MauledAgain

It was one of those tax questions that doesn't require much more than a paragraph to put forth. It was posted recently on the ABA-TAX listserve:

Client moved to Colorado from Maryland in 2007. They were not able to sell their home in Maryland, so turned it into a rental. They receive rent, but it doesn't even come close to mortgage interest and taxes expenses. Instructions for Maryland income tax returns specify that gross rents from property situated in Maryland must be reported. Gross rents exceed the level of income required for filing, but, of course, there's a large loss, so no tax will be due.

Right now I have classified the rental property as MD sourced. My clients don't want to file a MD return for just that.

The responses were almost unanimous in concluding that the Maryland return should be filed. One response put it succinctly: "Of course, your client must file a MD ret. the fact that he doesn't like it doesn't change the law, not [sic] does [the] fact that he has offsetting expenses." Another respondent gave a good reason for complying with the law: "If for no other reason than to establish the existence of the rental loss, which presumably would end up in some sort of carry over status, thus available for offset some day down the line when the property may be sold at a gain." This reasoning was echoed by yet another list participant. Three more reasons came from different participant: "… software makes it easy to do so. Besides the fact that most states require that you file such a return it also had the advantage of starting the running of the statute of limitations. Also the preparing of the return may be cheaper than having to respond to the state later when Maryland sends a letter asking why no return was filed." As for the client's unwillingness to file, this advice makes sense: "I'd prepare the return according to the rules. If they don't mail it in, it's their issue."

The implications of a the requirement that a nonresident who transacts business or engages in an activity in the state must file a return with that state become quite complicated when the nonresident's business or other activities touch multiple states. The cope of the complexity is illustrated by this inquiry which followed up the original question:

Related to this situation, what happens when K-1 activities are allocated to multiple states? I have one client that is invested in a private equity fund that allocates income across 32 states. In some states the income is as low as $5 and some of the states show losses.

I know that technically we should be filing in all of the states, but I don't think that is practical at all. And while I understand that technicalities should trump practicalities, there must be a feasible way to do this.

The first response to this question tried to soften the impact of multi-jurisdictional activity on tax compliance:

Just because income was allocated across 32 states does not mean that the client has a filing requirement in each of those states. It is likely that in many of those states the income threshold was not met and thus no return need be filed.

As someone else pointed out a while ago ( I'm not sure if it was here or elsewhere) the client is the one that made the investment decision. All we can do is advise them of the law.

If I know a return is required, it is my current practice to prepare one ( of course a client can instruct me not to prepare a particular
return). Once prepared it is up to them whether or not to file it.

That is when I jumped in with this observation:

This is a reason that some states permit the entity to withhold and pay taxes on behalf of the shareholder/partner/member. When I worked on the Model S Corporation State Income Tax Act, the drafters adopted this concept.

Unfortunately, many states do not provide for this mechanism, some make it optional, and some make it available for certain types of entities and not others.

As states begin to figure out what some of us already know, that mandatory withholding of income taxes by the entity on behalf of nonresident shareholders/partners/members will increase state revenue, we'll begin seeing this approach take hold across the country.

In the meantime, different states pursue nonresident shareholders/partners/members with varying degrees of intensity. New York is quite aggressive. Other states lack enforcement resources.

Withholding on behalf of nonresident shareholders and partners is a sensible solution but it also provides challenges.

The concept of withholding on behalf of nonresident shareholders and partners is simple. An entity that engages in activities in a particular state applies a specified rate to each of its nonresident owners' distributive shares of its income, and pays that amount to the state on behalf of the nonresident owners. At this point, application of the concept becomes more complicated. Some states provide for withholding on behalf of resident owners, even though the resident owner must file an income tax return with the state in any event. Other states do not. Some states make withholding on behalf of nonresident owners mandatory, while others make it an option. Some states do not provide for withholding on behalf of nonresident owners.

In an extended form, the concept evolved into the composite return. The amount paid by the entity to the state, rather than being treated as withholding claimed by the nonresident owner on the owner's state income tax return, is treated as payment of the state income tax on behalf of the nonresident owner, who is then absolved of any requirement to file an income tax return with the state. Even this concept can become more complicated, because some states permit the nonresident shareholder to file a return, report the income, and treat the payment as a credit, if the nonresident chooses to do so. Why would the nonresident choose to do so? If the nonresident also owns an interest in another entity with activities in the state but that incurs a loss, the nonresident would prefer to file a return on which both the income and loss are reported, with the loss offsetting the income and thus eliminating the tax liability. Whether a refund could be obtained depends on the precise language of the state's statute.

The drafters of the Model S Corporation Income Tax Act, and I must disclose that I was among them, agreed on the use of composite returns rather than simple withholding. Although not every state has adopted this model act, some have, even though some of the states that have adopted it did not include the composite return provision or modified it to some extent. On the positive side, the endorsement of the Model Act by the Multistate Tax Commission gave impetus to many states to focus on this issue, not simply for S corporations but also for partnerships and other pass-through entities. Progress, it seems, often is made one step, or one state, at a time.

One of the reasons for choosing the composite return approach is to avoid a federal income tax issue that arises for S corporations under the withholding approach. Many S corporation shareholders focus on after-tax returns, and seek to guarantee that each share of stock ends up with the same after-tax income. The problem with this approach is that under a withholding system as in place in some states, a nonresident and a resident shareholder are treated differently. Thus, if the corporation pays state income tax on behalf of one shareholder and does not pay it on behalf of another, the effect could be a difference in deemed distributions, causing there to be more than one class of stock. If the corporation complies with Regs. section 1.1361-1(l)(2)(ii), it can avoid being disqualified as an S corporation for having a second class of stock. But if it doesn't comply with that provision, the consequences could be quite disadvantageous.

Until all of the states and localities with income taxes adopt a uniform composite return approach to the issue, the aggravation of having to file multiple state income tax returns, perhaps several dozen of them, will continue to exist for persons who own interests in entities that engage in multistate operations. The independent taxing authority of each state, and if one wants to be precise, each locality within a state, is a political feature of the nation's governance system that imposes a transaction cost on doing business. Only the most local of businesses can avoid multistate taxation. And only a few can afford to ignore the increasing globalization of most types of businesses.

None of this, of course, addresses the further complications arising from differences in how each state or locality defines taxable income. Amounts deductible in one state may be disallowed in another. Even if the state or locality uses federal taxable income as a starting point in computing state taxable income, as most do, all sorts of adjustments are required, and those vary from state to state. Worse, something that may not need to be separately stated for purposes of one state's income tax may need to be separately stated for purposes of another state's income tax because the latter state may have a credit related to certain types of expenditures for which the first state makes no provision.

When I tell students in the Partnership Taxation course that we are ignoring more of the issues than we are addressing, they nonetheless conclude that the topic is brutally complex. It is. Though the course focuses on federal income taxation, from time to time I ask them to envision the issues that the transaction presents for state income tax purposes. And if that's not sufficient to help them understand the extent to which the course is "watered down," I remind them that many partnerships and S corporations engage not only in multistate activities but in multinational activities. Recession or no recession, someone needs to figure out how the partnership or entity fills out the many returns it must file. And going back to the original question, the folks who own rental properties in multiple states either need to sit down and do a handful or more of returns on their own, or stimulate the economy by paying tax return preparers to do so for them. It's no wonder that one preparer's client balked at the expense. But as the participants in the discussion demonstrated, that client has no realistic choice. The option of not filing the state income tax return isn't a viable one in the long term.

Last Friday, in Don't They Ever Learn? They're At It Again, I lamented the continued persistence of the Delaware River Port Authority (DRPA) in its plans to use toll revenue for purposes other than repair, maintenance, and protection of the bridges and rail line that generate the tolls. On Thursday, in Legislators eye limits on DRPA spending, Paul Nussbaum examined the issue, explaining what would be required to amend the DRPA charter so that its use of toll revenues for unrelated projects would come to an end. He interviewed Pennsylvania State Representative Paul Clymer, who noted that while costs for motorists were "ballooning," the DRPA was using toll revenues for "special pet projects" of politicians. He's in favor of amending the charter. A member of the New Jersey Assembly noted that there was interest in doing this but that it wasn't a priority. The American Automobile Association Mid-Atlantic club has come out in favor of a change. The people who emailed me, called me, and spoke with me after having seen my comments quoted by Paul in the article unanimously agree.

