MauledAgain

On Sunday, the Philadelphia Inquirer printed an editorial that advocated enactment of a federal value-added tax as a source of revenue to fund health care reform. The authors argue that because slowing the growth of health care costs will take time, the only way to cover the cost of extending coverage is to enact a tax to pay for the shortfall. Though the concerns that triggered the article make sense, the proposed solution is not the repair that the federal revenue system requires.

The authors contend, “There is no way to restore this nation to fiscal health without higher taxes.” They’re correct. The sorts of budget deficits that have been racked up during the past 18 months by the federal government threaten the survival of the nation. That’s not hyperbole and I’m not alone in that assertion. But the authors then argue that the higher taxes must be enacted “for the middle class as well as for the rich.” Why? What created this mess are the tax cuts for the rich. Those who argued for, and got, those tax cuts claimed that by reducing their tax burden they would repay the nation two-fold or three-fold or whatever-fold because of some theory called “trickle down.” There’s been trickle down on the unwealthy but it hasn’t been economic betterment. It’s time for the beneficiaries of unwarranted and unwise tax cuts to pay the piper. Bringing the middle class into the mix simply opens the door for the lobbyists employed by the wealthy to make certain that the middle class gets the short end of the stick.

The authors correctly note that health care reform will cost money, that cutting health care costs or even the rate of increase in those costs will happen, if it happens at all, over a long period of time, and that Medicare faces more financial stress as the number of retirees increases. Each of these challenges deserves separate attention. Some sort of revenue injection into the health care system, whether increased premiums or publicly-financed cost defrayals, is required. Cutting health care costs and trimming the rate of increase of those costs isn’t a tax issue. The Medicare issue requires changes in the definition of benefits, including raising the age at which individuals are eligible for Medicare coverage, and cleaning out the waste, corruption, fraud, and inefficiencies in the system.

The authors also make a profound statement when they tell us, “The dirty secret is that the revenue generated under current tax laws cannot pay for the government services – health care and everything else – that Americans want for their children, their parents ,and themselves.” Bingo. Haven’t I been arguing that point since the day this nation went to war with leaders who claimed that there was no need to raise taxes to pay for the war? Is it not fiscal insanity, and decision-making that puts the national existence in jeopardy, to put the preservation of tax cuts for the nation’s elite above the well-being of its citizens? Someday the nation will figure out that the biggest economic cost of the current war is not the lost equipment, the corporate profiteering by the elite and their friends, and not the economic disadvantages of international disapproval, but the collapse of the American economy. There’s still time to reverse this outcome, but it requires rapid and courageous decision making. What are the odds of that happening, considering what we see transpire in the nation’s capital day after day?

The authors, though, take a wrong turn when they argue that tax increases should be enacted now but phased in slowly. There’s no time to wait. The longer the nation waits to deal with the deficit, the more quickly the nation will spiral into the black hole of no return. It’s bad enough the unwarranted tax cuts of almost a decade ago were enacted, it’s worse that they weren’t rescinded when war broke out, and it’s outrageous to postpone the day of reckoning on the theory that requiring the financial elite to give back what they should not have had in the first place will cause economic disaster. The current economic disaster arose in part because the promised benefits of cutting the taxes on wealthy citizens never materialized, and it’s foolish to permit the same sort of flawed thinking to carry the day when it comes to unraveling the mess to which that flawed thinking has already contributed.

The authors, after taking that wrong turn, then take their good idea of fixing the tax mess and drive it off the cliff. They argue that “Congress should enact a value-added tax.” In describing for their readers what it is, namely, “the equivalent of a broad-based sales tax on all goods and services,” though that’s not quite what it is, they fly right by all of the defects and flaws inherent in sales-based taxes. Sales taxes are easy targets for lobbyists. Consider the example discussed in Another Step Toward Elimination of All Taxes, which involves a sales tax exemption for helicopters. Or consider the questions raised in Tax as a Measure of Values, the latest in a series of posts criticizing the Pennsylvania legislature for subjecting cigarettes and cigarillos but not cigars or smokeless tobacco to the state sales tax, and for carving out sales tax exemptions for tickets to sporting events while imposing the sales tax on tickets to cultural events. Do the authors of the editorial believe for one moment that the Congress would enact a VAT that has no exemptions, or that if did enact such a statute that it would remain untouched by lobbyists as time moved ahead?

The VAT proposal suffers from an even more serious flaw. It would shift the tax burden to lower and middle income individuals in terms of the percentage of income turned over to the government under the VAT. The VAT, in other words, is a regressive tax. A family of four earning $50,000 and spending $40,000 (after paying other taxes of $10,000) would pay $4,000 under a 10% VAT. That’s 12.5% of income. In the meantime, a family of four earning $100,000, after paying $25,000 in other taxes and setting aside $10,000 in savings, would spend $65,000, thus incurring VAT liability of $6,500. That’s 6.5% of income. When states enact sales taxes and encounter this regressivity phenomenon, they enact exemptions for food, clothing, and shelter, or other so-called “necessities.” Thus, assuming that both families are spending $30,000 on food, clothing, and shelter, the $50,000 family would pay a VAT of $1,000 (10% of ($40,000 - $30,000)), and the $100,000 family would pay a VAT of $3,500 (10% of ($65,000 - $30,000)). That’s an 2% of income for the $50,000 family and 3.5% of income for the $100,000 family. The fun begins, though, when it’s time to define food, clothing, and shelter. Are designer jeans “necessities” within the clothing exemption? Are cigars “necessities”? What about helicopters? Others have written extensively on the disadvantages of sales taxes, and there’s no need to repeat them here.

Once upon a time, it would be amazing to see how defenders of tax breaks for the elite and special low tax rates for the types of income constituting much of the elite’s overall wealth increases rush to offer a substitute for the repeal of that special treatment. Now, it’s no longer amazing. It’s par for the course. It’s disappointing. It’s deeply troubling. In terms of what it means for this country’s future, it’s dangerous. How much longer will the failed promises of the past continue to find takers among those charged with the stewardship of the country?

From time to time, more often than not, I point out the need for American citizens to become educated about the federal income tax system. My justification for that proposal is the combination of a fact and a premise. The fact is that very few Americans understand the federal income tax system. The premise is that only by understanding the tax system can Americans not only pay no more and no less than what they legally owe in taxes but also comprehend the sorry state of national politics and economics that threaten the well-being of the nation and its citizens. To a slightly lesser extent, I can make the same arguments with respect to state and local income taxes, and even taxes other than income taxes. For the moment, the federal income tax system is more than enough, and it’s the biggest of the bunch.

Though I could invest some words in defending the premise for my advocacy of more tax education for Americans, I want to focus on what I consider to be the fact that underlies my proposal. It is frightening how ill-informed Americans are about federal income taxation. Granted, there’s just as much misinformation floating about with respect to other areas of life, particularly the sciences. What makes it all appalling is that Americans possess the capacity to be well-informed, but many have chosen to devote their thinking, knowledge acquisition, comprehension processing, and memory brain cells to matter of far less import than national economics and fiscal sustainability.

Only a few days ago, in First Check the Tax Facts, I commented on one example of incorrect tax information acquiring a life of its own and replicating itself throughout the nation thanks to the pervasiveness of the internet. Now it’s time for another one.

In Will Obama pay taxes on his Nobel?, Pat Regnier explores the tax consequences of Obama’s announced plans to donate the money he will receive as a Nobel Prize recipient. The article contrasts assertions made by several bloggers, one of who doesn’t quite get it and another of whom directs readers to IRS tax instructions. It would help, of course, if the analysis took itself to the source, namely, Internal Revenue Code and Treasury Regulations provisions. Those are far, far more authoritative than are IRS tax instructions. No matter, provided the instructions are correct, as they are in this instance, the article’s readers are getting a good education.

What troubles me are some of the comments posted in response to the article. They can be found at the same location as is the article.

The first comment is that “The money from Nobel prizes is ‘TAX FREE’.” That’s not quite right. The money from Nobel Prizes is excluded from gross income if certain conditions are satisfied, principally, that it be transferred directly to a qualifying charity or government. A person who receives a Nobel Prize and keeps the money must include it in gross income.

Another comment alleges that “This is still unclear.” Hardly. Section 74(c) is quite clear, and the Regulations and IRS instructions tell taxpayers exactly what they need to do to avoid including the Nobel Prize money in gross income. The same comment then proposes that “Such prizes should not be taxable.” There’s no absolute right or wrong in the tax policy argument that this portion of the comment raises, though once an exception is made for one type of prize, then recipients of other prizes will also seek special treatment. The arguments in favor of including prize amounts in gross income unless they are transferred directly to a qualifying charity or government outweigh the argument that somehow Nobel Prize winners are more deserving of special tax treatment than are recipients of other awards. The weakness of the argument shows up in the comment that followed, “This shouldn't be taxable. Recipient of this prize are persons who has worked hard and should be able to have a tax break.” If this logic were applied uniformly, anyone who has income from working hard would not be taxed. Aside from trying to identify those who work hard and those who don’t work hard, advocates of such a taxation policy would need to figure out how to deal with the consequences of eliminating most federal income tax revenues.

