MauledAgain

I mentioned in last Friday's post that Nakul Krishnakumar, one of my former students, and I have been discussion the question of what government should fund. Although that discussion involves governments spending, it implicates the tax policy debate because the level of government spending is a factor, and should be the most significant factor, in determining tax rates.

It appears from our discussion that Nakul and I agree on zero-based budgeting. That is, an annual government budget should not be constructed by allocating increases to the previous year's budget, but should be determined by examining each expenditure and determining its appropriateness. Of course, there may be instances where previous year decisions constrain the decision making with respect to certain items, such as interest on government debt, but that ought not create a blank check for every program in the budget.

There's no question that Nakul and I are not the first, and will not be the last, people to sit down and ponder the appropriate role of government. Even where we agree in a general sense, such as the appropriateness of defense spending as part of a federal budget, we haven't focused on the details. After all, we haven't accomplished much merely by accepting the idea of national defense as an appropriate federal function. Questions such as weapons systems procurement, policy decisions such as those concerning the use of troops overseas and in humanitarian efforts can be resolved in ways that would require significantly higher or lower spending levels. In turn, this would affect the tax policy analysis.

Nakul and I also brushed aside the important question of whether an appropriate government function should be conducted by the federal government, a state government, or a local government. We also paid little attention to the question of whether a state or local government function should be funded at the state or local level or wholly or partially through the use of federal revenues. We also left to another day the issue of whether an appropriate government function should be funded through user fees, income taxes, consumption taxes, sales taxes, or some other one or more of the seemingly infinite collection of taxes that exists in the modern public arena.

Our discussion when I replied to Nakul's email that pointed me to the Wall Street Journal op-ed piece that I critiqued on Monday. I commented that the piece presented "regurgitated arguments" and mentioned the possibility of the post that I did in fact write and publish Monday. I noted that one flaw was "that the op-ed argues for a low rate on the deferred stuff, which is not as beneficial to Joe as a low(er) rate on the current (wage) income." Nakul responded, "Personally, I think the answer is a lower marginal tax rate on income for everyone who pays taxes, followed by a lower tax rate on capital gains. This should be financed by massive cuts in needless and/or wasteful government programs. But I doubt that will happen." Interestingly, in his last email, Nakul noted that I had "convinced" him on the capital gains issue. That leaves, however, the proposition that there can be "massive cuts in needless and/or wasteful government programs."

So I challenged Nakul: " I'd be interested in your candidates for spending reductions and the amounts to be cut (so we could then figure out how much of a tax cut could be implemented)." Nakul's response was philosophical:

In terms of "what is that something" that we should limit government spending to, I think that requires a philosophical/political argument as to what is the role of a government in a free society. I submit that the only proper role of government is the protection of individual rights - which means that the government has a monopoly over the use of physical force. Thus a government in a free society should be limited to a police force to protect individuals from criminals, a military to protect us from foreign invaders (or terrorists) and a court system so that we can resolve disputes (and seek damages for torts) and protect our intellectual property. Other than that, I don't really see much of a role for government. As the Declaration of Independence says (I'm paraphrasing): governments are instituted among men to secure these interests. A society where a government doesn't have a monopoly over the use of physical force is anarchy. A society where the government has a monopoly over the use of physical force, but does not recognize individual rights, is a dictatorship. A proper society must have both: (1) Government monopoly over the use of physical force; and (2) a clear and unequivocal recognition of individual rights. America is the first nation to ever attempt this.

Obviously, we don't live in that world right now -- and so applying these principles to our current situation, I would slowly start to phase out lavish entitlement programs such as Social Security (the President's plan is a start), welfare, Medicare and Medicaid. I believe these entitlement programs alone make about 40-50% of our national budget (as compared to national defense which is a little less than 20% - I believe). Phasing these programs out would allow for a significant reforming of our tax code. Obviously, there is a lot of other government waste that can be cut out once we've determined what the proper role of government is. That should be our primary debate.

In turn, I posed this question to Nakul:

Without taking a position on any of these at the moment (for in some instances I'm not sold one way or the other, nor am I focused on a federal v. state differentiation), what of....

Fire protection?

Health and rescue squads?

Protection from hazardous spills, etc?

Disaster prevention and relief?

Control of airspace for airplanes?

Construction and maintenance of highways, bridges, tunnels?

Protection of quality of agricultural products?

Protection of quality of medicines?

Protection of labor?

Protection of public health?

Prevention of negative environmental impacts on people and their
property?

Preservation of natural resources such as national parks?

Education of children?

I'm sure there are more.

Of course, there are some things government currently does that I
wouldn't have government doing ....

Demonstrating that his law school education had been assimilated, Nakul artfully answered some of my questions and sidestepped others:

I suspected that you were going to ask some of these questions! Like my father used to say (He's also a professor), a good professor is always one step ahead of his students.

First, I don't believe in "preventative law" -- thus I would again phase out government organizations such as the SEC, FDA, FTC, etc. Obviously, these things simply can't be disbanded immediately because we've gotten so used to them; however, they can be phased out over time. If I were President (or emperor), I would begin that process.

The building of highways, education, etc should largely, over time, be shifted to private ownership and operation. I think the free market would do a wonderful job in something like education. In fact, there was an interesting article in the WSJ the other day explaining how some municipalities (and soon some states) have begun leasing out their highways to private entities (such as foreign private equity firms — one of which happened to be in Australia). This should be encouraged. To be honest, I haven't completely thought through the fire squads
issue, so I could envision a government role there. However, that may be something that private entities could do as well.

The role of the government is to protect man from man. Certain natural disasters will dictate that the government get involved in emergencies (i.e. Katrina, Tsunamis), but these aren't going to be the normal course of business (hence the term emergency). Nonetheless, it shouldn't be government's role to protect man from nature qua nature. We should of course budget for these potential disasters, but I don't think that will be that expensive.

I know I haven't answered all the questions you asked below, but I hope I've at least conveyed my general belief that the government's primary role should be to protect rights (life, liberty, property, the pursuit of happiness) and not provide services. Services, whatever they may be, should primarily be a private function, with perhaps a few exceptions. Today's mixed economy has government involved in too many things that they shouldn't be involved in. As such, they are spending too much money, and taxing us too much.

I could not resist playing devil's advocate, which is a technique that can reveal the depth of another person's commitment to their argument:

I understand your point. I wonder if you have studied the history of public services? At one time government provided no services (it took land, conscripted peasants for military service, and left the population
to its own fortunes, good or bad, mostly bad). Think of medieval kingdoms. What services were provided came through the church (at least in Western civilization). Eventually, as technology changed and needs evolved, the private enterprises that operated public services had problems. Service was spotty. Canal companies went under. Railroads did a little better until they, too, went under. The societal cost of death and disability from injuries to unprotected workers began to exceed the cost of public regulation of the industries in which these injuries were incurred. So in some respects, the free market and application of economic principles shifted certain services to the public sector because that was more efficient. Then, of course, irrationality set in and policies were formed by those who thought that because some services were more effectively provided by government all services could be more effectively provided by government.

Imagine, for example, private ownership of snow removal from public roads. Wait, they would be private roads, much as Route 30 was once a private turnpike. What happens when the company goes under? Do we litigate for months or years while the road turns to slop? As was the case back then? How do we hold accountable some CEO living in Australia?

How many people must die from bad drugs before the mobs burn down the pharmaceutical company offices and labs? How many people get snookered by bad stock deals before brokers and dealers are gunned down in their offices?

In other words, to the extent government services protect individual rights so that individuals do not seek self-help, then those services which appear to be preventive are actually protective.

Nakul's response:

I have a casual understanding of the history of public service, but I have to admit, I'm certainly no expert. However, I would respectfully disagree with some of your characterizations of private industry.

As a preliminary matter, when I talk about privatizing certain industries and services, I am not under the false illusion that shifting services from the government to the private sector will be a magical elixir whereby all our problems are automatically solved. My argument is simply this: In the long run, private industry will better be able to provide services such as highways (even snow plowing), education, etc and will do so in more cost effective manner - because they have more of an incentive to do so. Of course, companies may still provide spotty
service, but in a free market they will not stay in business that long. In fact, failure is as much a part of capitalism as success. Except in a market economy, failure breeds success. When the government is involved, failure just breeds more failure.

Also, I would slightly disagree with your characterization of history. Yes, railroads went under, and sometimes wholesale industries failed. Howe ever, that period also saw tremendous economic expansion, an increase in people's standard of living, an increase in health and many other things. That is largely attributable to the largely free market system that existed.

Government, properly defined, is a gun, whose chief responsibility is to protect man from man. It should not be involved in endeavors of the mind. If the market can't figure something out, then I doubt government can either. I have a lot more confidence in an intelligent entrepreneur than I do in some government bureaucrat.

In the end, markets are much better suited to solve economic problems than the government is. History bears that out, and I think we would be wise to begin the process of privatizing government services and continue to do so for the foreseeable future. If we do that, we'll reduce spending, cut taxes and simplify the tax code.

P.S. As far as holding the CEO of an Australian company accountable —- I don't know. However, we could fairly easily get jurisdiction over the entity and assets that the CEO controls. If an Australian company owns assets in America, then we have "minimum contacts" and therefore personal jurisdiction over the company itself - which is probably more useful than having jurisdiction over the CEO.

Nakul had taken the discussion back to the philosophical and political question of how government and the private sector should relate, and I jumped on the opportunity, as I've emphasized in text that was NOT bolded in my response to Nakul but which I highlight here:

I agree with some of what you say, perhaps most of it, but when cast against the wider backdrop of experience and the realities of life, the theory of free market snags. Here are some thoughts.

Private industry is no less likely to fail than is government. This is true so long as the bureaucratic malaise and internal office politics which accounts for most of government failure at the boots-on-the-ground level continue to infect the private sector. Academia is responsible for much of this, arguing for theoretical rights and curtailment of worker discipline, and fueling the migration of bad ethics and lack of incentive from government to the private sector. Where's the free market incentive to excel when it's easier to ask the government to use its fake gun to protect some conjured-up right? Where's the free market to excel when the worker in the next cubicle is thinking about appropriating your ideas? That's why I'm no higher on private industry than I am on government. I'm not painting government with a brush of success when it comes to the enumerated services (though it has done well in certain instances, such as highway construction and the weather service). I'm simply discounting the myth of the marvelous private sector. My power went out again today for the umpteenth time because a moron contractor cut something rather than following government regulations (issued by public utility commissioners) to call before digging. Imagine what it would be like without such regulation. True, an isolated incident but so characteristic of post 1980s society.