Paul's exploration of the issue revealed that when the DRPA charter was changed in 1992, it was resisted by some New Jersey members of the DRPA because "they feared that toll revenues would be diverted from bridge maintenance." It's unfortunate how the warnings of the prescient too often are ignored. Since the DRPA's foray into projects other than bridge and rail line stewardship began, its debt increased from roughly $250 million to $1.2 billion, with an further increase to $1.5 billion expected. Bridge tolls have soared from $1.80 to $4, and will increase to $5 in 2010.

The DRPA defends its largesse to stadiums and other projects by claiming "We are confident that the authority's investment in these projects will generate increased toll and transit revenues for years to come." C'mon. Money has been poured into these projects by the DRPA for more than a decade and if toll revenues had grown as predicted there wouldn't be a need to throw two consecutive annual increases of 33% and 25% at motorists. The DRPA also claims that "even if every penny of the remaining $35 million in bond proceeds were diverted to the capital program [for bridge repairs and other improvements], it would not reduce the size of the bond issue needed to fund the program, nor would it reduce or eliminate the need for the toll increases that are being implemented to fund it." Simple accounting tells us that if the $35 million is used for repairs and improvements to the bridges and rail line, that's $35 million fewer dollars that need to be borrowed or $35 million fewer dollars that need to be collected in tolls.

On Wednesday, the Philadelphia Inquirer invited two public officials to opine on the question. In Should DRPA fund President’s House? No. Agency should stay on mission, Jack Wagner, Pennsylvania's auditor general, presented arguments similar to those set out by those opposed to the diversion of toll revenues. He explained that as a member of the DRPA he had voted against its contribution of $10 million to construction of a soccer stadium and intended to vote against the latest round of projects that brought the issue to the forefront once again during the past two weeks. In all fairness, I ought to stop painting the DRPA with a broad brush, as the decision to spend toll money on unrelated matters hasn't been a unanimous one. He points out that the projects to which tolls have been diverted won't fall apart without the DRPA money. That makes good sense. The analysis ought to be "we build and maintain bridges so that people can get to where they want to go" and not "we use toll money to fund projects so that people will want to use our bridges."

Taking the other position was Pennsylvania's Governor. In Should DRPA fund President’s House? Yes. Growth is a key part of the agency's role, Ed Rendell argued that the DRPA must make strategic investments as part of its "critical role in fostering growth throughout the greater Philadelphia region." Since when does an agency created to care for bridges and a rail line become the engine of economic growth for the region? What's next, the DRPA building public housing, collecting trash, and plowing Philadelphia's streets? Rendell makes a strong case for the quality of the projects, a conclusion with which I do not disagree and a conclusion with which few others disagree. Instead, as I pointed out in my comments quoted in Legislators eye limits on DRPA spending, "public anger with DRPA had less to do with the projects that are being funded than with the way the agency does it. These aren't bad projects. They're not funding the importation of illegal drugs or something [like that]. But the user fees are being used for purposes totally unrelated to what users are paying for." Something more than the project being worthwhile is required for the funding to come out of bridge tolls rather than from some other source. Otherwise, there would be no limit to what the DRPA would fund. That would be wrong, because the DRPA is not a general fund government but an agency charged with bridge and rail line stewardship.

Rendell's justification rests on this rather revealing argument: "Seventeen years ago, elected leaders in New Jersey and Pennsylvania recognized that the DRPA was uniquely situated to support economic development." Uniquely situated? The DRPA is as uniquely situated as is any unregulated monopoly. It's in a position to collect tolls from motorists who, as I pointed out in Legislators eye limits on DRPA spending, "don't have another way to cross the river, and … don't have a way to vote against DRPA board members." Rendell's argument is not unlike the "we're in a position to take the money, so we will" approach that was embraced by certain business entrepreneurs, investment bankers, brokers dealing in toxic derivatives, boiler room sales forces, and others who abused the so-called "free" market to the point this disregard for the obligations of holding a position of stewardship significantly contributed to the current economic downturn. Just because it's possible to gouge the motorist or the customer or the client doesn't mean it ought to be done.

Rendell points out that "They amended the agency's charter to make that one of its essential functions. The amendments were reviewed and approved by the Pennsylvania and New Jersey legislatures, Congress, and the president." That might make the DRPA's actions legal, but it doesn't make them wise or responsive to the electorate. Did any of these officials tell the voters while they were campaigning for office, "We're going to raise bridge tolls to finance the Army-Navy game, the Kimmel Center, and other projects that the DRPA happens to take a liking to"? Why is it that the DRPA hasn't funneled toll revenues to feeding the region's hungry or financing scholarships for the underprivileged? Expanding the DRPA's mission to include improvements to feeder highways, to improve access to the bridges, though beyond the technical boundaries of the bridges, is defensible, even to the point of probably getting my support.

Rendell does make a good point that the DRPA has painted itself into a corner. Some of the money that it is about to disburse was committed some time ago. According to Rendell, the DRPA "must honor those commitments." I'm sure he's right. I'm sure there are contractual obligations in place such that if the DRPA does not cut the check, it will be sued, successfully, by the designated recipients. That's too bad. It may be too late to back out of those expenditures just as it's too late to back out of hundreds of thousands of ill-advised mortgage loans.

Rendell then asks, "Does anyone seriously dispute that this will generate significantly more trips across our bridges and on our trains?" Yes, Ed, I do. Where are the surveys? How many motorists would answer "No" to the following questions: "Would you have crossed this bridge if the DRPA's refusal to put $250,000 into the Army-Navy game caused it to be moved to some other city or cancelled? Would you have crossed this bridge if the DRPA had not contributed to the funding of the Kimmel Center? Would you have crossed this bridge if the DRPA had not funded some of the cost of the President House project?" How many people in New Jersey are saying to each other, "Hey, Sam, they managed to get the soccer stadium built with help from the DRPA, so let's cross the bridge without eliminating any of our existing bridge crossings"? Yes, there are some motorists who might make a crossing that they otherwise would not have made, without cutting back on existing trips, to see something that arguably would not exist but for DRPA funding, but there's nothing to demonstrate that there's enough of them to "generate significantly more trips across" the bridges. The burden of proof is on the supporters of this spending spree. To date, they haven't generated the evidence.

Legislators in Oregon are considering a bill that would increase the per-barrel excise tax on beer producers from $2.60 per barrel to $49.61 per barrel, with the revenue to be used for alcohol and drug abuse, treatment, and recovery programs. That's a whopping increase. Why?

According to the legislation, the rationale for the propsal is as follows:

Whereas Oregon ranks 49th among states in its malt beverage
taxation rate; and

Whereas Oregon's malt beverage tax has not been raised in 32 years; and

Whereas Oregon's untreated substance abuse costs $4.15 billion in lost earnings, $8.13 million for health care and $967 million for enforcement and social services for a total cost of $5.13 billion each year; and

Whereas 'addiction' is defined as a chronic, relapsing brain disease that is both preventable and treatable; and

Whereas treatment capacity is so low that less than 25 percent of Oregon adults and only two percent of Oregon youth who need substance abuse services receive the help they need; and

Whereas research, the Governor's Statewide Leadership Team for Alcohol-Free Kids and the Governor's Council on Alcohol and Drug Abuse Programs show that increasing alcohol taxes reduces access to and availability of alcohol to underage drinkers; and

Whereas underage drinkers consumed an estimated 15.3 percent of all alcohol sold in Oregon in 2005, totaling an estimated $278 million in sales and estimated profits of $135 million to the alcohol industry; and

Whereas alcohol use by Oregon's eighth graders is 76 percent higher than the national average; and

Whereas on average, half of the students in every 11th grade classroom in Oregon drink; and

Whereas raising the malt beverage tax and indexing those taxes to the Consumer Price Index to keep pace with inflation is imperative to protecting Oregon's citizens;

How accurate are these assertions?

