MauledAgain

It's fun watching, and reading, how a dialogue can develop, through the use of blogs, when an idea is set out for comments and reactions. In Just Because It Didn't Work the First 50 Times Doesn't Mean It Will Work Next Time, I criticized the current legislative proposal to extend and expand bonus depreciation and first-year expensing. Within hours, Bob Flach, the Wandering Tax Pro, reacted, pointing my attention to Here is Something to Think About, in which he proposes eliminating the depreciation deduction for real estate. I took up that aspect of the issue in Instead of More Favorable Depreciation Deductions, Eliminate Them?. Then Goose the Tax Dog, a/k/a Your Fearless Blogger, considered the proposal in Real Estate Depreciation, and suggested tying the depreciation deduction to changes in the valuation of real property for state and local real property tax purposes. Bob then picked up on these exchanges in What's the Buzz? Tell Me What's A Happenin'. Joe Kristan, over at TaxUpdate blog, picked up on the original concept in Party Like It's 2002.

In a theoretical sense, tying depreciation to state and local real property tax assessments makes sense. It would restrict real estate depreciation to instances in which the property's value actually declined. The proposal rests on the presumption that real property tax assessments reflect value. As I noted in my comment to in Real Estate Depreciation, real property tax assessments rarely reflect value. In Pennsylvania, for example, properties aren't assessed at fair market value, assessments are done sporadically, state laws designed to generate uniform and current valuation fail to work, judicial decisions send messages that aren't heard, and efforts are underway to eliminate the property tax because its administration is so problematic.* So when the theory is transported into the practice world, it breaks apart. Perhaps it can be salvaged by creating a system that denies depreciation deductions unless the taxpayer demonstrates that the property has declined in value. Would this encourage appraisers to come in with absurdly low values? Because the best proof of value is an arms' length sale to a third party, would the deduction be postponed until the taxpayer disposed of the property? Such an outcome would be equivalent to repealing the depreciation deduction for real estate. Here's another idea. Could the deduction be tied to a national index for the type of property involved? If data shows that the average selling price of office buildings declined by 2% during a particular year, owners of depreciable real estate would be permitted to deduct an amount equal to 2% of adjusted basis. The deduction would not be 2% of value because the taxpayer has not been required to include increases in value in gross income. Perhaps the price to be paid for this revised depreciation deduction is the symmetrical requirement that gross income be increased by 4% of value if the average selling price of office buildings increased by 4% during a particular year. If this were required, the deduction would reflect a percentage based on value and not basis. Even with the current declines in real property values, I doubt property owners would support this arrangement, because in most years there would be gross income and not a depreciation deduction.

As the debate over an economic recovery stimulus package continues, the idea of eliminating a deduction that is inconsistent with economic reality may find more advocates. Tax breaks ought not be extended to those who don't need them. Casualty loss deductions don't exist for taxpayers who have not endured casualties, trade or business deductions are not allowed to taxpayers who are not carrying on a trade or business, interest deductions aren't provided to those who are not in debt, and thus depreciation deductions ought not be permitted for properties that aren't depreciating. Perhaps a realization that warps in the tax system contributed to the economic recovery, both directly and by encouraging people to play games in real estate in order to acquire tax breaks, will encourage the Congress to get to the root of the problem rather than sticking band-aids on the symptoms.

As a side note, it is worth noting that in the new digital world, an idea can be circulated in hours or days rather than in the months or even years that are required when an article is published in a traditional journal. A response can be crafted and published within hours or days rather than compelling people to wait for even more months and years. When people suggest to me that I bundle some of my MauledAgain posts into a law review article, I wonder why. By the time it appears in print, it most likely will be last year's story and an issue no longer getting attention. If the discussion of real estate depreciation, bonus depreciation, and first-year expensing doesn't show up until a law review can get it published, the legislative ship has sailed and the message arrives late. I share these thoughts because the development of the discussion concerning real estate taxation during the past week provides an excellent example of the point that I've been trying to make for the past ten or more years about the growing irrelevancy of traditional law review scholarship. Talk about something that is depreciating. But, well, to demonstrate that blogging can resemble traditional scholarship, here's the footnote.

========================

* For discussions of the problems afflicting the Pennsylvania real estate tax assessment process, see An Unconstitutional Tax Assessment System; Property Tax Assessments: Really That Difficult?; Real Property Tax Assessment System: Broken and Begging for Repair; and Philadelphia Real Property Taxes: Pay Up or Lose It; How to Fix a Broken Tax System: Speed It Up?; Not the Sort of Tax Loss Taxpayers Prefer; Uniformly Rejecting Tax Non-Uniformity.

It's January. Fast approaching is January 31, the date by which employers must get W-2 forms to their employees' and payors must get Forms 1099 to their payees. For most taxpayers, this signals the beginning of "tax season," a time for preparing and filing their tax returns. Or at least a time for having prepared and then filing their tax returns. For tax return preparers, the season began a few weeks ago, as they turned to installing tax software, running tests, stocking up on supplies, reviewing changes in the tax law affecting 2008 returns, and otherwise bracing for the stream of visitors. Recession or no recession, there are tax returns to be filed and tens of millions of people who need help in doing so.

But for some tax professionals, there's not much special about this time of year. For example, tax planners are busy throughout the year, and often their professional lives become chaotic in December. Tax faculty are busiest when preparing courses, teaching, and grading, and not much more happens in February, March, and April than happens in September, October, and November.

But this particular January brings a different type of tax season. Whichever way one turns, governments at every level are discussing tax issues as they focus on budgets, corporations and individuals are continuing to bring forth every imaginable tax break as "the" solution to the current economic turmoil, and Congress already is beginning to fracture as some insist on sticking to the disproven way of managing government revenue and spending.

Friday morning's Philadelphia Inquirer brought news that the Governor of Pennsylvania intends to hold the line on state sales and personal income taxes even though the state faces $2.3 billion projected deficit that weeks ago was a $1.6 billion shortfall. The Governor expects the federal government to provide stimulus payments to the state. Others have suggested a new tax on the extraction of coal, oil, and gas, which could generate a fair amount of revenue considering that a huge natural gas deposit has been discovered in Pennsylvania, or perhaps it already was discovered and they figured out how to get the gas out of the ground. To the extent the state cuts programs that local governments need to pick up, their budgetary woes will worsen and they will need to look at taxes.

For example, in Philadelphia, suggestions such as this one from a member of City Council, to delay scheduled wage-tax decreases have been circulating. People are debating whether a postponement of a schedule tax decrease constitutes a tax increase. Why argue about a label and then act based on the label? Why not debate the wisdom or lack thereof in delaying a wage tax decrease? Will it generate revenue? Only if it does not encourage businesses and taxpayers to leave the city. Will they? Has anyone done a survey?

Nor is that the only tax item getting attention in Philadelphia City Council. According to a Friday news report, legislation was proposed that would provide a $3,000 tax credit to employers who create jobs during the next two years. This credit is a revision of one enacted in 2002. That credit failed to generate jobs. Is it because the credit is only $1,000? City council is trying to decide why a tax credit predicted to create 3,100 jobs ended up creating 347 jobs. Perhaps for the same reason that brokers promise 31% rates of return only to see the actual outcome be 3.47%? Something about placing expectations that are too high on approaches that don't have a proven track record?

In D.C., Friday also brought news that Republicans in Congress are unhappy with the proposed stimulus legislation. The President has agreed to discuss with them their call for even more tax cuts. Somehow, the argument that cutting taxes will rejuvenate the economy continue to persist, even though a decade or more of tax cuts just didn't do it. Perhaps eliminating all taxes and government services will do the job?

In the meantime, another letter to the editors of the Philadelphia Inquirer keeps alive the idea of raising the gasoline tax so that reduced pump prices don't blunt the enthusiasm for alternative fuel development that had swept the country last summer. This is one of my favorites, a three-in-one plan to fix the economy, the environment, and the energy crisis. I've written about it extensively, with the most recent long analysis in The Return of the Federal Gasoline Tax Increase Proposal, which discussed a proposal that moved along the implementation path in a decision I discussed earlier this month in Whatever a Tax Increase is Called, Someone Needs to Sell It.

Friday's Philadelphia Inquirer was packed with tax issues. In yet another article, a former chair of Delaware County Council, arguing for a change in how state pensions are computed, pointed out that with the upheaval in the markets, the pensions that are promised to state workers and teachers will require "massive increases in taxes, especially property taxes for local school districts" because estimates of the revenue needed [to fund the promised pensions] are in the billions, and they will no doubt grow."

Today someone sent me a report advocating a two-year suspension of federal income tax on the gross income arising when a debtor purchases its debt from the creditor for less than the face amount. The report gives an example of a company that owes $100 but that can purchase it back for $75. We're supposed to agree that somehow the $8.25 tax liability arising from the $25 of gross income stands in the way of the company engaging in this buy-back and that somehow if many companies get this tax break not only will they engage in these transactions but by doing so they will restore consumer confidence and confidence in the free marketplace. My guess is that it would restore confidence in the belief that the system can be worked over by whomever is in a position to push through their favorite "for us and for us first" tax break.

