MauledAgain

A Philadelphia radio station has reported that Hawaii's Public Utility Commission has imposed a $2.15 per gallon cap on the price in Honolulu that can be charged for regular unleaded gasoline by wholesalers. Adding in taxes, that's equivalent to $2.67 per gallon. Other limits apply to other areas of the state.

The current average price in the entire state is $2.84. Predictably, the refineries who wholesale in Hawaii criticized the commission's action as counterproductive.

Of course. How long can a business survive if it is commanded to sell its product for less than the sum of the cost of the raw material and the prices paid to process that material? Does the commission think that the refineries' vendors will reduce the price they charge to the refineries? Oh, perhaps OPEC and other crude oil producers will reduce the prices they charge to their buyers, and the reduction will "trickle down" to Hawaii?

This is another limbic system, rabble pleasing, vote begging reaction to a situation that isn't going to be well managed when rational thought is pushed out the door. As I've pointed out in previous posts, the most recent one here, the solution requires cutting demand for oil, increasing supply, doing both, switching to alternative means of energy, or packaging some sort of combination of these options.

I really do hope that the refineries decide it makes no sense to sell gasoline in Hawaii for a price less than total cost of acquiring and processing it. Why? Because I want to see what the next brilliant decision to come out of Hawaii with respect to the gasoline market. Perhaps Hawaiian officials will then order gasoline producers to deliver free gasoline. Perhaps they'll even order OPEC and other crude oil producers to lower prices.

Reality check for Honolulu, anyone?

Sometimes the simplest of things can generate complicated tax law discussions, a phenomenon inconsistent with the assertion that tax law complexity is attributable to the complexity of the transactions in which taxpayers engage. According to a report in the ABA Journal eReport, when the pastor of a church challenged his congregation "to reflect their beliefs by devoting time, talent, and money to the church and the community," one member, an attorney, decided to draft simple wills in exchange for a small donation to the church by the people whose wills he drafted. The requested donation was less than his usual fee. He ended up writing about 45 wills, most for church members, and the church ended up with approximately $2,000.

It didn't take long before the tax experts scrutinized the arrangement. Prof. Ann Murphy of Gonzaga wondered if the attorney had gross income, and if he had a charitable deduction. She also asked if the church would be liable for the tax on unrelated business income. Good questions.

Simple transaction, simple rules, simple analysis, simple answer?

Nooooooo. Not at all. Well, the transaction is simple, the rules are simple, the answer is simple, but the analysis isn't.

A person who performs services for compensation must report gross income, subject to several exceptions not relevant to this discussion, such as the performance of certain services overseas. At first glance, someone unfamiliar with tax law would conclude that the attorney was not paid and thus has no gross income. But years ago, in fact, decades ago, the courts held that a person could not avoid gross income by having the compensation paid to another person. This principle reflects what is called the assignment of income doctrine, namely, assigning income to another person does not shift the tax incidence. Thus, there's no tax advantage to telling the employer or the client to pay the salary to the children, a trust for the children, or a charity. In fact, in Regulations section 1.61-2(c), the Treasury Department explicitly provides that in the sort of situation being described, the person providing the services must report the gross income.

So the attorney has gross income, and then is deemed to pay the amount involved to the church as a deductible charitable contribution. Would it make a difference if the attorney did not report the income and did not claim the charitable contribution deduction? Wouldn't taxable income, and tax liability be the same as if the gross income were reported and the deduction claimed? No, because the tax law is loaded with limitations, floors, ceilings, and other wrinkles that don't guarantee a dollar-for-dollar offset of deductions against gross income, though it can happen, but no one but the attorney knows whether any of those wrinkles would apply to his tax return. For example, if the attorney claimed the standard deduction, the charitable contribution deduction would be "wasted," though this is an unlikely scenario.

Yet isn't there something intuitively "wrong" about requiring the attorney to report gross income? After all, what if someone approaches the choir director and says, "If the choir sings Rutter's Magnificat on the third Sunday of Advent, I'll donate $3,000 to the music fund." Do the choir members have gross income? The answer surely is no, but why? Is it because the choir members aren't professionals? Suppose one or another of them is a professional, earning a living by singing during the week at other venues? Certainly there are differences between this example and the lawyer preparing the wills. The choir members did not pre-arrange the payment in exchange for their services. They did not perform a service solely for the donor, but instead provided it to the church (and I suppose, in a theological sense, as a worship gift to God). They almost surely would have sung something on that Sunday. As a practical matter, the donation probably was used to pay professional musicians whose presence would be needed for the piece, but that is a distraction from the core question.

The intuitive reaction, though, sparked an interesting discussion. One participant in the discussion initially noted that the lawyer did not receive the money, and the money was not available to him, thus precluding application of the constructive receipt doctrine, and thus precluding gross income. The constructive receipt doctrine is in part a gross income identification doctrine and is in part a timing doctrine. In its classic form, it deals with situations in which a taxpayer tries to defer gross income to a later year, because the time value of money encourages postponement of income that generates tax liability and because the tax rates in a later year might be lower. It also is a doctrine implicated in the principle that income deflected to another person is nonetheless the income of the person who performed the services because they were in constructive control of the income. But whether or not the constructive receipt doctrine applies, the assignment of income doctrine surely does, as evidenced by Regulations section 1.61-2(c).

It is fascinating that a matter as to which the law is settled can trigger extensive discussion. Yet, that is one way the law evolves. Otherwise, if no one discussed the question because the law was settled, the law would be less like to change, even if change was sensible.

The participant who raised the constructive receipt issue then backed away from that approach, and pointed out another interesting authority. In Revenue Ruling 74-581, the IRS concluded that law professors operating clinics under the auspices of law schools, who receive payment for services, and who turn those payments over to the law school, are NOT required to report gross income. It appears that the rationale is that the law professors are acting as employees of the law schools, receive the payments as agents of the school, and thus do not own the payments. This makes sense. A cashier in a store does not report as gross income the amounts paid by customers to the cashier because the cashier is acting as an employee and agent of the store owner. The gross income is the store owner's gross income. So the clinic income is the law school's gross income, but because the law school is almost certainly tax-exempt, it won't pay a tax on that income. Could the lawyer assert that the amounts paid to the church are not his gross income because he is acting as agent for the church? No, not under these facts. The lawyer is not the employee of the church. The church is not, and cannot be, in the business of preparing wills. One participant noted, in a very clever and smile-generating comment, that "I have always thought that part of a church's 'business' was to prepare people for the hereafter and seems that will-prep fits right in to that mission !" I doubt, though, this would get very far in tax litigation!

Several participants pointed out that "it does not make sense" to treat the donations as the lawyer's gross income. There's something to be said for this position. Yet, it is not unusual for the tax law to require an outcome that does not make sense.

Another participant pointed out a serious practical problem. The persons whose wills were drafted and who wrote a check to the church probably claimed charitable contribution deductions. Yet, applying the assignment of income principle, they were in effect writing checks for legal services for which no deduction is allowable (because of the personal nature of the services). The attorney, required to report the gross income, and allowed to claim a charitable contribution deduction, already claimed the deduction. It violates basic tax law principles, and policy, to permit two taxpayers to claim the same $50 charitable contribution deduction for one $50 check written to the church. Yet, absent the imposition of additional reporting rules (translate: more paperwork), the IRS is unlikely to identify these situations and correct the tax returns.

Note that if the services are provided directly to the church, there is no gross income and there is no charitable contribution deduction. Thus, had the attorney volunteered to fill out information and/or payroll tax returns for the church, there again would be an easy answer. The attorney isn't being paid, no one is making a payment "in recognition of" the attorney's volunteer work, and no income is being assigned.

And note that if the person whose will is prepared donates more than the services are worth, which apparently was the case with several of the people involved in the story, the excess would be not be gross income to the lawyer, would not be deductible by the lawyer, but would be deductible by the person making the donation. Determining what the services are worth ought not, as a practical problem, be too difficult.

Thanks to Paul Caron for bringing the story to our attention, and thanks to Bryan Camp, Joe Dodge, David Hasen, Calvin Johnson, Stuart Lazar, and Elliott Manning for their helpful, interesting, and sometimes humorous comments.

# posted by James Edward Maule @ 10:45 AM

Too often, someone starts an on-line project and then lets it go, for whatever reason, good or bad. If the project is a good one, it's disappointing to see it fall by the wayside. That's not the case, though, with Andrew Mitchel's tax charts collection. It's growing. This is at least his fourth update. Perhaps I've missed one or two, but in the previous three posts (here, here, and here), I described generally what he was mapping out and why it's worth a visit.

Of course, each update brings new material, but the reasons for visiting don't change. The tax law, like most other areas of the law, lends itself to visualization through charts, pictures, animation, and other devices that helps us "see" the rules and their application to the facts.