According to Draft Magazine, Oregon does have a low beer tax compared to the rest of the country. It does appear that the excise tax in question was last raised in 1967. Studies indicate that untreated substance abuse imposes economic costs to the state of Oregon in an order of magnitude roughly approximating the cited amounts. Underage drinking is an acknowledged problem in Oregon just as it is throughout the country. Whether it is worse there is a debatable question, even if the number of eight graders who are drinking suggest that Oregon youngsters are getting a head start.

The tax and user fee policy question is whether increasing the excise tax on beer production will cut underage drinking by reducing the availability of alcohol to underage drinkers. The editor at Draft Magazine suggest that the answer is no. He notes that commonly referenced studies indicate the alcoholic drink of choice for underage drinkers is liquor and wine. Studies such as the two summarized in this report correlate that position. Though using revenue from an increased beer excise tax to educate youngsters with respect to the dangers and costs of underage drinking, to increase enforcement of laws prohibiting underage drinking, and to encourage underage individuals from drinking should have a positive result, if done effectively, the question is why increase the excise tax on beer production while not imposing a user fee or tax on the production of the alcoholic beverages that underage persons are more likely to drink?

A related question is whether increasing the tax and user fee on all alcoholic beverages would cause a decline in underage drinking. Is there a correlation between the current low excise tax rate in Oregon and the higher level of underage drinking in Oregon? At first glance, the answer would seem to be less. But perhaps there is more to the analysis than a simple correlation. According to Draft Magazine, Oregon has "one of the most robust beer industries in the nation" and "a plethora of breweries." Surely the state's low excise tax on beer production has encouraged breweries to set up operations in Oregon. Does that translate to a cultural condition in which underage drinking gets more "winks" than in other states? According to this National Survey on Drug Use and Health Report, the answer appears to be that underage drinking in Oregon puts the state in the middle of the pack.

Nor is underage drinking the only substance abuse behavior that needs to be prevented and treated. The producers of beer are not responsible for underage individuals' use of illegal drugs, abuse of prescription medications, or addition to household chemicals and other items such as glue. If revenue from a beer production excise tax flows into rehab centers, it is unlikely that those specific dollars will be restricted to dealing with problems arising from beer consumption.

Justification for taxes or user fees on the production or use of alcoholic beverages ought to be based on the same considerations that apply to other user fees, namely, shifting to the producer or user the costs imposed on society by that production or use. What seems to be missing are empirical studies that measure that impact. Presumably, it is difficult to separate the cost imposed by underage use of beer from underage use of other substances, especially because in some instances multiple abuse exists. The goal of those introducing the legislation in question is admirable. The scope of the legislation is deficient, and its impact threatens legitimate businesses who produce beer for consumption by those legally entitled to use it. The legislation would be improved by the addition of provisions focusing on identifying and shutting down the pathways by which beer, other alcoholic beverages, and other abused substances find their way into the hands of underage drinkers. Perhaps adults who leave alcohol in unlocked cabinets ought to be treated in the same manner as adults who fail to put their guns and bullets in secure places.

I describe the proposed increase as one that amounts to 1808%. I computed this number by subtracting the current rate of $2.60 per barrel from the proposed rate of $49.61 per barrel, which provided an increase of $47.01, and then by dividing $47.01 by $2.60. According to Draft Magazine, the increase is 2008%, the same increase described in posts on this Sporting News blog. According to the CNN report that steered me to this story, the increase is 1900%. The Oregon Brewers' Guild describes it as an increase of "over 1900%," as does the Examiner. The only reported percentage increase that I can explain is the 1800% increase reported by Oregon Live and by Boston Multimedia, because that reflects simple rounding. I'll resist the temptation to offer explanations for how a simple arithmetic computation based on two numbers can generate so many different answers, other than to note that it's not unlike giving the same facts to several dozen professional tax return preparers and getting several dozen different tax liabilities.

Section 1008 of the American Recovery and Reinvestment Act of 2009 as passed by the House-Senate Conference allows purchasers of qualified motor vehicles to deduct the sales taxes paid on the purchase of a qualified motor vehicle. Only the sales tax paid on the first $49,500 of the purchase price qualify. The deduction is phased out if the taxpayer's modified adjusted gross income exceeds $125,000, and is fully phased out once it exceeds $135,000. A qualified motor vehicle is a passenger automobile, a light truck treated as a passenger automobile for purposes of the Clean Air Act provided it does not weigh more than 8,500 pounds, a motorcycle that does not weigh more than 8,500 pounds, and a motor home. The original use of the vehicle must begin with the taxpayer. The deduction is available both to those who itemize and those who claim the standard deduction, because the deduction is added to what would otherwise be the standard deduction. The deduction is not available to taxpayers who elect to deduct state sales taxes in lieu of state income taxes, almost always a decision made by taxpayers in states without income taxes, because these taxpayers already are deducting the sales tax in question. The provision is effective for purchases made on or after date of enactment in taxable years ending after the date of enactment but does not include purchases made after December 31, 2009.

The question is how does this deduction stimulate the economy. There are two elements to this inquiry. First, there is the assumption that an increase in the number of people purchasing new vehicles during 2009 stimulates the economy, presumably by creating jobs in the auto industry and in the secondary industries that derive business from the auto industry. Second, there is the assumption that the tax savings from deducting the sales tax on the purchase of a new vehicle will cause more people to purchase vehicles than otherwise would have purchased vehicles.

Whether an increase in the number of people purchasing new vehicles during 2009 will stimulate the economy is a debatable point, but at least it is a plausible proposition. This is not the aspect of the question that generates the greatest concern.

It is highly questionable that the tax savings from deducting the sales tax on the purchase of a new vehicle will increase the number of people purchasing new vehicles during 2009 by more than an insignificant few, when compared to the number of people who would have purchased new vehicles in the absence of the deduction. The reason for this conclusion is that the efficacy of the deduction is weak.

Consider that most people who purchase new vehicles do so by trading in their currently owned vehicle. In many states, the sales tax is imposed on the amount paid net of trade-in allowance. Also consider that the people permitted to claim this deduction are most likely to be purchasing vehicles in the lower end of the automobile retail price range. When these two factors are combined, the amount of sales tax paid by someone could be as little as several hundred dollars or perhaps as much as $2,000. The tax savings to someone in the 10%, 15% or 25% marginal tax bracket ranges from as little as $30 to at most $500.

For how many people is $30, $100, $300, or even $500 the critical factor in deciding to purchase a $15,000, $20,000, or $30,000 vehicle? If a person does not have the financial werewithal to make the purchase absent the tax savings, it is highly unlikely that this small tax savings, most likely showing up in early 2010 in the form of a larger refund or smaller tax due remittance, will trigger an automobile purchase in 2009. For people without jobs, the question of a new car purchase is a non-starter. For people fearing loss of an existing job, the focus is on saving up a nest egg in case the pink slip arrives, and a new vehicle purchase is not on the to-do list. For people trying to deal with increased living expenses while facing pay freezes or pay cuts, undertaking a transaction that increases monthly outlays isn't going to happen. For those in dire need of a vehicle because the existing vehicle has reached the end of its days, or because life without a vehicle has become impossible, the most efficient path is to acquire a used vehicle, something for which the deduction is not available.

Folks who were planning on purchasing a new car during 2009 receive a windfall. They will be getting a small tax savings for doing something that they would have been doing in any event. What will they do with the tax savings? Everything else being equal, presumably they will save it. This stimulates the economy only to the extent that the bank in which they deposit the money chooses to lend it, in turn, to someone who will use the borrowed funds to engage in economically stimulative behavior. That's a fairly inefficient way to move stimulus payments payments into the economy.

When I teach the basic tax course, though I have no time to examine credits in any detail and am constrained to dealing only with the general nature of a credit, I do manage to squeeze in an example of the tax policy issue that questions the effectiveness, let alone efficiency, of using tax credits to influence behavior. My favorite is the adoption credit. I tell my students I can imagine a couple sitting around and deciding, "Hey, we get a $10,000 credit for adopting a child. Let's go get one." The point is that $10,000 isn't worth the decision if the couple doesn't have the prospect of a good chunk of income over the next 18 or more years to support the child. Again, the $10,000 is hardly the make-or-break tipping point of the adoption decision.

