and unequivocal language, give the American people your solemn pledge not to sign any legislation that will increase the tax burden on families earning less than $200,000 a year during your first term, Kerry replied, “Absolutely. Yes. Right into the camera. Yes. I am not going to raise taxes. I have a tax cut. And here's my tax cut.”

So what happens if Kerry is elected, and a serious national emergency requires so much revenue that even a 100% tax on people earning more than $200,000 would be insufficient? This is the reason that credible proposals for balanced budget amendments come with a national emergency exception.

Listening to these two candidates spar over taxes was unpleasant. They toss about sound-bite phrases but I would be shocked if they really understood the underlying issues.

Though each candidate tried to paint the other’s tax philosophy as bringing a significantly different approach to the table, neither one persuaded me that they get it. Both hold philosophies that complicate the code. Neither one addressed the flaws inherent in taxing capital gains and dividends at lower rates; the plans advocated by each candidate would continue to treat these types of income as less deserving of taxation than are wages.

Wouldn’t it be fun if they’d let me debate each of these two fellows on tax policy? No, it would not. It would leave many Americans as distressed as I am when I realize that the tax philosophy of one or the other of the two candidates is what this country will endure for the next four years. I remain unimpressed.

The recently-enacted Working Families Tax Relief Act of 2004 attempts to establish a consistent definition of the term "child," which is used in many provisions of the Internal Revenue Code. Because the provisions using the term child came into the Code at different times, and because there was little or no coordination with or reliance on existing definitions, on many occasions when the term was added it received a different definition. The resulting complexity and confusion drew so much criticism that Congress finally chose to act.

Enactment of a consistent definition of child is incorporated in a totally revamped section 151(c) and 152. For a very long time, section 151 provided the deduction for personal and dependency exemptions. Section 151(c) provided that a dependency exemption deduction could be claimed for any dependent who satisfied either a gross income test or who was a child of the taxpayer who satisfied an age or student test. For purposes of the child requirement, section 151(c)(3) defined a child as a son, stepson, daughter, or stepdaughter of the taxpayer. A definition of student was provided, and an exception to the gross income test was established for certain disabled individuals. A special rule applied to the treatment of missing children. Section 151(d) specified the rules for calculating the exemption amount.

Section 152 provided the definition of a dependent. Generally, a dependent was a person who satisfied a relationship test and a support test. Section 152 also provided special rules for multiple support agreements, and a rule with respect to the impact of scholarships on the support test as applied to children. Another set of special rules dealt with children of divorced parents, specifying which parent was entitled to the dependency exemption.

For taxable years beginning after December 31, 2004, section 152 is substantially rewritten. Though many of the existing rules are kept intact, they have been moved. This, of course, will be a frustration to all those who will need to re-learn the Code citation providing authority for a principle or rule. To make the rewrite of section 152 work technically, the rules in section 151(c) are removed and replaced with a simple provision that provides a dependency exemption deduction for dependents as defined in section 152.

Section 152 changes the definition of dependent. Under new section 152(a), a dependent is a qualifying child or a qualifying relative. These are new terms in the section 152 context.

New section 152(b)(1) provides that an individual who is a dependent of a taxpayer for a taxable year beginning in a calendar year is treated as having no dependents for any taxable year beginning in that calendar year. This is a new provision. The individual who is a dependent of another taxpayer continues, under section 151(d)(2), to have a personal exemption amount of zero. New section 152(b)(2) contains the rule formerly set forth in section 151(c)(2) with respect to dependency exemptions for married individuals. The rule is unchanged. New section 152(b)(3) contains the rule formerly set forth in old section 151(b)(3) with respect to the treatment of individuals who are not citizens, and though the substance is retained, it is reorganized and now contains subparagraphs and clauses.