The tremendous economic expansion to which you refer was carried on the backs of developing nations. Where is the success of the west without the cheap (or free) labor of the rest of the world? And now that the rest of the world is catching up (or at least chunks of it are), the pressure is on. It was private industry that ran the slave trade, though with the government gun at its side for a while ... and look what happened when government changed its position. It is private industry that to this day moves unwilling workers through the pipelines from
eastern Europe to who-knows-where. It is private industry that could participate in a tremendous economic expansion because it externalized costs such as environmental protection, instead dumping toxic materials everywhere from the Love Canal to the waters of southeast Asia.

Unlike you, I have no more confidence in an intelligent entrepreneur than I do in a government bureaucrat. Intelligence does not guarantee, and often stands in the way of, far-sighted judgment and ethical considerations. Worship of the bottom line profit is what has cheapened, in the long run, the effectiveness and efficiency of the economy. This is not a rejection of capitalism. It is an argument that unregulated capitalism, which flourished in the 18th and first half of the 19th century, brings slavery (real and economic), poisoned environments, worker injury, and a whole host of problems that lets the capitalist class, to its long-run detriment, damage the peasant/worker class on which it depends. And some functions are just too important to leave to an unregulated or a modestly regulated free enterprise system. I don't want the current Russia as the role model.

This inspired Nakul, who was having as much fun as I was having, and as I hope readers are having, with this discourse:

Thanks for your reply. Although I disagree with you, I have greatly enjoyed this debate. That being said, I think a great many of the points you made below are based on incorrect premises. I think this argument needs to go back to the basics i.e. fundamental premises and theories. Here is my quick attempt to essentialize this debate:

Capitalism, properly defined, is both a political and economic system. Politically, it requires the full recognition of individual rights. Those being life, liberty, property and the pursuit of happiness (and all derivative rights i.e. freedom of speech, religion, freedom from unwarranted searches and seizures, etc). Fundamentally, capitalism is the only moral political system in the world and is the only system that can accommodate man qua man. Therefore, in a capitalist society, no person can infringe on the rights of another - and if they do so, the government must resolve the dispute (as I stated earlier, government has a monopoly on the use of initiation of physical force. Certain exceptions apply, of course, but those are fairly self-evident. Examples include protecting your self from a burglar, and other necessary methods of self-defense that may have to be done before the "government" can get involved). The protection of individual rights also means the protection (and full recognition) of property rights, including intellectual property (which means no one could exert force and steal or appropriate your ideas, especially if they are patented or trademarked) As such, under capitalism, there can be no such thing as slavery, involuntary servitude, or forced labor. Slavery is the antithesis of a society that respects individual rights and cannot exist (for long) in a capitalistic system. Slavery existed in America, but we fought a war to end it because it was not consistent with our fundamental principles and values as a country. The fundamental tenet of capitalism is individual rights: Countries such as Russia are not capitalistic -- they are at best autocratic bordering on a dictatorship. Note the recent government take-over of certain oil companies without due process. That wouldn't happen in a society that recognizes
individual rights.

Along those lines, under capitalism, there is only one way to deal with other men: VOLUNTARILY. If one wishes to buy or sell a good, that sale must be done voluntarily. Each man will work for his own profit and understand that every other man is doing the same. Some men will be better at others than making money (i.e. Bill Gates versus me), but all trade will be value-for-value and will be done freely and without compulsion A man is not a slave to another man if he voluntarily chooses to work for him, even if that man must work to feed his family, and must work for a low wage. Freedom and capitalism do no guarantee every man a living - it just provides a system in which almost all men - who are willing to work, will be able to do so, and be able to do so voluntarily.

Economically speaking, one has to again, start with fundamental premises. All wealth is created - and those who create it deserve to keep the fruits of their own labor (hence the recognition of property rights). America was not created on the backs of cheap labor in foreign countries (although I fully advocate using cheap labor - so long as those providing it do so voluntarily and those seeking it do so ethically). America was made by entrepreneurs, like Rockefeller, Carnegie, Henry Ford and Bill Gates (and many, many, many others). Were those individuals perfect? No. Nonetheless, their ingenuity helped America burgeon into the great country that we are. Moreover, the outsourcing of cheap labor has done a tremendous amount of good for developing countries - see Singapore (who at one time was poor), India, the Philippines for examples.

Capitalism, like humans will not be perfect. People will commit frauds and try to cheat other no matter what system you are in - and those people should be brought to justice, in a rational legal system, which punishes them accordingly. There will still be bad businesses (i.e. your power may still go out because of some moron contractor). Nonetheless, the simple idea that under Capitalism bad people might take advantage of others does not mean that we should simply do away with the system. That would be like discontinuing the use of the automobile
because X amount of people die each year in car accidents. Overall, a capitalistic society, based on individual rights, will be free, prosperous and most likely, very wealthy.

I could go on forever, but I think I stated the essentials. Politically, capitalism means the recognition of individual rights and a government whose sole aim is to vigorously protect them.
Economically, it means the profit motive, trading values for other values, and by-in-large being able to keep the fruits of your own labor - no matter how big or small those fruits may be. Taxes will still need to be levied to pay for critical government functions, but they should not be levied to redistribute wealth or fund massive entitlement programs.

Resisting the temptation to prove that I, too, could go on forever, I kept my reply as succinct as I could, because we had reached the point where we knew each other's position and understood it:

I think perhaps where you and I differ is that you have much more faith in people than do I. If it were a matter of an occasional fraud, a rare theft, sporadic laziness, and once a decade deviousness, I'd be much more likely to agree with your analysis. However, like Diogenes with his lamp, I continue to seek people who can resist the seemingly easy path to quick profits with a well developed moral code.

Capitalism is the best of what's available, but regulated capitalism is better. Until people recognize individual rights, is there any solace in a government that tries to protect them? Ideally, government's least used function should be protection of rights, for ideally, people would respect each other and not steal, plunder, rape, pillage, and maim. But they do. And after millennia of attempts to create civilization, there is more peace and prosperity when government sets boundaries through democratic processes than when it's a free-for-all free market.

The risk today is that government itself is being corrupted by those who evaded the rules, escaped prosecution, and are taking over the democratic process. They are taking capitalistic control of government. So, no, I would not ditch capitalism but I find it ineffective and inefficient in unregulated form.

If the world had a common religion or ethic, or at least a common set of values shared by all religions, then a spiritual or theological value set could replace the government's role that I am describing. Unfortunately or fortunately, religion does not serve that role well because genuine religious values are irrelevant to large segments of the population. I am not a Catholic Social Thought advocate, but having been exposed to it I recognize that it is sending, in part, a similar message. There is more to social and economic interaction than profit.

You know I wish you were right, and things worked as you describe. But they don't. The answer lies, I think, more in psychology and theology than in economics. But until those disciplines come up with cures, the economic and tax world needs to manufacture better band-aids.

And I let Nakul have the last word and wrap up our fascinating, informative, and pleasant discussion:

I agree with you 100% on the idea that economics is not a primary - philosophy/morals is. A society cannot have the right economic system if it does not have the right moral code.

I'm not suggesting that human interaction is solely for profit (I don't think my wife would like that very much). But at the same time, the profit motive is profoundly moral and should be encouraged - however, it is not the end all, be all of life. You're right that no political party these days really recognizes individual rights. Democrats certainly don't recognize property rights - at least not consistently. The so-called conservatives are much better on property rights, but don't really recognize a right to privacy (which is a common sense derivative of the right to life) and other "unenumerated" rights.

Anyway, capitalism, as I want it, doesn't exist today, and probably won't exist in my lifetime. Despite our different philosophies, I still think we could probably take a look at the budget and come up with some programs that we could cut. I think even the most ardent of government regulation enthusiasts would have to admit that we are spending way too much money. Cutting even a few programs - or at least trimming them down, would be a good start.

As a side note, you've convinced me on the capital gains tax issue. Although I think that cutting the capital gains tax should be done - I can see why doing that would disadvantage middle class and low-income wage earners. I would propose one flat tax - maybe 15% on all income, no matter how it was earned. Those who don't pay taxes now, will still not have to pay taxes under my plan (low-income earners). I would eliminate most deductions - except maybe the exemptions for dependents we have now.

So, ending with his revised tax reform proposal, Nakul never did specifically mention that he and I agreed governments ought not be funding student travel to college Bowl games, as I pointed out in last Friday's post. Of course, dealing with this sort of government expenditure, so clearly inappropriate, would not have given Nakul and I to engage in our typically extended analysis. There's no fun, in this context, with mutual "You're right, that's a totally unwise government spending decision" emails.

Readers of MauledAgain know that one of the features of the current income tax system that I strongly dislike is the preferential low rates on capital gains and certain dividends. I've commented on this silliness repeatedly, and it is unquestionable that the distinction adds significant complexity to the tax law. Perhaps as much as one-fourth of the substantive provisions of the Internal Revenue Code could be jettisoned if the principle "a dollar of income is a dollar of income" prevailed over the fiction that capital gains and dividend income is more important and deserving of less tax burden.

One of my former students, Nakul Krishnakumar, referred me to a Wall Street Journal op-ed piece from last Thursday. The commentary is a regurgitation of some of the dozens of arguments that have been made over the years to justify continuance and expansion of tax breaks on capital gains and other investor activities. This piece goes further, arguing that the benefits of lowering taxes on investment are so wonderful that it justifies raising taxes on wages. It's nice to see that the advocates of putting the income tax burden on wage earners are beginning to demonstrate some candor about their position.

The op-ed piece begins with the usual "boilerplate" conclusions about the "distortions" of taxing interest, dividends, and capital gains, and how those distortions are bad for the economy. There's no proof as such, but the commentary then attempts to prove the point with an example.

In the example, a person presumed to be in the 35% bracket earns an additional $1,000, and thus pays $350 of income taxes. Of the remaining $650, $500 is spent and $100 is invested in bonds paying interest at 6%, but which the op-ed piece claims is yields 3.9% after tax. That's an application of the 35% tax rate to the interest. Assuming inflation of 2%, the real after-tax return is only 1.9%. Assuming the taxpayer is 40 years of age, and plans to retire 35 years later, the $100 will grow to $193 in current prices.

The example then compares what happens if the interest on the bonds is taxed at 15%. The 6% rate would generated a 5.1% after-tax return, and after inflation is taken into account, a 3.1% real after-tax return. Thus, the $100 would grow to $291 by the time the taxpayer retires.

The commentary claims that this example illustrates two tax distortions. First, it asserts that the tax on interest is also a tax on the reward for doing work that generated the additional $1,000 of wages income. Accordingly, according to the op-ed piece, this taxpayer has an incentive to refrain from doing the extra work. The second alleged distortion appears to be an argument that if the person increases savings to account for the impact of taxes on the savings' earnings, the person's retirement-time consumption would still be reduced.