Though the notion that federal spending, either of tax revenue or borrowed money, will stimulate the economy, that notion ought not support the contention that any infusion of money into the economy is fiscally stimulative. It would make much more sense, for example, to invest the money in assets, such as infrastructure, schools, homeless shelters, prisons, and energy facilities, because the outlay would be matched, at least to some extent, by the production of an asset owned by the government and because there would be no doubt that the outlay would create and preserve jobs. It is difficult to imagine that whoever lobbied for this qualified vehicle sales tax deduction made that sort of strong case that it would rev up the engines of the automakers' production facilities.

The key to climbing out of the economic downturn is to restore confidence in the economy and the infrastructure of the economy. So long as people don't trust banks, so long as people think that the manufacturer of the automobile they purchase might be out of business the following week, so long as people wonder if the store from which they buy an appliance might close its doors next month, so long as people worry that their next paycheck might be their last, they're not going to buy cars, or much else other than what is needed to get by from day to day.

About the only thing this deduction will stimulate, other than the writing of blog posts, is more tax complexity that generates more work for tax return preparers and the programmers re-tooling tax return preparation software. That simply isn't the way to get America's productive, intellectual, and creative capacity back to humming along.

ADDENDUM: It seems that the Tax Policy Center has similar views, though the C- it awards to the provision is far more generous than the F it earns from me. It thinks that the provision "would increase sales of qualifying vehicles but would disproportionately benefit middle- and high-income households." I disagree. As I've explained, there's no reason to think any sort of meaningful increase in vehicle purchases will occur, nor is there any reason that there would be a flood of car buying by taxpayers with modified adjusted gross incomes below the cut-off threshhold.

Almost a year ago, in Soccer Franchise Socks It to Bridge Users, I questioned why bridge tolls were being used to fund a professional soccer franchise rather than to maintain and repair bridges under the care of the Delaware River Port Authority (DRPA). I suggested that the DRPA charter be amended so that it could spend bridge tolls only on bridge maintenance and repair, and not on handouts to "Lincoln Financial Field, the Kimmel Center, the New Jersey Aquarium, and dozens of other projects that surely are not bridges." A week later, in Bridge Users Easy Mark for Inflated User Fees, I criticized the failure of the governors of Pennsylvania and New Jersey to veto the inappropriate use of bridge toll revenues by the DRPA, a power that each governor has and can exercise independently. I explained that "[t]he governor's attorney revealed that [New Jersey Governor] Corzine perceived the $10 million hand-out to developers of restaurants and businesses to be 'a legitimate alternative use.'" I also explained that the real reason was his concern that if he vetoed projects in Pennsylvania, the Pennsylvania governor would veto projects in New Jersey. A few months later, in Restricting Bridge Tolls to Bridge Care, I noted that the DRPA determined it need to raise bridge tolls and PATCO rail line fares, and that at the two days of public hearings held by the DRPA on these proposes, "motorists and others showed up and blasted the DRPA for its mismanagement of revenues."

In Bridge Users Easy Mark for Inflated User Fees, I predicted that "in the not too near future, expect to see the DRPA raise tolls yet again, to finance perhaps a private shopping mall in New Jersey, there being such a shortage of them, he says sarcastically, or some other private venture whose owners think it's a legitimate business plan to get taxpayers to pay for their enterprises." So what has happened?

According to this Philadelphia Inquirer report, the DRPA now plans to spend $9.5 million on a President's House memorial in Philadelphia, a restaurant in Philadelphia, the Lights of Liberty show, a proposed medical school in Camden, and the demolition of the Parkade Building near Philadelphia's City Hall. It also plans to spend $1.5 million for improvements to Admiral Wilson Boulevard in New Jersey "to aid expansion of the Campbell Soup Co." The American Automobile Club has requested that the DRPA cancel the first set of projects, noting that the planned highway improvements "could be considered transportation-related." AAA made the same point that I and many unhappy toll payers have made: "Toll revenues from motorists should not be used for economic development projects, especially at a time when our roads and bridges need money."

The DRPA claims it can spend the money despite having promised at the previously-mentioned hearings that it would use the revenue from the toll increases only for "transportation-related expenses." It argues that the proposed new spending is acceptable because it comes from previous borrowing. As I explained in Bridge Users Easy Mark for Inflated User Fees, "the DRPA has been handing out so much money to unrelated development projects that it has racked up more than a billion dollars in debt. To service this debt, almost half of the tolls that it collects is used to pay interest and principal on these loans." So the DRPA proposes to use borrowed funds for these new non-bridge projects and to repay the loans wth toll revenue. Why not, instead of using the borrowed money on these non-bridge projects, use the money to pay down the debt? Has the DRPA board not been reading about the dangers of being in debt?

There is something very wrong with how the DRPA operates. As I explained in Bridge Users Easy Mark for Inflated User Fees, "Members of the DRPA are appointed and do not run for their positions, so they simply are not accountable to the people on whom they impose bridge tolls." The only vote that the motorists have is with respect to the election of the governors, but there are so many other issues affecting gubernatorial election campaigns that this misuse of bridge toll revenue is too easily shoved out of the spotlight. As I asked in that previous post, "Where's the democracy in this system?"

So in addition to proposing that the DRPA's charter be amended to prohibit use of its revenues for other than building, repairing, maintaining, and patrolling its bridges and rail line, I also suggest that the members of the DRPA be elected, say, four from each state, with the ninth selected by the eight who are elected. Apparently, this is the only practical way to bring accountability to bear on the DRPA. Insulated from the ballot box, impervious to citizen input, oblivious to the realities of a new economy, unaware of the dangers of debt, unschooled in the tax policy considerations applicable to the use of user fees, and dead-set on plowing other people's money into pet projects unrelated to the stewardship of bridges and a rail line, the DRPA board needs to be replaced. Its charter must be reformed and rewritten.

The DRPA has been told, in no uncertain terms, by everyone except those who are feeding at the toll trough, to stop spending money on matters not related to the building, repair, maintenance, and patrolling of the bridges and the rail line. The DRPA has given lip service to the idea, but has turned a deaf ear to the message. What does the DRPA not understand about a simple directive? Its thinking, I suppose, is that it does not answer to the motorists, the citizens, and the taxpayers. It's time for some changes that will ring through loud and clear. Someone needs to turn up the lights and explain that the party is over.

So what does a city do when its projected revenues are revised to turn what was planned as a break-even situation into one promising a $2 billion deficit? Aside from cutting expenditures, which carries its own risks, a city could raise revenue. It could raise rates on existing taxes. It could postpone scheduled decreases in existing taxes. And it could propose a new tax.

A new tax is precisely what two members of Philadelphia City Council are planning to do. According to this Philadelphia Inquirer story, Council members Frank DiCicco and Jim Kenney introduced legislation to impose a 35-cent-per-barrel tax on petroleum refined in the city. As a practical matter, this would be a tax on the Sunoco refinery in South Philadelphia, which is the only refinery in the city. The proposed tax would raise $20 million. That is a drop in the bucket, or should I say, a drop in the barrel, when compared to a $2 billion revenue shortfall.

In a news release, DiCicco explained, "Oil companies saw huge profits in 2008 and the City of Philadelphia continues to struggle to meet service demands. With these considerations on top of the industry's impact on our environment and the health of our constituents, I think it's appropriate that the oil industry contributes more." Would not the city gross receipts and business income taxes paid by Sunoco increase if its refinery gross receipts and refinery profits have increased?

Does it make sense to create a new tax when the cost of setting up a system for administering the tax will itself cost money? Will there not be a need for the city to spend money auditing the oil flows at the refinery to determine if the correct amount of tax has been paid?