Yet another comment disagreed with the conclusion in the article, suggesting, “So don't say that the IRS doesn't come after people for money even though they give it away and don't even keep it.” Unfortunately, section 74(c) provides that the IRS cannot “come after” someone who satisfies the conditions of that statutory provision, which has absolutely nothing to do with the Joe Louis story that highlights the beginning of the comment. Still another comment claims that the “award was given to [Obama] for what he will ‘accomplish’ in the future . . . ” and that, accordingly, “[t]he award does not meet this criteria [the statutory requirements” and “fails the second statement.” The “second statement” to which the comment refers is one of the statutory requirements repeated in the IRS instructions included in the article: “You are not required to perform substantial future services as a condition for receiving the prize or award.” Nowhere in the Nobel Prize award is a requirement that any recipient perform future services, let alone substantial future services.

Fortunately, several of the comments are nicely articulated expressions of current tax law. Which ones? The ones that I didn’t critique and that addressed tax, rather than other, issues. I particularly liked the comment that addressed two previous comments by explaining, “But Damien (and Travis) the whole point is that there IS a provision in tax code that allows Obama, or anyone else receiving a similar kind of prize, to not include it in income provided he gives it away in the proper manner.” The person writing this comment understands this part of the tax law. I didn’t say no one understood the tax law. But too few do.

The nation is becoming, if it hasn’t already become, a country inhabited by individuals who understand so little about the federal income tax system that they don’t know if they are paying what they should be paying, more than they should be paying, or less than they should be paying. They rely on the accuracy and competence of tax return preparers and tax preparation software. As we know, <begin sarcasm> all tax return preparers are honest and totally competent and computer software is flawless</end sarcasm>. With the resurgence of the “Ready Return” proposal, which I criticized in Oh, No! This Tax Idea Isn't Ready for Its Coffin, and the previous posts cited therein, huge numbers of taxpayers are at risk of having the government prepare their tax returns, with an option for those taxpayers to examine what the government generates, identify any errors, and make corrective adjustments. And, as we know, <resume sarcasm> the government doesn’t make mistakes </end sarcasm>. Part of the problem is that even some employees of revenue agencies, including the IRS, don’t understand tax law or understand it insufficiently to get it right enough of the time.

Most people who don’t understand the federal income tax system are in that quandary because they haven’t had the opportunity to learn about it. In some respects, it’s not their fault. Thanks to the Congress, which ultimately is responsible for the incomprehensibility of the federal tax law, and state legislatures, which have increasingly muddled state tax law, people are reluctant to study tax law, and educators are afraid to make it part of a general curriculum for K-12 students or for college students generally. Although most of us can get by in life without understanding quantum physics or the technical analyses of the first law of thermodynamics, tax law affects everyone, from cradle to grave. Understanding the basic principles should be a requirement of participation in the civic debate and the selection of those who enact and amend tax law. There’s a deep need to end too many years of the ignorant electing the ignorant.

Lobbyists are quite skilled at persuading legislators to fork over the citizens’ money for the pet projects of the lobbyists’ clients. A good example of this ploy is the Pennsylvania tax credit for film making, which survived an attempt by some legislators to repeal it during the recent Pennsylvania budget negotiations. According to this very informative Philadelphia Inquirer article, the credit survived, though it will be reduced for several years before returning to its present level.

The credit is designed to persuade movie production companies to make films in the state. The credit equals 25% of a company’s qualified film production expenses, subject to several limitations as described in the legislation. According to its backers, the credit has generated $300 million of spending in Pennsylvania by film production companies and has created 4,000 jobs. The 45% cut-back in the amount of the credit provided by the current budget is expected, according to the credit’s advocates, to cost “45 percent fewer jobs.”

There are three problems with the tax credit. One involves a factual assumption, one involves the appropriate role of tax credits, and one involves horizontal equity among business ventures.

The first problem with the credit is that its backers assume that without the credit, the film companies that film in Pennsylvania would not do so. Trying to prove that point, one way or the other, is very much a matter of proving a negative. If a movie’s story line involves Pennsylvania, it usually is cheaper to film in the state than it is to have the production crew manufacture a replica somewhere else. The threat from lobbyists that doom and gloom await the citizens of those states whose legislatures that don’t give the lobbyists’ clients the tax breaks they seek proves too much. Should we believe that all jobs will disappear if there are no special tax credits enacted for the various interest groups that come knocking at the legislative door? If the backers of the credit are correct in their theories, perhaps a credit for 1,000 percent of production costs would bring every film making company in the world to Pennsylvania, creating 500,000 jobs, but also the need for more highways, more schools, more hospitals, more police, more fire fighting equipment and personnel, more airports, and a wide array of other demands on government services. Oh, and I’m sure the state’s citizens will be pleased with even more street closures, traffic jams, entrance refusals at sites being used by film companies, and the other inconveniences suffered by all for the benefit of a self-selected special few.

The second problem with the credit is what its enactment says about the state’s ability to attract movie makers, or, for that matter, any business, based on the merits of the state’s natural and human resources. Pennsylvania offers scenic views, dynamic cities, vibrant small towns, sports venues, cultural attractions, historic sites, a full range of weather and temperature, and just about everything else that a movie maker might need. Yet Pennsylvania acts as though no film production company will show up without being bribed. And bribe is the next word. The situation isn’t unlike that of a guy who decides that the only way to persuade a woman to go out on a date with him is to send some money her way. There’s an amazing lack of self-confidence involved, and the lobbyists play on it. What are film companies going to do? Take their operations to a state that has a double-digit income tax, thus causing its employees to ask for higher wages to cover the increased tax burden, and thus making the production more expensive? Head to a low-tax state where the quality of infrastructure and the overall education levels and skills of the residents reflect the consequences of minimal tax policies? True, if a movie company needs scenes of the Rockies, Pennsylvania won’t be able to oblige, but neither will Florida, Iowa, or most other states. You are what you are.

The third problem with the credit is the most serious one. Even assuming that the credit generates jobs that would not otherwise exist, and even assuming that the credit makes up for whatever Pennsylvania deficiencies would otherwise deter film companies from showing up, why is the credit limited to one industry? Cannot one say the same about almost every other business? If Pennsylvania were to offer a credit for 25% of manufacturing expenses to an automobile company, or a credit for 25% of research, design, and salary expenses to a software development company, or a credit for 25% of production expenses to a music recording company, would not those companies also relocate to Pennsylvania and generate thousands and tens of thousands of jobs? If the backers of the credit are correct in their arguments, the industries for which there is no credit already would have left the state. Somehow, other industries prosper without a credit. Why can’t the film industry do likewise? The answer is that it’s a road of less resistance to ask for money from the pockets of Pennsylvanians, a road whose resistance is quite low because too many legislators cave in to the promises and campaign contributions of the industry’s lobbyists.

The movie companies are telling Pennsylvania, “You’re not good enough for us unless you line our pockets with taxpayer money.” Even if they were admitted when they knocked on the legislative door, these companies, after saying that, should be shown the door, just as anyone who says that under other circumstances should be escorted out. Hopefully, this tax credit, and others like it, will be escorted out of the Pennsylvania tax laws.

One of the basic principles I try to push into the brains of my tax students is that speculation about laws and outcomes wastes energy unless the facts are known, and unless the rules are understood. One of my former students, now a successful tax practitioner and an adjunct teaching tax at another institution, got the message. I had already known this when yet another bit of proof came along. His mother received an email, which I will share momentarily, and sent it to her son, the former student, for his reaction. His mother earns points for checking things out rather than jumping to conclusions. My former student directed his mother to my posting, State Tax Consequences of Cash-for-Clunkers. What a great way to find new readers! In that post, before digging into the state tax consequences, I noted that the IRS had directed taxpayers’ collective attention to the statute enacting cash-for-clunkers, which made it abundantly clear that there is no federal income tax liability on the rebate.

That doesn’t stop the ignorant from generating erroneous allegations and circulating them by email. Nor does it stop the folks who figure that because it’s in an email, it must be true. Isn’t it obvious why I congratulate my former student’s mother on having the good sense, better yet, the common sense, to determine the tax facts before passing along what clearly is an erroneous email designed either out of ignorance or out of spite and hate?

Here’s the email in question:

"DEMOCRATIC MATH "

Here’s what my friend Peggy in Texas had to say about “Democratic Math”:

It’s worse than that... Ignore all the gas crap, and just look at how the stupid car buyer got taken to the cleaners:

If you traded in a clunker worth $3,500, you get $4,500 off for an apparent "savings" of $1,000.

However, you have to pay taxes on the $4,500 come April 15 (something that no auto dealer will tell you). If you are in the 30% tax bracket, you will pay $1,350 on that $4,500.

So, rather than save $1,000, you actually pay an extra $350 to the feds. In addition, you traded in a car that was most likely paid for. Now you have 4 or 5 years of payments on a car that you did not need, that was costing you less to run than the payments that you will now be making.

But wait, it gets even better: you also got ripped off by the dealer. For example, every dealer here in LA was selling the Ford Focus with all the goodies including A/C, auto transmission, power windows, etc for $12,500 the month before the "cash for clunkers" program started. When "cash for clunkers" came along, they stopped discounting them and instead sold them at the list price of $15,500. So, you paid $3,000 more than you would have the month before. (Honda, Toyota, and Kia played the same list price game that Ford and Chevy did).

So lets do the final tally here:

You traded in a car worth: $3,500

You got a discount of:          $4,500

                                                --------

Net so far                             +$1,000

But you have to pay:        $1,350 in taxes on the $4,500
                                                --------

Net so far:                               -$ 350

And you paid: $3000 more than the car was selling for the month before

                                                 ----------

Net:                                       -$3,350

We could also add in the additional taxes (sales tax, state tax, etc.) on the extra $3,000 that you paid for the car, along with the 5 years of interest on the car loan but lets just stop here...