The name of the game when making arguments is premises. And the premises in the Wall Street Journal's op-ed commentary are questionable. For example, it is assumed that the person in question would forego the additional $1,000 of income because the tax on the earnings accruing from the $100 portion that is saved aren't low enough. But most people who take on additional work do so because they have children to feed, mortgages to service, bills to pay, and other financial needs. Some people work "for the fun of it" and after-tax return is about as important to them as it is to the people who volunteer their time for charitable organizations and get zero economic after-tax return. Perhaps members of some elite leisure class, rolling in money, base their choices about earning additional compensation or playing more tennis on the sort of analysis shared by the Wall Street Journal commentary, but I've yet to meet a person who admits to having done so. Every person I know, personally or through anecdote, who has taken on additional work has done so either to earn money to make ends meet or to satisfy a psychological need to "do something for the fun of it," even if that sometimes borders on being a "workaholic."

But let's look more closely at the example. One problem with the example is that it assumes an equal tax rate on wages and investment income and then tries to justify lowering the rate on investment income. It makes more sense to deal with the situation as it now exists and to analyze the impact of the proposals to reduce even more the tax rates on investment income and to bring interest income within that preference, which is what the op-ed piece is defending.

Let's take the same person, named MC, and again have MC earn an additional $1,000. But put MC in the 15% bracket. MC has $850 after taxes from this additional work. MC pays $750 of bills and invests $100, planning to use it 35 years later. Again, assume that the investment earns 6% after taxes, generating income that qualifies for a lower 15% rate. After 35 years, the $100 grows to $570. In another part of town lives RP, who is in the 35% bracket. RP earns an additional $1,000 for the fun of it. RP has $650 of after-tax income, which RP invests because RP has already paid all of her bills. RP also earns 6% from her investment, and that income also qualifies for a lower 15% rate. After 35 years, the $650 invested by RP grows to $3,705.

Now let's assume that the "low or no income tax on investments" crowd prevails. Let's assume that the special tax rate on investment income is reduced from 15% to zero. But let's also assume that the tax rate on wages must be raised so that the change is revenue-neutral. In other words, reject the notion of deficit funding the additional tax break for investors. Even though Congress, under the influence of the investment crowd, would probably put MC into a 25% bracket and RP into a 40% bracket, let's assume that each bracket is increased by 10 percentage points, MC to 25% and RP to 45%. Keep in mind that the Wall Street Journal op-ed piece advocated an increase in the tax on wages if that was necessary because the decrease in the tax rate on investments is supposedly so important. What happens?

Of the $1,000 additional compensation earned by MC, only $750 remains. MC uses it to pay bills, and has nothing left to invest. So, 35 years later, MC's investment is worth nothing because there is no investment. RP, now with $550 remaining from the $1,000 of additional compensation, invests it at 6%, but with no tax, the after-tax return is 6%. After 35 years, RP's $550 grows to $4,227. It's not too difficult to see who benefits from the proposal, nor is it difficult to see how this plan does absolutely nothing for MC, other than to increase the chances that MC will become or continue to be a serf of MP.*

Suppose instead that MC somehow figures out how to save $100 from the $750 after-tax compensation from doing the additional work, cutting back on food, clothing, and other necessities. The alternative, incurring debt, exacerbates the disadvantages to MC because the interest on the debt would put MC into a negative investment return situation, making it even more likely that MC would reside in the modern-day equivalent of debtor's prison. If MC can somehow stash $100 into an investment, at the end of 35 years it would be worth $768 if it grew at 6% after-tax. So what does the "cut taxes on investment income even more" plan do for MC? At the cost of $100 in present day expenditures for food, clothing, or other necessities for the family, MC now has an additional $198 35 years in the future. Remember that RP has managed to use the zero rate on investment income to increase RP's "nest egg" by $522. Again, it's easy to see why the "no tax on investments" crowd likes the plan.*

Another problem with the Wall Street Journal op-ed approach and its example is that it addresses the concerns of a person saving for retirement, without dealing with the reality that earnings on retirement savings, properly invested, qualify for a ZERO tax rate until those earnings are withdrawn from the retirement account. So the typical wage earner already has the benefit of an ideal retirement plan earnings tax rate. So who would need more? Folks with huge amounts of dollars to invest beyond the limits applicable to retirement plans. In other words, the call for low or zero tax on interest and dividends is nothing more than an attempt by the wealthy to do an end-run around the current limits on how much can be stashed into a tax-free retirement savings plan.

In other words, it is very likely that under current law MC's $100 investment could be put into a qualified retirement savings plan and grow to $768. Reducing the tax rate on investments has little value for MC because MC has the benefit of the zero tax rate on retirement savings. True, when MC withdraws the $768, $668 will be subject to tax, but that will be 35 years in the future, and MC would presumably be in a lower tax bracket after retirement.

On the other hand, under current law RP's $650 investment will grow to $3,705, whereas the "no tax on investment income" plan would increase RP's investment to $4,995 if RP invested the same $650. Additionally, there would be no tax on the $4,995 when it is withdrawn and consumed just as there is no tax on the $3,705 when it is withdrawn and consumed.

Because most Americans do not understand present value, tax deferral, or the other concepts used in making these analyses, it is too easy for the economic elite and their advisors to mask this grab as some sort of wonderful sacrifice on their part for the American economy. It's not unlike the merchandise sales representative who tries to convince the customer that the grudgingly proposed price reduction is putting the seller into near-bankruptcy. Excuse me, does anyone have any tissues to offer the sales reps so that they can wipe away the crocodile tears? I'm hoping that I'm doing some sort of public service by taking apart the mirrors and blowing away the smoke from the piteous pleadings of the apparently nearly bankrupt economic elite.

Of course, as I cannot resist turning attention for a moment to another of my favorite topics, it remains a mystery why we don't mandate the teaching of these basic principles to all citizens, while they are still in mandated education, namely, early high school. Imagine a nation of citizens familiar with present value, tax deferral, and other basic financial concepts. Imagine how much more difficult it would be to pull the wool over their eyes. Imagine... WAIT!!! Perhaps I just answered my own question as to why "they" don't want this taught in the K-12 system. Hmmmm.

No matter how it's sliced, reducing the tax rates on investments outside of qualified retirement plans does NOT benefit the average taxpayer. It's a bad idea. Even the existing system is a bad idea. If Louis XVI and Marie Antoinette had put this sort of tax plan into effect, France would still be a monarchy. The peasants wouldn't have understood that they were being fleeced. By the time anyone explained it, the guillotine would have been falling on the necks of the critics. Turning to yet another of my favorite topics, yes, there's a reason I value the First Amendment. It protects my right to explain the chicanery and protects your right to read it and to share it with others (which I encourage you to do.)
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*Note that inflation was ignored, because it presumably affects each taxpayer in the same manner. It very well could be that inflation for food, clothing, and other necessities is higher than inflation on luxury goods, which would cause inflation to disproportionately disadvantage MC. However, that is such a speculative consideration it does nothing to assist in the analysis of the issue.

Serendipitous timing is wonderful. Nakul Krishnakumar, one of my former students, and I have been engaged in another one of our tax policy email dialogues, which may or may not eventually end up in some summarized form posted on this blog. One aspect of our discussion is the question of what government should fund, because that relates to the question of how high tax rates can or should be and how they should be distributed. Last evening I challenged Nakul to list items that he thinks the government has a proper role in funding, and when he replied, I tossed back a list of functions he had not mentioned.

At about the same time, I noticed a story, and an editorial column on that story, that described government funding for something that I know Nakul would list on his "ought not be funded" list. I agree, so I didn't toss this one at him. Hey, what's the fun in challenging each other with points on which we agree? Who knows? Maybe most people would disagree with us.

According to this Philadelphia Inquirer story, culled from wire services, the State of New Jersey has "donated" $25,000 to a Rutgers University fund established to fund almost 300 randomly selected Rutgers students who wish to travel to Phoenix to attend the Insight Bowl in which the Rutgers football team is playing Arizona State. Each student will receive a $300 "stipend." The balance of the money comes from alumni donations and some other apparently private gifts. According to Gregory Blimling, Rutgers' vice president for student affairs, "The university encourages students to support the football team at the Insight Bowl. Events like these enrich the college experience."

Who authorized the state "donation"? Acting governor Richard J. Codey. He's not up for re-election, John Corzine already having been elected to fill the next term. So whatever the reason, it's not connected to vote seeking.

Yesterday, the Inquirer's Monica Yant Kinney ripped into this boondoggle in a way that I just cannot match for elegance, sarcasm, pointed jab, and overall common sense. Read her column. For anyone who cares what happens to tax revenue, it's priceless. But I doubt she'll mind my sharing several of her observations, especially if they spark a visit to the full article. She notes that this $25,000 donation is "[a]ll for the worthy cause of helping college kids get drunk and sunburned and scream themselves silly at the Insight Bowl in Phoenix over the holidays." She's not very supportive of the fact that the state "can scrape up 25 grand to subsidize a bunch of sorority girls doing Jell-O shots in the Arizona desert." She quotes the governor's spokesman, "Rutgers hasn't been to a bowl game since 1978. It's the state school of New Jersey. We see this as an opportunity to show a national TV audience what New Jersey is all about."

Where she drives the point home is with this comment, one with which I full agree, and I am sure Nakul would agree even if he trimmed down her list: "And here I thought the state was too broke to pay for things like road repairs, homeland security, school construction, child-welfare reform and stem-cell research." For those unaware of New Jersey fiscal news, the state has been cutting spending left and right (no pun intended) because of a fiscal crisis.

Of course, the acting governor can't be voted out of office. So it was a low risk proposition for him. But, was it his idea? I doubt it. I wonder who proposed the give-a-way. An aide? Parents of students who want their children to get a full and complete education preparing them for a worthwhile career? Students themselves? I know it wasn't Nakul, and I guarantee it wasn't me!

It's this sort of fiscal nonsense that energizes the "cut all taxes and eliminate government spending" mantra. That's understandable. Of course, and this is the point on which Nakul and I are engaging each other's minds, some good programs may get axed as collateral damage. The problem, though, isn't the program. It's the people. Yes, the politicians who make the decisions. Whether it's the Congress, or an acting governor, or some other official, politicians are doing the citizens a disservice.

But in all of this there is one gleeful question: Do the students who receive the $300 "stipends" have gross income for federal and New Jersey state income tax purposes? Hmmm. Now won't THAT be a surprise!