New section 152(c) defines qualifying child. A qualifying child must satisfy a relationship test, must have the same principal place of abode as the taxpayer for more than half the year, must meet age requirements, and must not have provided more than half of his or her own support for the calendar year in which the taxpayer’s taxable year begins. The relationship test requires tha the person be a child of the taxpayer, a descendant of a child of the taxpayer, a sibling or step-sibling of the taxpayer, or the descendant of a sibling or step-sibling. This definition is very different from the definition of child in old section 151(c)(3). The age requirements are the same as those in old section 151(c)(1)(B), namely, the child must be under 19 or a student who is under 24, except that individuals who are permanently and totally disabled are treated as satisfying the age requirements. Under new section 152(c)(4), a child who could be claimed as a qualifying child by more than one taxpayer is treated as the qualifying child of the child’s parent, or, if the child has no parent, by the taxpayer with the highest adjusted gross income for the year. If the child has two parents and they do not file a joint return, the child is a qualifying child of the parent with whom the child lives for the longest period of time during the year, but if this test does not resolve the issue, the child is the qualifying child of the parent with the highest adjusted gross income. The first rule, which is required because siblings and their descendants are considered to be qualifying children, poses the rather interesting practical problem of putting two or more taxpayers in the position of learning each others’ adjusted gross incomes so they can decide who is entitled to the dependency exemption. The second rule should be interesting when it is applied in practice, as parents not filing joint returns must disclose adjusted gross income to each other.

New section 152(d) defines qualifying relative as any individual who meets a relationship test, a gross income test, and a support test, and who must not be a qualifying child for any taxpayer. The relationship test is the same as the one in old section 152(a), except that stepchildren are no longer listed because they are included in the new definition of child. The gross income test is the same as the one in old section 151(c)(1)(A), namely gross income less than the exemption amount. The support test is the same “more than one-half” test in old section 152(a) that applied to all dependents.

New section 152(d)(3) contains the same multiple support agreement rules that existed in old section 152(c). New section 152(d)(4) contains the same special rule for computing the income of disabled dependents as was in old section 151(c)(5), with a minor change in the placement of the cross-reference to the definition of permanently and totally disabled.

New section 152(d)(5)(A) contains the same rule for treatment of deductible alimony payments as was in old section 152(b)(4). New section 152(d)(5)(B) contains a new rule providing that if a parent remarries, support payments paid by that parent’s spouse is treated as received from the parent.

New section 152(e) changes the rules for determining which parent is entitled to the dependency exemption for a child when the parents are divorced. The trigger for the rule is unchanged. Under the new rule, for the noncustodial parent to claim the exemption, the decree or separation agreement must provide that the noncustodial parent is entitled to the exemption, the custodial parent must sign the declaration that was required under old law, and for pre-1985 agreements the noncustodial parent must provide at least $600 of support during the year. The definition of custodial parent is revised to mean the parent with whom the child shared the same principal place of abode for the greater portion of the calendar year, in lieu of the old test that used the phrase “having custody for a greater portion” of the year. Unchanged is the definition of the noncustodial parent as the parent who is not the custodial parent. The exception for multiple support agreements is unchanged.

New section 152(f) defines a child as an individual who is a son, daughter, stepson, or stepdaughter. The rule in old section 152(b)(2) with respect to adoption is retained in new section 152(f)(1)(B), and the rule in old section 152(b)(2) with respect to foster children is slightly modified, in new section 152(f)(1)(C) to reflect the changes in the definition of child.

The definition of student in old section 151(c)(4) is maintained, but in new section 152(f)(2). The rule in old section 152(b)(5) excluding persons whose relationship with the taxpayer violates local law from the “member of same household” branch of the relationship test is maintained in new section 152(f)(3). The half-blood rule for siblings in old section 152(b)(1) is maintained in new section 152(f)(4). The rule with respect to the impact of scholarships on support computations in old section 152(d) is maintained in new section 152(f)(5). Finally, the rules for exemptions with respect to missing children in old section 151(c)(6) are maintained, with slight conforming modifications, in new section 152(f)(6).