But there is a bigger glitch. The city has no authority to enact this sort of tax. Only the Commonwealth of Pennsylvania is permitted to do so. The City of Philadelphia had a 5-cent-per-barrel tax on petroleum processing for the fiscal year July 1, 1976 through June 30, 1977, but that was a one-time provision enacted under special circumstances. The City has no authority to levy taxes without the express authorization of the state legislature. A summary of the state statutes presently in effect that permit the city to impose taxes is set forth in Taxation in the City and School District of Philadelphia. There does not exist any authority to impose a tax on the production of an oil refinery.
A legislative aide to DiCicco claims that the proposal would simply re-enact the provision that was in effect for fiscal year 1977, but state authority for that exaction does not exist. In fact the aide admitted that the city probably is barred from enacting the tax. He added, "It's at least worth a conversation in tough times, and the oil industry is one of the few that is still making money." Ought not conversation be directed toward actions that the city is authorized to take? What is the sense in debating whether to do something that cannot be done? Kenney provided the answer to that question. Apparently his approach is to do what he wants to do and to let the legal issues work themselves out later. According to this KYW News Radio report, he explained, "That's why they have courts of law and lawyers, to determine which is the right course. And we're going to do our best in this time, when the city is struggling to provide services and maintain revenues; everybody's got to pitch in."

So if this miniscule idea goes forward, where will the city find the funds to pay the attorneys it will need to retain to present its case as the matter works its way through the judicial system? And if it loses, as it very likely will, how will the proponents of the proposal defend the outcome if the net impact on the city's finances is to increase, rather than reduce, the deficit that it faces? It would make more sense for the proponents to think again about the idea, and to refine their budget-fixing plans by turning to some other remedy.

It's time for a short break from the world of nominees with tax difficulties, economic recovery legislation, and stimulus packages. It's time for a return visit to the world of substantive tax law, in particular the land of a state "meals and rooms tax."

Under section 9241 of title 32 of its statutes, Vermont imposes a 9 percent tax on "the sale of each taxable meal." Under section 9202(10) a taxable meal is defined as

(A) Any food or beverage furnished within the state by a restaurant for which a charge is made, including admission and minimum charges, whether furnished for consumption on or off the premises.

(B) Where furnished by other than a restaurant, any nonprepackaged food or beverage furnished within the state and for which a charge is made, including admission and minimum charges, whether furnished for consumption on or off the premises. Fruits, vegetables, candy, flour, nuts, coffee beans and similar unprepared grocery items sold self-serve for take-out from bulk containers are not subject to tax under this subdivision.

(C) Regardless where sold and whether or not prepackaged:

(i) sandwiches of any kind except frozen;

(ii) food or beverage furnished from a salad bar;

(iii) heated food or beverage.

Under section 9202(10)(D), taxable meals do not include the following:

(i) Food or beverage, other than that taxable under subdivision (10)(C) of this section, that is a grocery-type item furnished for take-out: whole pies or cakes, loaves of bread; single-serving bakery items sold in quantities of three or more; delicatessen and nonprepackaged candy sales by weight or measure, except party platters; whole uncooked pizzas; pint or larger closed containers of ice cream or frozen confection; eight ounce or larger containers of salad dressings or sauces; maple syrup; quart or larger containers of cider or milk.

(ii) Food or beverage, including that described in subdivision (10)(C) of this section:

(I) served or furnished on the premises of a nonprofit corporation or association organized and operated exclusively for religious or charitable purposes, in furtherance of any of the purposes for which it was organized; with the net proceeds of said food or beverage to be used exclusively for the purposes of the corporation or association;

(II) served or furnished on the premises of a school as defined herein;

(III) served or furnished on the premises of any institution of the state, political subdivision thereof or of the United States to inmates and employees of said institutions;

(IV) prepared by the employees thereof and served in any hospital licensed under chapter 43 of Title 18, or a sanitorium, convalescent home, nursing home or home for the aged;

(V) furnished by any person while transporting passengers for hire by train, bus or airplane if furnished on any train, bus or airplane;

(VI) furnished by any person while operating a summer camp for children, in such camp;

(VII) sold by nonprofit organizations at bazaars, fairs, picnics, church suppers, or similar events to the extent of four such events of a day's duration, held during any calendar year; provided, however, where sales are made at such events by an organization required to have a meals and rooms registration license or otherwise required to have a license because its selling events are in excess of the number permitted, the sale of such food or beverage shall constitute sales made in the regular course of business and are not exempted from the Vermont meals and rooms gross receipts tax;

(VIII) furnished to any employee of an operator as remuneration for his employment;

(IX) provided to the elderly pursuant to the Older Americans Act, 42 U.S.C. chapter 35, subchapter VII;

(X) purchased with food stamps;

(XI) served or furnished on the premises of a continuing care retirement community certified under chapter 151 of Title 8.

Vermont's Commissioner of Taxes audited a movie theater and determined that it failed to collect and pay the meals-and-rooms tax on sales of popcorn and nachos. When the taxpayer appealed, the Superior Court affirmed the Commissioner's decision, and the taxpayer again appealed. Thus, the Supreme Court of Vermont faced the issue of whether popcorn and nachos served by a movie theater are taxable meals. See Eurowest Cinemas LLC v. Vermont Department of Taxes (13 Jan 2009), which is not yet on the court's web site but might be found here.

When the theater sold popcorn to its patrons, its employees heated the popcorn and, if asked, added hot, melted butter to it. When it sold nachos, the employees added warm, melted cheese. The Department of Taxes concluded that the popcorn and nachos were taxable meals because section 9202(10)(C)(iii) includes all heated food and beverages in the definition. Because the exceptions in section 9202(10)(D) do not apply, and the taxpayer did not so argue, it would appear to be an easy case. But it wasn't.

The taxpayer relied on Tax Department Regulation 1.9232.8(D), which excludes popcorn and nachos from the definition of taxable meal. The regulation, adopted in 1969, provides that "popcorn, potato chips . . . and other similar products" are "[e]xamples of items considered to be candy and confectionary not subject to the [meals-and-rooms] tax." The Court noted that even though popcorn is in the list of excluded items, in context it is included in a list of packaged items and thus does not include popcorn prepared by the taxpayer in individual, ready-to-eat portions. The Court also noted that Regulation 1.9232.8(A) subjects to the tax "all prepared meals, [and] snacks . . . sold in individual portions and ready to eat … served [by] … an 'eating and drinking establishment.'"

The theater was an eating and drinking establishment because, under regulation 1.9232.8(B), "'Eating and [d]rinking [e]stablishments' shall include every … place where food . . . [is] served." The taxpayer, however, argued that its snack bar was not an eating and drinking establishment because, under the regulation, an eating and drinking establishment does not "include any portion of an operator's premises which is devoted to the sale of packaged food or candy." According to the taxpayer, its "snack bar is not an 'eating and drinking establishment' subject to tax, because it is a 'portion of any operator's premises which is devoted to the sale of … candy' under [section] (C), where candy is defined by [section] (D) to include 'popcorn, potato chips, crackerjacks, and other similar products.'"

The taxpayer also relied on regulation 1.9232.8(C), which excludes from the definition of eating and drinking establishment "ordinary retail food stores where packaged food products and/or candy and confectionary are sold." That provision also excludes any portion of a business premises devoted to the sale of "packaged food or candy."

The court concluded that the taxpayer misconstrued regulation 1.9232.8(C). It explained that the regulation allows a restaurant, for example, to sell mints or chewing gum at its register without collecting tax on those items. It does not preclude the imposition of the tax on prepared meals simply because a taxpayer's premises includes both sales of prepared items and pre-packaged items.

The court further reasoned that even if the taxpayer's interpretation of regulation 1.9232.8(C) was correct, and even if its contention that the popcorn and nachos were within the definition of "candy," the theater's snack bar was not "devoted" to the sale of candy. In addition to selling popcorn, nachos, Sno-Caps, and Milk Duds, the theater sold, and collected meals-and-rooms tax on, non-bottled beverages, soft pretzels, and hot dogs.