A story in today's Washington Post summarizes the most recent tax legislative action by the House of Representatives. The House has passed three bills and is ready to approve a fourth. What does the legislation do?

* Tax cuts to encourage rebuilding in areas damaged by hurricanes;

* Extension of the low tax rates on capital gains and dividends;

* Fixing up the earned income tax credit snag afflicting members of the Armed Forces serving in Irag;

* Extending the temporary "fix" for the alternative minimum tax (AMT) to prevent it from affecting middle-income taxpayers.

The cost? $94.5 billion in revenue. It's $31.2 billion for the AMT remedy, $7.1 billion for the Gulf Coast reconstruction, $153 million for the Armed Forces tax fix, and, taking the prize, $56.1 billion for the protection of lower rates for capital gains and dividends. Priorities, priorities. Says a lot about a nation, doesn't it?

There had been some speculation during the past few days that because only $50 billion or so in spending cuts had been identified and tentatively approved by the Congress, that the Bush Administration and the Republican Congressional leadership would face a tough choice between extending the low capital gains and dividends rates while letting the AMT jump back up to bite the middle-class, or extending the AMT fix while leaving capital gains and dividends to be taxed at regular rates starting a few years from now.

In the spirit of the holiday season, our "leaders" decided that everyone gets a gift. No matter that they're purchased on credit by a nation way past its credit limits.

How could anyone think this way? Easy. Consider this quote from Representative Deborah Pryce from Ohio: "Our economic policies have done the trick. We are in the middle of one of the strongest economies this country has ever seen."

REALLY?

That must be news to the thousands of people scraping by from day to day, to the folks who are lining up for unemployment benefits, to the workers at U.S. companies such as Ford who are hearing about imminent job cuts, to the workers at enterprises such as airlines who are watching their pensions get flushed down the drain, to the youngsters who go to bed hungry, to the homeless. Perhaps if say, 5 or 10 million families are doing so well that they can afford the second or third home, the investment flyer, and the high-end consumer goods, then the economy is doing so well that it ranks in the top five of all time. No, a rising tide does not raise all boats because those already at the bottom or with holes in them aren't floating.

Consider where the $50 billion used to fund half of these tax cuts comes from: new fees on Medicaid recipients, a reduction in the number of people qualified for food stamps, cuts in education lending, and downsizing federal child support enforcement. It amazes me that our "leaders" can conclude that it is far better for the folks hit by these cut-backs are in a better position to bear the burden of the tax cuts on their backs than investors can handle an increase in their special tax rates by one or two percentage points (which would still leave them significantly undertaxed). Note: pending in my "to be posted" list is commentary on a Wall Street Journal editorial that attempts to defend the taxation of wages and non-taxation of investment income.

The economic data is interesting. According to Maya MacGuineas, president of the Committee for a Responsible Federal Budget (CRFB), tax revenue as a percentage of economic activity "remains below the 2002 level and well below the level of 2001. .... The argument that tax cuts will grow the economy and pay for themselves is very attractive, but it's just not true." Yeah, but it makes for great sound-bites used to gather the votes of unsuspecting citizens, no? Citizens for Tax Justice explains that "the richest 1 percent of taxpayers, of Americans, with an average income of almost $1.3 million in 2009, would enjoy 53 percent of the value of the extension that year, while 78 percent would receive no benefit." The Washington Post article refers to a "recent study by economists at the Federal Reserve[, which] concluded that the dividend tax cut had no real impact on the stock market and prompted 'only muted gain in total corporate payouts.'"

Rest easy, though, as our "leaders" once again have used the tax laws to protect us from ourselves. The legislation providing tax benefits for rebuilding hurricane-damaged area excludes from its provisions casinos, country clubs, hot tub facilities, liquor stores, massage parlors, golf courses, racetracks and tanning salons. I suppose the jobs that those industries create aren't important to the reconstruction of the Gulf Coast economy. Now if the Congress were to exclude crack houses, chop shops, and similar illegal businesses from the tax benefits, I could understand. But singling out certain legal businesses because they offend the sensibilities of "Rep. Frank R. Wolf (R-Va.) and other social conservatives" is downright nonsense. If these folks can't find the votes or the popular support to outlaw enterprises such as tanning salons (perhaps on the ground they cause skin cancer?), then leave them alone. After all, most of us probably have a list of legal businesses we think ought not get tax benefits. Perhaps the rebuilding of re-election campaign headquarters should be denied tax breaks?

And the other $44.5 billion in revenue reduction? That will simply enlarge the already bloated federal budget deficits. No matter, I hear the Chinese are looking for a good investment, and might just gobble up some more Treasury securities. Sarcasm aside, it seems that the concerns I expressed about the nation living beyond its means, and trying to fight a war while pretending that the economy is not and ought not be a war economy are no less serious now than they were when I wrote about them back in September of this year, in "Taxes and Sustaining a Civilized Society." There indeed is something uncivilized in watching the grab-bag tax break free-for-all craze that has swept through the Congress, yet again.

Now before my criticism of this free-for-all grab-bag fest gets painted in partisan flavor, understand that the three bills that have already passed did so almost unanimously, with almost all Democrats joining Republicans. With the Senate having already signed on to these provisions, or close variations, it doesn't take a seer to predict that the Internal Revenue Code will very soon be undergoing its umpteenth official re-write. Despite predictions of a loud and argumentative debate on the fourth bill, the one extending the low tax rates for capital gains and dividends, it appears that the votes for passage exist. And even though this one may be closer, it's the reticence of moderate Republicans (you mean we're not extinct yet?) that makes the matter not as open-and-shut as the other three bills.

I close with a quote from Maya MacGuineas, president of the CRFB, "In a highly partisan atmosphere, tax cutting without regard to the growing federal debt appears to be one area that both parties can agree on. Everybody's losing credibility right now." May I paraphrase? "In a highly frenzied mob action atmosphere, looting without regard to the impact on future generations appears to be one area that the rioters can agree on. Everybody's losing respect right now."

I hope I'm wrong. All I want for Christmas is a legislative defeat of the capital gains/dividend low tax rate. Wait, I lied. What I really want for Christmas is an instant repeal of the capital gains/dividend low tax rate, and I'll even wish for the indexing of adjusted basis for those who want it.

Reports are popping up throughout the news world that tax reform is dead. Technically, it's being described as "postponed" or "delayed" but the reality is simply that there is insufficient support for the sort of changes that the Tax Reform Panel proposed. Or perhaps for any sort of change. That's good news and bad news. It's good news because it sinks the bad ideas floated by the Tax Reform Panel. It's bad news because it seems as though "business as usual" once again has trumped the public interest in genuine tax reform. The cynic in me wonders if the plan all along was to poison the entire tax reform process by dishing up indigestible servings totally unacceptable to most of the nation. After all, there are a lot of politicians, lobbyists, power brokers, and governing elites who have done quite well by the current arrangements and surely don't relish the thought of their tax feeding trough being shut down.

According to bloomberg.com, the delay reflects the Bush Administration's conclusion that the proposed "changes are too tough to sell to the public and lawmakers." Supposedly the President plans to use 2006 for speeches and other efforts to find support for tax reform in 2007 or 2008. Pushing the Tax Reform Panel's proposals almost surely would lead to the same place Social Security reform went, namely, the Congressional back burner.

According to a Boston Globe report, the President has jettisoned his earlier idea to have Treasury study the Tax Reform Panel's report and prepare something for inclusion in January's State of the Union speech. Supposedly there is insufficient time, but worse, the office that would supervise the process remains vacant, a situation on which I have previously commented. Coincidence? A similar report on the denouement of tax reform was issued by CNN and the New York Times, both using the same Reuters lead. A story in Time Magazine pretty much dovetails with the other reports.

Although a few members of Congress continue to talk the tax reform game, it is just that, talk. The chair of the Ways and Means Committee, bound by House rules to step down no matter the outcome of 2006 elections, professes a desire to revamp portions of the Code, but it's a safe bet he won't get the chance. Moving forward with the Tax Reform Panel's suggestions is not something most members of Congress want to do in an election year. Criticism of the report has been so widespread and intense that advocating its ideas is political suicide. Even sensible tax reform proposals are tainted by the way in which the Tax Reform Panel painted the concept of tax reform.

The lessons to be learned aren't new. Here are some considerations for anyone interested in genuine tax reform:

1. In the long run, tinkering with the current system isn't genuine reform. People know that, particularly in an information age where back room machinations aren't the secret proceedings they once were.

2. Tax reform requires the input of, and guidance from, people who understand the tax system, who have dealt with it in practical terms, but who aren't beholden to special interests. There don't seem to be very many people with those qualifications.

3. Politics, especially the desire to be re-elected, always trumps tax reform. Serving the public interest takes a backseat to preservation of personal power.

Of course, even though there's not much sense in dissecting the Tax Reform Panel's suggestions any more than they already have been, there surely will continue to be a parade of tax nonsense stepping forth from the halls of Congress to get attention and earn, where appropriate, deserved criticism. After all, the Tax Reform Panel can't be blamed for the "songwriters are too special for their taxes" proposal that I lambasted last week.

Perhaps it's easier now to understand why I simply laugh when people ask me, "So what are you going to do after tax reform makes your specialty irrelevant?" Aside from the fact that I can, and do, teach in other areas of the law, and aside from the fact that there always will be taxation, any concern about the need for wholesale restructuring of courses, rewriting of course materials, revision of tax publications, and modification of computer-assisted tax law instruction exercises barely registers a faint blip on the radar of tax futures. There are far too many other things over which I could fret if I wished to do so. Tax reform is pretty much on the same page of my "things to worry about" list as is the possibility of an asteroid hitting my house. Yes, it's possible. No, I'm glad I haven't held my breath and have no intention to start doing so.

In yesterday's post on why we blog, I mentioned that several of my colleagues were considering entry into blogland. Well, today one of my colleagues, Prof. Michelle Anderson, flipped the switch to "on" for her No Rape blog. To quote her blog description, "Villanova law professor Michelle J. Anderson analyzes the legal and social issues surrounding rape and sexual assault and devises strategies to bring these practices to an end."

Michelle addresses very serious and important questions. She is focusing on an area of law that does not appear to have had much blog (or technically, blawg) attention. She brings to her blog experience in both teaching and writing about the issues. I am confident her posts will be enlightening, and I encourage you to visit and to pass the URL along to others. As challenging as it is sometimes to write about tax and my other areas of interest, I can usually cut the tension with humor. Michelle's undertaking is daunting, because she's dealing with concerns that are no joking matter.

Needless to say, but I'll say it anyway, I'm delighted that Michelle has joined our colleagues Mark Sargent and Patrick Brennan (Mirror of Justice) and myself in the world of law prof blogging. I'm hoping that this is not the last such welcome announcement.