That's not all. Friday's paper brought news that former state senator Vincent Fume lost his appeal of the reassesment of his home by the Philadelphia Board of Revision of Taxes. The last time I had written about this on-going story, in Not the Sort of Tax Loss Taxpayers Prefer, the Board was explaining that it had lost the file for Fumo's case. At that time the Board had voted 4-3 to refrain from reassessing Fumo's 27-room mansion, which had an assessment of $250,000 though it was on the market with an asking price of $7 million. After the file problem was somehow handled, the Board met again, one member changed his vote, and Fumo's mansion was assessed at $953,500. Fumo appealed, claiming that was too high a value. At the hearing, Fumo's appraiser testified that he had never been inside the mansion. The saying about not judging a book by its cover comes to mind. On Thursday, the Board met to consider the appeal. With two members absent for medical reasons, the Board voted to reject the appeal, reportedly by a 5-0 vote. Fumo, in the meantime, collapsed during his corruption trial in Federal court, though it is unlikely the news of the Board's decision was the triggering event. The charges include allegations that Fumo used state money and non-profit organization funds to pay for some of the renovations he undertook at the mansion. The house is on the market, at a reduced price of $5.5 million, because Fumo needs to raise funds to pay for his legal defense. The Board's decision can be appealed. The story isn't over.

Like that last story, the tale of this wild 2009 tax policy season is far from complete. It's just beginning. At every level of government, from Congress down to City Councils and local tax assessment boards, tax issues are coming out of the woodwork. In some ways, I'm glad that tax policy is now center stage, though it's too bad it took an economic catastrophe to get it there and even though it must share the stage with other very important issues, including environmental, energy, national security, and health care concerns. The latter arrangement isn't really an obstacle, because these issues are inter-connected, and tax has played and will play a role in dealing with each of them. People need to let their legislators and public officials know what they want the tax system to be, how they want it administered, how they feel about the activities of lobbyists, their reactions to the parade of special interest groups trying to get their particular tax break enacted, and what each proposal would do in terms of their confidence. Without a restoration of confidence, the tax policy game could end up being window dressing in a house of cards. To make their comments valuable, people need to learn about taxes, to read the proposals and not just the advocate's news release, and to study the analyses that have been published by commentators, tax practitioners, and taxpayers on every side of the issue. An informed electorate is a powerful electorate. That's one reason I write. Surely there is no shortage of material about which to write. I'm going to guess that somewhere there was a tax story on Friday somewhere that I missed. That's bound to happen, because I do not read all of the nation's local papers. I'll leave those stories to others.

Several comments have arrived reacting to my post earlier today, Taxing High-Income Individuals. One, from a former student, simply noted that he had "enjoyed" the post. Reading about taxes rarely causes joy, but sometimes it happens!

Another comment came from Mary O'Keefe, who is a public policy economist teaching tax at Union College and coordinating the Union College/Schenectady Department of Social Service VITA site. Today, in Tax Planning for the Rich and Poor, Mary quoted part of my Taxing High-Income Individuals post, and then added the insights and perspectives of someone who is in touch with many taxpayers, none of whom qualify as high-income individuals and almost all of whom face a variety of challenges, procedurally and substantively, from the tax law. Mary brings to the discussion a much-needed look at tax policy in the context of its everyday application to the lives of ordinary people.

Consider the sorts of questions encountered by Mary and people helping the not-so-wealthy with their tax returns. "What will getting married to our taxes?" or "What is negative marginal rate, what does it mean, and will it be with me forever?"

I'll leave it at that. The entire post is well worth reading. I wonder how many tax policy decision makers in Washington, D.C., understand these sorts of questions and concerns. I wonder how many of them understand those questions and concerns. I hope that somehow one or more of those folks make the opportunity to read what Mary has written.

There was an interesting article in this week's Tax Notes. In "What is the Appropriate Tax Base for a Tax on High-Income People," 122 Tax Notes 416 (2009), David Bernstein writes:

Imposing taxes on high-income households can be especially challenging. First, high-income households tend to be fairly adept at arranging their affairs to avoid paying tax. Second, a disproportionate number of high-income households are dual-earner couples that can afford to have one spouse quit his or her current position. Third, high-income households tend to have multiple sources of income and sometimes have the ability to define the form of their own compensation.

Bernstein addresses the question of whether tax rates can be decreased if the tax base with respect to high-income individuals is widened. He explains that social security and Medicare have been funded with taxes imposed only on wages, asks if that base should be expanded, and notes that doing so "could be" politically challenging.

Bernstein draws our attention to several concerns. Each deserves consideration.
The fact that "high-income households tend to be fairly adept at arranging their affairs to avoid paying tax," though true, ought not dissuade Congress and the new Administration from making that adeptness a useless skill. High-income individuals have this adeptness for several reasons. First, they can afford to hire people willing to craft tax avoidance schemes. Second, they can afford to enter into arrangements from which typical taxpayers are excluded because they lack funds. Third, they can afford to contribute huge sums to political campaigns, thus acquiring a louder voice in the democracy than has the typical citizen. Fourth, they benefit from existing tax loopholes, tax breaks, Code complexity, and IRS inability to defend the Treasury.

The answer is simple, though surely unpleasant. Eliminate deductions for tax advice fees. It's bad enough people pay for advice on how to escape civic duty, but it adds salt to the wound to finance those expenditures through a tax deduction. Make it more difficult for these folks to stash their funds into tax shelters by leaving them with fewer dollars to use as tax avoidance tools. In other words, increase the marginal rates on incomes over $1,000,000, ideally in progressive stages. Require total transparency with respect to campaign contributions, revealing the names of those who contribute to PACs, foundations, and other conduits used to funnel money into campaigns, and publish the lists on April 13. Clean up the tax law, removing the loopholes, breaks, and complexities that provide cover for the tax avoidance merchants. Increase funding for the IRS so that it can track down and deal with tax shelter promoters, offshore schemes, fraudulent returns, and other gimmicks used to make a person with high income pay taxes at rates lower than those imposed on the middle and lower income echelons.

The argument that raising taxes on the high-income cohort would backfire because "a disproportionate number of high-income households are dual-earner couples that can afford to have one spouse quit his or her current position," then go for the backfire. So what if the spouse of a multi-millionaire quits a job held for some reason other than supporting the family. Will the economy suffer? No. There's a long line of people who need jobs in order to survive who would be willing to step up and step in.

Indeed, "high-income households tend to have multiple sources of income and sometimes have the ability to define the form of their own compensation." That's one of the problems. Income should be income. Eliminate the various "qualities" attached to specific dollars on account of some label that is difficult to justify. If a person has $10, it can purchase $10 of goods or services whether it came from wages, interest, dividends, property disposition gains, gambling, or any other source of income. Giving a preference to certain income, such as capital gains and dividends, encourages people to play games to make salaries look like capital gains, to make interest look like dividends. Tax alchemy is bad stuff. It brews up economic turmoil.

Bernstein's question about funding social security and Medicare is a good one. The answer depends in part on what those programs are intended to be, which may or may not be the same as what those programs were intended to be. Is social security a retirement plan? Then perhaps it makes sense to fund it through a tax on wages and self-employment income. Or is social security a welfare plan? Then perhaps it makes sense to fund it through a tax on all income. The number of people added to the social security rolls by including those who did not earn wages or sufficient wages costs adds far less to the payouts that would be required than would be the revenue increase generated by taxing all income. Taxing all income would probably permit either a rate reduction, or an employment tax credit for low-income taxpayers, or some combination of the two. Medicare is easier to address. Medicare is health insurance. People get sick and need health care whether or not their income consists or consisted only of wages, or included wages and interest, or did not include wages. Medicare should be funded by a tax on all income. While they're at it, many of the exceptions and limitations can and should be swept away.

A plethora of tough economic questions face the nation. Tax issues abound. The ones highlighted by Bernstein are but a few, but they're an important few. Congress and the Administration need to act, they need to act quickly, they need to act decisively, they need to act sensibly, they need to act free of lobbyist manipulation and control, and they need to act for the well-being of the nation and all of its people. Can they do this? Surely. Will they do this? We'll see.

My Monday post criticizing, among other things, the proposed expansion and extension of bonus depreciation and first-year expensing deductions, Just Because It Didn't Work the First 50 Times Doesn't Mean It Will Work Next Time, brought a response from Robert D. Flach, the Wandering Tax Pro. He pointed me to his post, Here Is Something to Think About. In this post, Bob suggests the elimination of the depreciation deduction for real estate. I agree.

Ask any person who has been in one of my tax courses what they learn about depreciation of real estate, and they will tell you not only that they picked up some understanding of how it is computed, depending on the course, but that they learned the bizarre impact of a deduction that is allowable to a taxpayer even when the taxpayer is becoming wealthier. Deductions should be triggered by a decline in wealth, or out-flow, just as gross income is triggered by in-come. Not all income becomes gross income, and not all out-flow becomes a deduction, but it's flat out silly to permit a deduction to someone on account of a pretensive decline in value of property that has not only failed to decline in value but that has increased in value. Despite the recent stagnation and decline in some real estate prices, chiefly homes, over the long haul, real estate increases in value. Why? The supply is limited and the demand, that is, world population, increases steadily if not exponentially.