It begins with an email from a student to a tax law professor, who shares the question with other tax law professors.

The student had been watching Food Channel, which put up a factoid that said in 1893 the Supreme Court ruled that a tomato was a vegetable, making it subject to a vegetable import tax. Fruits were not taxed. The student wanted to know if this was true, and could the Supreme Court do this?

It is impressive that within minutes, two tax law professors came through with responses, identifying the case (Nix v. Hedden, 149 U.S. 304 (1893), along with the explanation that the Supreme Court relied on the "ordinary meaning" of the words fruit and vegetable. Before there was a federal income tax, tariffs were important revenue sources, requiring courts to decide if dictionary definitions should be used when statutes failed to define terms. See Aprill, The Law of the Word: Dictionary Shopping the Supreme Court, 30 Ariz. St. L. J. 275 (1998).

Yet another response brought this quote from the case:

Botanically speaking, tomatoes are the fruit of a vine, just as are cucumbers, squashes, beans and peas. But in the common language of the people, whether sellers or consumers of provisions, all these are vegetables, which are grown in kitchen gardens, and which, whether eaten cooked or raw, are, like potatoes, carrots, parsnips, turnips, beets, cauliflower, cabbage, celery and lettuce, usually served at dinner in, with or after the soup, fish or meats which constitute the principal part of the repast, and not, like fruits generally, as dessert.

And tax law professors being the way they are, while I was drafting a response, someone asked how happy we would be if a fruit salad ordered at a restaurant came with tomatoes and beans, both of which are classified as fruits by botanists. Someone else noted that in North Carolina it is said that tobacco is a vegetable (but I wonder if something that should not be eaten is a vegetable, but wait, brussel sprouts are vegetables). Another person reminded us that ketchup is a vegetable (remember the school lunch issue from a few years ago?).

I then shared this typical MauledAgain response (with the requisite dig at Congress):

But what of the cranberry, often served with turkey during the meal?

Or pineapple, often served with ham?

Or apples, not rarely served as a side with dinner.

And then there's duck in orange sauce......

Perhaps the Congress, in using words that do not have established meanings (after all, people have been arguing over the classification of tomatoes ever since they were discovered), should have defined the word vegetable in a manner that eliminated the need for Supreme Court consideration.

Remember of course, the most important definition. Chocolate is a vegetable. Really.

Which brought this retort (retorte?):"Orange you glad we moved to an income tax system?" The professor who started the discussion replied off-list with ":))))))))))))))))" which I suppose was a reaction to the "chocolate is a vegetable" quip. (Chocolate IS a vegetable. Vegetables are good for heart health. Recent studies tell us chocolate is good for heart health. Therefore, chocolate is a vegetable.)

The deep discussion of Supreme Court tax analysis with respect to tomotoes having reached this point, I made another scholarly contribution to the tax world with this:

I came very close to sending an email about the way the Supreme Court SLICED through the case, hoping the justices GRILLED the attorneys, and didn't let themselves get STEWED about the issue. Oh, for a moment my resistance was stronger than the temptation. But this email got me SOUPED up, and at least via email there's less risk someone will be tempted to PASTE me after I do this to everyone. I haven't been near the SAUCE, and I just got in from doing some work outside which caused me to become SUN-DRIED.

The original poster replied, "I should post more often. This group will bite on anything :)" and I, of course, had to send this message: "Brilliant, but remember that some of the arguments made on this list are tough to swallow. Chew on that for a while. :-)"

I hope that my taxprof colleagues don't get all JUICED up over this publicity.

With thanks to Prof. Ellen Aprill of Loyola, Prof. Bryan Camp of Texas Tech, Prof. Sam Donaldson of Washington, Prof. Linda Galler of Hofstra, Prof. Alan Gunn of Notre Dame, Prof. Calvin Johnson of Texas, Prof. Michael Lang of Chapman, and Prof. John Swain of Arizona, and with special thanks to Prof. Paul Caron of Cincinnati, who maintains the list on which this gourmet discussion took place, and who will hopefully be blogging this topic on the famous TaxProfBlog, with a reference to this posting as I try to drag along on his coattails.