With things slow on the tax news front, as Congress spins its wheels trying to deliver tax legislation, I get a chance to dig into my "save this for the blog" pile and pay some attention to items that had to take a back seat to other news when they first came to my attention. One is a New York Times Article by Jonathan D. Glater about the recent proliferation of blogs by and about lawyers. They've acquired the name "blawg" .... which I suppose adds a word to the list of words that rhyme with "dog," an observation that might come in handy writing poetry. Poetry about blawgs.

After reading Glater's article, though, I have the impression that blawgs are not simply blogs by and about lawyers. They're blogs about the law, written not only by lawyers, but also law students, law faculty, paralegals, and folks with law degrees no longer actively involved in the legal profession.

How prolific are blawgs? The article cites a Blogads survey that reveals lawyers in fourth place among those maintaining blogs. Almost one-fifth of bloggers identify themselves as educators, the largest such group. Slightly behind them are computer software professionals, and in third place, slightly above one-twentieth, are people working in the media. In fourth place? Legal professionals, just 3/10 of one percent behind the media folks. I didn't participate in the blog. Are law professors who blog a tiny fraction of the group in first place or a slightly larger fraction of the group in fourth place? Who knows? Who cares? I do, because the statistics indicate that a larger percentage of lawyers are blogging than are law faculty. It seems to me that it should be the other way around. After all, there's certainly an audience for blawgs.

Who's reading blogs? Another survey by Blogads puts lawyers and judges in fourth place among blog readers, behind computer professional, students, and retirees. The first two groups aren't a surprise. One would expect computer professionals and students to have the incentives to wander the blogosphere. But retirees? Aren't most retirees among the demographic cohort that is stereotyped as left behind by the computer technology revolution? Apparently retirees have not only the time to explore blogs, but I'm guessing also the interest in the many interesting and important topics that are discussed in blogs.

It's not that difficult to figure out why lawyers enjoy blogging. Lawyers work with words, and blogs offer a place to share them with others. Lawyers find all sorts of things to discuss, and blawgs certainly reflect that phenomenon. Lawyers' blogs touch not only on black letter law, but on just about everything. It has long been said, even before the Internet came into being, that lawyers were frustrated writers and actors. How true. After all, lawyers love to talk, and a blog in many ways is simply another outlet for words. I've been writing for a very long time, and looking back, I realize that those who encouraged me to write were in some ways trying to introduce me to a quieter way of generating words. For their peace and quiet. It worked to some extent, but not entirely!

Even though they constitute less than one percent of the population, lawyers appear to publish a disproportionate number of the influential blogs. Perhaps it is because most lawyers not only like to talk and write, but they speak and write well. According to one source in the article, unlike most people, who are shy about making arguments in public and risking the inevitable attack, lawyers seem to delight in conflict and argument. Lawyers tend to be people with high levels of talent and ambition. Perhaps lawyers caught in mundane practices find blogging to be a nice outlet for their interests with no role in their daily work.

Is it as easy figuring out why people read blawgs? Explaining why lawyers read blawgs is simple enough, but more than 99% of the population aren't lawyers. So what brings the non-lawyers to the world of blawgs? Needless to say, the answer to this question matters to me, because I write in a style not specifically tailored to lawyers as an audience. One answer is that the law fascinates everyone, because it is omnipresent in modern culture. After all, law and lawyers tend to dominate the news, if not in direct ways, such as headline-grabbing trials, in indirect ways relevant to most topics making today's news. Perhaps blawgs are popular among non-lawyers because lawyers have something worthwhile to say about the legal system. To paraphrase Denise Howell of Reed Smith, blawgs demystify the law, spawn discussions about politics, law, and morality, and "break down barriers" between the legal profession and the people it should be serving.

Law faculty blogs are beginning to increase in number. Though it varies from school to school, the percentage of law faculty who blog appears to be catching up to the percentage of other legal professionals who blog. Within the past several weeks, four of my colleagues have sought my advice, and help, in starting blogs. All four will have something to offer that fills a gap in the subject matter of blawgs. If all four bring their plans to fruition, it would triple the number of blogs maintained by Villanova law faculty.

Ultimately, though, the best explanation comes from Ann Althouse, a law professor at the University of Wisconsin. "Compared with spending a year writing a law review article, she said, blogging is fun."

She is so right!

Once more I can demonstrate why it is true that one can learn much by teaching. The recent changes in the definition of dependent for purposes of the personal and dependency exemption deduction required me not only to provide the new statutory language to the students in the basic federal tax course but also to revise the answers to the problems that we tackle as part of the statutory interpretation process. As we worked our way through several different hypothetical fact situations, I noticed something and pointed it out to the class. Two weeks later, when it was time to administer another in-class graded exercise, I presented the students with four questions (to be answered using their student response pads ("clickers")). Here is one of those questions:

Exer #10(F05) Ques #3. F marries W1, and they have a child C. W1 dies. F marries W2, who has a child S from a prior marriage. Later, when both are over 25, C marries S and they have the same abode. S has gross income of $670, and otherwise is entirely supported by C. If C files a separate return ....

A. C can claim a personal exemption for S.
B. C can claim a dependency exemption for S.
C. C cannot claim a personal or dependency exemption for S.

Go ahead. Try to answer the question. You can evaluate your performance by continuing to read.

Of course, the question drew snickers just as my observation two weeks earlier had raised eyebrows. I'll get back to that in a moment.

Here's the analysis that I expected students to do, that would take them to the correct response. In this sort of question, they would be thinking through this process and selecting an answer rather than writing out a full explanation. And so here's another example of why working with the law is not much different than working through a puzzle, which is why I am startled when some law students tell me they detest doing puzzles, a phenomenon I discussed in a Law School newsletter column several years ago in "Doing Puzzles While Learning & Practicing Law".

First, with respect to any possible personal exemption, a taxpayer cannot claim one for his or her spouse unless three conditions are satisfied. Quoting section 151(b), "a joint return is not made by the taxpayer and his spouse," "the spouse ... has no gross income," and "the spouse ... is not the dependent of another taxpayer." In the hypothetical, the spouse has gross income, and that precludes the taxpayer C from claiming a personal exemption. Choice A must be discarded.

Second, with respect to any possible dependency exemption, the taxpayer cannot claim one for his or her spouse unless the spouse is a "qualified child" or a "qualified relative." Let's look at each in turn.

Now before jumping to instinctive conclusions and gasping at the thought of a spouse being a qualifying child, consider the definition. Under section 152(c)(1), "a qualifying child ... with respect to any taxpayer ... [is] an individual (A) who bears a relationship to the taxpayer described in paragraph (2), (B) who has the same principal place of abode as the taxpayer for more than one-half of [the] taxable year, (C) who meets the age requirements of paragraph (3), and (D) who has not provided over one-half of [the] individual's own support for the ... year." As to the first condition, the individual qualifies under section 152(c)(2) if the individual is "(A) a child of the taxpayer or a descendant of such a child, or (B) a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of any such relative." The spouse is taxpayer C's stepsister, so the first condition is met. We'll come back to this a little later. As to the second condition, the facts state that C and the spouse share the same abode, so it is met. As to the third condition, the individual does NOT qualify under section 152(c)(3) because the individual has attained the age of 24; to satisfy this condition, the individual must either have "not attained the age of 19 as of the close of the ... year ... or be "a student who has not attained the age of 24 as of the close of [the] year." So the spouse in this case is not a qualifying child. Can it happen? A momentary tangent. Suppose the spouse were 18, or a full-time student not yet 24. The third condition would be satisfied, leaving us with the fourth condition to analyze. The facts tell us that C provides all of the spouse's support, which means the spouse does not provide half of his or her own support, and thus the fourth condition would be satisfied. Yes, had I set the age of S at 18, or made S a full-time student with an age under 25, the outcome would be different. But, giving a peek into the design of questions, I didn't want S to be a qualifying child because I wanted students to go further in their analysis.

So we turn to the question of whether the spouse can be a "qualifying relative." Under section 152(d)(1), a "qualifying relative ... with respect to any taxpayer ... [is] an individual (a) who bears a relationship to the taxpayer described in paragraph (2), (B) whose gross income for the ... year ... is less than the exemption amount ... (C) with respect to whom the taxpayer provides over one-half of the individual's support for the .. year ..., and (D) who is not a qualifying child of [the] taxpayer or of any other taxpayer for [the year]." Having already determined that S is not a qualifying child of C, and knowing that C provides all of S's support, we know that the third and fourth conditions are satisfied. What about the first? The individual qualifies under section 152(d)(2) if the individual is "any of the following with respect to the taxpayer: (A) A child, or a descendant of a child, (B) A brother, sister, stepbrother, or stepsister, (C) The father or mother, or an ancestor of either, (D) A stepfather or stepmother, (E) A son or daughter of a brother or sister of the taxpayer, (F) A brother or sister of the father or mother of the taxpayer, (G) A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law, (H) An individual (other than an individual who at any time during the taxable year was the spouse ... of the taxpayer) who, for the taxable year of the taxpayer, has the same principal place of abode as the taxpayer and is a member of the taxpayer's household." Because S is C's stepsister, S satisfies the third condition. Note that the prohibition against spouse only applies to persons trying to qualify under subparagraph (H) and not those, like S, who qualify under any of subparagraphs (A) through (G). What about the second condition? S satisfies it because S has gross income of $670, which is less than the exemption amount.

Wow! S is a qualifying relative. So the correct response is choice B.

How did you do? Good guess? Good reasoning? No clue? Or, as is the case for many, no way this is possible?

It does seem strange, doesn't it? Interestingly, the possibility existed under the statute as it existed before last year's changes, but I didn't notice it. What caused me to pay close attention was the change in the definition of child, for the idea that a child could include a sibling or step-sibling for dependency exemption purposes was counter-intuitive. Last year, I shared a detailed explanation in the post, "Redefining Children (at least in the Tax World)". There is a good reason for the change. To accomplish the legislative goal of creating one definition of child for purposes not only of the dependency exemption but also the child credit, the earned income tax credit, and other provisions, the language needs to reach beyond child and include those other close relatives who are eligible for purposes of those credit and other provisions.