Thus, the court reached the question of "whether the operator-prepared, ready-to-eat popcorn and nachos offered for sale at taxpayer's snack bar are better characterized under the regulation as 'prepared … snacks … sold in individual portions and ready to eat' or 'candy.' It decided that the "popcorn, potato chips … and other similar products" described in the definition of candy are not prepared for sale by the operator and are pre-packaged. Thus, they are not subject to the meals-and-rooms tax no matter where they are sold. But, the court continued, "the unpackaged popcorn and nachos, as prepared and sold by taxpayer at its snack bar, are operator-prepared snacks sold by an 'eating and drinking establishment' and subject to meals-and-rooms tax."

The case illustrates why there are limits to simplification of tax laws. As soon as the legislature decided to impose a tax on "taxable meals," it had to define "taxable meal." Thus, we get the lengthy statutes previously quoted. Would it have been simpler to tax "meals"? No. When I take students in the basic tax class through the exclusion from gross income of meals and lodging provided by an employer, they encounter an issue best summarized by the question, "Are groceries meals?" The IRS says yes, and the Third Circuit says no. What is required is a definition of a meal. Ask the next ten people you meet, what is a meal? It would not be surprising to hear ten different definitions, not simply in terms of the words chosen to express the concept but in terms of the concept. Or, as one student once claimed, "HoHos can be a meal."

Once the Department of Taxes decided to define candy and to include popcorn in the list, it created a need to distinguish between popcorn that qualified for exemption and popcorn that did not. That left the court in the position of asking, "What is candy?" Ask those same ten people, or another group of ten people, to define candy. Is something candy if it does not include sugar? Is something necessarily candy if it does include sugar? These are not simply tax law questions. Someone who adheres to a belief system that includes the giving up of something for Lent would encounter the same questions if he or she decides to give up candy for Lent. Would they argue, as did the theater, that popcorn and nachos purchased at the movies were not within the self-imposed restriction?

Some might argue that the easiest answer is to repeal the tax, but that simply shifts the definitional challenge to another type of tax. Others might argue that the easiest approach is to tax all meals, with no exceptions whatsoever, although that still raises the question of what is a meal. Still others might argue that the tax could be imposed on food, but there are people who eat things that other people would not consider to be food. This question brings back memories of the pumpkin nonsense described in Halloween Brings Out the Lunacy. That's the story of Iowa revenue officials declaring that pumpkins are not food.

So to those advocating the flat tax, the FAIR tax, the VAT, consumption taxes, and all other sorts of replacements for the income tax, there is a lesson to be learned. There is no escaping the need to determine what is in the base. What is income? What is within the VAT? What constitutes consumption? And, of course, the one to which I refused to give an answer: "Are HoHos a meal?"

Timing is everything, I suppose. At about the same time that my musings on the tax troubles of several of President Obama's nominees, in Tax Problem or Tax Symptom?, entered the blogosphere, the Washington Post, in Victims of the Tax Code? Not So Fast took the position that even though the tax law is complicated, the nominees' troubles were preventable. Several experts, including colleagues in the tax law professorship business, explained that these were not the most complex issues that taxpayers can encounter, that the complexity of the code is not an excuse for the errors on their tax returns, and that they should have known what was going on. Yet one practitioner, Kenneth Brier, a tax lawyer in Boston, noted, "What this is telling us is that even people who should know better somehow don't. People who should be able to hire good tax help still don't get it right."

So why aren't they getting it right? Back in 1997, Money Magazine (March 1997 issue, page 80), in what appears to be the last test of this sort that it conducted, asked 45 tax return preparers to do the tax return for a hypothetical family. There were 45different results. None were correct. Fewer than one-fourth were within $1,000 of the correct answer. The tax liabilities that were computed ranged from $36,322 to $94,438. So why didn't these 45 experts get it right? Should we expect any better of a performance today, with eleven years of additional provisions, exceptions, definitional refinements, and other technical changes added to the tax law?

If it's not the unmanageable complexity of the tax code, then is it necessarily the incompetence of the preparers? Congress has created a tax system that is groaning under the weight of its own absurdity, teetering on the edge of a collapse no less striking than the track record of the economy during the past six months.

Consider the issues that created the problem. Geithner failed to enter into a particular Turbotax entry box his income from the International Monetary Fund. According to this report an accountant told him that he did not owe self-employment taxes on that income. According to this report the IMF provides its employees with information concerning their taxes, and that it provides assistance to employees who request it, though Geithner apparently did not do so. On the other hand, the same report observed that "Tax professionals noted that even trained preparers sometimes miss the subtleties involved in taxation of employees of international organizations." What Geithner did was sloppy, careless, and at worst, negligent. He didn't try to hide income. He didn't stash money in an off-shore trust. He didn't buy into some tax shelter deal. He didn't skim cash from the cash register. In other words, he didn't commit tax fraud.

The same can be said of Daschle's problems. He received a Form 1099 and handed it to the accountant who prepared his return. The Form 1099 was wrong. That's not Daschle's fault. Should he have audited the payor? How many taxpayers add up the interest credited by the bank to their checking or savings account to determine if the Form 1099 sent by the bank is correct? Should they be expected to do so? The Form 1099 was off by $80,000 but that was just a small fraction of the amount being reported. Had the error been one of several orders of magnitude, then it would have been much more obvious. It's not fraudulent to rely on a Form 1099 that is prepared by an independent third party. Daschle also failed to report the use of an automobile and driver provided by an employer. When Daschle was in the Senate, he received the use of a vehicle and driver for security reasons, and under the tax law the value therefore is excluded from gross income as a working condition fringe benefit. Only the astute tax practitioner understands the subtle distinction that causes a different result for the vehicle and driver provided to Daschle in his post-Senate enterprise. Again, he almost certainly thought he was doing the correct thing, probably because he was doing the same thing that had been done in the past, that is, not reporting any income on account of the vehicle and driver. No one knows if the accountant asked questions about the vehicle and driver. Unless taxpayers are required to review the substantive law analyses performed by their preparers, they should be held accountable for unpaid taxes, interest, and penalties, but they ought not be characterized as perpetrators of fraud or as deadbeats as this commentary concluded.

There is no doubt that the taxpayer and professional tax return preparer error rate would decrease if the tax law were not so complicated. When Kenneth Brier tells us, "What this is telling us is that even people who should know better somehow don't," we should understand that the "somehow" is the inability of Congress to put a sound tax policy ahead of special interest lobbying. My suggestion that Congress might come to understand this point if its members were required to do their own tax returns, submit them for review, scoring, and repair before filing, and to publish their scores inspired Mary O'Keefe to embellish the suggestion. In Professor Maule's prescription for "tax law disease" --and mine she proposes:

All members of Congress who serve on the House Ways and Means Committee or the Senate Finance Committee as well as the Commissioner of Internal Revenue and the Secretary of the Treasury should annually take and pass the VITA volunteer tax preparer certification test and then volunteer a few hours each year at a VITA site preparing and explaining tax returns to a random cross-section of low-income working families and senior citizens.

Hooray! Yes, I'll vote for that idea. But I'd extend it to every member of Congress. Let them walk in taxpayer shoes for a while. Perhaps then they'll think twice about continuing to overload the Code.

First it was Timothy Geithner, nominated to be Secretary of the Treasury. Next, it was Tom Daschle, nominated to be Secretary of Health and Human Services. It turns out both have filed federal income tax returns beset by major errors. Technically, they are not the first and second nominees for a federal office to have a tax problem. Almost fifteen years ago, Zoe Baird's nomination to be Attorney General was withdrawn after it was disclosed that she had failed to pay social security taxes on wages paid to household workers. I'll let someone else catalog the parade of nominees whose returns contained significant deficiencies.

Mr. Geithner failed to report income earned while employed by the International Monetary Fund. Mr. Daschle failed to report as income his use of an automobile and chauffeur, along with $80,000 of consulting fees that he received after his Senate term expired. These aren't the most basic of tax issues, but neither are they the complex challenges of partnership taxation, section 280A dwelling unit deduction limitations, or the computational nightmare of section 1 or section 86. In Daschle's case it appears that his return reflected what was reported on Form 1099 but the issuer of the form erroneously understated the income by $80,000.