So who actually made out on the deal? The feds collected taxes on the car along with taxes on the $4,500 they "gave" you. The car dealers made an extra $3,000 or more on every car they sold along with the kickbacks from the manufacturers and the loan companies. The manufacturers got to dump lots of cars they could not give away the month before. And the poor stupid consumer got saddled with even more debt that they cannot afford.

Obama and his band of merry men convinced Joe consumer that he was getting $4,500 in "free" money from the "government" when in fact Joe was giving away his $3,500 car and paying an additional $3,350 for the privilege.

(emphasis added by me).

Throughout the email, the writer claims that the rebate is subject to federal income taxes. That’s flat out wrong. I doubt that “Peggy in Texas” is the author of the email, and I am convinced that the person who wrote this email has remained anonymous because he or she is unwilling to stand up to the challenges brought by people who are in better touch with reality. I invite the author of this email to defend the allegations made in the email. Do I expect the author to accept this invitation? No, the author has already demonstrated an astounding lack of courage to go along with an astounding lack of knowledge, understanding, and diligence.

The writer of the email also asserts that there are state sales taxes and other state taxes, including, presumably, state income taxes, on the rebate. But as I pointed out in State Tax Consequences of Cash-for-Clunkers, most states do not subject the rebate to income taxes, and only a handful of states subject it to sales taxes. Once again, it’s so much easier to fire off unsupported allegations than it is to take time and do some research.

Did auto dealers increase the price of new vehicles so that the rebate simply replaced the discount that the dealer otherwise would have offered? There are surveys indicating that this happened in some instances, and information indicating that in other instances it did not happen. If the rebate moved the car off of the lot, dealers would be better off even if the existing mark-down was left in place. Some dealers may have been more interested in reducing inventory, thus leaving the dealer discounts in place. Others may have seen a chance to grab a windfall by eliminating all, or a substantial portion, of the dealer discount. That’s the free market, yes? Savvy consumers would be expected to shop around, identify the dealers with the best price, and shift business away from the windfall-seeking dealers. Did that happen? No one yet knows with any certainty. Nonetheless, had the government included safeguards to prevent dealers from generating windfalls by eliminating the dealer discount, the same minds that generated the email would have been screaming about the horrors of government regulation of marketplaces, defending the right of automobile dealers to operate in a free market, that is, a market free of government oversight. Yet the same folks who write these sorts of emails (as this is not the only one in circulation), as well as those who agree with those writers, are complaining, in the very same email, about the behavior of unregulated “free” market automobile dealers. I wish these people would make up their minds.

Whether trading in a clunker made sense for a particular individual depended on a variety of factors, but federal income taxation of the rebate was not such a factor, nor, in most instances, were state taxes. Whether sending emails filled with indefensible allegations makes sense can be answered without examining factors. It’s detrimental behavior. When receiving emails that make claims about taxes, do some research or, as my former student’s mother did, check with someone whom you trust and whom you know is educated, knowledgeable, and reliable. In this manner, the garbage emails can be stopped in their tracks.

There is light at the end of the dreary, depressing, and disappointing tunnel of Philadelphia real property tax assessment and administration practices. The inefficiency and corruption of the current system has reached the point where city political leaders cannot continue the decades-long pattern of speaking platitudes and doing nothing. Though I would like to think that my repeated criticism of the existing arrangement had something to do with what has happened, it’s more likely that the attention drawn to the matter by a series of articles in the Philadelphia Inquirer is what triggered what has happened. Before digging into the current new, permit me to share links to my previous discussions of the topic so that those who are not up to speed on the story can get the background in place before continuing with what must be the umpteenth chapter in the story.

Several years ago, I dedicated at least five posts, some lengthy, to the systemic problems of the Philadelphia real property tax, or, more specifically, the systemic problems in the operation of the Bureau of Revision of Taxes (BRT), the bureaucracy charged with administering the tax. In An Unconstitutional Tax Assessment System, Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, and How to Fix a Broken Tax System: Speed It Up? , I explained how the pervasive flaw in the administration of the tax was the irregularity, inconsistency, inequity, and inefficiency of the valuation process that generates the amount on which the real property tax is computed. In Not the Sort of Tax Loss Taxpayers Prefer, I explored the particular problems surrounding the Board’s low assessment on property owned by a Philadelphia-based state legislator now serving prison time and the disclosure by the Board that it had lost files associated with the property and its special valuation. In May of this year, in a pair of postings, Inching Closer to a Sensible Philadelphia Real Property Tax Assessment Process, and its follow-up Taxes, Sausage and Politics, I commented on steps that the BRT announced that it was taking to deal with the discrepancies between property values and assessments. Last month, in When Taxes Are Unfair, I addressed the frustrating news that despite announcements trumpeting changes in the system, the BRT had managed to generate thoroughly bewildering and totally inconsistent assessments on thousands of properties.

Late last week, as described in BRT Will Yield Assessment Tasks, the mayor announced that the BRT had agreed to let the city’s finance director take responsibility for the BRT’s operations and to supervise changes in how properties are assessed. Unfortunately, although the work is being shifted to another city office, the members of the BRT board will keep both their part-time positions and the $70,000 salaries that go along with them. That’s no surprise, considering that when asked by the mayor in May to resign, the board refused. The BRT also will handle appeals from property owners unhappy with their assessments. None of that makes any sense. If the work is being shifted to another office, then the money being used to pay salaries to board members with even less to do should be shifted to that other office, so that it can hire people to do what needs to be done. Otherwise, employees already burdened with workloads increased because of layovers triggered by budget woes will have even more work to do. Worse, if the BRT is incapable of getting assessments correct in the first place, why should it be the agency that reviews the assessments generated by the finance office? That’s like letting a person who flunks a pilot’s license test fly the rescue helicopter. As bad as all of that is, the outrageous aspect of the work shift is that the 80 people who hold jobs at the BRT because they have done favors for the two major political parties in the city will keep those patronage plums. Understandably, the mayor described the assessment responsibility shift as a first step, and perhaps, in all fairness, it will take several steps to clean out the Augean Stables of Philadelphia. The incentive for the takeover by the finance office was last month’s resignation of the BRT’s executive director.

A day after the assessment responsibility shift was announced, Bill Green, a member of City Council, introduced legislation to revise the Board of Revision of Taxes. Technically, as reported in Phila. Council Begins to Reinvent the Defunct BRT, the BRT would be dismantled after assessments for 2010 are finished. It’s safe to say that the legislation, perhaps with amendments, will be enacted, because 15 of the 17 members of City Council co-sponsored the bill. The proposal would create a new Office of Property Assessment that reported to the mayor, and a Board of Property Assessment Appeals. The current version of the bill does not specify what happens to those 80 patronage employees. Nor are the specifics of how members of a new appeals board would be selected or how it would be organized, though under the current version, the Board of Judges would no longer appoint those who hear assessment appeals.

Though I generally dislike sound bite education, Councilman Green managed to utter one that quite nicely summarizes what is about to transpire. “There are instances where reform can be accomplished through minor repairs, and then there are times where it is better to just raze the structure and start fresh. With this bill, Council has fired up its bulldozer." That’s along the lines of Bill Archer’s "pulling the tax code out by its roots" comment. Green’s bulldozing legislation has a much better chance of wiping the slate clean than did Archer’s attempt to clean out the Internal Revenue Code. Many critics of federal income tax reform worry that what would replace the current system would be worse. In the case of Philadelphia’s BRT, there’s no chance that the new arrangement would be worse. Nothing could be worse.

Recently, news reports have circulated data concerning the number of individuals who pay no federal income tax. For example, this CNN report summarizes and comments on the data. What grabs people’s attention, if assorted in-person, blog, and Facebook comments are any indication, is the fact that 47% of households have no federal income tax liability in 2009. Of the 71 million households in this category, more than 63 million are classified as having less than $50,000 of cash income. Though some use the data to support a claim that “half” the nation’s population isn’t contributing to the cost of government, others, including myself, ask how it is that in a nation of multi-millionaires and billionaires there are so many households trying to get by on incomes of, for example, $10,000, $20,000, or $40,000. These are households, so there may be two, three, four, or more people trying to live on rather low incomes.

It is important to note that very few, if any, of the people living in households with no federal income tax liability escape taxation or fail to contribute to the cost of government. These people, if they are employed, are subject to the social security tax. If self-employed, it’s the self-employment tax. If they purchase an item subject to federal excise tax, it’s an excise tax. They pay all sorts of state and local taxes, including sale taxes, real property taxes, and occupation-type taxes. Many pay state and local income taxes. The federal income tax is designed not only to defray the cost of federal government, but also to redistribute income because the market place is inefficient and causes income disparities wholly disproportionate to the value of what the income earner contributes to society.

A more important question is how do we end up with 5.7 million households with incomes between $50,000 and $100,000 of income paying no federal income tax? In some instances it might be the consequences of huge disaster loss deductions or some other outlier, such as the impact of dependency exemptions for a family with a houseful of adopted and foster children, but in some instances surely it is a tax law that provides a select few with special tax breaks. If that’s not disturbing, what of the more than 700,000 households in the $100,000 to $500,000 income range that pay no federal income taxes? If all of those can be explained away as reasonable outcomes, what of the 17,000 households in the $500,000 through $1 million income bracket that have figured out how to have no federal income tax liability? At the top level, there are 6,000 households with income over $1,000,000 that pay no federal income tax. That’s a lot of dependency exemptions, but we know that’s not what’s going on.