But wait. Isn't the hypothetical a bit bizarre? People don't marry their step-siblings. Two anecdotes not only are helpful but probably will end up being retold. Some years ago I happened upon a television movie starring, among others, Dermot Mulroney, whose father is one of my colleagues and who is director of the Graduate Tax Program. Knowing almost nothing about Dermot, I figured I'd watch the movie just to see who he was, whether he looks like his father (yes, the resemblance is apparent), and whether he was good at acting. This was long before he became the well-known star he is today. Well, the movie, "Sin of Innocence" (1986) turned out to be about a step-brother and step-sister who fall in love with each other. The next morning I'm in Michael's office. "Hey, I saw your son in a tv movie last night and he played the part of a guy who fell in love with his step-sister." Michael replied something to the effect that this was the sort of part Dermot had been getting. "Young Guns" and "My Best Friend's Wedding" were yet to come. Suddenly, as Michael and I were discussing the "tawdriness" of the film's plot, a light bulb went on. I looked at Michael and quietly said, "Wait a minute. My great-great-great-great-great grandfather Daniel Maule married his step-sister Hannah Brown. Whoa!" Michael just stared at me, as he sometimes does when I blurt out some startling fact. "Yep, and it's no big deal. We're talking four different grandparents for each of them. It's not a problem. It's not illegal. It's not morally unacceptable. It's not theologically prohibited." After I administered the graded in-class exercise, I explained the answer but still noticed some very suspicious looks. So I described another scenario, a bit different from the facts of the problem, but raising the same possible issue and based on a true life story. Two people, let's call them H and W, who are unrelated (at least in the sense they are not closely related) meet, fall in love, and decide to marry. The families meet. H and W get married. In the meantime, H's mother, whose marriage isn't so wonderful, and W's father, whose marriage is likewise falling apart, end up falling for each other, divorce their respective spouses, and marry. Does this not make H and W step-siblings? It also makes for a bunch of other things, such as really interesting Thanksgiving dinner seating arrangements, but I'm not going there.

But one more nagging hesitation exists. When C married S, did that terminate their step-sibling relationship? Yes, I researched this. No, there is no direct authority. What I did find, though, is some regulatory guidance with respect to other relationships. Working from another problem we do in the class, what happens under the following circumstances? H marries W. W has a brother B, who is supported by H and W. B has no gross income. So H and W, on their joint return, properly claim a dependency exemption for B. But then, sadly, W dies. H, a nice fellow, continues to support B. Does B meet the relationship condition for being a qualifying relative? Is B the brother-in-law of H? Well, yes, surely before W died. Does W's death end that relationship?

Regulations section 1.152-2(d) provides that "the relationship of affinity once existing will not terminate by divorce or the death of a spouse." I call this the "once an in-law, forever an in-law" rule, and it's yet another instance in which teaching tax can be fun, notwithstanding what some may think. Surely, this sort of rule makes this part of tax fun to teach. "You can divorce your spouse but apparently the tax law doesn't let you divorce the in-laws." The looks on their faces are priceless. But then I explain that in order for the tax question to exist, the person must be supporting their ex-spouse's sibling, suggesting that an amicable relationship between the taxpayer and the sibling-in-law exists. It could be, as one student pointed out, a case of a taxpayer who married a friend's sibling, perhaps against the friend's advice, and when things fell apart between the taxpayer and the spouse, the taxpayer and the friend maintained their friendship, along with a tax-eternal designation of siblings-in-law.

Anyhow, next question is whether a similar rule exists or should be inferred for step relationships, namely, "once a step-sibling always a step-sibling." It seems to me that just as a brother-in-law relationship is a relationship of affinity, so to a step-sibling relationship is one of affinity, caused by a marriage, in this instance, the marriage of a parent. After making inquiries, I learned from the lawyer who drafted what he calls the "rule that a relationship once acquired stays on forever" that it was raised by his boss, who knew of someone who supported a step-grandchild. So I'm even more confident that "once a step-sibling always a step-sibling" is the rule for tax purposes.

One last point. If Congress wanted to preclude spouses from being qualifying relatives under all circumstances, it would have put the "(other than an individual who ... was the spouse)" language in the introductory phrase of section 151(d)(2). Instead, it is in subparagraph (H), leaving subparagraphs (A) through (G) free of that limitation.

Whew! And people wonder why tax law is complicated. There are all sorts of reasons, and sometimes the complexity of life will be reflected in the complexity, not of the law, but of the application of the law to the facts. Sections 151 and 152 aren't all that complex. In fact, they're fairly easy to handle, as demonstrated by the adeptness with which students who have been in the basic tax course for all of 12 weeks deal with these issues. Life itself is complex.

A few may have noticed how, once again, I managed to bring together tax law, legal education, theology, and genealogy. All that's missing are the model trains, the music, and the chocolate chip cookies. Don't tempt me!

This blog has been selected as one of 51 blawgs (law-related blogs) featured in TechnoLawyer's new e-book, "Blawgworld 2006: Capital of Big Ideas."

I'm delighted. In an internet world where 80,000 new blogs appear every day, any spotlight is valuable. I'm hoping that at least a few members of Technoworld stop by for a visit and decide to return or to add MauledAgain to their RSS feeds.

I've browsed Blawgworld 2006 and have discovered that most of the blawgs featured in the e-book are ones I had not previously seen. I must confess that as much as I am immersed in law blogging, I was unaware of how pervasive law blogging has become. Perhaps I was concentrating a bit much on law faculty blogs and ignoring what the practitioners have been sharing?There are blogs on a wide variety of legal subjects, many acting as news providers with respect to cases and developments that otherwise would not come to the attention of lawyers and law professors because they end up in a disposition other than an appellate opinion. There are blogs topics dealing with patent law, medical malpractice, securities law, trial practice, electronic evidence, intellectual property, contracts, family law, the Fair Trading Act, environmental law, law office practice management, employment law, legal research, corporate law, First Amendment law, and other areas of law.

Knowing that tax practitioners have, and must have, a keen interest in other areas of the law, for those are the places where our tax issues germinate, I recommend that you visit TechnoLawyer, sign up (it's free), and get your copy of "Blawgworld 2006: Capital of Big Ideas." You'll also receive free newsletters from Technolawyer. Tell them I sent you. Tell them thanks for featuring a law blog that you read. And rather than tell you which of my postings was featured, I'll let you find out when you browse through your copy of the e-book.

The feeding frenzy at the tax trough continues unabated. The latest "we're special" provision was added to H.R. 4297, the Tax Relief Extension Reconciliation Act of 2005. Under section 204 of the Act, income from the sale of musical compositions or copyrights would be taxed at the lower capital gains rates. [Note: If the link does not work, go to the main Library of Congress Thomas web site page and search for HR 4297. Then, when getting the page that informs us that there are TWO House bills with that same number, choose the Tax Relief Extension Reconciliation Act of 2005. Don't ask how they ended up with two bills with the same number. Something about left hand, right hand....]

This amendment, procured by Representative Ron Lewis of Kentucky, who according to this Wall Street Journal story, is a country-music fan and guitarist, is not in the Senate version of the bill. Yet. Advocates for this tax break plan to have it inserted during the Conference when the House bill is reconciled with the Senate bill (S. 2020). The text of the amendment is oh so innocent:

SEC. 304. CAPITAL GAINS TREATMENT FOR CERTAIN SELF-CREATED MUSICAL WORKS.

(a) In General- Subsection (b) of section 1221 (relating to capital asset defined) is amended by redesignating paragraph (3) as paragraph (4) and by inserting after paragraph (2) the following new paragraph:

`(3) SALE OR EXCHANGE OF SELF-CREATED MUSICAL WORKS- At the election of the taxpayer, paragraphs (1) and (3) of subsection (a) shall not apply with respect to any sale or exchange before January 1, 2011, of musical compositions or copyrights in musical works by a taxpayer described in subsection (a)(3).'.

(b) Limitation on Charitable Contributions- Subparagraph (A) of section 170(e)(1) is amended by inserting `(determined without regard to section 1221(b)(3))' after `long-term capital gain'.

(c) Effective Date- The amendments made by this section shall apply to sales and exchanges in taxable years beginning after the date of the enactment of this Act.

As I tell my students, the story is in the details.

The proposed new paragraph (3) of subsection (b) would block paragraphs (1) and (3) of subsection (a) (of section 1221) from denying capital gains tax rate treatment to income from selling the results of one's song-writing efforts. Paragraphs (1) and (3), as they presently exist, are designed to prevent the following approach to obtaining low tax rates. "I built a machine. When I sell the machine I ought to be treated as having sold a capital asset, and be taxed at low rates." Paragraphs (1) and (3) in effect say, "No, the proceeds from the sale of the machine that you bought reflect compensation for the services you have performed. Otherwise people whose services create products would get those capital gains low rates that are intended for investors."

Put aside for the moment that investors ought not get preferential tax treatment. After all, if there were no distinction among types of income there would be no section 1221 and the issue would not arise in the present context. The point is that song writers have decided that their compensation income ought to be taxed at rates lower than folks whose services are rendered working in factories, mowing lawns, bagging groceries, sweeping floors, tending the sick, fighting fires, etc. The song writers think they are special. Note that even other artists, such as novelists, painters, sculptors, and designers, aren't covered by this proposed legislation. They, it appears, aren't special.

So how did the song writers sell this to the House of Representatives? How do they hope to persuade the Senate? According to the Wall Street Journal story, it works like this:

Begin with Bart Herbison, executive director of the Nashville Songwriters Association International (NSAI). He describes the current tax law, which taxes the compensation earned by song writers in the same manner as the compensation earned by other workers, as follows: "This is just such a glaring injustice." Herbison claims that because the average annual income of song writers who belong to the NSAI is $4,700, it is "fair" to give them more advantageous tax treatment. Excuse me, Bart, but someone whose income is only $4,700 has no taxable income and the tax rate is irrelevant. I don't buy your argument. Try again. Oh, I see, that income is added to income from the "day job." And if the day job generates a tidy sum, what's unfair about taxing the $4,700 added to taxable income from the moonlighting song writing efforts in the same way as the $4,700 earned by a middle-aged working mother from a second job who is trying to scrape up more income so she can pay her child's school bills? Nah, Bart, you haven't sold me on this one. Pun intended.

Apparently song writers think that when they sell a song they should be taxed just as if they sold a stock. The logic fails, however, because the same argument can be made by a book author. Or a furniture maker. Or a person who grows fruits and vegetables and sells them at a truck stop. The fact that the services are embodied in a self-produced item or an item into which a person's services have been injected does not make the sale a sale of an investment.