Tax bills originate in the Ways and Means Committee. As in how many ways can we change what we mean?

Today the House-Senate Conference on HR 4520, the American Jobs Creation Act of 2004, came to an agreement. Will this one be called AJCA? Ouch.

If and when the House and Senate approve the Conference Report, it will be sent to the President for signature. When and if signed, it becomes law, though its provisions have all sorts of effective dates.

I touched on this bill in one of its previous incarnations in the context of a larger discussion on tax and economics. The bill has changed. Even if you aren't a tax professional, it's quite an education to browse through the titles of the sections in the Chairman's Mark of the bill. Doing so provides a bifocal view of the existing complexity of the tax law and the layers of complexity added by this bill if and when it is enacted. If you look closely you will see the most ironic provision, one that sets up a commission to study reform and simplification of the tax law. I guess that's like a group of litterers setting up a commission to study the adverse effects of littering and ways to stop littering. Yes, there are times when tax law and litter seem closely related and it's not because paper is involved in both.

I've been informed that a law professor who teaches in the state of Michigan and who specializes in the value added tax has VATMAN1 on his plates. He couldn't get VATMAN because it was taken. So for what else is VAT an acronym?

Paul Caron has posted up (on TaxProfBlog) photos of a Texas license plate with TAX CUTR and a Massachusetts plate with TAXHIKER. I'm very sure Paul (or someone helping him) is having fun with Adobe Photoshop.

The thought of putting TAXJEM on my plate met with an "Anonymity is key to a tax prof" advisory from an associate dean. Anonymity? For ME? Impossible. They wish we tax profs were anonymous. Never. We were engineered for the spotlight, just a hearbeat away from the grand stage.

Previous tax license plate postings:

More Tax License Plates

A License to Tax?

Listening to the vice-presidential candidate debates, I was puzzled by several comments concerning taxes (as taken from the transcript of the debate). Once again, politicians who have been involved in setting tax policy don't seem to understand it. What a marvelous bipartisan inadequacy.

Let's start with the incumbent. When responding to Edwards' response to the question of whether Kerry could lower the deficit and not raise taxes, Cheney asserted that Kerry-Edwards were determined to "go after" people in the "top bracket," and continued:

Cheney: "They talk about the top bracket and going after only those people in the top bracket. Well, the fact of the matter is a great many of our small businesses pay taxes under the personal income taxes rather than the corporate rate. And about 900,000 small businesses will be hit if you do, in fact, do what they want to do with the top bracket."

Wait. There are about 25 million small businesses in this country. One can argue about the precise measurement depending on how one counts and whose information is used but the order of magnitude isn't in dispute. That means roughly 24 million small businesses would NOT be affected by changes in the top bracket.

Interestingly, Cheney later pointed out, in an anecdote, that product liability insurance premiums may have a bigger adverse impact on small business hiring. Maybe a high tax on contingent fees would generate some revenue?

Now let's turn to the challenger. When asked the question about Kerry's plans to reduce the deficit and not raise taxes, he replied:

Edwards: "And I want everyone to hear this, because there have been exaggerations made on the campaign trail: Roll back tax cuts for people who make over $200,000 a year; we will do that."

A bit later, he adds:

Edwards: "We are for more tax cuts for the middle class than they're for, have been for the last four years. But we are not for more tax cuts for multimillionaires. They are."

Wait. Does that mean that rolling back tax cuts for "people who make over $200,000 a year" is the same as opposing tax cuts for multimillionaires? And what does "make" mean? Gross income? Taxable income? And what about married couples filing joint returns? If "make" means gross income, two spouses each with a $98,000 salary and $2,001 in interest income would have their tax cuts rolled back.