This time Andrew has added charts for cases such as American Manufacturing (Outbound D Reorganization), Clark (Boot Treated as Received in Hypothetical Redemption), Kimbell-Diamond (Stock Purchase & Target Liquidation Treated as Asset Acquisition), J.E. Seagram (Tender Offers with Forward Triangular Merger), and rulings such as Rev. Rul. 70-106 (Minority Redemption & Majority Liquidation Not a Sec. 332 Transaction), Rev. Rul. 70-140 (Purported 351 Followed by B Reorg) ,Rev. Rul. 75-161 (D Reorg with Liabilities Exceeding Basis), Rev. Rul. 83-142 (Circular Flow of Cash in Foreign Spin-Off), and PLR 200225032 (U.S. Tax Treatment of German Organschaft).

Andrew also announced that he had "updated many of the charts that were previously posted," and that the "site now has a total of 88 charts (25 cases, 32 rev. rul.s, 1 PLR, 9 generic tax free reorgs, and 21 indirect stock transfers)." He welcomes feedback. Hopefully there's some "More, more" among the comments.

Incidentally, this is a great resource not only for tax practitioners, but also for people teaching tax courses in these areas and for students taking courses that deal with these topics. That type of cross-activity utility is one of the reasons I'm a fan of Andrew's tax chart site.

Chocolate is back in the news. More specifically, the medicinal qualities of chocolate are back in the news. According to this story, there is even more scientific evidence that the flavanols in cocoa beans somehow reduce the risk of heart attacks, strokes, diabetes, dementia and hypertension. That's good news.

But when there is good news, the bad news isn't far away, is it? The bad news is that most chocolate available for purchase lacks the flavanols. They're removed during the manufacturing process because they have a bitter taste. More bad news. Chocolate has calories. And fat. So it needs to be ingested in moderation. My mother has been preaching that point for years, along with the principle that a good meal is multi-colored. After all, fat per se isn't bad. It's the quantity. Try taking all the fat out of a diet (as I did), and it's amazing how the energy simply disappears. And so, if fat is necessary, why not get it in a healthy form (chocolate) rather than in some other form that doesn't bring benefits and has other risks?

Of course, one can get flavanols out of red wine, grapes, apples, and green tea, but cocoa beans apparently have much more flavanol per ounce. Red wine and chocolate. Hmmm.

The news has had an impact on the food industry. Mars announced that its dark chocolate Dove bars are full of flavanols. Hershey's is introducing a new Extra Dark chocolate bar. Mars is also marketing a CocoaVia snack bar, to which sterols have been added. Isn't technology great? Getting through life living on medicinal chocolate snack bars..... :-)

But the bad news is that to reduce blood pressure, a person needs to eat a lot of chocolate. Bad news? Yes, if the caloric intake matters to the person.

Sarcasm time. How long until there is a tax credit for eating chocolate? After all, with its beneficial health consequences, increased chocolate consumption could lower health care costs. Or perhaps a tax credit for manufacturing and selling dark chocolate and reducing the sales of flavanol-poor chocolate. Wouldn't it be fun to write the regulations under that provision?

Former student Nakul Krishnakumar sent me an email a few days ago, inviting me to comment on Steve Forbes' revived flat tax proposal. Nakul wrote:

I'm sure you've already seen this, but Steve Forbes has a great article in the WSJ regarding the flat tax. Of course, having read this article, I was reminded about a discussion you and I had about two years ago on this same topic. I'm sure you've probably discussed this topic ad nauseum with other people, but I would like to get your take on his plan.

His plan calls for (I'm outlining the basic plan) the following:

(1) a 17% flat tax on all income;
(2) no tax liability for families that make under $47K;
(3) a 17% corporate tax rate (with immediate deductions for business expenses, thus no depreciation!);
(4) a 0% capital gains tax; and
(5) elimination of the death tax

Overall, I like this plan because it would simplify the tax code and result in an economic expansion (although I cannot say this for sure). At the very least, I think it would be easier to comprehend than the current system (then again, anything, including quantum physics is easier to understand than the current system).

I suppose the flat tax plan, no matter which version is current in vogue, is the tax reform idea that will not die.

This specific Forbes plan has been criticized by Michael Kinsley and others, and Forbes has penned a rebuttal. Despite all of the arguments, there are a few simple things about "flat tax" plans that need to be understood.

Flat Rates

As Kinsley notes, the basic rate structure is not the cause of tax complexity. Although there is a wee bit of multistep computational exercise in calculating tax at x% on the first $n and at y% on the next $m, computer software can handle that task and most taxpayers who paid attention during arithmetic class can figure out a tax liability even without the aid of a computer, though a calculator could come in handy. On the other hand, removing the alternative minimum tax and scrapping the special corporate taxes would be a worthwhile simplification. And keep in mind that so long as there are progressive rates, some sort of mitigation system and its complex computations is required to deal with after-the-fact adjustments in income.

What makes the tax law complicated is the definition (or computation) of the taxable income with respect to which the tax liability is computed, and the proliferation of artificial social policy credits that are subtracted from tax liability. The latter are even more convoluted than first meets the eye because some are refundable, and some are not, some can be carried over to other years and some can not, and some allowable against the alternative minimum tax and some are not.

Tax simplification will occur only when the special interest infections in the tax law are wiped out. Despite law professors taking their students on tours of the definitional edges of "what is income," in most instances income stands up and identifies itself. It's the exclusion list, the deduction list, and the timing rules that take the simple thing and make it unduly complicated. To the extent that any reform proposal, flat or otherwise, removes the exclusions and deductions, it simplifies the tax law. But political support would disappear once taxpayers understood that deductions for home mortgage interest would end, that scholarships and gifts would be included in the tax base, and employee fringe benefits would be taxed. Of course, the emotional outcry would prevent most people from taking the next logical thinking step, which would be to consider the huge decline in tax rates that such a truly broad base would permit.

I can hear the shouts now. "It is immoral to tax scholarships because these are poor kids trying to get an education." Au contraire! If they are truly poor, and a income less than the poverty level or something equivalent to it is exempt from tax, the youngster with only a $12,000 need-based scholarship would not be taxed, but the independently wealthy but highly intelligent student with a $12,000 merit scholarship would probably incur some small amount of tax. Similarly, taxing all social security received in excess of the employee contribution is a proposal that triggers cries of horror from every corner, but it makes no sense to tax more or less than what the recipient has received over and above his or her contributions, and again, the wealthy person hauling in these payments would be taxed and the poor person would not. All of the shenanigans in section 86 could go down the drain.

It would take, at most, one millisecond before the "my activities are special" bleatings begin to fill the hallways of Congress. This mentality, which is self-focused and cannot put the overall common good above the narrow-minded concerns of the self-appointed special, would bring highway traffic to a halt if it were applied to bridge and turnpike tolls. "We're on our way to college, so we get a discount on the toll that will take 20 minutes to compute...Hey, honey, do you have that information on how many nonqualified courses Johnny is taking?" "Hey, speed it up, my spouse and I are on social security and we need to figure out if we use the base amount or the modified base amount in computing the toll." "We're on our way to a hospital. Can we go through now for free and pay double when we return?" You get the picture. Do members of Congress see it?

Exemption Amounts

The idea that income under a specific amount should not be taxed makes sense. The tough question is faced when it is time to determine that amount. Should it be based on individual income? Household income? Marital unit income? Extended family income? I have proposed, over and over again, to no avail, that the amount should be computed for each individual, that it should reflect 110% (or some similar percentage) of the poverty level, and that an individual whose income is less than the exemption should be permitted to transfer or sell any "unneeded" (excess) exemption to anyone else. A similar arrangement exists with respect to pollution credits, and in the context of the income tax it would generate income for the poor and tax savings for self-defined groups, ranging from marital units to mutual friends and unmarried siblings sharing a household. It moves part of the tax law out of the government and into the private free market. Rarely is this proposal criticized. It simply is ignored. That suggests to me that it frightens a lot of people who are in the power elite. That, in turn, suggests to me that it poses a threat because it might, just might, work. And be the first crack in the present system of designing tax law.

Flat Corporate Rates and the Elimination of Depreciation

If I had my way, corporate income would be taxed to the owners of the corporation. Many other people share that idea, but it never seems to get off the ground. So long as corporations must be taxed, that is, assuming they cannot or do not elect to be treated as an S corporation whose income is in fact taxed to the shareholders, then the argument for a single rate fails for the same reason it fails in the individual context. It isn't the reason for complexity. Corporate tax law is complicated not only for the same reason as is individual income taxation (exclusions, deductions, credits, timing, etc.) but because the structural transactions of corporations, such as divisions, mergers, reorganizations, and similar changes, are subject to a complex maze of tax rules most of which could be eliminated if the special interest groups were pushed to the side.

The question of whether expenditures for property that is not consumed within the taxable year should be deducted has been vexing tax policy for decades. One side claims that income used to purchase buildings, equipment and other property ought not be taxed. The other side points out that the tax law is so twisted that people who purchase office buildings are permitted to deduct depreciation even as those buildings increase in value. I think the compromise would bring quiet to the room, at least until the tar and feathers are ready. I'd agree to deducting the cost of a building if the taxpayers agree to include in income the increase in wealth that occurs when the building increases in value. Why should a corporation, or any other business for that matter, be allowed a deduction when it is increasing its wealth? It makes no sense.