An important observation is found in the more detailed information on this issue provided by Roberton Williams in Who Pays No Income Tax? (Tax Notes, June 29, 2009). More than 16% of households with income between $10,000 and $20,000 pay federal income taxes. Ought that be the effect of the federal income tax law? Almost 40% of households with income between $20,000 and $30,000 pay federal income taxes. So the perception that is seen in some of the reactions to the publication of the CNN report, and others like it, reflects overstated and misleading generalizations. To conclude that “low-income people don’t pay federal income taxes” says too much and too little. Somehow we have a nation in which some low-income individuals pay federal income tax while some high-income individuals do not. That is a flaw in the federal tax system. It needs to be fixed. If this isn’t sufficiently convincing, read on.

An even more important question is what percentages of income do the low-income households and the high-income households shell out in total taxes? This question is important for two reasons. The obvious one is that when all taxes are considered, the tax burden on lower income households is more than what the “47% don’t pay” table in the CNN report suggests. The not-so-obvious reason is that the focus on households paying zero tax ignores those households, particularly those in the upper income brackets, who pay a few dollars or even a few hundred or thousand dollars of federal income taxes. How many high-income households escape the “paid no federal income tax” stigma but end up paying taxes equal to a very small fraction of income?

Though it is tempting, and easy, to criticize the high-income taxpayers who pay no federal income tax, if they are not committing fraud, they ought not be the focus of the criticism. The focus should be on the handful of taxpayers who, with their lobbyists, have engineered the special low rates for the types of income prevalent among high-income taxpayers, though the others who go along for the ride aren’t totally free of complicity. The focus also should be on a Congress that just doesn’t get it, that just doesn’t understand what Americans generally consider acceptable in terms of tax policy. The middle-income taxpayers, who generally bear the highest marginal rates (because of phase-outs and other gimmicks in the tax law) aren’t so much annoyed by the tax breaks and low rates available to low-income taxpayers who are trying to scrape by in life, as they are by the huge handouts bestowed on high-income taxpayers who promised economic nirvana but delivered an economic agony that afflicts the lower and middle income classes far more than it does those upper income brackets.

Until Congress repeals special low rates for capital gains and dividends, repeals the phase-outs, increases the standard deduction and personal exemption amount, restores progressivity to the tax rates, eliminates the special breaks such as depreciation for appreciating property and deductions for depletion that exceed investment, and imposes rigorous information reporting, these inequities will persist. The first step in trying to create popular support for genuine tax reform is education with respect to what the current system does. That’s the primary reason I wrote this commentary. Share it.

A few days ago, a Philadelphia Inquirer article explained that one of the provisions in the Pennsylvania budget deal that is getting a rough reception among legislators and citizens is an exemption from the state sales tax for helicopters. Although, as described in Tax as a Measure of Values, legislators have argued over the appropriateness of taxing cigars, tickets to cultural events, and natural gas drilling, they all seem to be on board (sorry) this tax break for helicopters. How does this come to pass?

It seems that many legislators, and the governor, think that by exempting helicopters from the state sales tax, they will provided the decisive factor in Sikorsky Aircraft Corporation’s anticipated expansion of its Pennsylvania-based manufacturing, bringing 300 new jobs to the state. In terms of tax effects, the arithmetic is as follows. Helicopter sales in Pennsylvania during 2008 generated less than $100,000 in sales-tax receipts. The 300 new jobs are estimated to generate $500,000 in additional income tax revenues. Where does this number come from? A spokesperson for the Senate Majority Leader described the 300 jobs as having an average salary of $60,000. Keeping the numbers simple, the Pennsylvania income tax on $60,000 of salary is $1,800. If one multiplies $1,800 by 300, one gets $540,000. What’s missing from the equation, though, is a reduction to reflect the additional expenses that state and local governments face when a manufacturing facility is built or expanded and 300 workers begin using public infrastructure to get to, and to carry out, their jobs. These jobs most likely would go to existing residents who need jobs, and thus would not trigger the economic benefits that arise when 300 workers arrive from some other place and require construction of 300 new homes and related facilities. Also missing from the equation are the millions of dollars in sales taxes that would be collected if Sikorsky was persuaded to increase its activities in Pennsylvania without getting a sales tax exemption. Perhaps offering Sikorsky a genuine reform of the business tax structure in Pennsylvania would do the trick, especially because it is long overdue.

But there’s a problem. Sikorsky isn’t the only helicopter manufacturer in Pennsylvania. If it gets an exemption, ought not similar treatment be given to Boeing? And what of manufacturers who crank out (sorry) small planes? Last year they tried for a sales tax exemption, but failed. Is there some sort of essential difference between small airplanes and helicopters that justify treating them differently for sales tax purposes? As noted in Sales Taxes as Logically Illogical, legislators who can justify taxing Twix candy bars differently from Hershey Bars surely can find ways to distinguish helicopters from small airplanes for sales tax purposes. As for treating Sikorsky differently from Boeing, this sort of thing goes on constantly. If Boeing makes the right moves, and says the right things, it, too, will get to fly along with the sales tax break.

Sikorsky makes it clear that if the sales tax exemption does not pass, it very well may end up moving its operations to some other state, or at least place the expansion elsewhere. The legislature is, in effect, being held hostage. The existence of a helicopter manufacturing facility is not essential to Pennsylvania residents the way, for example, grocery stores are. No matter what is done with sales taxes, someone will continue to operate grocery stores in Pennsylvania because people need food. Ultimately, by exempting the non-essential goods and services out of fear that their providers will locate elsewhere, and taxing essential items because they’re the only things left to be taxed and there’s a guaranteed market, the sales tax is evolving toward its policy antithesis, namely taxation of essential items and exemption of non-essential goods and services rather than taxation of non-essential items and exemption of essential goods and services. It’s much easier, isn’t it, to threaten the removal of manufacturing jobs than it is to threaten a boycott on food purchases? Not many Pennsylvania residents are prepared to go on hunger strikes to make a tax point.

The argument that by eliminating sales taxes on helicopters, more jobs will be created and, in turn, generate much larger income tax revenues runs into a problem when taken to its logical end. Why not eliminate sales taxes on everything? Surely, if sales taxes on automobiles were eliminated, cars that would otherwise not get sold would be sold, generating more jobs at dealerships both in the sales and repair departments. Repealing sales taxes on auto parts and auto manufacturing services should bring auto manufacturers into the state, generating more jobs and more income tax revenue. Would not repeal of sales taxes on cigarettes cause people to purchase more cigarettes, thus tempting tobacco companies to locate facilities in the state, and thus increasing income tax revenues? In theory, and that’s all the Sikorsky proposal is, a theory, every sales tax exemption would bring income tax revenues. Once the sales tax exemptions subsume the general rule, the next step is the income tax. Surely, reducing income tax rates would cause economic growth that would trickle down to all economic segments of society, such that over time bringing the rate down to zero guarantees economic nirvana. Do you detect some sarcasm here? That theory has been tried. It failed. So, too, has the gimmick of offering developers, manufacturers, and other entrepreneurs tax breaks ranging from real property taxes to income and sales taxes, on the “guarantee” that doing so will be good for the surrounding community. In almost every instance, the burden on the community of increased traffic, growing demand for government services by the business in question, failure of the business to follow through on its promises of jobs and other returns to the community, has left the locals in dire straits long after the out-of-towners have moved on. Ask Philadelphia how well the tax breaks for real estate developers and companies like Comcast have played out. The city’s economic situation turned out just fine, didn’t it? Yes, you’re noting a wee bit more sarcasm. Sorry, I don’t buy the “be nice to us now with tax breaks and we’ll be nice to you later” song and dance routine. It doesn’t work with taxes just as it doesn’t work with life generally.

It boils down to this. Eliminating taxes for a specific person or company definitely helps that person’s or company’s bottom line. But if all taxes are eliminated, that person’s or company’s bottom line suffers because they now need to pay for what formerly was provided by the government with those tax revenues. So the only way tax elimination works for a particular person or company is to limit the repeal to that person or company while continuing to tax everyone else. The problem with this approach is that it’s nothing more than having others bear the burdens that the person or company should bear. Getting others to bear the person’s or company’s tax burden is not unlike getting others to do the person’s or company’s work. For free. Think about it.

So what does it mean when politicians decide that sales taxes should be imposed on tickets to cultural events but not sporting events, that sales taxes should be imposed on cigarillos and cigarettes but not cigars or smokeless tobacco, and that taxes should be imposed on raffles and small games of chance sponsored by fire companies and fraternal organizations but not on natural gas drilling? What does it mean, as revealed in State Budget in Jeopardy, when a group of legislators, all affiliated with one party, claim that they “cannot support” sales taxes on cigars and smokeless tobacco or taxes on natural gas drilling?

This question has risen to the surface of the ongoing stalemate afflicting the Pennsylvania budget process. In Taxes, Tobacco, and Tickets: Punching Through the Smoky Haze, I commented on reports that political leaders in Harrisburg were optimistic that a deal had been reached and would be passed. Though leaders of the various legislative caucuses and the governor had come to terms, rank-and-file legislators have balked. The principal reason is the selection of some transactions as subjects of taxation and the exemption of other things from taxation. When news of the deal between the governor and legislative leaders was announced, a wave of consternation and objection swept through volunteer fire companies, patrons and supporters of cultural events, and employees and the many volunteers who devote their time and efforts to the operation of zoos, the presentation of community theater performances, and the maintenance of museums.