Mr. Geithner apologized, and said he had made "careless but unintentional mistakes." Mr. Daschle also apologized, and said, "My mistakes were unintentional." Mr. Geithner further explained that he had used Turbotax, but as noted in this commentary, tax preparation software is only as good as the information entered into it. I haven't been able to discover any confirmation that Daschle used Turbotax, but as there are references to "his accountant" the best guess is that he did not.

Are they "deadbeats" as contended in this commentary? Only if the evidence demonstrates that they knew they had gross income to report and deliberatly and wilfully failed to do so. In that case they should be barred from office, and prosecuted for tax fraud.

Were they negligent? Yes. Should they have asked for help? Perhaps they did, and perhaps Geithner figured that using Turbotax was the equivalent of getting help from a tax professional. Daschle apparently had professional assistance.

Should they be barred from office because they don't know how to do their tax returns? The better question is whether everyone who makes mistakes on a tax return should be denied employment. That's a harsh result and it highlights the deeper problem. Daschle has since withdrawn from consideration.

Though these nominees have a problem, and perhaps problems that they should have prevented, their issues are much more a symptom for the nation. The tax law is so complicated that it's too easy to make a mistake. The opportunities for error multiply exponentially as provision after provision are inserted into the tax law. The rules applicable to employees of the International Money Fund are not as simple as some seem to have reported. Whether Daschle's use of a vehicle provided by a friend constitutes gross income depends on the facts and circumstances. This isn't to minimize or excuse their tax filing problems, but to point out that the true problem is the tax law and that noncompliance arising from negligence and ignorance is a symptom.

Over the years, I have suggested that members of Congress be required to do their own tax returns. My rationale is that if these folks were compelled to suffer through what other taxpayers must endure they might think twice before using the tax law to accomplish what ought to be handled by the Department of Energy, the Department of Commerce, the Department of Education, and a long list of other agencies that somehow cannot achieve their objectives without assistance from the Internal Revenue Service. Until now I haven't embellished my suggestion, but perhaps it makes sense to explain that after members of Congress prepare their returns, they would be examined by tax professionals before they were filed. Otherwise, there's too high a risk that all or nearly all of the returns would be wrong. I don't think I'd permit them to use tax return preparation software, because I don't want them to have a scapegoat for their return preparation inadequacies.

The present course of action, fixing the mistakes and giving apologies, is insufficient. These incidents are a warning sign to the Congress. They are the tip of a huge noncompliance iceberg that extends far beyond the world of tax fraud, tax shelters, and tax gimmicks. They illustrate the extent to which tax compliance is falling short. They serendipitously indicate why the Congress must avoid loading more tax junk into the pending legislation. Otherwise tax compliance will become a game of "if they catch me, I'll pay and apologize" played in a context of "it's unlikely they'll catch me." Tax compliance, and the fiscal integrity of the nation, will be reduced to this sort of nonsense. Already, one well-known tax fraud defendant has raised what is now being called the Geithner defense. There will be more. Many more.

Until these incidents of tax noncompliance are seen as symptoms rather than as isolated problems, the underlying tax law disease that is stifling the nation will spread. Until the Congress determines to stop jeopardizing the integrity of the tax law by using it for political purposes, the economic malaise that pervades the nation will deteriorate into much worse.

According to this CNN Report, Rudy Giuliani, former mayor of New York City and one-time Presidential candidate, has explained that huge corporate bonuses are good for the city and the economy. Giuliani's theory is that if the bonuses aren't paid, "it really will create unemployment." He adds, " It means less spending in restaurants, less spending in department stores, so everything has an impact." Giuliani explained, "I remember when I was mayor, one of the ways in which you determine New York City's budget, tax revenue is Wall Street bonuses. Wall Street has $1 billion, $2 billion in bonuses, the city had a deficit. Wall Street has $15 billion to $20 billion, New York City had a $2 billion, $3 billion surplus, and it's because that money gets spent. That money goes directly into the economy. First of all, it gets taxed as income. Secondly, it gets taxed again when somebody buys something with it."

So let me see if I understand this. Someone earning $800,000 discovers that an expected $1,000,000 bonus is not forthcoming. Does this person stop eating meals? Does this person stop buying clothes? I doubt it. To this extent, Giuliani is overstating his case and trying too hard to defend bloated compensation. Does New York City's tax revenue go down? Yes, because it's not collecting an income tax on the unpaid $1,000,000. To that extent, Giuliani is correct, but he doesn't follow through with the analysis.

The employer has a choice between paying $1,000,000 as a bonus, paying it as 10 $100,000 salaries for 10 employees who otherwise would not have jobs, or retaining it and adding it to the employer's own income. Under which scenario is the bonus most likely to be spent? The 10 employees have no choice to spend their salaries in order to survive. The highly-compensated employee and the employer most likely would have stashed the $1,000,000 somewhere, principally in an effort to reduce taxes and to maximize capital. If Guiliani wants spending in restaurants and department stores to rebound, see to it that there are fewer unemployed people, even if that comes at the expense of reducing someone's salary from $1,800,000 to $800,000.

The "trickle down" theory that underlies the defense of excessively high compensation has been proven to be a failure. It doesn't work. Otherwise, in theory, the employer should pay $50,000,000 to one employee and fire the rest of the employees. No one has demonstrated that the highly compensated employee makes better or wiser spending choices or does a better job stashing away the excess income. As for the use of the phrase "excessively high" compensation, remember that the folks getting these bonuses are the folks who engineered the economic calamity that continues to erode away the lives, health, and dignity of far too many Americans.

Giuliani is correct that New York City tax revenues decline if the bonus is not paid. His statement suggests that the revenue loss equals the bonus multipled by the employee' marginal rate, presumably the highest applicable rate. But pushing the analysis further suggests that this is not the case. If the $1,000,000 is used to hire 10 employees who would otherwise be unemployed, there will be taxes paid by each of those employees, though not as much in the aggregate as would be paid by the bonus recipient. That revenue loss to the city would be offset by the removal from the city's list of expenditures the costs of extending to 10 unemployed individuals the benefits of the various programs put in place to assist the unemployed. The city is better off with one person earning $800,000 and 10 people earning $100,000 than it is with one person earning $1,800,000.

If the employer is in some manner compelled to refrain from paying the bonus, whether for public relations purposes or through this sort of legislative cap on compensation, and determines not to hire anyone, then the employer would have more income subject to taxation. There could be a slight revenue loss or gain for the city, depending on the relative marginal rates of the would-be bonus recipient and the employer, but the city would still need to fund the various safety net programs maintained for the unemployed, including the ten individuals not hired by the employer. The question remains, what is the employer going to do with the $1,000,000, net of taxes, not paid as a bonus? Perhaps it will spend it. Does that not solve Giuliani's concern about bonus non-payment causing reductions in spending at restaurants and other enterprises? Perhaps the employer will lend the money, directly or through making a worthwhile investment, that finances a new business or continued existence of a currently operating business, thus maintaining spending and other economic activity? Or perhaps the employer will shuttled the money overseas.

Giuliani is correct that when Wall Street compensation falls, it likely indicates budget problems for the city. But is that a consequence of less compensation to tax? No. Falling compensation on Wall Street means that Wall Street is generating less income, and that means it is quite likely that the entire economy has slowed. That means there is less economic activity throughout the city, and thus fewer salaries to tax and less spending to generate city revenue. Yet if Wall Street is stumbling and the economy is stalling, why are people getting bonuses? Are they being paid for having done a good job taking Wall Street to unprecedented heights of economic accomplishment?

There are two ways that Wall Street compensation can end up in the fiscal ranges that Giuliani cites as indicative of a healthy New York City budget. One is a few people being paid huge bonuses. Another is a significant increase in the number of people who are employed. The first generates slightly higher tax revenue but even higher social welfare and unemployment safety net costs. The second generates slightly lower tax revenue but even lower social welfare and unemployment safety net costs. The city, and its administrators and legislators, ought to favor the second alternative. And in that event, unlike Giuliani, they ought not be critcizing the critics of the bonus payments. They should be joining in the outrage that payment of those bonuses is a misdirected use of money. If the critics of how Wall Street, the investment bankers, and the other financial manipulators did business succeed in cleaning up the greed culture that sold itself with false promises of "trickle down," New York City will be no less a beneficiary than will be the rest of the nation and its citizens. And then perhaps the critics of the critics of the critics of the bonus payments will not have written in vain.