The song writers and the NSAI point out that the lower rates would not apply to royalties earned when the songs are played, but only to sales of the song itself (which transfers royalty rights to others). In other words, the special low tax rates would apply to sales of what are called "song catalogs." But this distinction is somewhat facetious. Suppose a person writes a book. Or makes a bunch of hand-made rocking horses. When the person sells a book, or a rocking horse, the income is taxed at the regular rates because the person is being paid for his or her services. Should it make a difference if the person sells all of the horse or all of the books in a bulk sale? No. Should it make a difference if the person sells the right to manufacture more horses or to print more books? No. True, sale of a building generates capital gain taxed at the lower rates whereas the rental income from the building is taxed at the regular higher rates, but this distinction does not involve embodied services. And it demonstrates, of course, why a policy of treating capital gains as "different" is such nonsense.

Songwriters also argue that because their income comes in spurts they end up with a few taxable years in which their incomes are high, and subject to the high end regular rates, and many years in which their incomes are low, and subject to lower regular rates. They claim that unlike book authors they cannot arrange for the spreading of the payments over a number of years. Oh? There's a law against negotiating for longer contractual payouts? Professional athletes (another group that can experience wide income swings) manage to do so. And those book authors pay a price. If they wait for their royalties they don't have the use of the money. Hey, song writers, get a spreadsheet and factor in time value of money against probability-adjusted future tax rates. Use those numbers in your negotiations. And if you can't get what you want, don't ask the taxpayers to subsidize your negotiation table failures.

The very examples used to illustrate the "plight" of the song writers actually proves my point. One writer sold 200 songs for a "mid-six-figure" amount. She paid "more than $100,000 in taxes." Ok, $500,000 maybe $600,000 of income, $100,000+ in taxes (federal AND state?) seems to fit with current regular rate structures. That leaves $380,000? $450,000? Another writer, who has had 10 hits out of his collection of 800 songs, sold his songs for an amount in the "high six-digits" and claims he paid 39% in taxes. Guaranteed, he did NOT pay taxes at a rate of 39%. The rate on the top end of his taxable income was 39%. The average would have been closer to 20%. Clever, isn't it? Trying to get people to think he paid $320,000 of federal income taxes on $800,000 of income when in fact it's more likely he paid $200,000. Oh, how those rolling in money can plead poverty. Of course, the song writers are doing nothing more than taking good lessons from the multimillionaire "investors" who claim the right to be taxed at the lowest of rates. A third song writer claims that she must work in a department store selling handbags because "high taxes" prevent her from selling her songs. Excuse me, some good contract negotiations, taking advantage of what is known as installment sale tax treatment, spreading the payments over a period of years, will leave you with taxes no different than those encountered by the rest of us who work for a living. Apparently some song artists also do well as drama queens.

One song writer notes that because she hasn't had a hit in five years she has to make that money last, "When the hits do come, we have to be like squirrels and bury the money." Of course. So do all the other folks whose incomes peak and sag. Folks like farmers who deal with drought and floods, computer programmers and video game authors who hit the big time one year and then watch other designers' efforts get the attention of the game players, authors who have one great book followed by years of writers' block, professional athletes who rarely earn in middle age what they pulled down in their twenties, and so on. Yeah, it's called planning and budgeting. The fact you need to do this doesn't mean you deserve a tax break. Unless, of course, all taxpayers who need to plan and budget get the same tax break. Fat chance.

Interestingly, the NSAI does not have any paid lobbyists working on its behalf. It claims it does not make political donations or shower legislators with trips. Instead, Herbison has made more than 400 visits to Washington, bringing song writers along to plead their special status to "every member of the tax-writing committees in the House and Senate," according to the Wall Street Journal story.

So the NSAI has drummed up support from legislators representing southern states. Or perhaps I should say they have plinked and plunked and warbled up support, as they did the troubadour thing on the Hill. The song writers helped create a Songwriting Caucus in the House. Two Senators created one in the Senate. Iraq war. Terrorism. Starving children. Flooded out city. Storm damage across the nation. Energy crisis. Peak oil. Nuclear weapons in North Korea and Iran. Impending shortages of fresh water. And our legislators are creating songwriting caucuses? It's nice they have so much spare time.

But apparently the song writers knew better than to try to limit the special tax break to country music song writing. That would have been too obvious. So they generously included other genres. But not other forms of art. Or other forms of earning a living by rendering services.

What's at stake? About $4 million of annual tax revenues. Amounts that could be used to lower all taxpayers' tax bills. Or to reduce the deficit.

Sadly, one legislator predicts, "The chances are very good for this staying in the final bill." In a representative democracy, it amazes me that tens of millions of Americans will end up on the short end of yet another "we're special" stick and not even realize that they're getting ripped. We live in an information age, drowning in data, and somehow some people think they can slip this one by us.

This entire saga is raw material for a country song. So how long until we see "My Taxes Are So High I'm Stuck Behind a Store Counter" or "When You Write Country Music You Get Muted by the Tax Man"? Perhaps, "I'm Too Special and Maule Won't Admit It."

Rick Telberg's column this week on CPA2BIZ reviews tax and accounting blogs. Of this one, he says:

"www.mauledagain.blogspot.com isn't as much fun as "mauled again" might imply, but if you're the type who needs to know about section 164(b)(5) of the Tax Reform Act 1986 or IRS Form 4868 and its "companion" Form 7004, then Villanova Prof. James Edward Maule's blog is the place for you."

I guess all I can do is to try harder with the puns and the jokes. :-)

The thought that being mauled again can be fun leaves me almost at a loss for words. Oh, well. :-)

Andy Cassel's column in yesterday's Philadelphia Inquirer set forth yet another early warning about the impending pension deficit crisis. Putting the almost inevitable crisis in the context of an "old vs. young" competition for insufficient resources, he outlined the problem in his usual clear and concise style. The problem is that the governments and businesses who promised old-age and health care benefits to workers and taxpayers have failed to fund those promises. In order to pay these pensions and health care costs, governments will need to raise taxes and businesses will try to shift their unfunded liabilities onto government, creating even greater revenue needs. Of course, as Andy points out, the younger generations asked to pay these costs will be far from thrilled and honored to do so.

Absent tax increases, or in some instances price increases for the products and services offered by companies with unfunded or underfunded retirement plan obligations, companies will go under. Governments will be forced to cut back on services, including, as Andy points out, hiring teachers and fixing potholes. This is not some "way in the future" problem, because the very early signs of the upheaval are already crossing the news wires. Andy mentions General Motors and the airlines, but these are but a few of the companies in deep trouble. The gap? It could be as much as $450 billion.

There are two huge lessons that America, Americans, American business, American politicians, and American governments need to learn before anyone attempts to solve the problem. After all, what's the point in repainting the foyer walls if the ice dam problem on the roof hasn't been fixed?

The first lesson is simple. Don't make promises that you cannot keep. That's at the core of the advice I gave on how to avoid being bashed by a blog. It's advice that's been favorably quoted by a broad spectrum of web sites, including The Big Picture, WFMU blog, The Center for Realtor Technology, Boing Boing, Undernews, the online report of the Progressive Review, Germany's Blogbiz, Blogzerk, Germany's Blogging Tom, Learn to Trade Futures, Wicked Word Craft, Crain's Cleveland Business on the Web, Gandalf23, Blogaritaville, Peter's Reviews, and the Head Lemur's Raving Lunacy. Apparently I hit a very responsive chord.

The second lesson is the flip side of the first. If you make a promise, focus resources and energy on keeping it. In other words, plan. If retirement pensions are promised to workers, set aside the appropriate amounts of money, in a secure pension trust, so that the pensions can be funded. Of course, with the decades-long Social Security ponzi scheme serving as a role model, private companies have adopted the same "what? me worry? (about tomorrow)" attitude that has come home to roost.

In all fairness, the Social Security arrangement is but a reflection of American culture. It's tough, isn't it, to set aside funds for a child's college education or a possible period of disability or job loss, when so many "needs" compel immediate spending. And spending is good for the economy, isn't it, almost patriotic? After all, when tomorrow arrives, and a college tuition bill looms or a pink slip is received, someone, somewhere, somehow will step to the rescue. It's not just financial matters that manifest this attitude. People go off hiking in the wilderness without appropriate supplies. Students seem shocked when December 1 arrives and there are examinations to take that require far more preparation than there is time, because not much has been done during the semester. War planners are befuddled by the need for post-invasion planning. Gasoline shortages and accompanying price hikes come as big surprises to those not able or willing to think or see beyond the horizon of the evening's last call. The long-standing Boy Scout motto, "Be Prepared," is about as popular as are the Boy Scouts.

The pension and social security shortfalls are magnificent illustrations of the planning deficiencies afflicting American culture. These aren't theoretical issues. These are real, hit-the-pockets, lifestyle-disrupting crises. These hit very close to home. These scare people. These bring out emotions. Andy's right. Dealing with these problems poses a real possibility of getting downright ugly. And nasty.

How did we get here? Does anyone care? Does it matter? Ought we not let the past be bygone and move forward? Why cry over spilt milk? How does casting blame fix things? Figuring out how we got into this mess is valuable, not for pointing fingers, which does nothing to solve the problem, but for identifying the deficiencies in thinking and the flaws in character that permeate culture and that need to be expunged before solutions can take hold. Remember, I'm not going to repaint the entrance hall until I know that there won't be more ice dams on the roof. (Good news: I finally found a roofer, who was willing to deal with the job, and who found the problem. Yep, construction errors.)

What happened is this. Promises were made to pay pensions. The amount required to fund the pension should have been calculated and set aside. I can't say that no one did this, for surely there must have been people who computed the cost, and even called for funding the promises. It's likely they were ignored, seen as Jeremiahs intent on taking the fun out of the party. So companies, awash in cash, chose to hire executives at salaries 10, 100, 1,000, even 10,000 times the salaries of the rank-and-file (or should I say, the rank-and-fodder?) who face pension-free retirements. Why? The standard defense is that these are the salaries commanded by these executives. And hindsight tells us that many of these highly compensated business geniuses didn't do much to rescue or improve the companies. They simply grabbed what they could grab, stock optioned themselves into low-taxed gains, and skipped town. Are we to believe that there were no competent, worthy, sensible managers willing to work for a fraction of what the "elite" were demanding who could have done no worse and probably a much better job? Why did no one say, "Look, the CEO can be paid $40 million instead of $60 million and we'll sink the difference into the pension fund"? Perhaps someone did ask that question so the inquiry should be: why did no one listen?

All pensions, including Social Security, ought to be funded, and that's a place to start. Existing unfunded or underfunded pensions need to be made secure. The question is, "Who pays?" Why not a user fee on corporate executives and shareholders whose failure to fund, and whose mismanagement of, pension promises and pension accounts has imposed a cost on society much like the cost imposed on infrastructure by the vehicle crossing the bridge and appropriately charged a bridge toll? Before the "it's a free market" object is raised, let's examine the market and see how "free" it is. Is it a free market when the same folks sit on corporate boards, playing round-robin games with executive appointments, as insiders move from boardroom to boardroom? Is it a free market when labor and management conspire to portray a pension plan soothing to the union but in reality a paper configuration? Is it a free market when pension plans fall short of funding goals because the accounts are not invested consistent with secure long-term pension funding growth?