The Zero Percent Capital Gains Tax

This is the deal breaker. Forbes wants to retain the special treatment of capital gains. Most tax practitioners, but few taxpayers, know that at least one-third, and perhaps one-half of the complexity in the substantive portion of the Internal Revenue Code, a similar portion of the regulations, and a huge chunk of rulings and cases, arise from the need to distinguish capital gains from other income. The existence of any capital gains tax break encourages taxpayers to play the "let's make ordinary income look like a capital gain" game. What a waste of time. Income is income. The bartender doesn't ask if the dollars being used to pay for a drink are capital gains dollars or ordinary income dollars. The only plausible argument for treating capital gains differently is that some of the gain is artificial because it reflects inflation. The solution to that problem is to index the adjusted basis of property, just as all sorts of amounts in the tax law are adjusted for inflation. It's easily done, and it would permit trashing a huge portion of the tax law.

Any "flat tax" that has a capital gains preference is not going to be simple. Not by any stretch of the imagination. And the presence of such a preference in a proposal is an excellent clue as to the consequences of such a flat tax, whether or not that consequence is intended or simply misunderstood by the proponent. And until and unless the American tax-paying public comes to understand what's going on with the capital gains game, the prospects for genuine reform are slim.

Elimination of the estate tax

I have mixed feelings about this one. The gap between the haves and have nots is widening, and the middle class is beginning to disappear. So the emotional reaction is a temptation to advocate some sort of "tax the [fill in the adjective] rich" provision, whether it is the very rich, exceedingly rich, super rich, filthy rich, whatever. But logic also suggests that the cost of administering an estate tax, especially when it affects such a minuscule percentage of estates, is inefficient.

There are two easier ways of achieving the same goal. The first is to tax unrealized gains at death, subject to a rate that reflects the bunching effect of putting all that income into the final income tax return of the decedent. Perhaps "year of death" gains should indeed be subject to lower rates, coupled with a much higher exemption amount. The second is to tax unrealized gains as they are realized (remember the folks who want deductions for property that is increasing in value?), with a deferral of the tax payment until property is sold and cash becomes available. The tax payment provision is not a new one; it already exists in the tax law for certain estate tax situations.

Either of these two solutions removes the emotional argument that is made on the repeal side of the issue. It would eliminate the "it's being taxed twice" argument, one that does not withstand logical analysis even when the current income and estate tax structure is considered.

I'm sure this is much more than Nakul had expected. No, wait, he's been in my courses, and he knew that my short email response to him would expand when I took this to the blog. And none of it is news to him. He's heard, at least one and probably a few times, my income tax reform plan: genuinely expand the base by removing exclusions and deductions, provide a substantial per-individual transferable exemption, trash the social policy credits, and subject the taxable income to a genuinely progressive rate structure. And he has heard me say that the chances of this happening are slim to none.

But it is fun to discuss. And it is fun to write about it. Even if it is ad nauseum. What's nauseous, of course, is a close look at the existing tax law.

In eight days it will be time, once again, to teach the first class of the new semester. The students in my Introduction to Federal Taxation course are second and third year students. During the past decade, the enrollment in this necessary, but elective, course has become progressively more self-selective. Students who do not want to do the work that I require during the semester, and who prefer a course in which they can coast, find an old outline, and cram for an "all eggs in one basket" final examination avoid my courses. It's no secret.

They claim that I am too demanding. My response is that I am as demanding as is the law, as are the clients, and as are the partners, judges, or other supervisors to whom the students will be reporting when they graduate. There's little room in practice to coast for fourteen weeks and then cram everything into one all-nighter. Law practice is a rude shock to most law graduates. Those who make the smoothest adjustment are those who have been in law school clinics, in well-run externships, in law firm summer programs that are more demanding than the "we are wooing you, so let's go to a ball game or concert" experience, and those who somewhere in their previous education acquired robust self-discipline and good academic study habits.

One of the reasons that my courses are so challenging is that they involve subjects requiring far more than the 42 50-minute class sessions allocated to them. Introduction to Federal Taxation remains a three-credit course, as it was 30, 40 years ago, even though the Internal Revenue Code, the regulations, and case law have multiplied many-fold during that time. Even setting aside the arcane and irrelevant, the individual income tax provisions that are the primary focus of the course have blossomed like weeds after a week of rain. There's insufficient time to devote several classes to one provision, and there's insufficient time simply to have extended discussions about the specific tax policies reflected in the provision or to air each student's "feelings" about tax law (as if none of us could guess).

To learn the basics of federal taxation, therefore, students need to do a significant amount of self-teaching. They need to read and ponder before class, even if they don't quite grasp what's going on with the statute. After all, as I explain to them on the first day, a failed effort is far more valuable than no effort. After class, they need to assimilate the material. By creating their own outlines, graphs, charts, tables, or other learning aid, they are learning through that process. Grabbing someone else's outline or other work product from the previous year is useless, not only because it is equivalent to trying to get in shape while watching someone else run the treadmill, but also because in tax the previous year's work product will be obsolete to some extent. I always include a few questions during the semester and in the examination designed specifically to identify those students who studied from an outdated study aid, and during the past few years, as self-selection has increased, the number of students making this particular, and critical, mistake has diminished significantly.

Note that although it is important to take notes, I teach in a way that emphasizes the need to think about what is said in the classroom, and to write down the essential points, rather than to take dictation. To discourage note-taking of the college lecture-hall variety, I make my Powerpoint slides and other materials available ahead of time so that students have less need to write things down. Fortunately, the days of students asking me to slow down as I read a Code section so that they could write every word have come to an end, because students do understand there's no point in writing down what's already in front of them as I read it. Instead, they can rely on my voice tones, pacing, and repetition of phrases to highlight the key words and phrases in the provision.

Yet, for most students there still is a rude shock when on the first day of class I tell them that I expect them to do several hours of work outside the classroom for every hour in the classroom. I explain why, pointing out what I've already written in this post. That they are no longer in college is a fact that needs to be highlighted. I describe how they are at a disadvantage, trying to earn a doctoral degree in a discipline in which they have not studied and for which they do not have a bachelor's or master's degree. There's a lot of catching up to do. Underneath my policy is this simple dose of reality: Law students are enrolled in a graduate program, working toward a doctoral degree, in preparation for professional practice. Concomitant with that posture is a requirement of diligence, independent study during the semester, class attendance, preparation for class, and post-class assimilation. Yes, welcome to what should be, and often is, a most demanding graduate school preparation for professional practice.

There is so much to do that proposals have been floated from time to time suggesting that law school be extended from three years to four years. This would provide the opportunity to increase course credits in areas where the law has expanded since the current core method of teaching law school was adopted more than a century ago. It would permit, assuming the requisite funding were obtained, additional law school clinics so that every law student, rather than several dozen, had a taste of law practice before entering law practice. It would provide more flexibility in scheduling, so that more students could enroll in an externship, another experience that, if properly administered and operated, can introduce students to the realities of law practice. The principal downside is that the cost to a student of a law school education would increase by roughly 33 percent. If adopted, the proposal would put classroom and other physical facility strains on those law schools (translate, most law schools) lacking capacity to absorb a larger student body.

Others have proposed that law school be shortened to two years. The principal argument for this proposal is that the third year of law school is a waste of time because students are learning anything they haven't already learned. Wow, that must be a surprise for the third year students who've been in my courses. Of all the criticisms, they've never said they're not learning anything, or that they are bored, or that they are wasting time.

Thus, carrying the outlook on legal education part of which I have shared in this post, I was shocked to read the following excerpt from a New York Times article on the wisdom of having a third year of law school. Entitled "Some Question Third Year of Law School," it begins with this delightful yet eye-catching anecdote:

Now a corporate lawyer, Jennifer Leong fondly recalls her third and final year of law school. A job secured, she traveled frequently. Her courses included feminist jurisprudence and a half-semester bankruptcy seminar -- each carefully chosen to get her weekend started by Wednesday afternoon.

"A lot of beer and softball," recalled Leong, who got her University of Virginia law degree in 2000. "Third year was probably the best year of my life."

Here's a graduate of an arguable elite law school sharing but one example of many anecdotes that permitted the article's author to then write:

At many top law schools, the third year is famously relaxed, a halcyon interlude between rigorous introductory courses and the long hours that await graduates at law firm jobs. There is research and volunteer work, but also a lot of bar-hopping and little studying: 15 hours per week, according to one survey at 11 law schools, compared to 33 hours for first-year students.

Note that according to my computations, a student enrolled in 14 hours of class during a semester should be putting in anywhere from 28 to 56 hours a week outside of class, with most students needing roughly 40. First year students at top law schools are very bright, so the 33 hour average probably isn't that far off the mark, but 15 hours for the third year students? What's going on?