So when the deal reached the state House, a committee rewrote the tax portion. It eliminated the proposal to impose taxes on cultural events and civic organization raffles. It substituted a higher rate in the proposal to subject casino table games to tax, and it imposed a tax on cigars, smokeless tobacco, and natural gas drilling. This move by Democrats on the committee triggered threats from Republicans. They warned that the change would cause the agreement to implode. The governor warned that if the deal goes down, legislators will need to compromise. Compromise was not the order of the day, though, because, as noted in Rendell Chides Democrats for Undoing Budget Deal, the House approved the committee's rewrite. The governor, whose position on the tax questions aligns with the House version, nonetheless claims that the legislature is bound by the deal reached by the party leaders. Yet rank-and-file Democrats, and even some leaders, note that the House version of the legislation raises the same amount of revenue and spends the same amount of money as does the deal reached by the governors and some legislative leaders.

In the meantime, Republicans claim that if the deal as written fails, it’s “back to square one.” The Senate Majority leader claims, “[I]t is obvious that you can not simply swap out one source of revenue for another.” To that assertion, I ask, "Why not? What is so sacred about cigars? Why are cultural events more deserving of being taxed than sporting events? Are cigars less of a burden on society than cigarettes and thus worthy of sales tax exemption? Are cultural events more harmful to society than sporting events and thus a more defensible source of tax revenues?"

Another legislator stated, “We have an agreement, and let’s stick to it.” But who is the “we”? The legislators who are responding to angry phone calls, letters, and emails from constituents didn’t agree to the deal. What law or norm requires them to assent quietly to what a few legislators have worked out with the governor? Legislatures can reject proposals that come out of committee, so why can’t committees and entire legislative bodies reject deals made in the back rooms? Not only are rank-and-file Democratic legislators repudiating the deal, rank-and-file Republicans are objecting to the spending levels in the deal and to the enactment of any new taxes.

The people of Pennsylvania aren’t thrilled about the budget deal as originally crafted. According to a Quinnipiac University poll, only 31 percent of those polled like what was negotiated, whereas 37 percent disapprove, and 31 percent aren’t sure. Surprisingly, 27 percent blame the governor for the stalemate whereas only 21 percent blame Republicans legislators. Yet only 9 percent blame Democratic legislators and 30 percent say “they are equally to blame, though it’s not clear whether the governor is included in the “they” who are equally to blame. When asked about budget cuts, 43 percent wanted to cut even more from spending whereas 44 percent concluded that more cuts would jeopardize vital state services. Since July 21, the percentage of those polled who blame Republican legislators has risen from 17 percent to 21 percent, whereas the percentages who blame the governor or legislative Democrats have fallen.

The people of Pennsylvania also aren’t thrilled about the legislature. According to that same poll, when asked about how the state legislature handles its job, only 27 percent approved whereas 64 percent disapproved. Nor did the percentages vary much across party or gender lines. If the legislature insists on taxing tickets to cultural events and raffles held by volunteer fire companies, but not on cigars or natural gas drilling, the approval rating surely will continue to fall. Somewhere along the line, the values reflected by legislative decisions are deviating more and more from the values that matter to the people of Pennsylvania. That’s not good.

About a week ago, in It Could Be Worse Than Taxation, Worse Than Stimulus, I noted an English precedent for stimulating an industry, not through stimulus payments and not through tax credits, but through behavioral mandate. When the wool and textile industries fell on hard times, the English government passed a law requiring citizens to wear domestically produced wool caps on certain days. The law was riddled with exemptions for the haves of society, ironically those in the best economic position to afford wool caps. But aside from the exemptions that riddled the law, what struck me was the notion that government mandated citizen behavior in the economic sphere. Governments have always reserved, and often exercised, the right to compel citizens to render services in the military and defense arenas, so my inquiry focuses on mandated purchases and acquisitions.

The issue has surfaced, in a present-day context, with a vibrant discussion of the provision in Senator Max Baucus’s health care legislation that would require citizens to purchase or obtain health insurance, and that would subject them, if they failed to do so, to a tax, fine, or penalty, depending on who’s defining it. The President says that the $1,900 imposition is not a tax. The House bill is calling it a tax. The proposal from Senator Baucus calls it a “shared responsibility payment.” The conservative group Americans for Prosperity not only described it as a tax, but directed attention to a dialogue between Senator John Ensign and Thomas Barthold, chief of staff of the Joint Committee on Taxation, in which Barthold, responding to a question from Ensign, explained that people who refused to acquire health insurance could go to jail if their refusal to purchase the insurance was fraudulent. This dialogue has caused a ruckus, but careful thought suggests that imprisonment would be a risk for those who tried to make it appear as though they had acquired health insurance when in fact they had not, whereas those who openly defy the mandate would not be acting fraudulently because they would be disclosing more than enough information to make it clear they weren’t hiding anything.

Here are my concerns about the proposal. One is that the debate over the word used to describe the monetary punishment distracts attention from the bigger issues. Even if the payment is called something else, so long as it was set forth in the Internal Revenue Code, there’s no doubt that any fraudulent attempts to circumvent the mandate to purchase health insurance, in contrast to openly defiant refusal to acquire health insurance, would be subject to the fraud penalties of the Internal Revenue Code. The solution isn’t to argue about it’s name as though that’s determinative, but to draft language that provides an answer to the question without the need to play with implications and inferences.

Another concern is the use of a purchase mandate. As best as I can figure out from discussing this question with others, there is no other governmentally mandated purchase obligation in the United States. In every other instance that came to mind or that was suggested by a colleague, the mandate can be avoided. Every state requires vehicle drivers and owners to carry insurance, but a person who chooses not to own a vehicle nor hold a driver license can avoid the mandate. Property owners often are compelled to spend money to clear debris or weeds from the land, but a person who chooses not to own property can avoid this purchase. A thornier example is the requirement that parents get their children vaccinated, but people can choose not to have children, parents can choose to home school their children and avoid the vaccination requirement, and if parents cannot afford the cost of the vaccination, governments and possibly social service agencies provide them for free. A state or local per capita tax can be avoided by moving to another state, and the prospect of a federal per capita tax is zero. Prof. William A. Jacobson of Cornell makes a similar point in Taxing Your Mere Existence. Though he doesn’t say so, the implication of his post, and of the points I am making is that the tax or “shared responsibility payment” imposed for failure to acquire health insurance could be avoided only by buying the insurance or dying.

Yet another concern, one that I have been criticizing for at least thirty years, is the use of the tax law and the IRS to handle matters that are not revenue administration and collection matters. Perhaps it is the fact that I am working my way through dozens and dozens of tax credits as I revise T.M. 506, Tax Credits: Concepts and Calculation, almost all of which are designed to reward people for engaging in certain behavior, that causes me to be particularly disturbed by yet another non-tax program being implemented through the tax code. As Prof. Jacobson points out in IRS The New Health Care Enforcer, the Baucus legislation would require health care providers to file information returns not with the Department of Health and Human Services, but with the IRS. The House bill contains similar requirements. Why this information reporting requirement? The IRS cannot enforce the tax or “shared responsibility payment” unless it knows who has and who does not have health insurance coverage. So the IRS would end up policing compliance with the health insurance mandate. Why not let HHS do its work, and if there is to be a fine, penalty, tax, or other payment for failure to comply, which is yet another and a different question, let it send a bill to the individual. After all, a person who fails to stop at a red light and who receives a ticket, pays a fine that isn’t collected or administered by the local or state revenue department.

It would be interestingly sarcastic to ask, “What’s next? The IRS checking to see if people have had their vehicles inspected?” As far fetched as that might seem, or might have seemed, it’s really not so implausible a situation. The IRS administers tax credits for purchases of energy efficient appliances, for purchases and installation of residential energy savings improvements, for adoption of babies, for generation of electricity from nonconventional fuel sources, for pursuing education, for purchasing hybrid vehicles, for purchasing homes, for using alcohol as a fuel, for manufacturing biodiesel, for building low income housing, for engaging in research activities, for investing in orphan drug development, for employing native Americans, for providing access to disabled individuals, for investing in so-called new markets, for maintaining railroad track, for producing low-sulfur diesel fuel, for producing oil and gas from marginal wells, for operating advanced nuclear power facilities, for training mine rescue teams, for sequestering carbon dioxide, and for hiring individuals in high risk categories, to name just some of the many social programming goals that are in the hands, not of the federal agency tasked with overseeing energy, health, employment, and the like, but the IRS.

Because actions speak louder than words, we know that Congress knows, understands, and respects the fact that the IRS is far more efficient an agency than are any of the others. Despite the public IRS-bashing in which members of Congress engage in order to gather up votes at the expense of misleading citizens about the value of the IRS, Congress repeatedly turns to the IRS when something needs to be done. Some weeks ago, in Tax Talk at the Gym, I shared a conversation I had at the gym: “During this conversation, I noted to this fellow that it was surprising that the Cash for Clunkers program didn't involve the IRS. Does the Congress have a higher level of confidence in the NHTSA than in other agencies? Considering the reports of long delays faced by car dealers waiting for reimbursement checks under the program, I would not be surprised to see Congress return to administration of these sorts of programs through the IRS. I would prefer the Congress investigate why there is such sluggishness in the NHTSA processing the reimbursement claims.” I learned a few days ago that the IRS ended up lending several hundred of its employees to NHTSA to help it process the reimbursement claims being filed by auto dealers. That almost guarantees that any program, whether health care, climate remediation, public education, or energy development, will end up somehow, someway, being the responsibility of the IRS to administer and the subject of many more pages of Internal Revenue Code language. The future indeed, if not looking worse than taxation, is promising worse taxation.