No one seems to comprehend that the top bracket is TAXABLE income over roughly $319,000 (which translates to gross income from $325,000 to infinity). No one seems willing to discuss the idea of creating a new bracket for millionaires and another new bracket for multimillionaires. Lumping taxpayers who earn $500,000 a year with taxpayers who earn $15,000,000 a year is as silly as lumping taxpayers who earn $10,000 a year with taxpayers who earn $150,000 a year.

They don't talk about it because (a) it's complicated, (b) it requires a long audience attention span, (c) it doesn't generate great sound bites, (d) and they don't really understand it.

I'm not impressed. As usual.

With the presidential campaign debate over domestic issues (including taxes and the economy) looming on the horizon, I decided to share some thoughts about taxes and the economy in the context of the disagreement over tax cuts that gets so much attention. My thoughts are mostly questions rather than answers.

At present, the federal government is incurring a deficit, that is, it is spending more money than it is collecting in tax and other revenue. One can argue about the measurement, because there are so many ways to classify the specific income and expenditure items and to determine the year in which they should be accounted, but no matter how that is resolved, the deficit exists, it exists for the current and past years, and it is projected to exist for future years. A key point is that no matter who is elected, the deficit will exist. No President and Congress, however aligned, is going to take the step of raising taxes to the levels to which they need to be raised to eliminate the deficit even if coupled with reduced spending. That's not the issue.

The issue is whether some portion of the deficit should (and will) be eliminated through tax changes. I say "changes" rather than "increases" because the issue is more complicated than simply setting rates.

One charge that is made is that the tax cuts enacted in June 2001 (and subsequently tweaked in March 2002 and May 2003, and extended on September 30, 2004) caused the deficit. More reasonable minds assert that the cuts caused part of the deficit, acknowledging that the cost of the conflict in Iraq and the expansion of the Medicare prescription drug program contribute significantly to the deficits.

A recent study (Household Expenditure and the Income Tax Rebates of 2001) suggests that the rebates received as part of the 2001 tax cuts generated more consumption expenditures on the part of households with lower liquid wealth and low income than for higher income individuals. This is not a surprising conclusions. People with less income and less wealth have a longer or much longer list of consumption items (clothing, food, medicine, etc) which they need to purchase and for which a tax rebate provides the need than do upper income taxpayers. So what? The "so what" is that in mid-2001 the economy was reeling from a recession set in motion before 2001, and was about to hurl into a deeper recession by events several months in the future. Recessions reflect, to some extent, insufficient consumption, generated by reduced income (which in turn causes businesses to spend less, causing even less income). Recession, like inflation, is spiral in effect, constrained only by the forces underway in the economy that have a countervailing effect. If the countervailing effects are few in number or strength, things get out of control. After the Great Depression (a recession gone out of control), the government enacted a variety of controls (such as the Federal Reserve Board's control of the interbank funds interest rate) so that countervailing pressure could be brought deliberately rather than in a happenstance uncontrollable manner. Thus, if the government delivers rebates to taxpayers who spend the rebates, the recession is dampened (and theoretically reversed). Accordingly, lower wealth and lower income taxpayers, make better use of rebates in this regard. So, the argument goes, if what is needed is consumption, funnel the rebates and the tax cuts to the lower wealth, lower income taxpayers because they'll spend it.

But does taxpayer use of the rebate forecast taxpayer use of the tax cuts that went into effect in 2001? Perhaps. I'll assume that the answer is probably, because even with the rebate most, if not all, lower wealth and low income households still had a long list of items which they need to purchase.

The position that tax cuts should be directed to the lower wealth and low income households in order to energize the economy encounters at least three strong and popular objections. They are related. First, it is argued that tax cuts should go to those who pay taxes, consistent with the tax burden being borne. If everyone gets a 10% tax cut, the high income taxpayer with a $100,000 tax bill will get a tax cut that is 20 times the tax cut received by the taxpayer with a $5,000 tax bill. Second, it is argued that the high income taxpayers will use their tax cuts in ways that will "trickle down" to other taxpayers. Third, to the extent the tax cuts are directed disproportionately toward low income taxpayers, the government is engaging in wealth redistribution, a policy and practice inconsistent with the philosophy of limited government and libertarian principle.