It is true that real estate is depreciated under principles that are less generous than those applicable to other property. Real estate depreciation is limited to the straight-line method, whereas accelerated depreciation is available for most other depreciable property. Real estate depreciation is computed using a mid-month, rather than half-year or mid-quarter, convention. Real estate depreciation is computed using periods of time longer than those used for most other depreciable property, even though the periods of time used for real property are significantly shorter than the economic useful lives of buildings. But these differences are misleading. Giving two pounds of cheese to a wealthy person when distributing five pounds of cheese to a poor person when operating a food bank for the hungry doesn't reduce the absurdity of giving free food to someone who is not financially bereft.

Bob asks, "So why do we allow a tax deduction for the depreciation of real estate?" The answer can be given in one word. Lobbying. Many years ago, lobbyists for the real estate industry convinced the Congress that if depreciation deductions were not allowed for real estate, the economy would collapse. They didn't invent this approach. Lobbyists for other industries, such as oil and gas, also used this tactic. Never mind that the real estate industry should have been happy that the increases in real estate value weren't included in gross income as they occurred. After seeing depletion deductions that permit, even to this day, certain extractive industries to deduct their investments many times over, it's no wonder that the real estate industry figured it had to "get ours" before there was no more getting to get. They probably did not expect what happened. Over time, everyone jumped onto the "give us a special tax break or the economy will collapse" bandwagon. Is it any wonder that the tax law is filled with provisions that are not only complicated, usually because of the attempt to restrict the provision to the select group represented by the lobbyist, but also economically untenable, unwise from a policy perspective, and often lacking in common sense?

Real estate not only benefits from disproportionately and unjustifiably favorable deduction principles, it also escapes the worst of the depreciation recapture rules. Whereas gain from the disposition of equipment and other non-realty depreciable property triggers ordinary income to the extent of previous depreciation deductions, the gain on the disposition of real estate is capital gain, either directly or through section 1231, and thus is taxed more favorably than is gain on the disposition of depreciable personalty. Why? I suppose without these special tax breaks, the economy would collapse.

If there is a blessing from the current economic meltdown, it's that it presents a lesson. Tax breaks do not prevent economic collapse. The only exception would be a tax break for truth-telling. What kills the economy is lack of confidence in one's trading partner, whether that partner be a retailer, a loan applicant, a manufacturer, an employer, or a customer. What causes lack of confidence? Lack of confidence is simply lack of trust, and what causes lack of trust is the constellation of deceitful actions, ranging from overhyped products, cooked books, fraudulent receipts, overstated deductions, hidden gross income, embezzled funds, Ponzi transactions, and, yes, lying, including lying about the impact of a tax break on the economy. Of course, I'm being facetious, because there is no way to administer a tax break for truth-telling. Too many people would lie when filling out the tax form that asks if they are truth-tellers. Instead, there need to be powerful disincentives for lying, and those penalties need to be enforced. Otherwise, people lose confidence in those charged with protecting the economy, particularly the government. When lack of confidence spreads from the market-place to the public arena, governance stability is threatened.

Reform needs to begin not only with the elimination of depreciation on property that does not depreciate but also with the other tax breaks that were advertised as economic palliatives and that turned out to be skid-greasing for tax shelters, tax fraud schemes, and financial rip-offs. If real estate or extractive industries, to give two examples of the most egregious beneficiaries of bad tax breaks, are that essential to the economy, they ought to be able to do well iin the absence of government assistance. If the product is good, and delivered truthfully and well, people will manufacture it and people will purchase it. If the service is good, and delivered truthfully and well, people will offer it and people will pay for it.

Someone who commented on Bob's post noted, "On the other hand, the real estate industry thrives on getting as much of a write-off as you can right now and worry about the future later. I doubt you could get political support for that." How true. How sad. Is not one of the underlying cultural problems with the economy the notion that one can have it now and pay later? The people who sell that approach, whether implementing the debt mess that enabled it or preaching the me-generation attitude that nurtured it, owe the country a confession and an apology.

The whole point of my Monday post, Just Because It Didn't Work the First 50 Times Doesn't Mean It Will Work Next Time, is that the time for change, true change, is upon us. Today is the first full day in office for a new Administration. The opportunity exists to implement change or to hang in with more of the same. Undoubtedly the advocates for those who have done well in ways that have hurt most Americans will continue to harp on why they, and their clients, are special and deserve to go straight from the left-turn lane, so to speak. It will take powerful and courageous leadership to look these lobbyists in the eye, publicly, and let it be known that their day in the sun has faded. They had their chance, they cajoled and manuevered the country into doing it their way, and the outcome is painfully obvious. Enough is enough. No more bonus depreciation gimmicks. No more first-year expensing extensions. No more depreciation of assets that are worth more now than when they were acquired. No more multiple deductions for investments. No more supremacy of short-term greed over consideration of long-term cost.

It's Groundhog Day, rerun city, and déjà vu all over again. Ask the Congress come up with a solution to the current economic crisis, and watch it turn to tax provisions that have been dragged out over and over and over as solutions every time an economic warning flag went up during the past two decades. The House Ways and Means Committee has released a summary of its proposed economic recovery package. Among the provisions are expansions of, and increases in, the earned income tax credit, the child credit, the education credits, the first-time home buyer credit, bonus depreciation, first-year expensing, NOL carrybacks, and several of the energy credits, widening of tax-exempt bond availability, and extending some of the existing tax benefits for economically distressed areas to a new category of tax-favored zones. If these sound familiar, that's because similar provisions have been included in some or all of the several dozen major revenue bills enacted during the past 20 years.

To its credit, Congress has tossed a "making work pay" credit into the mix, along with a small expansion of the work opportunity credit. It also has added several non-tax provisions, such as expanding Trade Adjustment Assistance job funding, increasing unemployment compensation, and adding funds to the Temporary Assistance for Needy Families program that focus more directly on the immediate needs of people in economic distress. But these proposals are, in the grand scheme of things, relatively minor.

Does it make sense to increase deductions for acquistions of equipment? How does that restore confidence in the economy, which is essential to putting the nation back on track. How does a tax provision that encourages businesses to use their limited funds to buy machinery put people in this country back to work? Nothing in the provision requires that the property be built in the United States, and it's almost certain that such a requirement would violate at least a few trade agreements and treaties. What's the point of enacting tax breaks that create jobs in other nations? Dollar-for-dollar, a tax break for creating jobs directly is worth much more than a tax break for purchasing equipment.

With the nation's economy in rampant turmoil, does it make sense to turn to the same shop-worn provisions that came with promises of outstanding national economic performance that failed to materialize behind the façade of debt-driven unaffordable consumption? Advocates of these provisions argue that they give businesses an incentive to create jobs, but if that were the case, why hasn't unemployment dropped while previous increases and expansions of bonus depreciation and first-year expensing were being increased?

What Congress is proposing to do is more of the same. It didn't work last time around. Why would it work now? Sometimes persistence is a virtue. Other times it is foolishness.

The answer is simple. The things that need to be done are neither palatable nor easy to explain. Dishing out more tax breaks that are easy to explain and promise relief with no sacrifice sell better when election day rolls around. The depreciation provisions, including bonus depreciation and first-year expensing, have contributed to the current economic mess by allowing taxpayers to compute taxable income as though their economic position declined when in fact it remained the same or improved. Packaged into tax shelters, LILO deals, tax-exempt leasing arrangements, and other devices that contribute to the tax gap, these provisions ought not be considered remedies for the very economic diseases that they have caused and aggravated.

If, indeed, it is time for change, Congress should be given that message and understand it. Change does not mean doing something over and over when it hasn't worked and shows no signs of working. Just as consumers need to abandon the bad habit of spending beyone one's means and borrowing beyone one's ability to repay, Congress needs to break its bad habit of using the tax code as a vote generator. The likelihood of Congress embracing genuine change and doing more than giving lip service to the concept remains, unfortunately, very low. Its recalcitrance may prove to be one of the most difficult obstacles to the incoming Administration's success in solving the mess in which we find ourselves.

Years ago, one of our then adjunct professors in the Graduate Tax Program told me a story about a taxpayer who thought he could outsmart the IRS by taking advantage of his church. This adjunct was an attorney who had recently retired from the IRS, and as best as I could tell either was involved in the case or knew the people who handled it. The taxpayer's return had been selected for audit because the charitable contribution deduction was quite high, particularly considering the taxpayer's modest income. When asked about the deduction, the taxpayer produced cancelled checks payable to his church that pretty much matched the deduction that had been claimed. Somehow the IRS made contact with the pastor of the church in question. The pastor confirmed that the taxpayer was a member, and when asked if he was indeed such a generous contributor, the pastor provided a damning explanation. The taxpayer had approached the pastor and expressed concern about the cash accumulated from the Sunday collections being left in the rectory. He offered an arrangement. He would write a check payable to the church in exchange for the cash collected during the Sunday services. The rest, as they say, was history. The taxpayer was charged with tax fraud, and some sort of deal was arranged. That is why, I suppose, that there's no official account of the tale. There is a slightly different version of the story in A Very Interesting Question, written by Robert D. Flach, known also as the Wandering Tax Pro. As best as I can tell, the pastor had no clue that the taxpayer was motivated by something other than security concerns.