This past Sunday, the Philadelphia Inquirer published an interesting front-page article, No Telling What’s Taxable (and What’s Not) in Pa., that directed readers’ attention to a sales tax phenomenon with which tax practitioners have long been familiar. Any tax practitioner, or any other person for that matter, who looks closely at a particular state’s list of what is and is not subject to the sales tax comes away bewildered, frustrated, and annoyed with the absurdity of the distinctions one finds between the items in the taxable and non-taxable categories. It makes no sense.

This problem with the sales tax has long interested me, and has been the subject of more than a few MauledAgain posts. For example, in Halloween and Tax: Scared Yet?, I mentioned the change in New Jersey that removed candy bars made with flour, and store-bought Halloween costumes, from the reach of its sales tax. In Halloween Brings Out the Lunacy, I commented on the decision by Iowa revenue officials to classify pumpkins as “not food” and thus subject to the state’s sales tax. In Don’t Tax My Chocolate!!!, I shared some sales tax tidbits from Prof. Beau Baez, including his explanation of how New York, after years of distinguishing little marshmallows from big marshmallows for sales tax purposes, treating the former as tax-exempt food and the latter as taxable candy, finally decided to exempt all marshmallows from the sales tax (a decision noted in No Telling What’s Taxable (and What’s Not) in Pa.), and also decided that the regular Oreo cookie is tax-exempt food but the double-stuff Oreo cookie is candy. In Why Tax Practitioners Must Be Good With Words, Not Just Numbers, I described how the Texas Court of Appeals, as part of its analysis in resolving a property tax issue, noted the separate exemptions in the Texas sales tax law for aircraft and for aircraft equipment. In "Taxing Lawyers" Taxes This Tax Lawyer’s Brain, I shared my thoughts on a proposal in California to expand the sales tax so that it would reach the delivery of professional services.

In Pennsylvania, this question of how universally a sales tax should apply is getting attention because of the proposal to expand the state sales tax to include tickets to theater, dance, music, and performing arts events, as I previously discussed in Taxes, Tobacco, and Tickets: Punching Through the Smoky Haze. The state needs to balance its budget, so the governor and a majority of legislators have decided to expand the reach of the sales tax to certain tickets but not, for example, tickets to sporting events. They have proposed to include cigarillos, but not cigars, in the list of tobacco products subject to sales tax. They would leave smokeless tobacco items in the exempted list.

As a teacher, I find it rewarding to observe someone discovering for themselves what I’ve already figured out, and that’s one reason I was impressed by the No Telling What’s Taxable (and What’s Not) in Pa. article. Like students, the authors bring, or at least share, a sort of innocent perspective on a grubby subject. Those unfamiliar with how tax legislation is manufactured would expect something more logical than what exists in Pennsylvania, or, for that matter, any other state with a sales tax. Consider the examples presented by the article. In Pennsylvania the sales tax applies to popcorn and soda purchased at a movie theater, corporate jets, and Bibles. And does not apply to food, clothing, diapers, caskets, burial vaults, gold bullion, dry cleaning, basic cable services, toothbrushes, trout, horses destined for out-of-state use, films purchased by theaters, Dots and Dentine purchased at a movie theater, corporate stock, newspapers, magazines, candy, gum, wood pellets used for fuel, midair meals, and computer services. For a full list, which entails hundreds of items, see Rev-717AS+, the Retailers’ Information Guide published by the Pennsylvania Department of Revenue.

The stated justification for the difference is that basic needs are exempt and other items are not. But is a top-of-the-line casket a "basic" need? And how does the "basic needs" justification cause contact lenses to be exempt, contact lens wetting solutions to be exempt, but contact lens cleaning solutions to be taxable. It’s not a “basic need” to clean contact lenses?

Even the governor, complicit in the plan to enact an indefensible distinction between cigars and cigarillos, claims to be puzzled by the inconsistency in the classifications. He has offered to "take to a Phillies World Series game anyone who could 'give me one plausible reason why we would exempt bullion, gold bullion.'" The authors of the article then share the news that "he should know." Why? "He signed the bullion exemption into law on July 6, 2006, as a small part of a much broader bill." More proof yet, I suppose, that legislators, governors, and Presidents don’t know the half of what’s in the legislation for which they vote or that they sign. Scary, isn’t it?

The governor then answered his own question, as well as the question racing through the minds of all those who consider the issue. Many of the exceptions "are solely the product of effective lobbying by special interests."

The flap over the distinction between tickets to cultural events and tickets to sporting events has brought out all sorts of opinions and commentary. That’s not surprising, and it’s a healthy development. Citizens need to learn about, and discuss, the operation of government. Similarly, one can ask, and many have asked, why the exemptions for candy, gum, magazines, and newspapers is untouched by the budget plan while tickets to cultural events would be taxed. The Senate Majority Leader explains that these tickets "are certainly not a necessity." No kidding. But neither are tickets to sporting events, neither are cigars, and neither are magazines. He also defends the distinction between cultural events tickets and sporting goods tickets by claiming that the proposed sales tax extension would hit "large-venue concerts" more than other events. Hello? How is that any comfort or relief to the many small, getting-by-on-a-string-and-a-prayer community theaters and other "small venue" operations that are at risk of going out of operation?

It comes down to one very logical explanation for the illogical sales tax law. Money talks. Industries with the money to pay lobbyists, to contribute to political campaigns, to influence citizens with expensive advertising and other media exposure get the better end of the deal. Industries without that monetary power get the short end of the stick. One of the reasons a democracy does not function well if there is a huge gap between the haves and have-nots, as the last decade has demonstrated, and one of the reasons that taxation needs to be implemented in a manner that prevents the widening of that gap, is that the haves end up controlling the nation while the have-nots are relegated to serf status. Oh, campaign contributions are not subject to the sales tax because they are not viewed as purchases, even though everyone knows that campaign contributions are intended by the transferor as a means to acquisition of power.

About two weeks ago, the American Institute of Certified Public Accountants (AICPA) sent me a press release in which it shared a letter it had sent to Michael Mundaca, Acting Assistant Secretary of the Treasury for Tax Policy. The letter transmitted the AICPA’s comments on tax compliance revenue proposals in the Administration’s 2010 budget. Unfortunately, there were no links in the press release to an online version of the press release, the letter, or the comments, and after hunting around the AICPA web site, I concluded either that these documents aren’t online, they’re hidden, or I don’t know how to search.

The Administration proposes that every person or entity engaged in a trade or business file a Form 1099 that reports amounts paid to corporations if those amounts equal or exceed $600 per year. Information reporting of this sort already exists for wages paid by employers to employees, for pensions paid to retirees, for miscellaneous income amounts paid to individuals, and to a long list of other transactions. Somehow, eighty-six years into the life of the income tax, there is no information reporting for amounts paid by business operators to corporations. Perhaps the assumption had been that corporations report gross income with such high levels of compliance that Forms 1099 aren’t necessary. Experience tells us otherwise.

The AICPA raises three objections to the Administration proposal. Two of the objections are technical matters that can be handled with a bit of attention. The AICPA explains that corporations are on the accrual basis and many business operators are on the cash basis, and thus Forms 1099 would reflect cash paid during the year, which would not necessarily match the income accrued by the corporation during that same year. Ultimately, though, that income needs to show up on the corporation’s tax return, so the IRS should take steps to extend its information return matching program so that it spans taxable years. The AICPA also explains that many corporations use fiscal years but business operators use calendar years in filing information returns. This, too, can be solved by implementing multi-year matching programs.

The AICPA’s principal objection, though, is its assertion that the proposal would be “extremely burdensome for business taxpayers, resulting in compliance burdens far in excess of any appreciable gains in federal tax revenues” and that it would cause “a significant increase in the costs associated with the preparation, mailing and filing of Forms 1099 for many small businesses.” These arguments are not unlike those presented by banks, corporations, and other institutional payors of interest and dividends, who objected to legislation mandating information reporting with respect to those items of income, and who succeeded in bringing about its repeal by use of a scare tactic campaign directed at payees. The banks and corporations claimed that Congress had enacted a “new tax on dividends and interest,” provided pre-written postcards for mailing to payees’ representatives in Congress, and triggered what was, at the time, the largest mass mailing directed at the Congress. The compromise, if one can call it that, was backup withholding, namely, a requirement that income tax be withheld from interest, dividends, and other sources of income not usually subject to withholding if the IRS notified the payor that the IRS had determined backup withholding was necessary on account of the payee’s noncompliance track record.

So here we go again. But perhaps there can be a different outcome. Two thoughts cross my mind.

The first thought is that business operators do incur costs in preparing and filing information returns, though it probably isn’t the “significant” amount the AICPA claims that it is. The second thought is that there is at least one instance in which a government in effect reimburses taxpayers for assisting in the tax collection and compliance process. Pennsylvania, and it probably isn’t the only state doing so, permits those who collect sales taxes to take a “discount” when remitting the sales taxes that have been collected. The discount may or may not cover the cost of doing so, though the availability of software surely makes the process easier than it was in the days when the computations were done with paper and pencil. And thus an idea popped into my head.