My guess is that what is going on is that the students are not being offered, or are staying away from, demanding courses. By definition, a demanding course, one that reflects what the practice world will require, doesn't permit a student, no matter his or her intelligence, to get by on what works out to be about 3 hours a week per course. Where is the rigor? Where is the in-depth focus that a capstone third year course should bring to an area of law, where material learned in multiple previous courses is synthesized into a transactional experience? For those who haven't been to law school, a quick example would be Business Planning. Students in this course, having been through the Business Entities or Corporations course, perhaps a Securities Law course, certainly a course covering Corporate or Business Entity Taxation, and maybe a Secured Transactions or Bankruptcy course, are given the opportunity to plan the formation, operation, and termination of a corporation, limited liability company, and partnership. Goodness, it's like being in a law firm practicing law. It isn't going to go well, except for the rare paralegal who previously practiced in the area or the occasional student who had an externship doing this sort of work, if the investment is 3 hours per week.

The Times article nicely explores some of the arguments for shortening or lengthening law school. It points out that some third year law students put in enormous numbers of hours. Enrollment in a clinic, for example, will make that inescapable. The article quotes faculty whose research disclosed that many third-year students attend no more than 60 percent of their classes. A well-taught course brings the tag "going to class is essential." Even though I would expect someone preparing to be a professional to attend classes because of dedication to the goal, I also understand that a poorly taught course can make class attendance counter-productive or at best, useless. There are ways to encourage class attendance, and the best ones are those that also improve the course and make it so attractive that students cannot afford to stay away.

Some of the arguments with respect to the length of law school involve money. Money, though, should not be such a driving force that quality is sacrificed for the sake of economy. That's true in other worlds, as manufacturers of many products have discovered. Yes, if there are less expensive ways to achieve the same level of quality those opportunities should be pursued. But if it takes four years of law school, including a semester of externships and a law school clinic experience, to produce law graduates who can more easily and efficiently transition to law practice and provide quality services to the clients who ultimately pay their salaries, then that is what needs to be done. After all, medical professionals invest far more years in their studies, including the advantage they get by starting their medical studies while in college through courses such as organic chemistry. Law school ought not be, for the reasons described in Money for Nothing and Work for Free?, a "quick and (therefore) cheap" path to a high-salary career, nor should it be a "cash cow" for universities seeking to finance economically inefficient academic programs or athletic departments. The appropriate investment, in time and money, must be made.

I know there are many lawyers, and law students, who work hard, attend(ed) class, prepare(d) for class, study, and continue to self-teach (which is, of course, as I describe in Learning to Teach and Teaching to Learn, the best form of learning). But I wonder if the rising levels of frustration among young associates in law practice is not only the product of the changing nature of practice that demands high billable hours and fosters cutthroat behavior but also is the difficulty of making up for lost law school education opportunities in a practice world that doesn't permit billing out the learning of an avoided course or the re-learning of an unattended course and that cannot afford to provide hours of mentoring time by similarly pressed older associates and partners.

Law schools, hopefully under increasing pressure from practitioners and judges, need to do some serious self-examination. Long before the details of curriculum, schedule, credits, number of years, adoption of clinics and other matters are tackled, law schools need to resolve the question of what they are trying to do. Putting aside the elegantly worded mission statements, the ultimate inquiry comes down to resolving this debate: Are law schools preparing their students for the practice of law or are they preparing their students to be legal philosophers? I've engaged in that debate numerous times.

On the one side is this sort of statement from former Supreme Court Justice Felix Frankfurter:

T]he business of a university [is not] to turn out finished practicing lawyers. A law school is not a law office or a court room. In these days of overemphasis upon the immediately practical, it cannot be insisted upon too often that a university law school is part of a university. Intellectual issues are its concern. [A law school must promote and encourage] the continuous critique of all law-making and law-administered agencies. [This falls] peculiarly within the competence of scholars, and the promotion through formulated reason of wise adjustments of the multitudinous and increasingly conflicting interests of modern society.

Do I dare disagree with the great Frankfurter? Yes, unless one understands that he made his statement when the practicing bar still had preceptorships that were to law graduates what residencies are to medical school graduates. Yes, the practicing bar has contributed to the problem by abolishing preceptorships, which it did because those were expensive experiences, more in terms of mentoring time than in terms of money, but expensive nonetheless. After all, if they fit within the profit-centered business approach that has overwhelmed the profession, the profession would have brought them back.

More importantly, there is no conflict between the notion that law schools prepare students to be practicing lawyers and the idea that law schools should engage in analysis of the law. Law schools are not trade schools. It's inefficient to teach law students, other than in clinics, how to find the office or web site of a court clerk. On the other hand, when second-year students tell me that I'm the first professor to use the word "client" in a classroom or to put issues in terms of client interaction, it alarms me. Clients, after all, are an ingredient in how the law develops, and anyone who wants to focus on analysis of law needs to understand the reality, because reality is what stands between theory and implementation (or non-implementation) of theory.

The point is that law school should, and usually does, teach its students to think. Not that lawyers are the only people who need to learn how to think, and not that one should expect the K-12, or the undergraduate system, to have done the job, but there is something a bit more refined in legal thinking than is found in most K-12 classes and many undergraduate classes. Law, whether in practice or at the theoretical level, is and needs to be focused on the prevention of problems and the solving of problems. It is, therefore, a matter of learning how to solve puzzles and how to understand the creation of puzzles, as I argued in Doing Puzzles While Learning & Practicing Law. It requires rigorous effort. Any program that permits a student to slide by drinking beer, playing softball, having 4-day weekends, and investing only a few hours in studies, is failing. Whether it is an individual student who isn't meeting requirements, or a culture that tolerates mediocrity, the situation demands correction. After all, do practicing lawyers really want to hire students who have not maximized their opportunities? Are law firm interviewers asking the right questions of their law students?

I was embarrassed to read the quotation that led the Times article, and I'm not even affiliated with the law school in question. I'm embarrassed for the legal education profession. After all, what are the readers of the Times article to think when after hearing for years that law school is "so tough" they see that its third year gets portrayed as, to quote the article, a "famously relaxed, a halcyon interlude." And then practitioners wonder why their clients object to the $500 per hour fees that are charged.

It was inevitable. As gasoline prices resumed their climb, conversations have once again turned to the "awfulness" of "high" gasoline prices. Toss in discussion of home heating oil price concerns as the oppressive heat and humidity fail to deter homeowners from pondering the not-so-distant change in seasons, and the makings of a good flurry of rumors and panicked cries are beginning to percolate.

This morning, as I was driving home from the gym, burning all of four cups of gasoline, the air personality on a New Jersey station was commenting that even though American gasoline prices were nowhere near those in places such as Europe and Hong Kong, there was something about the sticker shock that he didn't quite grasp. He did a fine analysis of how gasoline prices have risen proportionately to income over the past 30 years. He challenged people to compare their gasoline prices to their incomes, and to ascertain if the percentage has changed significantly.

His take on the question makes sense, but it misses several key points. First, for someone who began purchasing gasoline in the late 80s or early 90s, gasoline prices have risen more quickly than has income. For these people, the relative price of gasoline 30 years ago is history rather than experience. The same can be said for someone who started paying for gasoline a year or two ago. It all depends on the precise point in the price-history curve that the person arrives. Second, for some people, income has not risen as quickly as has gasoline prices. After all, average income increases are inflated by the huge pay inflation at the top of the pay scale. Third, comparing per-gallon gasoline price to income misses one of the chief ingredients of the energy crisis, namely, that most people are driving more miles each year.

I addressed the gasoline question in detail more than a year ago, in May of 2004, when gasoline price increases were being closely covered by the press. That discussion followed an earlier post in which I argued that gasoline taxes needed to be increased to keep pace with inflation and the rising costs of road maintenance, and it was quickly followed by a Memorial Day 2004 post rejecting the notion of toll-free highways for vehicles with higher fuel efficiency. Late last year, in an election-oriented post, I pointed out that politicians don't help Americans analyze the problem because they present inconsistent and inaccurate soundbites with respect to the issue, choosing to say what people want to hear rather than the truth that needs to be told.

Considering how much bad information, emotionally-driven exaggerations, politically-motivated alarms, and frustrated expressions of self-centeredness have infiltrated the newspapers, radio talk shows, and cable networks, it's worth once again looking more closely at the facts. Failure to do so is what lets lawn contractors get away with increasing overall prices by 20% when gasoline prices, constituting 15% of their costs, increase by 25%. Do the math.

Has the passing of 15 months discredited any of my comments from May of 2004? Here are those comments, and today's reflection on them.

I began with the same point I just made:

It's amazing how an increase in gasoline prices can generate so much consternation. Politicians grab onto the issue as though it's the be-all and end-all of life. Accusations fly, bizarre solutions are suggested, and very few take the time to sit down and THINK their way through the situation.

In this respect, nothing has changed. No surprise there. I then proceeded to assert that "There are five major considerations: supply and demand, inflation-adjusted cost, industry patterns and government regulation, taxes, and strategic reserve." and I continue to think that these remain the focus of any analysis.