These objections raise questions. One question seeks to identify what high income taxpayers do with their tax cuts. It appears that they are not spending them to the same degree as do the low income taxpayers. That makes sense. One can eat only so much food, one can wear only so many clothes (though someone obsessed with clothes or shoes can rack it up in this category), one can take no more than 52 weeks a year of vacation, etc. Presumably, the tax cuts directed toward the high income taxpayer are invested. This is the basis of the "trickle down" argument. The investment can take the form of expanding a business owned and operated by the high income taxpayer, thus generating one or more lower-income jobs that would absorb an unemployed person (or a person employed at a lower wage whose job would then open for the unemployed person). The investment can take the form of the purchase of stock in a corporation (same scenario, simply removed one step), or in a mutual fund (same, removed two steps), or in a bank or other financial institution which in turn lends the money to someone who is either (a) starting or expanding a business (same scenario, removed so many steps I've lost count or (b) spending the money, which infuses business with more receipts, helping it to expand. The investment might also be the purchase of a capital good (home or home improvement, car, appliance) by the higher income taxpayer or by the lower income taxpayer borrowing money from the bank in which the higher income taxpayer invested, thus creating jobs for construction workers, auto workers, etc. I'm a bit convinced by this aspect of the argument, because it truly is difficult to find a construction worker or home repair laborer (and that was before Florida became the "winter of 2004" destination for construction workers).

But as a general proposition, despite the demand for construction workers, it hasn't quite worked out this way. Unemployment hasn't changed all that much. Something is out of kilter. Could it be that the investments made by high income taxpayers of their tax cuts are being made abroad? Perhaps. And would these foreign investments be financing off-shore employment? Perhaps. Is that good for the U.S. economy? In the short run? In the long run?

Some say it is not. Return, now, to the objection that it is better to let the taxpayer decide what to do with a dollar than to let the government to take that dollar and decide what to do with it. This objection necessarily is constrained by the reality that the government will take some dollars in order to finance national defense, national parks, and other programs. In other words, taken to its extreme, this objection would put government revenue at zero and government expenditure at zero. There would be no government. There are people who advocate this extreme position but they are few in number.

When there is a surplus, because the economy is humming along and tax and other revenues increase faster than does government spending, the question of whether the surplus should be returned proportionately or directed totally or disproportionately to low income households poses an interesting question. Would the tax cuts be better used by the low income households? Recall that these households would spend the money. In this economic environment, with the economy humming along, throwing more money into the consumption bucket would increase the spiral, cause shortages of goods and services, and trigger inflation.

On the other hand, if there is a deficit, a tax cut means that the deficit is larger (no matter who gets the cuts). Then the question is whether the deficit would be reduced more quickly if the tax cuts were directed to the low income households or to the high income households. If the high income households are going to funnel their tax cuts to enterprises abroad, the tax revenue would be less than if the money were spent (by any sort of taxpayer) on domestic consumption. After all, the folks being paid to clean gutters and build home improvements, etc., now have higher income and thus will pay more taxes.

Here is the conundrum. The tax cuts were enacted when it appeared that (a) there was and would be a surplus and (b) the economy was in recession and needed a boost. Though the cuts were not directed as disproportionately to the low income households as some may have desired, there was some sort of positive impact. And then a mostly unnoticed declared war went hot in very visible places and life, including economic life, changed. Permanently, but that's another posting someday.