Why not provide that business operators who file information returns on account of payments to corporations be permitted to claim a credit equal to, say, one cent for each Form 1099 prepared and filed? If the information returns are filed electronically, the cost of postage disappears. If that’s insufficient, perhaps a credit for the cost of software purchased to generate the Forms 1099, or for the cost of upgrades to existing software.

But as I thought about my idea, I started to think that it could be modified in a way that tested the assertion of the AICPA that these information returns are unnecessary because they will not do much in the way of federal tax revenue increases. In other words, the AICPA’s unspoken premise is that compliance by corporations is sufficiently high that information reporting and matching isn’t worth the effort. So let’s find out. Let’s turn it into a game. Maintain the requirement that the Forms 1099 be filed as proposed by the Administration. Require the IRS to determine, as it necessarily would be determining, if a particular Form 1099 issued to a corporation revealed the existence of income not reported by the corporation. Assume that the AICPA speaks for business operators and that business operators are unanimous in their agreement with the AICPA position. If necessary, permit business operators to opt out of the proposed game if they are willing to file the Forms 1099 without getting a credit. As for those business operators who share the AICPA view, if they are correct with respect to a particular Form 1099, and the income was reported, making the Form 1099 of no practical value, then the business operator filing the Form 1099 gets a credit of say, five or ten cents. If, with respect to a particular Form 1099, it turns out that the business operator filing the Form 1099 wrong and that the Form 1099 reported income not included on the payee corporation’s return, the IRS gets a credit, so to speak, of twenty-five cents. In other words, put your money where your mouth is. These amounts could be doubled or multiplied ten-fold (e.g., $1 and $25, respectively) without diminishing the underlying concept and objective of the proposal. The outcome of the game might even persuade some business operators to reduce or eliminate their dealings with corporations that consistently underreport or fail to report gross income.

And if this works, perhaps it can be extended to other Forms 1099 and even W-2s. Technically, it’s not gambling, but it has that edge of uncertainty about it – business operators probably don’t know what their payees are reporting for tax purposes – that it should appeal to that enjoyment of risk-taking so prevalent in present-day American culture. Payors might find ways to “persuade” payees to report income so that the chances of payors making money rather than losing money from their tax information reporting activities increases. If too many payors are making money, the Congress can adjust the ratio between the payor credit and the IRS credit amounts. Opening up an information reporting credit determination letter from the IRS might become as much fun as scratching off the gray spots on a scratch-and-win lottery card.

Who said tax needs to be boring?

The other day I had a conversation with a student concerning job searches, employment prospects, law practice realities, and the changes that have swept over the legal profession. I returned to my office to find an invitation to a brainstorming virtual conference on the challenges facing legal education. Unfortunately, the conference schedule and my professional commitments overlap, so I won’t be able to participate. But my conversation minutes earlier and the invitation dovetailed nicely, and I decided to share my thoughts with the world. That’s fitting, because those who selected me as a conference invitee did so in part because of this blog.

An interesting thing about evolution is that it doesn’t grab our attention in the same manner as do revolutionary events. With a few notable exceptions, the dying out of a species is noticed after the fact. It’s unlikely that some early homo sapiens sapiens turned to his parents and said, “Goodness, look at me. I’m homo sapiens sapiens and you’re just homo erectus.” The change is gradual, more easily noticed by those who look in from time to time than by those who have almost constant contact with events. Some years ago, my son and I went to visit my parents. As we walked away from the house, my son, who had been away at school and had not seen my father for a few months, said to me, in words very similar to these, “Granddad doesn’t look good at all. He has really deteriorated.” Because I had seen my father much more frequently, I didn’t see the gradual changes. My son had the advantage, if I dare call it that, of looking in from time to time. And so it goes with what is happening with legal education.

To get a handle on evolutionary change, one who is close to the situation must step away and force themselves to look at selected locations on the developing timeline. That is what I try to do. I try to freeze-frame legal education and law practice as it is now, as it was five years ago, ten years ago, twenty years ago. It’s not so much the trends that I seek, but the extrapolation of change from the differences between characteristics associated with two or more of the selected moments in time. What I see causes me to conclude that during the next ten or fifteen years there will be gradual changes that will make the picture in 2024 very, very different from what it is today. It will be so different that our successors in the twenty-second or twenty-third century will look back and see the early twenty-first century as a time of revolutionary change in legal education because from that distance, it will appear that things changed very quickly.

The process of evolutionary change in legal education already has begun. Large law firms are making changes to how they deal with their first-year associates, by instituting what can be called apprenticeship programs. One arrangement can be seen in the details disclosed by Howrey LLP. Another arrangement has been developed by Drinker Biddle and Reath LLP. The differences between the arrangements are small, whereas the similarities are predominant. Generally, firms will reduce first-year associate pay significantly, will limit the number of hours that first-year associates can bill to clients, will cut back the rates at which clients are charged for those associates’ time, and will offer those associates a variety of opportunities to learn what law practice requires of them. Some of those opportunities will consist of judicial externships and following more senior attorneys to observe them in action. But there also will be traditional training in the sense that associates will attend what can be called classes. The firms that are doing this have moved beyond the earlier development, namely, law firms deciding not to hire law school graduates but to restrict entry to lawyers with a few years of experience. In other words, the initial reaction was to let others provide the education that law school graduates need and then to grab the best of them. Other law firms, though, perhaps listening in on my comments, figured out that if everyone sat back and waited for someone else to hire and train law school graduates, there wouldn’t be any trained law school graduates waiting to be grabbed. So firms like Howry and Drinker, and I’m sure there are many others, decided to tackle the problem.

What’s next?

Law firms will discover that to provide the best training without curtailing the production of more senior attorneys, they will need to hire lawyers who have that rare combination of practical experience and pedagogical expertise. For more than a few years, some firms have hired people to come in and teach legal writing, legal research, and similar skills to law school graduates who somehow, much to my consternation, earned J.D. degrees without having polished their ability to do these tasks. So it’s a natural, and evolutionary rather than revolutionary step, to hire a few more people to teach other skills, such as interviewing clients, figuring out where and how to find facts rather than black letter law, counseling clients, professionalism, and even substantive law. These steps will cost the law firms a not insignificant sum of money. Justified by treating the expenditures as an investment, law firms will see growth in what I will call their training staff. Over time, law firms will decide that they cannot permit the cost of training to grow uncontrolled. Someone will suggest that law firms could attain savings through economies of scale, by entering into cooperative arrangements with other firms. Suppose Firm A has someone who is particularly good at training law school graduates in the skill of client interviewing, and Firm B has someone who is just as good at training law school graduates in professionalism. Firm A arranges for its newly hired law school graduates to sit in on the professionalism sessions being taught at Firm B while permitting Firm B’s newly hired law school graduates to sit in on its client interviewing workshops. Either at the outset, or soon thereafter, law firms will create cooperative partnerships or LLPs, or perhaps even non-profit organizations, to handle this training. Advocates of bridge-the-gap programs will be delighted with this development. But it won’t stop there.

As law firms pump money into their “educational cooperatives” while paying law school graduates to attend, they will struggle with the fact that this model generates negative cash flow. There are several ways to deal with this. One is to eliminate the salaries being paid to the first-years associates except to the extent the associates generate the little revenue that they might be generating. Another is to charge the associates for the education that they are receiving. Still another is to invite smaller law firms, firms that cannot afford to set up these sorts of arrangements on their own and that don’t have much of an opportunity to set them up with other small firms, to participate in the “educational cooperatives.” These firms would pay a fee on behalf of their new associates that would permit them to attend the classes, workshops, and other educational activities undertaken by the educational cooperatives. These smaller firms may, in turn, reduce first-year and perhaps even second-year associate pay.

Critics might toss these arrangements aside as nothing more than “glorified apprenticeships.” Apprenticeship in law is not a new thing. In fact, it was the norm until roughly half a century ago. Apprenticeships died out because the time and money challenge to solo practitioners and small firms, which dominated legal practice at the time, pushed legal training into law schools, whose enrollment numbers quickly mushroomed when they and their universities discovered that law schools are profitable operations. Lawyers, for the most part, gladly relinquished the task of training other lawyers because they wanted to practice law, not teach it. The few who found teaching to be fun joined rapidly expanding law faculties or took positions as adjunct faculty often more for the fun of it because the pay for adjuncts was, and continues to be, insubstantial.

The difference this time around is that the bigger law firms have become sufficiently large to permit them to set up these educational cooperatives. As these cooperatives mature, they will lure the best teachers away from law schools, partly because they will offer better pay, and partly because they will provide an environment that is more conducive to emphasis on teaching than is found in many law schools. A few law schools, savvy and prescient, will hasten to form partnerships with these cooperatives, perhaps, in some places, taking them over. These law schools, though, are often disregarded by their peers, in much the same manner as many law faculty sneered at, and continue to put low value on, law faculty who teach clinics. Law firm education cooperatives will also discover that economic and practical factors will compel them to consider, and then adopt, accepting individuals who are not law school graduates. Some of these individuals would receive additional training, destined not to become members of the bar, but to become paralegals, support staff, and other specialists necessary to the operation of a successful law practice. Others will become lawyers. How?