Turning to the first one, I stated:

Supply and demand is easy. If demand goes up, or supply goes down, or both, prices go up. That's Economics 101, which ought to be taught in high school, and perhaps it is, here and there. Demand is going up at a phenomenal rate, on a global basis, particularly because China is growing and its need for energy is skyrocketing. Total miles driven by Americans has increased at rates far beyond the rate of increase in the population. Supply has been decreased, but will be tweaked up a bit in the near future, for a complex array of economic and political reasons. Although OPEC controls only a small fraction of total world-wide oil, the oil market is a marginal one, which gives OPEC supply decisions a noticeable impact. Although OPEC is perceived as making its supply decisions solely for political purposes, in fact it is influenced by economic conditions in its member nations and by their desire to manage a finite national natural resource in careful ways.

This continues to be the case. The law of supply and demand has not been repealed or amended. All that I will add is that gasoline, heating oil, and other energy products are simply in the vanguard of a long line of commodities that will become relatively scarcer as populations skyrocket, developing nations develop, and environmental and other pressures curtail production; I'm thinking principally of fresh, clean drinking water.

On the second consideration, I noted:

Inflation-adjusted cost is easy. Take a look at gasoline prices in 2004 dollars over the past 85 years and it's obvious that gasoline has been selling for less than its real price for many years. During the 1990s gasoline prices reached record lows in real dollar terms. Consider this gem from a letter to the editor of the Augusta Chronicle in 2001: In 1960 gasoline sold for 30-33 cents a gallon and a full size Ford sold for $2,000-$3,000, and in 2001 the Ford sold for ten times as much. Why Americans think they are entitled to "cheap" gasoline bewilders me. I've spent time in Europe, and despite the "non shock" of seeing "1.30" as the price, once that price in Euros is adjusted for the fact it is a per litre price, it's pretty obvious that the per gallon cost of gasoline in Europe is far more than what's being paid in the U.S. today. Part of the reason is taxes. More on that in a moment.

As with supply and demand, nothing much has changed here. As I pointed out, these sorts of comparisons don't resonate emotionally with people who entered the gasoline market as purchasers at times when the price curve was below the overall average, but the same can be said with respect to any commodity that experiences a significant price fluctuation.

The circumstances with respect to the the third consideration also appear to have held constant. I stated:

Industry patterns and government regulation is more complex. Gasoline prices go up in the summer, because demand increases. But industry isn't always ready to crank up the production, because if there has been a cold and/or longer winter it has to replenish heating oil stocks and thus delay the switch over to increased gasoline production. Short-term prediction for tne next six months show gasoline prices dropping back after the summer. It's a pattern as familiar as the sun rising in the east and setting in the west. There hasn't been a new refinery built in this country for the past 30 years. Why? Unprofitable? Yes, after taking into account the cost of trying to wade through a gauntlet of government regulations. Some of those regulations are necessary, and some are well-intentioned but badly designed. This isn't a problem fixed overnight. The time from beginning a search for new oil fields and gasoline from that field reaching the pump is at least 10 years, perhaps more.

I should add, however, that work has begun on the construction of several new refineries and the expansion of several others. Though refinery capacity does not change crude oil supply, it might alleviate some of the seasonal cycling in gasoline prices. Whether that will ease people's distress is unclear.

The fourth consideration, gasoline taxes, hasn't had much, if any, attention during the current gasoline price surge. I will repeat what I stated so that I can tag an addendum onto my comments:

Taxes in this instance are easy to understand. Yes, the anti-tax politicians (who try to get elected on the "no taxes ever it's all free" delusion that sells to non-thinking voters) are yelling that the reason for the increase in gasoline prices is taxes. Rubbish. Here and there a few states have increased gasoline taxes but during this last gasoline price run-up taxes haven't changed. They should, of course, because a ten cent per gallon gasoline tax enacted in 1970 to pay for road maintenance needs to be more than that to provide the same level of maintenance. These politicians scream that the solution is to reduce gasoline taxes. Well, then who pays for road maintenance? And what does that do to the "there's an energy crisis and something needs to change" message? These politicians are catering to the uneducated emotionally upset folks, some of whom, granted, operate businesses that are adversely affected by gasoline price increases (such as florists and pizzarias that deliver). Sorry, but pass those costs onto the consumer. If anything, taxes should be increased. That's the case in most other nations, where the true cost of consuming a gallon of gasoline, in terms of impact on highway infrastructure, environment, police highway patrols, accidents, and all of the other economic effects of driving is reflected in the gasoline tax. Yes, I'm back to my preference for the user fee model.

When I suggested that gasoline price increases incurred by businesses be passed onto the consumer, I was not suggesting using "gasoline prices have increased" as an excuse to raise prices by more than the prorated portion of the increase. My somewhat overstated example of what at least some lawn contractors are doing may not be the numbers applicable to most who are doing so, but they demonstrate a pattern that often is seen in businesses dealing with supply price increases, namely, establishing consumer price increases higher than the supply price increase. In the ideal free market, customers challenge these increases. I know someone who did (no, not me), and the entrepreneur relented. Unfortunately, most people don't have the skill, time, or willingness to "work the numbers" and determine if they are getting the short end of the deal. After all, I guess that sort of exercise reminds people of doing taxes, and triggers some sort of traumatic response.

The fifth consideration,tapping the strategic petroleum reserve, has also disappeared from the current conversation, so I'll simply state that nothing has happened that changes my conclusion that tapping into it to alleviate gasoline prices is unwise.

If the current gasoline price increases are so horrible, would we not begin to see some changes in lifestyle? Here and there a person is quoted by a news reporter as having cut back driving or combined errands into one trip, but what I've seen on the roads and in life generally suggests that most Americans aren't adversely affected, or don't see the connection between their lifestyle and driving habits and gasoline prices. Fifteen months ago, I pointed out five significant lifestyle or behavioral factors that contribute to higher gasoline prices, principally on the demand side, namely, development sprawl, teen-age autonomy, inefficient public transportation, insufficient telecommuting, and impulse decisions. Read the earlier post for the details. After fifteen months of increasing gasoline prices and record-setting crude oil prices, sprawl continues unabated, as developments continue to pop up "in the middle of nowhere" miles from stores, offices, hospitals, and other necessary facilities. Many teen-agers continue to drive to school rather than ride school busses. Public transportation, long hampered by its inability to move most people quickly from where they are to where they want to go in a straight line, has been saddled with the impact of terrorism and a drop-off in ridership. Until someone invents a cheap, safe, alternative along the lines of a custom carpool system, not much supply efficiency will be realized in this sector. I don't know if telecommuting has increased. If it has, it hasn't been a significant change, because the quantity of vehicles on the local roads during commuting hours has surely not decreased. Have people managed to condense errands into fewer trips and to cut down on the impulse run to the store? I don't know. Traffic volume suggests no, that hasn't happened.

I didn't expect much to change, and predicted that in my May 2004 post:

None of this can or will be changed in the near future. Houses have been built where they are and they're not going to be moved. Jobs are where they are. It would take years to get public transportation back to where it once was, that is, something that was of good use to most Americans. Maybe high schools can compel the use of school busses, or perhaps the driving age can be increased to 18 (for reasons far more important than gasoline consumption), but let's face it: not going to happen. Telecommuting and distance learning probably will increase over the next few decades but not at rates that would alone offset increases in per capita driving mileage. What MIGHT change driving patterns is an increase in gasoline prices (yes, increase) through taxes (yes, taxes) to levels comparable with world prices, reflecting inflation, and sufficient to keep the highway infrastructure in repair (remembering that bad roads cause decline in fuel efficiency).

And I noted that my analysis wouldn't play in the political universe or in the media world of sound bites.

I did some driving this summer. Enough to figure out that at 65 mph the fuel mileage was 10 to 15 percent higher than at 75 or 80 mph. Yes, those speeds were within the applicable speed limits. At one time maximum mileage was said to be at 55 mph, but perhaps it's improved technology or the fifth gear in the transmission that has shifted that higher, at least for the vehicle I was driving. For several reasons, including fuel efficiency but also involving the more relaxing nature of 70 mph as compared to 80 mph, I settled in, where possible, for 70 mph. I could have been killed. I was a roadblock, even when speed limits were at 60 or 65. Yesterday, back home, driving at 62 on a highway with a 55 mph speed limit, the doors were almost blown off the vehicle by the traffic that went by, at speeds easily in the 75 to 90 mph range. I may have passed two or three vehicles, not counting a slow-moving truck. If these folks are upset about gasoline prices, they're surely not showing it by their driving actions. Do they even know that by slowing down to 60 or even 65 mph, still above the speed limit, that they will reduce gasoline consumption by 10 to 15 percent? As an interesting aside, it wasn't just the high-performance sports cars that zoomed by. Minivans, panel trucks, SUVs, sedans, motorcycles, you name it, they got to some checkered flag somewhere before I did. Well, I never saw it. Even though they flashed by, I could see these drivers. Young, old, male, female, every size, shape and color. Everyone is in a hurry (except, of course, when they're in front of me in a line). I'll leave that discussion for some other time. The difference between 65 mph and 75 mph for a 65 mile trip is 8 minutes. For a 16 mile trip, it's 2 minutes. For an 8 mile run, it's 1 minute. Putting aside the increased risk of accident, is that 1 minute or 2 minutes worth the additional $2 for gasoline consumed? Americans seem to be voting with their accelerator pedal and griping with their mouth. So what's louder? The action, or the words?