Why no tax deduction for the payments to the church? It's not a charitable deduction unless it is, among other things, a gift. There is no gift if the taxpayer receives something in exchange for what is transferred to the tax-exempt organization. The rule is that there must not be a quid pro quo. Does a legal principle seem much more authoritative when it is expressed in Latin?

Now comes another story involving a church, and a taxpayer using its unknowing parishioners in a scheme to defraud the federal government. According to a news release from the Southern District of Florida, the federal government has arrested and indicted a tax return preparer on 24 counts of making and presenting fraudulent refund claims against the United States. According to the indictment and statements made in court, early in 2008 the defendant offered free tax return preparation to the members of a church in Westchester, Florida. Numerous parishioners took him up on the offer. Without telling them, the defendant included false deductions and credits on the returns, generating more than $84,000 in false refund claims. The defendant diverted part of the refunds to his personal bank account without telling the parishioners. I suppose his thinking was as follows. So long as the parishioners receive the refunds that they would have received had accurate returns been filed, they're not being deprived of anything by the defendant's actions. In other words, he wasn't stealing from them. But he was stealing. From whom? Many would respond, "From the government." But they're wrong. He's stealing from us, from you, from me, from people who pay taxes expecting that the money will go somewhere other than into the pocket of a tax return preparer through the filing of false claims.

One question did pop into my brain. Would not at least one of the parishioners look at the return before signing it, and then notice that the refund deposited into his or her bank account was less than the amount on the return? Would not at least one of the parishioners look at the return and notice deductions and credits that were inconsistent with the parishioner's financial situation? Imagine a childless taxpayer noticing a claim for the adoption credit. Imagine a renter noticing a claim for a mortgage interest deduction. But perhaps the answer lies in the general tax illiteracy of the American population, as reflected in the results of an H&R Block survey noted in Americans Failing Taxes 101. The less involved Americans are in their own tax reporting, the less likely they are to notice errors and preparer fraud, the less likely they are to understand their actual tax liability and the effect of their decisions on tat tax liability, the les likely they are to realize the impact of tax policy on their lives, and the less capable they will be of participating as citizens in public discourse about taxes that reaches beyond trite sound bites. Tax fraud is not sacred, but a citizen's obligation to understand taxes is no less sacred than the citizenship to which it is attached.

Spring semester classes began last Thursday. The Introduction to the Taxation of Business Entities course in the J.D. Program already has met twice, and Partnership Taxation in the Graduate Tax Program meets this evening for the first time. Long before I walk into the first class in any course, I have been investing significant amounts of time preparing for the course. For fall semester courses, the preparation usually begins in April or May, is suspended during most of the summer, and resumes in August. For spring semester courses, the preparation usually begins in late October or November, is suspended during part of December, and resumes in early January. Some people, including law students, think that there's nothing much for the professor to do but to pick up the book assigned to the course and last year's notes, walk into the classroom, and begin talking. Though that might happen in some courses, it ought not happen, and it surely doesn't happen in my courses. I've been meaning, for several years, to dedicate a posting to an explanation of the process that I use to prepare a course that I have previously taught. Hopefully, it's informative to people inside the law school community as well as to those who are on the outside looking in.

For illustrative purposes, I will go through the tasks undertaken to prepare Introduction to the Taxation of Business Entities for the Spring 2009 semester. The publishers of the book that I use produced a new edition in the late summer of 2008, so that made the list of tasks longer than it otherwise would have been.

1. I went through my class notes from the Spring of 2008, looking for notations that I had made in the margins, corrections that were necessary when I discovered something wasn't right, modifications I suggested to myself when I found a better way to make a point, and warnings that I gave myself that indicated some revision was required because that particular topic or point didn't flow as smoothly as it ought to have. Wherever necessary, I made changes to the class notes document.

2. I then did the same thing with the Course Outline and Assignments document that circulates to the students. Here, I am looking for typographical errors, notations suggesting increases or decreases in time allotted to a topic, items that were assigned that can be eliminated, or suggestions to myself for items that should be added. Where necessary, I made changes to the Course Outline and Assignments document.

3. I then did the same thing with the Powerpoint slides for the course. Not only are there typographical errors, there are programming errors. Far too often, even after checking the slide, something ends up not appearing in the correct sequence, or something doesn't show up on the classroom projector the way it did on the office desktop. It's not unusual for me to notice something that can be improved in terms of presentation, arrangement, or sequencing. Where necessary, I made changes to the slides.

4. Then I turned to the materials that I provide to students to supplement what is in the assigned book and in the currently available Code and Regulations student edition volume. These materials are in html format. I update the references to the semester and year, and I update the links from the materials back to the table of contents and the Course Outline and Assignments sheet. I review the materials to see if any of them should be removed, that is, if the experience from the previous semester or semesters suggests that including a particular item is more disadvantageous than advantageous.

5. Then I determined if there was any new legislation affecting the course. The answer is derived from a combination of saving things in a file during the period of time since I last taught the course, looking at the text of legislation passed during that time, and culling my memory to dig up whatever entered it but that did not make it into the file in which changes were stored. For the legislative changes, I then decide if students need to see the text of the change, and where they did, I created a new item for the supplemental materials by copying the text into my html editor, editing the text, and setting it up so that it takes its place in those materials. I modify the table of contents. I add the item as an assignment in the Course Outline and Assignments document, which also is in html format. I modify my class notes to reflect the change. Where appropriate, I made changes and additions to the Powerpoint slides to show the impact of the legislative changes. I determined which problems required either fact modification or new answers and solutions, worked those out, made changes to my class notes, and then made changes to the relevant Powerpoint slides.

6. I then went through a similar process with respect to regulations, cases, rulings, and other materials that emerged since the last time I taught the course. These developments also required removing some materials and adding some materials, making changes to class notes, the Powerpoint slides, the table of contents to the materials, and the Course Outline and Assignment document.

7. Then I went to the IRS web site and downloaded the 2008 version of Forms 1065, 1120, and 1120S and the Schedules K-1 for Forms 1065 and 1120S. Actually, I went to the IRS web site at least four times before those forms showed up. Then I changed the year reference to those forms in the table of contents to the supplemental materials.

8. Next it was time to update the questions used with the student response pads ("clickers"). As the previous semester progressed, I made notes to myself about better wording of the questions and improved choices. I noted instances where additional questions would be helpful. I identified a few questions as candidates for the scrap heap. I noted instances where more choices were required. Accordingly, after importing the spring 2008 version of the .cps file into a new .cps file, I then went through the file and edited existing questions, deleted a few questions, and added some questions.

9. The next step was to go through the Table of Contents to update the references to the semester and year, to make certain the year references for IRS forms were updated, to modify the edition and copyright information, and to make certain new items were included and that references to deleted items were removed.

10. I turned to the Course Information Document, which contains several pages of administrative and similar information that in my early days of teaching was shared during the first day of class. Class time is valuable, so I provide this information through the Blackboard classroom. Aside from updating the links to the other course documents, a variety of other things had to be reviewed and in some instances updated.

11. The instructions provided to students for using the clickers was next in line. Because einstruction had changed its registration process since the spring 2008 semester, I revised this document.

12. It was time to review the Course Outline and Assignments document. I updated references to the semester and year. I went through the document, changing the days and dates to those corresponding to the spring 2009 semester. I double checked the addition and removal of items in the supplemental materials. I updated the links to the table of contents and Course Information Document, as well as the html code for the copyright.

13. There was a new edition of the book used for the course. I prepared a page correlation sheet, going through the old edition and the new edition page by page, looking for changes. They could be as noticeable as the addition or removal of a case, or as subtle as the change in a single dollar amount or taxable year reference in a subset of a problem. Depending on the change, I determined if I needed to remove any items from my supplemental materials. I did, because the new edition "caught up" with developments that had required me to add items, in this case proposed regulations, to the supplemental materials. This time, unlike other instances, the changes did not require me to add something to the supplemental materials. Occasionally a new edition will remove a case, ruling, or other item that I consider essential for the course. Because of the changes from one edition to the next, specific items in the book appeared on different pages. So I took a copy of the Course Outline and Assignment document, printed it out, and changed every instance where a page number appeared. They appeared in assignments and they appeared as problem identifiers. I returned to the html editor and made those changes. Then I returned to the class notes and changed the corresponding page numbers, as well as any notations referring to items deleted from the supplemental materials to reflect that change, along with any facts or computational solutions to problems that had been changed. Next up, the Powerpoint slides, which contain numerous page references to the book. Those were changed, as were the presentations and solutions to any problems for which the facts had changed, in those cases where the problem was presented on the slide or its solution mapped out on the slide. The clicker questions, many of which reference a problem from the book, also required the opening of each batch of questions in order to change the page references.

14. Not yet quite finished, it was time to archive the files for the spring 2008 version of the course, moving them off the desktop to make room for the fall 2009 course changes to be developed in April and May. Usually this step and the following ones are handled about a week before the semester begins.

15. The files for the spring 2009 version of the course were copied to the external hard drive. I only can imagine what would happen if the internal hard drive in the desktop crashed.

16. I copied the files for the spring 2009 version of the course to my allotted space on the network drive so that I could access them from the classroom.