Eventually, the law firm educational cooperatives will find it profitable to take over the training of those individuals that they perceive have potential to be excellent lawyers. It might help to compare this trend to the process by which major league baseball teams ended up with a minor league system, finding it more sensible to “train their own” even though many of their prospects end up with other firms, than to rely solely on players developed by baseball academies. There’s a reason the baseball academy concept didn’t pan out. There are two hurdles that the law firm education cooperatives will face. One is the perception that will lull most existing law schools into lethargic apathy. “They’re not accredited,” will be the usual comment. Yet, if one thinks about it, accreditation isn’t the issue. The issue is whether state Supreme Courts, or the boards under their supervision, will accept “graduates” of these cooperatives as bar examination applicants. Though law schools might think that they have some sort of monopoly, and thus guarantee, on this issue, practicing lawyers outnumber law faculty and law deans, by huge ratios. As the ranks of law school graduates dissatisfied with their law school educational experience, and distressed by the challenges they faced when they started their law practice careers because of deficiencies in their legal education, begin to increase, the political support for changes in bar examination application rules will strengthen. It’s only a matter of time. The other hurdle is the confidence on the part of many law schools, law faculty, and law deans that the only students who would even think about attending a law firm educational cooperative rather than a law school are those who don’t have the qualifications to be admitted to law school. Practical realities, though, will erode that assumption. A huge advantage held by the law firm educational cooperative will be its ability to charge a much lower tuition than do law schools. These cooperatives will not be under pressure to remit cash to a sponsoring university. These cooperatives will not be compelled to hire forty faculty when twenty-five or thirty, or perhaps even twenty, could do the teaching because they’re not caught up in the “scholarly writing” game. In recent years, more and more “young scholars” entering law teaching have demanded a course load of three courses, not for the semester, but for the year. And most of them have received what they have requested.

As these changes continue to follow one after another, or even alongside each other, increasing numbers of students will head for the law firm educational cooperatives. They will be joined by law faculty who aren’t enamored of the transformation that overtook law schools during the past several decades. What will save some of the schools is the fact that many judges will continue to hire graduates of top ten or top twenty law schools to be their clerks, and because those clerks should find jobs, law school applicants with high confidence in their ability to land a clerkship will still head for the Harvards and Yales of the legal education world. Many of the lowest tier schools, with their focus on practical training, will survive, either in tandem with specific law firm educational cooperatives or as absorbed components of those cooperatives. The middle two tiers of law schools, the ones that thought they could out-Yale Yale or out-Harvard Harvard, will fade away. Law firm educational cooperatives might outsource some education to top level law schools, but only if the course meets the needs of law practice. It’s more likely that the cooperatives will try to pry those it considers to be the best teachers away from the law schools. At this point, for reasons of economic security, the teachers will depart.

What will remain? Far fewer law schools, with faculties almost entirely composed of “legal scholars,” with fewer students, and serious financial challenges. Faced with the prospect of raising tuition or increasing teaching loads, the schools will be compelled to choose the latter. If anything, the economics of the law firm educational cooperatives will reinforce tuition reductions. Law faculty accustomed to investing most of its time in writing will find themselves in the classroom for six, seven, perhaps ten courses a year. Those who truly want to spend most of their time writing will depart for think tanks, institutes, and other organizations capable of finding funding to support an activity that the law practice market cannot afford. Others might persuade their universities to transform their law schools into legal institutes, taking on a handful of students as paying fellows, and desperately trying to work out some sort of survival arrangement with the law practice world and its law firm educational cooperatives.

Some law schools might learn the lesson and transform themselves before all of this comes to pass. Surely, as I’ve noted, a few will have done so. But unless Harvard or Yale or Stanford or several of the other “top” law schools does so, almost all the other law schools will “stay the course” (sorry) and wither. Most law schools, and that’s too many law schools, are afraid to buck the trend, in part because of their addiction to the rankings game. Because I think the Harvards and Yales of the legal education world will not see, and cannot see, the implications of what is happening in the law practice world, I doubt that they will evolve, or if they begin to evolve, it will be too late.

Ultimately, universities will seek to enter into arrangements with law firm educational cooperatives. Universities will have almost empty law school buildings to rent out. Some sort of deal will be worked out, though I have not persuaded myself that the cooperatives will become “schools” within the universities. The law firms that operate them will worry that if universities took over their educational cooperatives, the cycle would start over. And having been there and done that, law firms and their cooperatives will be reluctant to return.

And so, one day, ten or fifteen years from now, those who haven’t been paying attention will look around and wonder, “How did this happen? WHEN did this happen?” The answer to the second question is “Not overnight.” The answer to the first will require at least as many paragraphs as are within this blog posting. The details will be somewhat different, but the story will be the same.

Those who object to using the tax system and the IRS administrative mechanisms to accomplish what should be undertaken by other federal agencies in a more direct way count me among their number. Those who object to the federal government transferring money to particular industries, directly or indirectly, count me among their number under certain circumstances but part ways with me under others. Sometimes the so-called free market doesn’t do what it needs to do because it really isn’t free. Sometimes one can consider intervention with federal dollars, whether in the form of tax credits, stimulus payments, or cash-for-clunker reimbursements, to be the price that society pays for having let special interest groups crush the freedom of the marketplace by taking it hostage.

As bad as some might think that the use of tax credits and stimulus payments might be, it could be worse, at least in the eyes of some. Suppose that the federal government, instead of using a cash-for-clunkers arrangement to persuade people to trade in their fuel-inefficient vehicles for more energy-friendly models had instead simply mandated that everyone dispose of fuel-inefficient vehicles and purchase a fuel efficient vehicle. Better yet, suppose that the mandated purchases were limited to the products of domestic automobile makers actually manufactured in the United States. Or suppose that the federal government, instead of persuading people to install storm windows or to purchase energy-efficient appliances simply ordered all homeowners to make those purchases. How loud would the howls of protest be? How many would march on Washington? How many talk show hosts would have on-air fits?

Are my alternative scenarios absurd? Are they the product of some theoretical contemplation? Hardly. Bear with me as I explain one of the many ways I learn things.

Near the end of last year, my pre-eminent friend, a librarian who shares my enthusiasm for the study of language and words, bought me a gift. It was the 2009 Forgotten English 365-Day Tear-Off Calendar. Though a few of the words that I’ve encountered aren’t, strictly speaking, forgotten, at least not from my perspective, and though a few had previously crossed my path, most were new. Perhaps some will enter my lexicon because I like them well enough to try bringing them back into the world’s daily vocabulary. The calendar presents a word, gives its definition and the source of that definition, and then amuses the reader with trivia that may or may not have a direct connection to the word or its definition.

On Monday, I peeled back the Saturday/Sunday page to discover the word flat-cap. It turns out, according to Robert Nares's Glossary of the Works of English Authors (1859), to be exactly what it says, a flat round cap that was the height of fashion during the reign of Henry VIII. If you watch The Tudors, as I do, or some of the other period pieces dealing with that era, you’ve seen them. But the word took on another meaning. As inevitably happens in the world of fashions, the flat cap went of style. But some people, especially Londoners, kept wearing them, and were ridiculed for doing so. The term flat-cap became an insult, directed at those who weren’t keeping up with the latest fashion trends. I almost could take pride in being a flat-cap, except that no one has ever called me a flat-cap.

The trivia presented by the calendar was titled, "Feast Day of St. Maurice." Maurice is a patron of hat makers, something I probably learned in elementary school but forgot. The reader was then educated on a bit of information related to hats. When Elizabeth I was Queen of England, the wool and textile industries fell on hard times. The government intervened. No, there were no income tax credits. No, there were no stimulus payments. Instead, the government passed a law that provided:

Every person above the age of seven Years shall wear upon the Sabbath and Holiday . . . a Cap of Wool knit, thicked and dressed in England, made within this Realm, and only dressed and finished by some of the Trade of Cappers, upon pain to forfeit for every Day not wearing three Shillings four Pence: except Maids, Ladies, and Gentlemen, Noble Personages, and every Lord, Knight and Gentleman of twenty Marks land and their Heirs, and such as have borne Office of Worship in any City, Borough, Town, Hamlet, or Shire; and the Wardens of the Worshipful Companies of London.

Did compliance with this law mean that people spent less money on other things? Did it simply do no more than to divert expenditures for hats and other fashions from imported items to domestically produced headgear? The government did not issue reimbursement checks to hat dealers. It did not provide tax credits. It simply commanded people to spend their money in a particular way. Those who did not comply became contributors to the Treasury.

What’s even more interesting about this approach to government regulation of the marketplace is the existence of exemptions. There’s probably some sense in exempting persons not yet seven years of age, perhaps for practical reasons and probably for reasons connected with the idea that a person not yet seven years of age was not “of age.” But why the exemption for maids? Or for ladies? Or for noble personages? Or for lords, knights, and gentlemen owning land worth twenty or more marks? Why the exemption for clergy? Why the exemption for the London company wardens? Perhaps clergy were required to wear silk headdress rather than woolen caps? Perhaps maids had some similar head covering for which wool was not an appropriate or workable substitute? But even if some rational explanation exists for the exemption of maids and clergy, it appears that the legislation exempted some people for no reason other than money and power. Today’s special interest group lobbyists appear to be following a centuries-old tradition, a tradition that ought to become as obsolete as the term flat-cap. Why? Every time a special interest group obtains an advantage, it puts everyone else at a disadvantage. Unless there is a rational, reasonable, and appropriate justification for shifting an advantage to a small group, putting burdens on the many to benefit the few violates the values of equality and community essential for survival of a democracy.