The need for increases in government spending (even aside from the Medicare prescription drug program expansion) quickly became apparent to some and eventually to most. The conditions which had justified a tax cut evaporated. The tax cuts should have been delayed, at least for higher income taxpayers. After all, during war, taxes increase. When I tell my students the marginal rates during the Second World War (which I know from research and not first-hand experience), they gasp. Vietnam brought a tax "surcharge" (a tax increase by any other name is a tax increase). So what happened? Not only were the tax cuts not delayed or discarded, they were subsequently extended.

Why?

Begin with a President who refuses to take away a tax cut, having seen first-hand the adverse effect similar decision making had on his father's re-election bid in 1992. Even Ronald Reagan had to scale back his initial tax cut, but he was gifted with a personality, charm, demeanor, wit, and private meeting persuasion skill that does not exist in any of today's political headliners. In other words, Ronald Reagan could "get away" with raising taxes (and the timing was such that it did not adversely affect him).

Then add in a Congress controlled by the tax-cutting wing of the Republican Party. Having promised constituents that they would go to Washington to cut back the size and intrusiveness of government, including taxation, they are not in a position to go back on that promise so long as they value re-election over economic necessity.

Yet with all the accusations being tossed about concerning the deficit and the horror of the tax cut, the Congress extended the tax cuts in a bill signed into law a few days ago. The vote?
In the House, 339-65. in the Senate, 92-3. Surely the tax-cut Republicans don't hold that sort of majority. No, this was a bipartisan effort. Politicians of all parties (431 to 68) had something in common: the need to trumpet to the voters back home that they had voted to extend a tax cut. "Aren't we nice?"

It's like giving candy to a diabetic child. What the nation needs is fiscal discipline. If the nation is going to provide all that it has promised, the nation needs to pay for it. One can argue the merits of what should be spent on prescription drugs, social security benefits, homeland security, national defense, and the tens of thousands of other expenditures in the federal budget or waiting to be added (no matter who is elected). Tax revenue must equal expenditures. Raise one or cut the other. One can debate how the tax burden should be allocated, and I am not going to reinvent that wheel. Suffice it to say that the worst thing that can be done is to increase spending (something both candidates propose to do, because votes come more easily that way) without raising taxes (something one candidate promises not to do and something the other candidate seems to support though with campaign trail words very different from the realities of the plan).

Yet that is where we are. One last piece needs attention. If government expenditures exceed revenues, how is cash flow managed? Is there a huge Federal credit card? No, there is something better. The government borrows money. From whom? From two sources. Remember the question about the high income taxpayers and what they're doing with their tax cuts? They're investing in U.S. Treasury bonds (and other obligations). And foreign governments (especially China), awash in U.S. dollars because of the trade deficit, are also buying U.S. Treasury obligations.

So, instead of the Congress directing tax cuts to people who would spend the money because they have no choice, the Congress directed most of the tax cuts to the high income taxpayers who then loaned the money back to the government so that it could spend it. When the smoke clears, the government (us) is indebted to the high income taxpayers (and to China, if that makes anyone feel any better).

My next-to-last question: so how is this all that different from a feudal economy, in which the low income serfs were beholden to the high income nobles and royalty (and, tossing in some theology and annoying a few folks, the very high income church)?

Someday, we will wake up and the creditors will be at the door. My last question: Who is going to pay?

This is real. From a reader:

have you considered approaching a publisher about a compilation of the "Best of Mauled Again?" I think your work has a much wider audience than it is able to reach via the Internet. While many articles are timely in nature, most have pervasive timeless themes. I think it provides a fundamental understanding of our system of taxes, both in criticism and foundation of its intent(s). It's worth a thought. The publisher would have to be one who can reach a mass market, not merely a legal or educational market. Think about it!

So, of course, never at a loss for a reply, I asked:

I wonder if a paper publication of a blog is inherently inconsistent or
oxymoronic? Perhaps not. Perhaps it makes for good beach reading, where sand deters taking along the wireless laptop!!