17. I copied the files for the spring 2009 version of the course to my laptop, which I take into the classroom.

18. I requested the Audio-Visual Department to make certain that a projector, a screen, and a network connection were available and functioning in the classroom in which I would be teaching the course. They're very good about this, having already anticipated my request. Later, I would meet with them in the classroom to check out the facilities because I had not taught in that particular classroom for almost a decade.

19. I requested the Department of Academic Computing to create a Blackboard course for Introduction to Taxation of Business Entities Spring 2009, and to move whatever preferences and settings could be moved from the spring 2008 course.

20. The next task was to open the clicker software, and connect the new .cps file for the spring 2009 version of the course with the einstruction website so that student clickers could be registered and linked to the answers they provided to the database when questions were posed to the class. That provides a registration number, which then is inserted into the clicker instructions made available to students. Why wait this long? The course cannot be created more than two weeks before the class begins, because there is a time limitation on how long the course remains open at the website.

21. Then it was time to configure the Blackboard classroom created for the course. Though usually most of the settings are preserved when the previous version of the course is copied, the change in the version of Blackboard being used prevented some of those from being saved.

22. Then it was time to upload the Powerpoint slides, the supplemental materials, the table of contents, the Course Outline and Assignment document, the Course Information Document, and the student clicker instructions to the Blackboard classroom. Each Powerpoint file is uploaded individually, and because of a transition in the version of Blackboard being used, required re-creating an identification label and access settings for each file. The other documents are bundled together in a .zip file, and then uploaded, which permits the Course Outline and Assignment document and table of contents to have links to the items in the supplemental materials, for each of those materials to have links back to the Course Outline and Assignment document and table of contents, and for those two documents and the Course Information Document to have links to each other. After this has been completed, I created the discussion forums that are used on Blackboard, namely, one for semester exercises, one for substantive discussions, and one for course administration matters.

23. A time-consuming task awaited. Load up the printer with paper and to crank out what I need in the classroom. Class notes, Powerpoint slides, clicker questions, new or revised supplemental materials, the table of contents, Course Outline and Assignment document, and the Course Information Document find their way into hard copy format. The slides are then annotated with references to the clicker questions that are designed for use with that topic.

24. While that process was underway, I took a walk to the Registrar's Office and obtained blank seating charts for the classroom in which I would be teaching the course.

25. A day before the first day of class, I visited the University's registration system and obtained a list of the students who were enrolled in the course. This would be the first of at least three visits, as students add and drop the course through the drop-add period.

26. On the first day of class, I sat down with a calendar and planned the timing of the semester exercises in the courses that I am teaching. Without planning ahead, I could end up with students doing 3 exercises during the last week of the semester, or with myself having several exercises to grade and to prepare on the same day. Attention must be given to spacing the exercises correctly, avoiding first-week-of-class exercises, refraining from scheduling due dates that correspond with days that the school is not in session, etc. etc. It definitely was a bit easier than it was last August, because fitting in 25 exercises for 3 classes is much more challenging than fitting in 15 for 2 classes. Those numbers reflect the fact that there are only 5 exercises in the Graduate Tax course, because it meets only once a week and not three times a week.

27. As the drop-add period comes to a close, I will reconcile the official class list with the seating chart, and with the list of students self-enrolled in the Blackboard classroom, and with the list of students who have registered clickers. All sorts of combinations are possible. There usually are students on the seating chart but not on the class list, because something went wrong with their registration. Sometimes students think they have dropped a course but have not done so, and thus they show up on the class list but not on the seating chart. Students who drop the course after self-enrolling in the Blackboard classroom cannot remove themselves from Blackboard. Clicker registration rarely matches any of the other lists. After doing this reconciliation, I send emails to any student who is not on all four lists. When that is cleared up, I then create a seating chart with digital photos, which are obtained from the official class list. I use Powerpoint to do this, through a process that I have passed along to the one of the fellows in the Department of Academic Computing. Someday, I hope, it will be fully automated.

When people who are not teachers learn that I have five, or as was the case last semester, eight hours in the classroom, they usually compare that with a 40-hour work week and wonder what I'm doing to justify calling law professorship a full-time job. What they overlook is the four or five hours that I invest for every hour that I am in the classroom, four or five hours invested in preparing the course, preparing and grading semester exercises, preparing the examination, and grading the examination. That's a fairly constant time allocation. What varies significantly, depending in part on the number of students in a course and the extent to which they communicate with me, is the time invested in answering questions that are posed by email or in person. Some of these hours are invested during the semester, and others are invested before or after the semester. It's a very risky thing to try to teach a course by showing up on the first day of class.

Well, that's how I get ready for a course. There are law faculty who follow a similar pattern. There are others who do not. Someone who does not use Powerpoint slides, clicker questions, or problems requiring preparation and solution, and who does not provide supplemental materials, can omit a good chunk of what I do as I prepare. If they also omit semester exercises, there's even less to do. I do what I have decided needs to be done for my teaching to be effective. I doubt I'd be comfortable trying to get by on less. And without my checklist, which is a shorthand version of the 27 steps I've described in this post, I'd be lost. So, when someone asks what I am doing when I'm not in the classroom, I explain that in addition to writing and dealing with committee and other administrative matters, I'm working through my course preparation checklist. I'm usually getting ready for next semester while the current semester is underway. In a few years there will come a semester when I won't be getting ready for a next semester. I will ditch those checklists and I will be …. yes, listless.

About a year ago, in When All Else Fails, Throw Tax Money At It, I criticized the manner in which the federal government was handling the conversion of broadcast television from analog signals to digital signals. Congress, which in 2005 mandated that the switch occur in 2009, allotted $1.5 billion to the National Telecommunications and Information Administration (NTIA) to provide $40 coupons that would be distributed to people who requested them. The coupons can be used for, and only for, paying some or all of the cost of a converter box for analog televisions. After computing that there was enoguh money for 33.5 million coupons, I then asked, "Who gets them."

I answered the question as follows:

CNN reports that "The giveaway basically works under the honor system." Does that make you feel as wonderfully confident as I do that the people who need the converter boxes and who lack the resources to acquire one are the people who will get the coupons? Surely the con artists, the identity thieves, the credit card imposters, the greedy, and the troublemakers will sit this one out. What controls are in place to prevent the well-intentioned, confused, and yet affluent citizen who notices the giveaway from requesting, and getting, two coupons? Apparently, none.

The only distribution arrangement that appears to be in place is a reservation of 22 million coupons to anyone who asks for one or two. In theory, those who enacted and administer the program expect the requests to come from people who, despite having televisions connected to cable or satellite systems, also own analog televisions not connected to those systems, or who own only analog televisions without any cable or satellite connection. In practice, I predict that some coupons will be requested by people who understand that when the cable or satellite system goes down, over-the-air broadcast might be the only communication connection to the outside world, and that for analog televisions, the converter box will be necessary. Of the 33.5 coupons, 11.5 are set aside for people who do not have cable or satellite television. Even if people requesting coupons are asked about their television situation, what's to prevent them from saying what they need to say to get the coupons? And even if the honor system works perfectly, industry information suggests that there are 2.8 million more households without cable or satellite system connections than there are coupons reserved for those households.

The Government Accountability Office has criticized the NTIA, claiming that there is no comprehensive plan in place for the transition to digital television. Of the $1.5 billion set aside by Congress to finance the transition, only $5 million was earmarked for programs that explain to the public what is involved in the changeover. One survey indicates that slightly more than half of Americans do not know that the shift from analog to digital is underway. Now the government, through the FCC, is considering a regulation that will require broadcasters to donate air time to educate the public about the new technology.

* * * * *

When all is said and done, some of the taxes paid by taxpayers will be given to people regardless of genuine need, so that technological changes benefitting wireless providers can be implemented through government planning that is far from comprehensive or sensible. The government is implementing a system financed by taxpayers and designed to help not-so-poor wireless providers, with no controls to prevent $40 coupons from enriching those not in need, with no guarantees that the planned auctions will reimburse the taxpayers.

Unfortunately, the criticisms levelled by the GAO and by yours truly have not turned out to be groundless. The NTIA has no more money for coupons. Since January 4, it has been putting people who request coupons on a waiting list. There now are more than a million people on that list. Barring more funding, the only way these folks can get a coupon is expiration of a previously-issued coupon. Of course, people can purchase converter boxes without coupons, but it will cost them an additional $40. That's assuming converter boxes are available.

Last week, as described in this story, the Consumer Union urged that the changeover from analog to digital be postponed. Why? Because the program for the change "has been underfunded and poorly implemented." What a surprise! Just as predicted.

President-Elect Obama has joined in the call for a delay in the implementation of the analog-to-digital transition. According to this report, the incoming Administration cites as the principal reason for its recommendation is that the Commerce Department, of which the NTIA is a part, has run out of money for the coupons. The incoming Administration also expressed concerns that not enough has been done to assist people in making the transition. The Chair of the House Committee on Energy and Commerce admitted that the transition is not going well.