As I pointed out fifteen months ago, when a crisis really hits, and lines begin forming at the pumps, then a lot of people will start running around, and screaming, and shouting, and asking, "How did this come to be?" and "Why weren't we warned?" And all the folks who yelled "Chicken Little" at the prophets will begin picking up pieces of the sky.

My posting back in May suggesting the courses that undergraduates should take in preparation for law study brought a very interesting response from Carlos Collazo, who makes an excellent point:

I just read your post suggesting to pre-law undergrads to learn a bit of French if they haven't taken any Latin, or even if they have.

I would like to suggest that Spanish may be a more valuable skill to add during the undergrad days. In fact, it is so much more valuable, not only for LSAT performance and law school success, but also for practical success in the real world of law.

Modern Spanish is really contemporary Latin as it is spoken in the Iberian peninsula and Latin America (and elsewhere). The same could be said of French; however, French resembles English considerably in many ways whereas Spanish does not. There are many, many terms that appear in Black's that are instantly understandable for the genuine knower of Spanish.

Not only that, but Spanish will help them succeed professionally to far greater extent than knowledge of French will. Just think how many law offices nowadays have lawyers rushing to learn Spanish that they should have learned many years ago. Future civil litigators, criminal defense attorneys, immigration attorneys all will have increased business through a mastery of
Spanish and not a merely a passing acquaintance.

I replied to Carlos:

You make a very good point. I suppose I was a bit caught up in the fact that having taken many years of Latin, I can read Italian and Spanish without too much agony (though listening, speaking, and writing are not within my skill set).

I was thinking in terms of preparation for law study rather than practice. You are correct, that in practice Spanish is very useful to know because 20 percent or more of the world's population speaks it as their native language.

In our continued correspondence, Carlos and I discussed the value, and importance, of getting children to dig into second (and third) languages at an early age. It's no secret that language is far easier to pick up when young than when the years have passed. So, I suppose if I were to nit-pick, I'd point out that it isn't as an undergraduate that one should take languages, but as an elementary and middle school student. Even though most children of that age haven't locked down their career plans, what's the harm in learning a second or third language? I can think of many advantages. Being multilingual is a plus in most careers. Studying languages is a good intellectual discipline, and will help in studying other subjects. Even as a tourist, the multilingual American contributes to the erosion of the "ugly American" although lack of second language is but just one portion of why folks abroad sometimes bristle when the ill-behaved American tourist shows up.

Carlos and I also agree that there's much to be gained by starting with Latin. Although perceived as a "dead" language, a mastery of Latin sets the stage for picking up Spanish, French, Portuguese, and Romanian, far more easily than if each of those languages were learned independently. There are as many, or more, Latin words, phrases, and sourced language in the law as there are French contributions. And learning a few years of Latin in elementary school provides future science majors with an advantage.

When Carlos suggested that his multilingual skills will serve him well if and when he applies to, and attends, law school, he's unquestionably correct. After all, lawyers are wordsmiths. They work with language. Their practices are becoming increasingly global. Multilingual lawyers are in demand. Even multilingual law students are in demand, as demonstrated by their retention for translation assistance in the Law School's Immigration Law Clinic.

I'll conclude by pointing out that there are other languages that deserve attention, such as Chinese, Japanese, Russian, and Arabic, to name a few without intending to provide an exhaustive list. Those languages may not be as valuable in terms of learning law because they haven't had the influence on the legal lexicon that Latin and French have had, but there is no doubt that in the practice of law, attorneys who can speak and read these languages fluently will be highly valued.

Now I'll go back to preparing fall courses, in which I teach students to speak tax. Yes, it is almost its own language!

My post on Andrew Black's difficulties with tax withholding on his gambling winnings and the maneuvers in which he had to engage in order to avoid withholding brough a note from Jeffrey Ring of Berry, Dunn, McNeil & Parker. He explains that although he does not work in the international tax area, he was sufficiently curious to dig out what is called the Technical Explanation to the United States-Ireland Tax Convention. Yes, technically it is a Convention and not a Treaty, but I use the word treaty because that is what most folks understand and use in their everyday conversation, even many international tax types with whom I've worked and conversed over the years.

Anyhow, Jeffrey pointed me to Article 22 of the treaty. Recall that I had considered Article 17, which applies to income earned "as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as a sportsmen" and wondered if gambling was a sport. I noted that Mr. Black would prefer that the income be covered by Article 14, which applies to income earned "in respect of professional services or other activities of an independent character." The reason is that Mr. Black would be better off, tax-wise, if Article 14 applied. Article 22, which I had scanned, applies to "income ... not dealt with in the foregoing Articles" and that income is taxable only in the country in which the person getting it resides.

The Technical Explanation states, "Examples of items of income covered by Article 22 include income from gambling..." Isn't that a surprise? I'll ignore, for a moment, the fact that the word gambling isn't in the treaty itself. It means that the folks interpreting the treaty decided that gambling is not a sport, for otherwise it would be covered by article 17, thus pre-empting article 22. It means that the folks interpreting the treaty decided that gambling was not the result of a person providing professional services or other activities of an independent character, for otherwise it would be covered by article 14, also pre-empting article 22.

Understandably, there are good arguments that gambling is not a sport, but to the extent they rest on the notion that sport requires skill and gambling does not, what little I know about gambling tells me that some gambling, such as playing the slots or the lottery, isn't a matter of skill, but that playing something like poker, which is where Mr. Black excelled, involves a combination of chance and skill. I'll let others ponder if Mr. Black, by playing poker in front of a national cable television audience, is or is not an entertainer. But what of the fact that he earned his winnings by engaging in activities of an independent character? Mr. Black surely is in the trade or business, as an independent contractor, of making money by playing poker. So why, if somehow he is not within article 17, is he not within article 14?

The answer is that the folks interpreting the treaty say so. Without any explanation, they simply dictate that gambling income is not in article 14 or article 17. The parallels between the incomplete Code and the "fill in the rest" regulations is striking. The conclusion that gambling is not a sport and not the activity of an independent contractor not only flies in the face of cases such as Groetzinger, but also reminds us, and I mean us, that just because something says something doesn't mean it means what it says because there always is the possibility that there is something else that says something different.

No wonder people complain that the tax law is complicated. Jeffrey Ring noted that because section 22 applies, there would be no tax, and apparently no withholding obligation on the part of Harrah's. He qualifies his statement by pointing out he isn't an expert in the field, and neither am I. So why, then, did Harrah's try to withhold? An abundance of caution? An in-house rule that simply required withholding absent the showing of an exemption number, as was done by Mr. Black's "backer" from Canada/United Kingdom?

If in fact there was no withholding requirement, then it's unfortunate that Mr. Black had to get annoyed at what should not have been an annoyance. It's even more troubling that he had to engage in some post-fact restructuring to deal with the situation. It's even more unfortunate that the state of the tax law is such that compliance is difficult, even when the people involved are trying to comply.

Perhaps someone who is expert in international taxation can enlighten us. I remain curious. So, too does Jeffrey Ring, and I am sure, other people who read the story (or my blog post).

Every once in a while I get lucky and write something that ends up preceding rather than following a tax-related event. Back in October of 2004, I posted a summary of the then-pending American Jobs Creation Act, and pointed out that one of the provisions was

"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?

Sure enough, along comes a poker player who's more than annoyed about the imposition of taxes on poker winnings. Apparently playing poker isn't as tax-favored as betting on the dogs. R. J. Schoettle of Indiana has passed along a story published in the Irish "Taxes and Tips" and available on the Pokerati site, about Andrew Black, who won $1.75 million coming in fifth place in the recent World Series of Poker. Harrah's, which handled the financial aspects of the tournament, informed Black that it had to withhold 30% for federal income taxes, because there is no Ireland-United States tax treaty provision setting aside the otherwise required tax withholding.

Black, rather unhappy, somehow arranged for his prize to be paid to his "backer," who holds a passport from a country that does have such a tax treaty provision. It's unclear from the story whether the backer is from Canada or the United Kingdom. This permitted Harrah's to pay the prize without withholding any taxes. According to the Harrah's staffer handling the paperwork, a woman named Dixie, she was "fine" with the arrangement, under which he transferred his winnings. She stated, "Whatever ... as long as we can do our paperwork to keep the IRS happy."

Will this make the IRS happy? Sure, if happiness for the IRS is tracking down Mr. Black and informing him that (1) he owes federal income tax on the prize, (2) he may owe gift tax on the transfer to his backer, and (3) there may be state, local, or other national governments interested in taxing Mr. Black's prize. Of course, there are two sides to every story, and perhaps Mr. Black and his backer had additional arrangements in place that would change the nature of the transaction.