As the stimulus package works its way through Congress, the debate is shaping up as one that pits spending against tax cuts. Democrats claim the package will create jobs and get the economy rolling along. Their position is that spending is a better way of reaching those goals than are tax cuts. In contrast, the House Minority Leader, according to this report, claims that the proposal "has a lot of wasteful provisions and slow-moving spending in it" and that "we think that fast-acting tax relief is the way to get it done."

There are two issues in the debate, but it's unclear that Congress recognizes them as such. The one getting the attention is whether tax cuts or spending works more quickly to spur economic recovery. The other one is whether economic restoration is best accomplished by rushing or by taking a moment to think. Even in the emergency room, it is essential to think before acting. Acting quickly can be fatal if the action is the wrong choice.

The proposed legislation, having the nature of a compromise, is riddled with flaws. Not only are there specific provisions that are flawed, there also are flaws in the package as it has emerged. Mixing tax cuts with spending provisions might be a good hedge when Congress cannot agree on which approach is the best, but by dividing the resources, assuming money borrowed from abroad can be considered a resource, between two approaches might cause both approaches to fail because both end up being underfunded.

Should resources be devoted to extending the home purchase credit so that it's no longer in effect a loan but a grant? Over at Tax Almanac, Death&Taxes noted, in Mule Chasing Tail Department, that Congress is forging ahead "without anyone in either Congress or the real estate industry saying, 'guess what, that one we passed last year didn't work.' What's coming next? 40 Acres and a Mule?" Well, guess what? No one in Congress seems to have bothered holding hearings in order to find out what is working and what isn't working. Why there have been no hearings, or should I say, public hearings, is an interesting question, but I digress.

The same problem arises with the proposal to extend and broaden bonus depreciation and first-year expensing. As I pointed out in Just Because It Didn't Work the First 50 Times Doesn't Mean It Will Work Next Time, no one has demonstrated that increasing deductions for capital expenditures will create jobs or stimulate the economy. Let's think about it. Businesses without money cannot make the expenditures that generate the deduction, nor can they borrow the money, so the provision is useless for them. Should there be some incentive to compel the lending industry to lend money? Surely they are doing something with the hundreds of billions dished out under the TARP program. Even if businesses with available cash make more capital purchases than they otherwise would have made, how does this create jobs if the item being purchases was manufactured abroad? Oh, it creates jobs overseas. How does that help?

One of the comments I received in response to Just Because It Didn't Work the First 50 Times Doesn't Mean It Will Work Next Time caused me to wonder, Instead of More Favorable Depreciation Deductions, Eliminate Them? As I pointed out in Abolish Real Estate Depreciation Deduction? An Idea Gathers Attention, that idea has generated discussion, even beyond what I reported several days ago in that post.

Wayne Silverman responded to my idea of using a national real estate index to peg, in effect, real estate mark to market by noting that while he liked the idea, he was "afraid that it would get re-jiggered like CPI and be useless." He suggested using aggregate regional numbers similar to those kept by the NAR, and then working that over some useful life. I explained that no matter who does the appraisal, no matter its regional, local, or national nature, and no matter how it is done, the output is an estimated. It might be a good one, and it might not be. Even values based on selling prices are warped, in part because there often are other considerations not showing up (e.g., price includes furnishings, sale was to a friend or relative and thus at the lower end of the fmv range, etc.) and the numbers lag some weeks behind reality as reporting takes time. Perhaps months, if data collectors are waiting for deeds to be recorded. I also am not proposing dividing anything if there were such a system. It would be a comparison between the Jan 1 value and the Dec 31 value, and taxpayers could elect to do nothing, or, if they want to deduct declines in value, they must agree to be taxed on increases in value. Over the long haul, because prices tend to rise, I suspect most taxpayers would elect to do nothing, that is, give up depreciation because the gross income is too high a price for the occasional deduction. There would need to be a decision about transition. Should a value-changed system permit the grandfathering of existing owners, in turn creating a need for an antichurning provision? Should the system starting fresh with values as of a particular date? Should the system start fresh with adjusted basis as of that date? That approach would generate huge amounts of tax liabilities at the end of the system's first year. Wayne noted that the devil is in the details. Indeed. But the point is that someone needs to think about the provisions being rushed through. Bonus depreciation and first-year expensing ought not get express lane treatment just because they were tried. No one has demonstrated that they work. Would the changes I have tossed about work? I don't know. Why not leave depreciation alone, as it is, until its impact on the economy can be studied. If excess depreciation is a contributing factor to the current economic mess, the existing stimulus proposal pretty much is not unlike a medieval physician who prescribed "bleeding" as the cure for someone bleeding to death.

The tax cut advocates are so glued to a disproven technique that they cannot bring themselves to comprehend the reality. Years of tax cuts have made the economy worse, not better. How does a tax cut help someone without a job? I suppose the answer is that tax cuts mean employed individuals can spend more than they are now spending, which would generate business so that entrepreneurs and companies will hire. But there is a huge fallacy in that assumption. Wasn't there a rebate, oops, economic stimulus payment not very long ago? Big help that was. People won't spend the increase in take-home pay because they lack confidence. They will save the money, perhaps in banks and perhaps in a jar buried in the back yard. And the banks won't lend the money, because they're not lending the money that they have. For all we know, some of the tax cut money would be invested overseas.

What will work is spending that creates jobs. Is this sort of spending slow-moving? Not knowing what spending speed limits are, I can only suggest that money designated to pay people to do work will find its way into productive economic use more quickly than tax cuts put into banks by employed individuals lacking confidence in the economy. If the people who are paid to do work are currently unemployed, they will be compelled to spend the money flowing into their hands, because they need to eat, they need a place to sleep, they need food, etc. There are millions of people who are unemployed, and getting money into their hands is much more important than getting money into the hands of people with jobs. It's called triage. Of course, there may be a mismatch between the jobs for which the government would be providing funding and the skills of the unemployed. Our nation needs people who can repair and build infrastructure like roads, bridges, and electrical grids. We need construction workers to renovate dilapidated schools. We need health care workers, including physicians, nurses, and hospice attendants. Unfortunately, we don't need some of the skills held by some of the folks who have lost their jobs. The adjustment from one career to another is painful, and no matter how the government provides economic stimulus, whether tax cut or spending, the transition of the economy from one misbalanced in favor of services back to one that has the nation building itself and manufacturing things that people abroad are willing to purchase will be painful. Surely getting people abroad sending their money for items manufactured and services rendered in this country, rather than as loans that need to be repaid, will help in restoring some sense of economic stability.

The problem with tax cuts is that they are financed by debt burdening our descendants but they end up either stagnating in a bank or funding consumption of resources. In contrast, spending money on schools, bridges, electrical grids, renewable energy facilities, and the like, at least transfers to our descendants not only the debt, but some assets that counter-balance the debt. It's the difference between borrowing from an adult child to build an addition to the family home and borrowing from an adult child to finance an early retirement filled with golf. No, I didn't make that up. You can read that in this Ask Amy column.

Unfortunately, the stimulus proposal is zooming along some sort of legislative process that omits hearing and dutiful deliberation. Like the bandwagon of a team warming up as the season comes to an end, all sorts of people waiting in the wings with their pet proposals jumped aboard without anyone checking for their sincerity, loyalty, knowledge, or utility. Ironically, some of the provisions were inserted to get votes that aren't going to be forthcoming. Sometimes a child who asks for 10 chocolate chip cookies and who is wisely given two will be happy, but sometimes children get angry and throw back the two cookies because they fail to remember that the last time they were given the 10 cookies they ended up with an upset stomach. That is what some people, including myself, might experience as this legislative mish-mash follows the TARP Express down the track to what very well could be a collapsed railroad bridge. Here's hoping that the sensible spending provisions are sufficiently funded, and aren't negated by the tax cut nonsense in the legislation.

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.

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* 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.