Of course, there is opposition to a delay. The current administration opposes it because government and the broadcasting industry have "invested so much in preparing for this date" and a delay "would create uncertainty, frustration and confusion among consumers." And the current mess isn't causing uncertainty, frustration, and confusion for people? The current administration instead is seeking another $250 million to fund more coupons. Yet at least one Republican member of the Congress opposes more funding, claiming that more coupons will be issued as unredeemed ones expire. But how does anyone know how many coupons will end up unredeemed? Also opposing the delay is the Consumer Electronics Association, which notes that the change is designed to make more radio frequencies available to first responders, who ought not be kept waiting any longer. The National Association of Broadcasters declined comment on the delay but also noted that the shortage of coupons can be remedied without a delay.

At this point, my question isn't so much addressed to solving the problem as it is to learning a lesson for next time, whatever challenge that next time may bring. Consider the facts. Congress enacted the legislation mandating the changeover back in 2005. In 2005, everyone who paid attention knew or should have known that there would be a change in 2009, and everyone who understands transactional planning knew or should have known that there things requiring attention long before January 2009. Not only were most people not paying attention, the folks who should have been getting everyone's attention didn't start to do so until 2008. The cultural mindset of leaving things until the last minute once again has demonstrated its shortcomings. Yet it continues to dominate the way this country operates, the way businesses conduct activities, the way students run up against deadlines, the way professionals are late for appointments, the way things aren't ready when they are supposed to be ready. It's no wonder that organizations and activities infused with the mindset of readiness and preparation do not get the attention or admiration that instead is given to the procrastinators.

Congress allocated enough money to provide 33.5 million coupons. That's just a fraction of the households in this country, and as I pointed out in my earlier post, anyone who thinks about the issue for more than a soundbite moment would understand that everyone needs a backup over-the-air television reception system because cable simply isn't as reliable as the cable companies claim. It's cheaper to buy a converter box, especially when outfitted with a $40 government coupon, than it is to purchase a digital television. So should it be any surprise that people gobbled up the coupons? Do we know how many coupons were sent to people who easily can afford a converter box and how many were sent to people whose financial situation prevents them from purchasing one? The NTIA distributed the coupons without asking, and without being required to ask, and probably without being permitted to ask, questions concerning the financial condition of the coupon recipient.

In my earlier post, I concluded with this observation: "The only good news is that the coupon distribution is not tied to the tax system, was not enacted in the form of a tax credit, is not implemented by the IRS, and is not reflected on federal income tax returns. I wonder how that happened." Now I am beginning to suspect that someone will sell to the Congress the idea that the converter box purchase problem should be solved with a $40 tax credit available only to individuals with some sort of modified adjusted gross income under some particular dollar amount. Talk about making a bad situation worse.

A little more than four years ago, in The Joys of IRC Section 86, I explained the convoluted manner in which Congress has specified that taxpayers determine how much, if any, of their social security benefits are subject to federal income taxation. I noted that Congress passed on the simple, appropriate, and valid approach of including in gross income the excess of what a person receives over what the person paid into the system. I described the origins of the provision requiring taxpayers to include in gross income the lesser of 50% of social security benefits or 50% of the excess of their modified adjusted gross income over a specified base amount. Next, I explained how Congress added an "85% layer" onto the "50% layer," causing totally unjustified complexity and abominable statutory language. I pointed out how this arrangement creates a bubble effect, which essentially means that someone receiving social security can be taxed at a higher marginal rate than the nominal marginal rate if they earn additional income because their gross income increases not only by the additional income but also by the additional social security treated as gross income because their modified adjusted gross income has increased and thus exceeds the base amount and the adjusted base amount by even more dollars.

Now, thanks to a comment by an anonymous reader, I've become aware of yet another quirk in section 86. It involves state income tax refunds. Generally, a state income tax refund is included in gross income if in the year the refunded tax was paid, a deduction for that tax was claimed and generated a tax benefit. The problem is that the state income tax refund, by being included in gross income, causes the taxpayer's modified adjusted gross income to increase, which in turn increases the amount of social security included in gross income. Yet, in the year that the state income tax was paid and deducted, the taxpayer's modified adjusted gross income was not decreased, because the state income tax deduction is an itemized deduction. So what exists is a double counting, not unlike the bubble effect. Not only is gross income increased by the amount of the state income tax refund, it is also increased by an additional portion of social security. An example demonstrates this bizarre phenomenon.

Suppose that in 2007 a married couple had $5,000 of state and local income tax withheld from their pension. They properly deduct the state income tax on their 2007 federal income tax return, but when they complete their 2007 state and local income tax returns they determine that they are entitled to refunds of $2,000. The refunds are paid to them in 2008. Because they itemized deductions in 2007, the $2,000 of state and local income taxes deducted in 2007 reduced their taxable income, thus generating a tax benefit. Accordingly, the $2,000 must be included in gross income for 2008. Assume that the $2,000 reduction in taxable income caused by the deduction of $2,000 of state and local income taxes destined for refund caused the couple's 2007 federal income tax liability to decrease by $300 because they were in the 15% bracket.

Assume that in 2008, the married couple has $40,000 of pension income, $10,000 of social security benefits, and no other income. Under the statute, their base amount is $32,000, and their adjusted base amount is $44,000. Their total gross income, before computing social security gross income, is $42,000 ($40,000 pension income plus $2,000 state and local income tax refund). Their adjusted gross income, and their modified adjusted gross income, is $42,000 because they have no deductions allowable in computing adjusted gross income. Fifty percent of their social security benefits is $5,000. This $5,000 is added to their $42,000 modified adjusted gross income and the $47,000 result is reduced by their $32,000 base amount, generating a section 86(b)(1) excess of $15,000. Because 50% of the social security benefits, that is, $5,000, is less than 50% of the $15,000 excess, that is, $7,500, the tentative amount to be included in gross income is $5,000.

Turning next to the second level of analysis, The $47,000 sum of the $42,000 modified adjusted gross income plus the $5,000 representing 50% of social security benefits exeeds the adjusted base amount of $44,000 by $3,000. Eighty-five percent of this $3,000 excess is $2,550. Next, an incremental amount is computed. It is the lesser of the $5,000 amount tentatively computed as social security gross income and $6,000, which is 50% of the $12,000 difference between the base amount and the adjusted base amount. This $5,000 incremental amount is added to the $2,550, generating an adjusted tentative amount to be included in gross income of $7,550. This is, in turn, compared to 85% of social security benefits, that is, $8,500. The lesser of the two amouns, $7,550, is included in the married couple's gross income. Accordingly, their actual gross income for 2008 is $49,550 ($40,000 pension income, $2,000 state and local income tax refund, and $7,550 social security gross income).

Does this make sense? Let's now assume that with careful, though pragmatically very difficult tax planning, the married couple had caused the state and local income taxes that were withheld from their pensions to be $3,000. Their 2007 federal income tax liability would have been $300 more than it was, because their state and local income tax deduction would have been $3,000 rather than $5,000. What happens in 2008?

In 2008, the married couple still has $40,000 of pension income, $10,000 of social security benefits, and no other income. Under the statute, their base amount is $32,000, and their adjusted base amount is $44,000. Their total gross income, before computing social security gross income, is $40,000 ($40,000 pension income). Their adjusted gross income, and their modified adjusted gross income, is $40,000 because they have no deductions allowable in computing adjusted gross income. Fifty percent of their social security benefits is $5,000. This $5,000 is added to their $40,000 modified adjusted gross income and the $45,000 result is reduced by their $32,000 base amount, generating a section 86(b)(1) excess of $13,000. Because 50% of the social security benefits, that is, $5,000, is less than 50% of the $13,000 excess, that is, $6,500, the tentative amount to be included in gross income is $5,000.

Turning next to the second level of analysis, The $45,000 sum of the $40,000 modified adjusted gross income plus the $5,000 representing 50% of social security benefits exeeds the adjusted base amount of $44,000 by $1,000. Eighty-five percent of this $1,000 excess is $850. Next, an incremental amount is computed. It is the lesser of the $5,000 amount tentatively computed as social security gross income and $6,000, which is 50% of the $12,000 difference between the base amount and the adjusted base amount. This $5,000 incremental amount is added to the $850, generating an adjusted tentative amount to be included in gross income of $5,850. This is, in turn, compared to 85% of social security benefits, that is, $8,500. The lesser of the two amouns, $5,850, is included in the married couple's gross income. Accordingly, their actual gross income for 2008 is $45,850 ($40,000 pension income and $5,850 social security gross income).

So without the state income tax refund, the married couple's 2008 gross income is $45,850, a whopping $3,700 less than the $49,550 that it would be if there were a $2,000 state and local income tax refund. Put another way, the inclusion of a $2,000 state and local income tax refund in gross income causes gross income to increase not by $2,000, but by $3,700. The "extra" $1,700 arises from the $1,700 increase in social security gross income. Note that $1,700 is 85% of $2,000. Ignoring the impact, if any, of the change in adjusted gross income on the couple's itemized deductions, the couple's taxable income increases by $3,700, causing their federal income tax liability to increase, assuming they are again in the 15% bracket, by $555. In other words, the $300 tax benefit generated by the state and local income tax deduction in 2007 requires the couple to pay not an additional $300 in 2008, but an additional $555. As I asked in The Joys of IRC Section 86 with respect to the section 86 bubble effect, "How can that be justified under any philosophical, moral, or theological canon?"