And then along came this food for thought:

I think that cross-platform publishing enhances messages that are powerful. Not everyone (believe it or not) is computer literate. What percentage of the population

a.) can define blog

b.) reads a blog regularly

c.) actually corresponds with a blogger, making them a bloggee..or would that be a blogger groupee .oh, that's me!

I don't know the answers, but I suppose some of you would have an idea of whether it makes sense to "paper the blog" as a concept. Even if that makes sense, how many people would want to be seen on the beach reading a book called "The Best of MauledAgain"?

Well, perhaps they'd think it was an anthology of stories about zookeepers who went back into the cage yet one more time.....

I'm beginning to understand what it must be like to be a newspaper editor, as yet more feedback arrives. Unlike the many letters to editors criticizing what's been written, this feedback refuels my ego. Uh oh, right?

A reader, who wishes to remain anonymous, wrote:

I've been updating myself again with the latest posts on your blog.

Many interesting and well done articles, including the baseball and school supplies topics. I read one of the Soapbox articles, Learning to Teach and Teaching to Learn, which one can only hope the students
who need to read it will truly "get" your point. Unfortunately, they either won't read it or won't "get" it. The problem there stems from years of exposure of students to high school and college teachers who are not required to have an in-depth knowledge of the philosophy of teaching and education. Rather, they are permitted to teach because they have an expertise in a specific field. Even though my car mechanic may be an expert in repairing engines, would he be capable of teaching others his craft?

Probably not. Many higher-level teachers continue to view students as "tabula rasa" (a blank slate waiting to be written upon) and as a result students learn to become receptive containers, rather than critical thinkers and learners. A course in the principles of the Socratic Method should be a requirement for every teacher at every level.

I replied:

The reason law school is so "tough" is that most faculty (not all) try to get the students to think. Once upon a time it was a universal truism of law faculty but it is eroding rapidly. The desire to be "loved" (there are more insecure faculty than I would have imagined) and the unwillingness to deal with all that needs to be done to get students thinking (quality feedback is time consuming) combine to encourage playing to the student evaluations.

I refrained from commenting about the outcry that would arise if "socratic" or even "quasi-socratic" methods were imported into K-12 and college education (even though it exists in some classes in some schools at that level). After all, no one really does it very well.

To my reply came a rejoinder that made me laugh (and has me wondering....):

This can also be said of many college professors and maybe high school teachers. The only teachers who don't worry about being "loved" are the elementary teachers because little kids just automatically love us! Maybe that's the secret....give your students crayons, scissors & glue sticks and have them draw pictures to show that they "think" and they'll do great!

Glue sticks? In a law school?

NAH.

Who would have guessed that the tax license plate posting would bring so much traffic to the site and trigger the largest number of responses?

Yes, more tax-related license plates have been brought to my attention:

TAX REBL - The license plate of convicted felon and tax protestor Lynne Meredith (see this very interesting write-up).

0 TAX - license plate of Portland, Oregon tax lawyer and former tax law professor at the University of Cincinnati School of Law Gersham Goldstein (which only goes to prove that some law schools try to corner the market on creativity). Speaking of creativity, I'm sure that other areas of the law have inspired some interesting license plates, but I think the tax folks are in the lead.

The owner of TAX GEEK emailed me, and passed along some plates she has seen:

501 C3S (rather clever, and my google search wouldn't have caught this one)

TAX ESQ

TAX GEEK explains that she "got the idea for TAX GEEK after seeing TAX NERD on a Virginia license plate in DC."

She adds: "It's been fun seeing the smiles on the highway and around Richmond." I wonder what sort of reactions the other tax vanity plates evoke.

The guessing game can begin to identify the owner of TAX NERD, with information found in this report.

You can go to Paul Caron's TaxProfBlog to see photographs of some of these plates. Yes, Paul is a current tax law professor at the University of Cincinnati School of Law (and I wonder what's on his license plate). Still waiting to find out if these are actual photographs or done up in PhotoShop. See, one of the vanity tags is on the wrong state's plate!