A market is not, and cannot be, free in the absence of truth and candor. Otherwise the market is deceptive, and deception is not free. That's the truth of this entire mess. And truth hurts. In this instance, it's going to hurt a lot. The debate will be intense, shrill, and frightening. Let's hope it gets straightened out before American industry crashes and tens of thousands or even millions of retirees are left on the very short end of a poorly planned stick.

The recent news about the guilty plea entered by a former aide to Representative Tom DeLay is most troubling. Michael Scanlon apparently conspired to bribe public officials, and has agreed to pay damages to Indian tribes whose interests were adversely affected by the attempts of Scanlon and his associates to "persuade" members of Congress to block those tribes from opening casinos. Not surprisingly, Scanlon and his crew were trying to prevent these tribes from competing with other tribes who had paid tens of millions of dollars to Scanlon et al.

It appears, according to this story, that this lobbying group had at least three dozen members of Congress on board in its Indian tribe casino efforts. Another member of the group has been indicted on fraud charges involving casino fleet boat purchases. Trips, tickets, and campaign donations flowed from the lobbyists and their clients into the coffers of politicians.

This is NOT how government should work. Years ago, when I studied civics, we were given the impression that legislators were public servants. They served the public. They made decisions based on the best interests of the nation as a nation. Of course, growing up brings all sorts of broken dreams and disappointing realities, but it is indefensible to accept government as a plaything of the moneyed interests. But that is what it has become.

How long until investigators discover what many of us already think we know? How long until we discover that what's in the tax law has been no less tainted than what's happened to native American casino enterprise efforts? Will the Republic endure? Or will the legislature follow the example of the Roman Senate, acquiescing to the wishes of an emperor and his elite? I know this sounds dramatic and exaggerated, but the bribing of legislators, overt or discreet, is thoroughly unacceptable. No law, tax or otherwise, ought exist for any reason other than the public good.

Perhaps that is why Civics disappeared from K-12 curricula. Teachers just couldn't bring themselves to set up more children for inevitable disillusions. Perhaps they came to understand that given the choice between answering the question "Where do tax laws come from?" and "Where do babies come from?" it would be easier and less uncomfortable to answer the latter.

It would be nice to think that 2,000 years of history brought some moral progress to match the technological progress achieved by the species. Somehow, it just hasn't happened. That's sad. Very sad.

Thanks for reading this blog, for without readers it wouldn't be much.

Thanks for sending informative and thought-provoking comments, for without feedback it wouldn't be as much fun.

Thanks for the Internal Revenue Code, for it provides so much material.

Thanks for good tax practitioners, for without them taxpayers would be adrift.

Thanks for diligent tax students, for without them the tax lore would die.

Thanks for the good that sometimes is done with tax revenues, for without those achievements it isn't worth collecting the tax.

Thanks for the First Amendment that lets criticism of tax law and its author Congress be expressed, for without it they'd be knocking at the door.

Thanks to all the folks who introduced me to the world of taxation and mentored me through my tax growth, for without their sage advice and patience I'd be doing something else and THAT is a worrisome thought.

Happy Thanksgiving to all.

It is so true that a great way to learn things is to teach. Although the principal reason for that seeming paradox is the need for the teacher to be prepared, and thus to learn what is to be taught, another reason is that students ask interesting questions that inspire teachers to do research in a hunt for a sensible response.

I had one of those moments recently in the basic federal income tax course that I teach. While examining the standard deduction, students asked why there was an additional standard deduction for the blind and for those who had attained age 65. Why not an additional standard deduction for the deaf? What is it about attaining age 65 that justifies an income tax reduction?

A bit of research turned up a fairly consistent explanation of the additional standard deduction for those who have attained age 65 or who are blind. Quoting from Jeffrey H. Kahn, "Personal Deductions - A Tax 'Ideal' or Just Another 'Deal"?," 2002 Law Rev. of Michigan State Univ. - Detroit College of Law 1 (2002), "[T]hese additional deductions ....reflect the fact that when a person or her spouse is blind or aged, she has greater subsistence expenses than do those who are sighted or young." According to Thomas D. Griffith, "Theories of Personal Deductions in the Income Tax," 40 Hastings L.J. 343 (1989), "The difference between these two interpretations of the principle of taxation according to material well-being can be illustrated by the treatment of a special tax preference for the blind. Under the egalitarian principle of taxation according to overall well-being, a tax preference for the blind can be justified simply on the grounds that a blind individual is worse off than an individual with sight, even if the tax reduction benefits the blind person less than an identical reduction would benefit a sighted person. In contrast, under the utilitarian principle of taxation according to the marginal well-being created by income, a tax preference for the blind is justified only if the blind person has greater needs than a sighted person, so that the tax reduction would be more valuable to the blind than to the sighted."

In other words, the Congress presumes that blind people and persons who have attained the age of 65 face higher costs of living and thus deserve a tax break. This sort of thinking is nonsense. Yes, there are blind people and older people whose expenditures increase because of blindness, aging, or one of thousands of other reasons one's expenses can increase. Yet there are blind people and older people whose financial resources are more than sufficient to defray those presumed additional expenses. Again quoting Thomas D. Griffith, "Theories of Personal Deductions in the Income Tax," 40 Hastings L.J. 343 (1989), at footnote 65, "For example, the additional personal exemption for the blind and the blind and the aged, now replaced with an additional standard deduction, each provided over 10% of their benefits to individuals with incomes in the top 1.4% of the population. See Emerging Issues, supra note 3, at 366-67 (citing 1977 Treasury Department figures)."

Notice that as one student pointed out, there are no tax breaks specifically directed to people who are deaf, or, I will add, suffering from any other debilitating or challenging condition, such as paralysis. What of persons who have not yet attained age 65 whose costs of living increase at rates outstripping increases in income? Answers in a moment.

A properly designed income tax system measures a person's ability to pay by measuring taxable income. If it is appropriate to consider the impact of medical or other conditions that impede ability to pay, a deduction reflecting those costs will reduce taxable income. For a wealthy person, the resulting taxable income will be higher than it would be for a similarly-afflicted poor person. Wealthy senior citizens don't need the benefit of an additional standard deduction. Nor do poor senior citizens. Citizens of any age, subtracting deductions from gross income, will establish ability to pay.

It's worth noting that the additional standard deduction for those who have attained the age of 65 is not the only goodie in the federal income tax law, state income tax law, or in federal and state law generally, that caters to the elderly on the principle that elderly are presumed to be financially needy. Extensive lists and descriptions of these benefits can be found in Jonathan Barry Forman, "Reconsidering the Income Tax Treatment of the Elderly: It's Time for the Elderly to Pay Their Fair Share," 56 Univ. Pittsburgh Law Rev. 589 (1995); Gail Levin Richmond, "Taxes and the Elderly: An Introduction," 19 Nova Law Rev. 587 (1995); and Louis Alan Talley, Congressional Research Service, Federal Income Tax Treatment of the Elderly (March 5, 1991), to cite but a few. Gail Levin Richmond alerts readers to the fact that the age at which various tax and other benefits kick in range from the mid 50s into the early 70s. In other words, there are almost as many definitions of "elderly" as there are senior citizens.

Nor is my criticism original or special. The title of Jonathan Barry Forman's article, "Reconsidering the Income Tax Treatment of the Elderly: It's Time for the Elderly to Pay Their Fair Share," 56 Univ. Pittsburgh Law Rev. 589 (1995), says it succinctly. The article, though, is worth the read. Only so much can be packed into a title. For example, the facts matter. Using the government's own information, Forman points out, "Indeed, the median incomes of families age 60-64 and 65-69 are greater than the median family incomes of families age 20-24 and 25-29. All and all, there can be little doubt that many elderly families have incomes greater than a significant portion of younger families[,] .... [and that] on average, the elderly are twice as wealthy as the nonelderly." He also explains that "The elderly are also less likely to be poor than are other demographic groups. For example, in 1992, when the overall poverty rate was 14.5 percent, only 12.9 percent of the elderly were poor. 6 In contrast, almost 22 percent of children were poor that year. 7 It is worth noting, however, that among the elderly, the poverty rate goes up as people get older. For example, while just 10.7 percent of those age 65 to 74 were poor in 1992; 15.3 percent of those age 75 to 84 were poor, and 19.8 percent of those age 85 and over were poor."

So how has it come to be that the elderly are in front of the line for tax breaks? Simple. For years, the elderly have been portrayed as the nation's neglected poor. Perhaps that was true at one time, but it no longer is, and once the problem is ameliorated, the remedies ought to be cut off. Unfortunately, politics being what it is, the late Claude Pepper made his career by championing the cause of the elderly, whom he portrayed to the nation as a cast-off segment of the population abandoned to widespread disease, early death, and all other sorts of evils. The reasoning deficiencies in claiming that finding a poor old person means all old people are poor somehow were overlooked as Pepper was re-elected time and again, even though similar reasoning in other areas of life would bring the political correctness police swat team within moments of its utterance.

If any age segment in American society is in need of special attention, it's the children. But they don't vote, even though sometimes they are taxed (another law review article in the making here), so apparently they don't matter as much except as pawns in the chess game of politics.

Any suggestion to repeal these special tax breaks based on stereotyping by age or affliction, relying instead on measurement of financial condition and ability to pay, has met and will meet stiff resistance. When the former additional personal exemption for those aged 65 and older was changed to an additional standard deduction, thus making the break unavailable to taxpayers who itemize deductions, the outcry was widespread and intense. In at least one instance a reporter described the affected taxpayers as "feeling cheated." I guess that's how a bank robber feels when the police take back the bank's money bags. Cheated. Oh, that poor millionaire retiree. Deprived of an additional personal exemption and not getting an additional standard deduction because there's all those real estate taxes on the resort condos to deduct.

Excuse my sarcasm. I just happen to appreciate the frank inquiries made by my students.

As I pointed out, when someone stops to pay a bridge toll, they're not asked their age (unless there is some "senior citizen bridge toll discount" of which I am unaware). And if bridge tolls were based on ability to pay, the questions would be about income and expenses, not about age or eyesight. Of course, bridge tolls aren't based on ability to pay but on user fee principles, so there's no way to prove that an ability-to-pay bridge toll would not be infected by all sorts of extraneous factors.

Now I'll sit back and brace myself for the response. I'm confident I'll be getting an email from Mom. Uh-oh.