It is true that the tax benefit rule itself is flawed, because even if 2008 gross income increased by only $2,000 on account of the inclusion in gross income of the state and local income tax refund, the married couple's 2008 federal income tax liability could have increased by more than $300 if they were in a higher tax bracket. Yet if they were in a lower bracket, their tax would increase by less than $300, or perhaps not at all. The flaw can work both against and in favor of taxpayers. On the other hand, the glitch in section 86 works against the taxpayer and only against the taxpayer.

So what we have here is yet another reason to jettison the abomination that is section 86. None of the arguments in its favor make sense. The Social Security Administration knows how much a person has paid into the system, as is evident from the annual statement that it sends to each person who has paid into the system at one time or another. The Social Security Administration knows how much it pays to each recipient, and thus easily can compute the amount, if any, of each payment, that represents amounts exceeding what the person has paid into the system. The excuse that this cannot be done is as weak as the excuse that a carry-over basis rule at death won't work because basis is not known, even though were the decedent to have gifted the property shortly before death a carry-over basis rule would have applied. One must be wary of bad rules that are justified on false claims of inability. Section 86 is such a rule. It is long past time for its demise.

Something that I read the other day in an article summarizing possible tax cuts under the Obama economic stimulus plan reminded me of how difficult it is to keep pace with the tax law as enacted, let alone project what the future tax rules might be. One of the provisions tagged for possible changes is section 179, though the article does not cite it, perhaps because of space limitations or perhaps because of concerns that the sight of a Code cite would encourage too many readers to close down the web page before finishing the article. Footnote to law students, lawyers, and accountants: please note that both "sight" and "cite" were used in the same sentence, correctly and without confusion, and please try to avoid switching one for the other.

According to the article, "Obama would increase the amount of expenses small businesses can write off to $250,000 in 2009 and 2010, up from $125,000 currently." This sentence refers to the deduction allowed by section 179, under which a limited amount of otherwise capitalized expenditures are permitted to be subtracted in computing taxable income in the year of the expenditure rather than over some period of time determined under the depreciation deduction provisions. The advantage to the section 179 deduction is that it reduces tax liabilities in the year of the expenditure by much more than would the depreciation deduction, thus, in theory, increasing the cash flow of the business making the expenditure. This increased cash flow, it is argued, permits the business to increase its consumption, thus stimulating the economy. What concerns me at the moment is not so much the theory as the ever-changing limit that applies to section 179.

Section 179 has a long history. Originally, it was enacted to spare business taxpayers the cost and aggravation of computing depreciation deductions for expenditures so small in amount that the time invested in doing the computations simply wasn't worth it. By 1983, the limit was a whopping $5,000. Under section 202(a) of the Economic Recovery Tax Act of 1981, the limit was scheduled to increase to $7,500 for 1984 and 1985, and to $10,000 for 1986 and thereafter. Section 13 of the Deficit Reduction Act of 1984 altered these changes before they went into effect, locking the limit in at $5,000 for 1983 through 1987, increasing it to $7,500 for 1988 and 1989, and delaying the increase to $10,000 until 1990 and thereafter.

Those scheduled increases went into effect as planned. Thereafter, section 13116(a) of the Omnibus Budget Reconciliation Act of 1993 increased the limit to $17,500 effective for 1993 and thereafter. The Small Business Job Protection Act of 1996, specifically section 1111(a), increased the limit to $18,000 for 1997, $18,500 for 1998, $19,000 for 1999, $20,000 for 2000, $24,000 for 2001 and 2002, and $25,000 for 2003 and thereafter. However, before the planned 2003 limit went into effect, section 202 of the Jobs and Growth Tax Relief Reconciliation Act of 2003 increased the limit to $100,000 for 2003 through 2006, and also provided that this amount would be increased to reflect inflation. Accordingly, the limit was raised to $102,000 for 2004 (Rev. Proc. 2003-85, 2003-2 C.B. 1184), to $105,000 for 2005 (Rev. Proc. 2004-71, 2004-2 C.B. 950), and to $108,000 for 2006 (Rev. Proc. 2005-70, 2005-2 C.B. 979).

A year after the limit was temporarily increased to $100,000, section 201 of the American Jobs Creation Act of 2004 extended the $100,000 limit through 2007. Two years later, section 101 of the Tax Increase Prevention and Reconciliation Act of 2005 further extended the $100,000 limit, as adjusted for inflation, through 2009. Section 8212 of the Small Business and Work Opportunity Tax Act of 2007 extended the limit through 2010, and also increased the limit to $125,000 for 2007 through 2011. But Congress wasn't finished. Section 102 of the Economic Stimulus Act of 2008 increased the limit to $250,000 for 2008, without any adjustments for inflation.

At the moment, this is where things stand. The limit is $250,000 for 2008, for 2009 it will revert to $133,000 ($125,000 adjusted for inflation), for 2010 it will be $125,000 adjusted for inflation, and then in 2011 it will be $25,000, without any inflation adjustment. Confused? Welcome to tax world. If there's an advantage to this ever-changing set of rules, it's that students cannot use outlines from earlier semesters and the same question can be used for testing purposes without last year's answer being correct!

Thus, the sentence in the article that states, "Obama would increase the amount of expenses small businesses can write off to $250,000 in 2009 and 2010, up from $125,000 currently." is technically incorrect, because absent any legislative changes the limit for 2009 would not be "$125,000 currently" but $133,000. The limit for 2010 would be some amount probably in the vicinity of $135,000 but currently incalculable because the requisite inflation adjustment factors are not yet known. It is understandable that considering the constantly shifting section 179 limit, someone looking at the statute would think that the 2009 limit would be $125,000.

Why the reversion in 2011? The legislation that increased the limit did so for limited periods of time rather than permanently because of budget considerations. It's easier to sell a tax cut if it does not impose a permanent revenue loss. Of course, as the history of this one provision indicates, the likelihood of the limit being $25,000 in 2011 is slim. It almost surely will be something much higher than that.

It has been said that a tax law professor could teach tax law using only one Code provision. Section 179 certainly is a candidate for such an experiment. It provides not only an excursion into tax policy but also a brutally realistic exposition of how one determines "what the law is." From the tax policy angle, one can debate whether these limit increases do much of anything for the economy, and one can have fun deciding if the titles of the enacting statutes accomplished what the Congress grandly proclaimed that they would. On the technical side, it demonstrates why a tax practitioner, and tax students, need to read more than the statute to determine what the law provides. In this instance, revenue procedures become very important. When I am going over a problem in class and students ask, for example, "Where did you get $105,000?" I knew that they had not read the assignment. When students rely on secondary information, they leave themselves helpless to keep up-to-date. For example, the revenue procedure to be issued at the end of 2009 will be the source for the inflation-adjusted limit for 2010, barring further legislative tinkering.

There are few, if any, businesses or professions that could survive with this sort of fiddling. Multiply section 179 by the hundreds of Code provisions that are tweaked or overhauled every year or two. Would a professional sport survive if the rules were changed two, three, or four times a year, or during the season? Would a manufacturer stay afloat if production line standards were altered three and four times a day? The learning process requires time to "digest" material and processes, and if the changes occur at a rate faster than the learning process, learning does not occur. Performance slips, critical and fatal errors are made, and societies crumble. Yes, that sound very dire, but studies prove that tax compliance declines as tax law change frequency increases.

A sharp-eyed reader will note that my entire discourse is technically flawed. Each time I referred to a year in the phrase "for [year]" I should have been writing "for taxable years beginning in [year]." Why did I not do that? Because I am trying to keep my sentences comprehensible. For the points I am trying to make, that technical expression of the effective dates isn't all that important. There are enough words in my sentences without my trying to be technically precise when it doesn't matter that much.

So what will happen? The section 179 limit for 2009 will almost certainly be something other than $133,000. In the fall of 2009, I will have yet another opportunity to give my students an example of how the Congress can obsolete a revenue procedure, or a provision in a revenue procedure, by enacting retroactive legislation. I will continue to have the opportunity to show my students that for tax and other lawyers what matters is not so much the answer, but how one arrives at the answer. I could have written today's post simply by listing the years and the limits for each year in a short and tidy table. That would provide information. What I did write provides understanding. Information is cheap, and floods our senses. Understanding is valuable and much more difficult to obtain. It is much easier to cope with rule changes when the rules are understood than when the rules simply are known.

Through all of this, I omitted any discussion of the reduction of the limitation, and yet another section 179 amount that is used in determining that reduction. It, too, has been changed numerous times. That is information not essential to the point I wish people to understand. I also omitted the many reductions and increases to the limit under discussion that are made for expenditures for sport utility vehicles, expenditures by enterprise zone businesses, expenditures by renewal community businesses, expenditures for qualified New York Liberty Zone property, expenditures for qualified Gulf Opportunity Zone property, expenditures for qualified disaster assistance property, and expenditures for qualified recovery assistance property. Please don't feel deprived. Even the students in the basic federal income tax course do not get to visit these places.

On Friday, reports such as this Philadelphia Inquirer story brought the news that the National Commission on Surface Transportation Infrastructure Financing (NCSTIF) has recommended a 50% increase in the federal gasoline tax to provide funding for road construction and repair. The increase is required simply to keep pace with previous year fuel tax revenues, because declining gasoline use has reduced revenues. Gasoline use is declining because motorists are cutting back on their driving and because the vehicles that are being used are more fuel efficient. Compounding the problem is the fixed rate nature of the tax, unadjusted for inflation and not increased since 1994. Further compounding the problem is the anticipated increase in fuel-efficient vehicle use in coming years.