I took a look at the tax treaty between Ireland and the United States. Article 17 states:

1. Income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as a sportsmen, from his personal activities as such exercised in the other Contracting State, which income would be exempt from tax in that other Contracting State under the provisions of Articles 14 (Independent Personal Services) and 15 (Dependent Personal Services), may be taxed in that other State, except where the amount of the gross receipts derived by such entertainer or sportsman, including expenses reimbursed to his or borne on his behalf, from such activities does not exceed twenty thousand United States dollars ($20,000) or its equivalent in Irish pounds for the taxable year concerned.

Translated, that reads "Income derived by a resident of Ireland as ...a sportsman, from his personal activities as such exercised in the United States, .... may be taxed in the United States, [unless it is less than $20,000 for the year].

Is Mr. Black a sportsman? Is gambling a sport? I don't know. I do know that these are questions about which the IRS and Mr. Black could argue. It matters because Mr. Black would not want the income characterized in such a manner as to come within Article 17.

Mr. Black would want to come within Article 14, by demonstrating that gambling is not a sport, and thus does not move him out of Article 14. But can he come within Article 14?

1. Income derived by a resident or a Contracting State in respect of professional services or other activities of an independent character shall be taxable only in that State, unless he has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities. If he has such a fixed base, the income may be taxed in the other State but only so much of it as is attributable to that fixed base.

2. The term “professional services” includes especially independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists and accountants.

Is gambling a professional service similar to those listed in Article 14?

So, unless Mr. Black demonstrates that gambling is a professional service and not a sport, or unless I've missed some other provision in the treaty that would make a difference, it seems that Mr. Black can't get off the hook for what clearly is a tax on his income. Every student coming out of a basic federal income tax class knows that one cannot avoid income tax liability by transferring income to another person after the fact.

Perhaps it will be difficult for the IRS to track down Mr. Black and collect. Perhaps not. But if he returns to the United States to play in another poker tournament, what's he going to do if there is a lien or other garnishment order hovering over any winnings? I can imagine the IRS proceeding against Mr. Black, his failing to appear, and a default judgment being entered against him, followed by the imposition of some sort of lien on future winnings. Of course, I am speculating, and perhaps Mr. Black intends to file a return and pay a tax. But then why object to the withholding?

Why does amaze me is that someone made this story public by reporting it. Why would the conversation between a payor and a payee get distributed, leaked, or announced to the press? I can't imagine why Mr. Black would have made the matter public. This is all very interesting, and I'd welcome any additional information about the story that might make it easier to analyze the tax issues.

I'll close by noting I've been kind, and have avoided the use of terms such as deal, hand, royal, straight, house, kind, or flush. Especially that last one. Next time, ha ha.

It’s not all that surprising that the debate over the alleged simplicity or complexity of the Internal Revenue Code continues. This will be my fifth commentary on the topic, the first four appearing here, here, here, and here. Because Kreig Mitchell’s latest posting revives the question of the law professor’s role in the development of tax practitioners’ perceptions of the Code, I welcome the opportunity to share my philosophy about the appropriate approach to teaching complicated legal topics. I’ll let Joe Kristan respond to the first part of Mr. Mitchell’s post, which addresses the question of whether Code complexity is a necessary consequence of all the things legislators use the Code to tackle. On that point, my view is that legislative action has contributed both to the volume of the Code, which does not itself require complexity, and to complexity, because the design of special provisions masking as general law indeed generates complicated language. I also think that there are complex provisions that can be drafted more clearly without changing the substance.

Mr. Mitchell also agrees that the Code is not perfect. Excellent. We’re making progress. But he also contends that any writing, if subjected to the critical analysis to which the Code is subject, will reveal "numerous inconsistencies and ambiguities" but I disagree. Not only is there much writing that presents few if any complicated glitches, it again is no defense that because something or someone is no worse than anyone else that the world should settle for mediocrity. I compare the Code to what it could be, not to the other material that is as bad or worse. That is a critical point, one that is a significant ingredient in the failure of post-modern culture.

Mr. Mitchell points out that using Code complexity as a device to instill fear in clients and to persuade them to pay additional monies for services that may or may not be professional or of high quality is totally unacceptable. On this point, I completely agree. This sort of “milking fear” happens in other areas of the law, and it happens in other professions. Much of the advertising industry reflects this mentality. Playing on fear is unacceptable. My philosophy, that fear is triggered by the unknown, generates more of my philosophy, namely, that intense education in which the student is immersed in the subject, beyond “main rules and interesting issues,” provides the antidote to fear.

Finally, Mr. Mitchell gets to the point that demands a response. He states:

Also, Mr. Maule also states that he does not see how persons who are not sitting in tax classes learn to fear the code if they have not taken the individual tax courses. I would suggest that reading a blog post entitled “The Tax Code is Simple. Not!” might do the trick -- especially if it was penned by a tax professor.

Mr. Mitchell confuses describing something as complicated with instilling fear of the thing that is complicated. The distinction is critical. It is one with which I deal at the beginning of every semester in which I teach the basic tax course. It arises each time a student arrives in my office or sends an email explaining their “fear” or “anxiety” about the tax course because they perceive themselves as incapable of dealing with such a scary topic.

There is no question that the Code, and the tax law, is complicated. So I’m not going to hide that fact. I’m not going to dumb it down. I’m not going to pretend it is easy. I’m not going to swim in the superficial waters of post-modern culture. The Code, and the tax law, is complicated. So let’s just deal with it.

How does one deal with it? One studies it. One immerses one’s self in it. One gets familiar with it. One works with it, under the guidance and tutelage of someone more experienced. Eventually, one begins teaching one’s self and one’s classmates. The key word in this approach is the word “works.” Getting past fear, any fear, requires work. Conquering fear cannot be purchased at Target or Wal-mart. It cannot be received on a silver platter. It cannot be done by someone else. It requires WORK.

At least with law students, and surely with at least some clients, it’s not a matter of ability. The ability is there. It’s a matter of discipline, of persistence, of dedication, of perseverance, of industry, of effort, of all the things that enter into meeting and overcoming a challenge. That is why I tell students, and others, that the Code and tax law are complex, that the complexity is a challenge, and that the challenge either will be met or will block the student’s progress toward becoming a genuinely fine professional. It’s the student’s choice.

Many students, especially those who approach me at the outset shaking (sometimes literally) with fear and anxiety, end up doing well because they follow my advice. So well at times that they find themselves enchanted with tax law and find their spot in practice as a tax practitioner. Others, relying on last year’s outdated outline, looking for the quick and easy path, and putting higher priorities on other things, scrape by, moaning and griping about "all the work" they are required to do. Some simply avoid my course, choosing a path of least resistance. Sometimes I am tempted to conclude that what is feared is the work that is required. Guess what's waiting in the practice world?

There is no reason to fear the Code, or the tax law. That’s because a good educational exploration of tax law dispels that fear. A good educational exploration requires work by the student. That’s why I explained that my students do not contribute to, nor spread, fear of the Code or fear of the tax law among their clients or among other practitioners. Mr. Mitchell comments that he applauds this fact. I’d prefer that he applaud how this fact comes to be so. It’s the approach to learning tax law, which is intense, challenging, and well worth it. Unfortunately, too many people give up when a challenge appears intimidating or scary. That, however, is not how the species makes progress. Challenges exist to provide opportunities for growth.

So, the complexity of the Code and the tax law can be seen as a challenge to be undertaken and overcome. Or it can be played into a source of fear. I prefer the former. That’s how I teach. Tax law presents a demanding challenge, as do some clients and many partners, and one who teaches tax law accordingly must be demanding.

Anyone who reads my posts about the complexity of tax law ought to walk away, not in fear, but with an understanding that to deal with the challenges tax law poses, a person needs to work, with perseverance and diligence. A person may end up feeling disappointment, frustration, or disgust with respect to the tax law and how it is created, but that is not fear. And those feelings are far better than obsequious resignation to the mess that the Code and tax law present to taxpayers and tax practitioners every day.

Complexity ought not generate fear in a person who is willing to work to get past the complexity. Complexity generates fear in those who do not give themselves the chance to undertake a challenge.

No sooner had I reported on the Congressional proposal to impose an excise tax on "regulated pornographic web sites" in yesterday's posting than I heard on the radio a report that Mike Tyson is considering going into the adult film acting business in order to make money that he needs to pay back taxes. A search of the web yielded stories such as this one, which appear to confirm that Tyson did state he has been having discussions with people in the adult film industry. Nothing, though, specifically referred to his tax problems, though Tyson's statement that "My options are pretty minimal, but I will examine them." in the context of his financial situation and the common knowledge that he has had serious tax problems makes the radio report far from implausible.

So wouldn't it be ironic (and a lot of other things) if the adult film industry cranks up its revenues by adding Mike Tyson to its "stars" list because he needed money to pay taxes? Especially when this news is popping up at the same time some members of Congress are trying to use taxes, among other things, to curb the industry's web presence and reach.