The NCSTIF views the increase as a temporary measure. It envisions a different long-term revenue mechanism. Much to my delight, the commission's long-term solution is a mileage-based fee system. I first explored this concept in Tax Meets Technology on the Road, examined the concept further in Mileage-Based Road Fees, Again, and early this year took an even closer look in Mileage-Based Road Fees, Yet Again. A few months ago, as reported in Introducing Mileage-Based Road Fees to the Pennsylvania Legislature, I wrote to Dwight Evans, Chairman of the Pennsylvania House Appropriations Committee, pointing out to him the existence of these fee concept and suggesting that it provided a way out of the road maintenance funding challenges facing the state. I've yet to receive a response.

The NCSTIF is the second commission to make a recommendation. About a year ago, the National Surface Transportation and Revenue Study Commission (NSTRSC) also recommended and increase. The latter group's recommended increase of 40 cents dwarfs the 10-cent increase contemplated by the NCSTIF. With an annual road funding gap of $105 billion expected to increase to $134 billion in less than 10 years, it seems unwise to provide only one-fourth of what is required.

The primary obstacle to the short-term fix, and perhaps to the more permanent mileage-based fee solution, is the crazy world of politics. Some claim that one of the reasons the Democratic Party lost control of the House and Senate in the 1994 elections was the gasoline tax increase enacted that year. The world of politics is a strange one. The same citizens who rail against gasoline tax increases also explode in anger when interstate bridges collapse. One of the members of the NCSTIF, a vice-president of a libertarian think tank no less, put it nicely when he said, "We can either let the roads go to hell, or we can pay more." In some instances, taxes, or more specifically, fees, could be the road to heaven, or at least to transportation paradise. Let the bridges fall down and the roads crumble into pot-hole-ridden tracks, and the delivery of food, medicine, and clothing breaks down, to say nothing of the ability of people to reach their ultimate destinations. Comparatively few people, few stores, and few factories are adjacent to airports and railroad stations.

Some have suggested that the increase be marketed as a cost of preventing more serious climate change. It could be called, they offer, a carbon tax. Others note that it could be advertised as a cost of reducing dependence on foreign oil, which has both economic and global security overtones. I wonder, though, whether that would make the impact at the pump any more palatable.

Someone needs to educate America about the connection between road fees and road condition. Reportedly, the president-elect has "expressed concern" about increasing the federal gasoline tax given the state of the economy. However, as I stressed in Leaders as Teachers: Fixing the Financial Fiasco, "the key will be getting people to admit that thoug a measure is not popular, it is necessary and needs to be undertaken….It's time for the nation to go to school." We're going to find out, very soon, how good a faculty the new faces in Washington will be.

On New Year's Eve I heard a commercial on the local news radio station for something called "Fix Housing First," and so I went to its web site to learn more about the proposition that the first thing Congress needs to do is to create a tax credit for home purchases and a permanent low mortgage interest rate. Indeed, the web site does advocate those two proposals. It is difficult to determine if the folks behind the web site are asking simply that housing relief be part of a stimulus package, which is what the tag line in the upper right corner of the web page explains, or pushing for the primary focus to be on these two housing market ideas, which is what the explanation near the bottom of the web page suggests.

According to the explanation of why housing matters, the web site presents an interesting prediction. The first step, it argues, is to "Stop the fall in home values and prevent future foreclosures." That will lead, so the argument goes, to "Restore consumer confidence," which in turn supposedly would "Create jobs." That step would then "Lift our entire economy." Wow, isn't it amazing how the success or failure of the entire economy depends solely or chiefly on the industry whose advocates are making the argument? The Fix Housing First web site is presented by the Fix Housing First Coalition, which describes itself as "a diverse group of housing stakeholders – including homeowner and community groups, home builders and manufacturers – dedicated to addressing the root cause of our economic troubles." Last week we were being told that rescue of the automobile manufacturing industry was the critical path to economic salvation. Several months ago we were told that pouring hundreds of billions of dollars into bad loans was the solution, though shortly thereafter the Treasury implied that the path to economic robustness was making money available to banks so that they could purchase other banks. It was only half in jest that in Cutting Up the Economic Distress Remediation Pie I advocated a $50 billion bailout of yours truly as the key to economic recovery, while I addressed the assertion that double taxation of corporate income was to blame. It seems to me that underneath each seemingly well-crafted "me/us first" argument is nothing more than greed combined with an inflated sense of self-importance.

If the advocates of Fix Housing First want a return to the housing market of 2006, they're asking for nothing more than a continuation of the current mess. The housing market collapse was and is a symptom of the problem. Dealing with symptoms is meaningless if the underlying issues are not addressed. The housing market collapsed because people committed themselves to mortgage payments that they were unable to make. A combination of living beyond one's means and banking on a delusional belief in eternal housing price increases doomed that market. The two proposals advocated by Fix Housing First are nothing more than a repeat of the "have a house even though you cannot afford it" mantra that fueled the housing bubble. Let's not repeat that mistake.

Surely it is a problem that many Americans cannot afford housing. They cannot afford housing for three reasons. First, some of them do not have jobs. Second, some of them have jobs, but those jobs provide pay that is inadequate for housing acquisition. Third, housing prices remain high relative to wages because of land shortages in the areas where people prefer to live. The solution to the first two causes is job creation. The solution to the third cause is job dispersal.

Job creation is a function of two variables. One is the existence of work that needs to be done. The other is the availability of resources to pay to have that work done. There is no question that much work needs to be done in this country. Infrastructure needs repair and expansion. Buildings need to be retrofitted for efficient energy use. Diseases need to be cured. Sick people need care. Lawns need to be mowed. Snow needs to be plowed. The challenge is not identifying work to be done, but in finding the money to pay people to do the work. Here is where one asks whether the most efficient allocation of wages is to pay huge salaries to a select few and poverty-level wages to the many. How many jobs could be created if some mechanism existed to discourage salaries exceeding, for example, $1,000,000? What company gets more done, the company with a CEO earning $50,000,000 per year and 1,000 employees each earning $30,000 per year, the company with a CEO earning $1,000,000 per year and 2,630 employees each earning $30,000 per year, or the company with a CEO earning $1,000,000 per year and 2,000 employees each earning $40,000 per year? Before the "free market" advocates step forward to claim that the first type of company must be the most efficient because it dominates the economy, one should note that if these companies were so stupendously getting things done the economy would be in great shape. What the first type of company does well is to make money for its shareholders and highly-paid executives, a goal consistent with unregulated capitalism but not necessarily favorable to the maintenance of a healthy economy.

Creating jobs and increasing the pay of rank-and-file employees, whether in this manner or in some other, increases the number of people who can afford home acquisition. That is how the housing market will rebound. People with jobs have more consumer confidence that those who do not. People with higher paying jobs have more reason to be confident. People who are surrounded by other people with jobs and by people whose pay is increasing tend to be more confident than those who watch their neighbors, friends, and relatives get pink slips so that the executives can continue to collect their salaries.

Job dispersal is a more complicated matter. People gravitate to the geographic areas where jobs are created. Despite predictions that internet and other technology would permit people to live wherever they chose, and despite the fact that a handful of people have been able to make those arrangements, the simple fact is that people continue to migrate into the large cities and the suburbs that are part of metropolitan areas, while small towns shrink into unsustainable existence or disappear from the map. Aside from the national security benefits of job dispersal, the movement of populations from areas where land is abundant to cities where land is exhausted puts upward pressures on housing prices that need not and should not be enabled by existing or proposed tax and economic policies. If tax credits are to be made available for housing purchases, they should be limited to purchases in areas in need of population in-flow. Several such credits already exist in the tax law. If mortgages are to be provided at below-market rates, they should be made available to persons purchasing homes in areas that are in need of housing rehabilitation, such as inner cities and desolate small towns. The idea of giving a tax credit and a permanent low-rate mortgage to a well-compensated individual to purchase a condominium in Manhattan or a second home on Nantucket or in Newport Beach makes no sense whatsoever.

The point is that by creating jobs, consumer confidence increases, and that confidence will rev up activity not only in the housing market, but in the automobile market, the clothing market, the electronics market, and the other markets dealing with the downturn and claiming to be THE market deserving of first-in-line status for tax credits, bailout money, or other special breaks. The interdependency of the market segments within the economy decries the outmoded notion of characterizing or treating one specific industry as THE essential foundation for the economy.

Perhaps in all of this is an answer to rescue the television and entertainment market. Rent a room. Invite a representative from Fix Housing First, a representative from Fix Automobile Manufacturing First, a representative from Fix Banks First, a representative from Fix Bad Loans First, a representative from Fix Oil Drilling First, a representative from Fix Airlines First, and so on. Set up a camera. Put one $100 billion tax credit, one $200 billion bailout check, and one Get-Out-of-Jail-Free card on a table. Set up and turn on a camera. Call the show "Me First." Perhaps viewer disgust at the proceedings would bring some attitudinal changes into the economic culture.