For years, I've had a book in the planning stages. It's called "Celebrities in Tax Trouble" and it would be long, because the list of celebrities who have had tax problems is long. But the list of things on my "to do" list with higher priorities also is long and the book idea simply ferments in the back of my mind, occasionally moving into the forward regions when something triggers it. But this Mike Tyson thing might end up changing the title. I'm not going there. Not now. Not in the near future. Maybe after I retire.

It's just getting weirder and weirder in the tax world. Good thing I'm noticing or I'd fit in too easily.

So a bunch of Senators has decided that the solution to the problem of Internet pornography sites luring children to their pages and products is, yes, a tax.

The full text of Senate Bill 1507 can be found by going to the Thomas Congressional web site. Thanks to Brian Coddington for the permanent link.

Clearly the goal of the bill is worthy. The purpose of the legislation is to "set tighter age verification standards to block minors from entering Internet pornography sites" and to "provide funding and support to law enforcement efforts to combat Internet and pornography-related crimes against children."

The bill imposes age verification requirements. I thought those already existed, but apparently not. Third-parties, such as credit card companies, are prohibited from providing services unless the web site complies with the legislation. That, I think, is something new. The Federal Trade Commission would have authority to regulate these web sites.

Here's the tax part: A new Internal Revenue Code section:

Sec. 4285. Internet display or distribution of pornography.

SEC. 4285. INTERNET DISPLAY OR DISTRIBUTION OF PORNOGRAPHY.

(a) Imposition of Tax- There is imposed on amounts charged by a regulated pornographic Web site for individuals to receive the display or distribution of pornography through the Internet a tax equal to 25 percent of the amounts so charged.

(b) Payment of Tax- The tax imposed by this section shall be paid by the operator of the regulated pornographic Web site receiving payment for the display or distribution taxed under subsection (a).

(c) Definitions- In this section:

(1) PORNOGRAPHY- The term `pornography' has the same meaning as defined in section 2256(2) of title 18, United States Code.

(2) REGULATED PORNOGRAPHIC WEB SITE- The term `regulated pornographic Web site' has the same meaning as defined in section 105 of the Internet Safety and Child Protection Act of 2005.

OK, this one can't be criticized for complexity. It's written in fairly plain English, although it does get away with a cross-reference for what is probably one of the most difficult words to define.

The revenue from the tax would be used to fund enforcement of the act, to fund a tip line, to fund a variety of child protection programs, some administered through the states, to fund research and development into filtering technologies, and to fund education of state agencies dealing with the problem. Any remaining revenue would be used to fund federal agencies, and certain private entities. If any revenue is not needed for these activities, it would be used for deficit reduction.

If it works, this would raise money. According to one of the sponsors, as reported by the Washington Post, the Internet pornography industry nets $12 billion annually.

Here's the problem. Or at least one of them. Most of these web sites are located outside the United States. Does anyone, including the sponsoring Senators, think that they will voluntarily pay this tax? Ha ha. Perhaps the plans are to send the military in to seize assets? What assets? Where?

This is what is called "for show" legislation. Even if it passes, like its predecessors, it will not solve the problem. At least one print version report that I read included a quotation from one Senator to the effect that they didn't think it would be effective but it would send a message. A message? To whom?

What would solve the problem is parental control, education, and discipline of children. That, of course, is asking a lot. Put the computer in the living room or den and look at the screen when the child is using it. That might interfere with the golf game, but, hey, aren't the children worth some attention?

So some members of Congress turn to the only thing that they think works, namely, a tax. To be administered by the Internal Revenue Service. Because it has nothing else to do?

The Internet is global. The problem is global. The solution needs to be global. It requires international agreement. The idea that the United States Congress can unilaterally police the Internet is not only short-sighted and narrow-minded, but a losing proposition.

And if another country imitates this legislation, will there be a credit for a tax paid to that country? Practical application of this theoretical idea is what will generate complicated amendments.

Sometimes tax isn't the answer.

A little more than a month ago I shared a summary of the tax provisions of the ENERGY POLICY TAX INCENTIVES ACT OF 2005, as approved by the Senate Finance Committee in late June. The bill has been through Conference, and has been signed into law.

Rather than listing its tax provisions again, I'll point out the major differences between the Senate Finance version and the bill that was enacted. My point isn't so much to turn myself or any of you into experts on these provisions (though eventually I'll need to scrutinize them more closely as I update Tax Management portfolios) but to illustrate how politics ravages the tax law. But we knew that!

** Congress added a provision, from the House version, that treats natural gas gathering lines as seven-year property for depreciation purposes.

** Congress added another provision, also from the House version, that treats electricity transmission property as fifteen-year property for depreciation purposes.

** Congress, again picking up something in the House bill that was not in the Senate version, removed some restrictions on the use of 60-month amortization for certainatmospheric pollution control facilities.

** Congress again went to the House bill to adopt a provision making the credit for producing fuel from a non-conventional source part of the general business credit.

** Congress yet again adopted a House bill provision loosening the requirements for deduction of nuclear decommissioning costs.

** Congress adopted another House bill provision, this one exempting prepayments for natural gas from the tax-exempt bond qualification arbitrage restrictions.

** Congress adopted yet another House bill provision, expanding the small refiner exception to certain restrictions on the use of percentage depletion.

** Congress added Indian coal to the list of additional energy sources specified in the Senate bill as newly eligible for the renewable electricity production credit.

** Congress rejected the Senate bill provision making clean energy coal bonds tax-exempt.

** Congress also rejected the Senate's proposed credit for investment in clean coke/cogeneration manufacturing facilities property.

** Congress rejected the changes to the enhanced oil recovery credit that were in the Senate bill.

** Congress adopted, from the House bill, a special excse tax rate for diesel fuel blended with water to form a diesel-water
fuel emulsion.

** Congress also adopted, from the House bill, a provision permitting geological and geophysical costs incurred in connection with oil
and gas exploration in the United States to be amortized over two years.

** Congress rejected the Senate bill provision that would have repealed the scheduled phase-out of the credit for electric vehicles.

** Congress rejected the provisions in the Senate bill making changes to the alternative fuels excise tax credit.

** Congress rejected the Senate bill provision creating a business energy-efficient property deduction.

** Congress rejected the Senate bill provision creating a combined heat and power system property energy credit.

** Congress rejected the Senate bill provision expanding the energy credits allowable against the alternative minimum tax.

** Congress rejected the Senate bill provision treatig underground natural gas storage facilities and cushion gas as ten-year property for depreciation purposes.

** Congress rejected the Senate bill provision creating a credit for equipment for processing or sorting materials gathered through recycling, and instead directed the Secretary of the Treasury, in consultation with the Secretary of Energy, to conduct a study to determine and quantify the energy savings achieved through the recycling of glass, paper, plastic, steel, aluminum, and electronic devices, and to identify tax incentives that would encourage recycling of such material.

** Congress rejected the Senate bill provision creating a credit for investment in pollution control equipment.

** Congress rejected the Senate bill provision creating a credit for the replacement of a non-compliant wood stove
with a compliant solid fuel burning stove.

** Congress rejected the Senate bill provision exempting bulk beds from the excise tax on retail sale of heavy trucks and trailers.

** Congress rejected the Senate bill provision establishing an exclusion for certain fuel costs of rural carpoolers.

** Congress rejected the Senate bill provision treating qualified energy management devices as three-year property.

** Congress rejected the Senate bill provision creating an exception from the tax-exempt bond volume cap for certain cooling facilities.

** Congress rejected the Senate bill provision making changes to the excise tax treatment of kerosene and other excise tax provisions affecting fuels.

** Congress adopted changes to the rules for recapture of section 197 amortization with respect to sales of multiple intangibles, in a provision not present in either the House or Senate bill.

Most of the Senate bill provisions that were adopted were modified in minor ways. Those details will not get attention here at this moment.

I may have missed a few things. Take a look at the Conference Report if you'd prefer to dig into the source material.

I close with these concluding remarks from the Conference Report.

Section 4022(b) of the Internal Revenue Service Reform and Restructuring Act of 1998 (the “IRS Reform Act”) requires the Joint Committee on Taxation (in consultation with the
Internal Revenue Service and the Department of the Treasury) to provide a tax complexity analysis. The complexity analysis is required for all legislation reported by the Senate Committee on Finance, the House Committee on Ways and Means, or any committee of conference if the legislation includes a provision that directly or indirectly amends the Internal Revenue Code (the “Code”) and has widespread applicability to individuals or small businesses.

The staff of the Joint Committee on Taxation has determined that a complexity analysis is not required under section 4022(b) of the IRS Reform Act because the bill contains no provisions that have “widespread applicability” to individuals or small businesses.

So if none of these provisions have widespread applicability, how is this bill going to make a difference with how the population uses energy? If almost everyone is unaffected, how does this bill make a difference in terms of energy conservation and development progress?

That was a rhetorical, sarcastic question.