MauledAgain

When, in Tax Law Going to the Dogs in a Fishy Proposal, I commented on the proposal to allow deductions for pet care expenses, I thought I had seen one of the most unwise tax ideas suggested for addition to the tax law. But now another idea has come along that is just as unwise. In Re-envisioning the Charitable Deduction to Legislate Compassion and Civility: Reclaiming Our Collective and Individual Humanity Through Sustained Volunteerism, 19 Kan. J.L. & Pub. Pol'y 269 (2010) (hat tip: Paul Caron’s TaxProf blog), Professor Alice M. Thomas argues that a tax deduction should be added to the Internal Revenue Code for “volunteerism.” In other words, taxpayers would be permitted to deduct some amount representing the value, or some presumed value, of the services they provide when they volunteer. The disadvantages of this proposal are numerous.

First, unless some arbitrary per-hour amount is prescribed for all taxpayers, the proposal, if enacted, would burden taxpayers and the tax return preparation system with the task of determining the value of the volunteer work provided by the taxpayer. If a physician does two hours of carpentry work for Habitat for Humanity, should the deduction reflect the hourly rate charged by carpenters or by physicians? If the quality of the carpentry isn’t of good quality and needs to be redone by someone else, does the taxpayer still get the deduction?

Second, who monitors whether the volunteer has done something of value? How does one administer a deduction that reflects volunteer work without determining if any work was done?

Third, who keeps track of the hours donated by volunteers? If the organization does not do so, almost every taxpayer in the country will claim to have volunteered. If the organization must keep track of volunteer hours, is that not a diversion of its resources away from its primary mission?

Fourth, does it make any sense to allow a deduction, or even a credit, for something in which the taxpayer has no basis? Unfortunately, some taxpayers are permitted, under certain circumstances, to claim a deduction for the fair market value of donated property even though they have not included in gross income the appreciation in that property. This is an atrocious tax rule, has been nominated for repeal on numerous occasions, and very well may not survive the next focus by Congress on available revenue sources to deal with the federal deficit. But its existence ought not be used to sell another atrocious idea as palatable.

Fifth, accepting the premise that encouraging volunteerism is a good thing, why use the tax code to accomplish that goal? Brushing and flossing one’s teeth is also a good thing, but there is no deduction for doing so, and hopefully no one proposes that there be one. There are all sorts of good things, but the tax law ought not be the driving force behind those good things.

Sixth, if a deduction for volunteerism in fact does increase the amount of volunteerism, is it going to bring into the soup kitchen, into the houses being rebuilt, into the hospitals the sort of people who truly understand what volunteering means and who can function other than as someone serving out their time in order to get a tax break? What genuine volunteer wants to be working alongside a mercenary?

Seventh, is a person “volunteering” if the person is doing something because there is an economic benefit, namely, a tax break, to be gained by engaging in the activity? When someone obtains an economic benefit from doing work, we call that a job.

This sort of proposal speaks volumes about two major trends in the disintegration of American culture. First, it is yet another theoretical idea that sounds good but when subjected to the realities of the tax practice world falls apart, and when subjected to the realities of tax policy comes up short. Professor Thomas makes a great case for why volunteerism is a good thing but fails to explain why the tax law is a better device to encourage more volunteerism than are the other means more readily available to society. Second, if it takes a bribe in the form of a tax break to get people to step up and help out, that’s a sad statement about the this country’s current cultural condition. Perhaps too many children have been successful with “I’ll do chores if you pay me” arguments presented to their parents, thus causing the “I won’t do anything without an economic benefit” mentality to permeate, and increasingly erode, the nation’s foundational value system.

If can be proven that it’s unavoidably necessary to use the tax code to fix yet another deep social problem, perhaps it makes better sense to have a special tax deduction for contributing to a program designed to educate parents on how to instill caring about others – rather than caring about self – in their children. I prefer not to use the tax code at all, but using the tax code to mask symptoms rather than getting to the root of the problem is even more foolish than using the tax code to deal with social, psychological, and cultural issues.

Unfortunately, this sort of proposal will appeal to some office-seeking candidate who would support it for the sole purpose of winning votes from people easily fooled into thinking that supporting this type of idea makes the person better suited for influencing the nation’s policies than are the people actually doing volunteer work for the right reason. The past several decades have demonstrated that the Congress has no qualms about cluttering the tax code, enacting bad legislation, and catering to whomever needs to be mollified in order to get, and hold on to, power. It is dangerous, and unwise, to put bad ideas into the heads of politicians. There are enough bad ideas already residing in the collective political brain, and it’s time to dislodge them with good ideas. What Professor Thomas has advanced does not qualify for that purpose.

The challenges posed by having the IRS enforce and regulate the newly-enacted provisions in the health care legislation requiring individuals to purchase health insurance and requiring certain employers to provide it to their employees are growing by the day.

In IRS Ought Not Be the Health Care Enforcement Administrator, I explained why health insurance regulation and enforcement belongs somewhere in the federal government other than the IRS. In Health Care: Enlarging the Code and Stressing the IRS, I expressed concern about the impact on the IRS and tax law administration of relying on the wrong agency to handle the reporting and insurance purchase requirements. In More Challenges of IRS Health Care Oversight, I shared a reader’s description of practical problems with the limited enforcement powers available to the IRS, which will encourage people to delay purchasing health care insurance until after they need the coverage. In effect, the enforcement mechanisms in the legislation are so lacking in teeth that they are pretty much useless.

Now comes yet another challenge, one that was expected. With great glee, Representative J. Randy Forbes of Virginia has introduced legislation to prohibit the IRS from doing anything with respect to the health care legislation. The proposed statute is sufficiently brief that it’s worth presenting in its entirety:

A BILL

To prohibit the Internal Revenue Service from hiring new employees to enforce the Federal Government's invasion into the health care lives of American citizens.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,
SECTION 1. SHORT TITLE.

This Act may be cited as the ‘‘Prevent IRS Overreach Act of 2010’’.

SEC. 2. PROHIBITION ON IRS FROM HIRING NEW EMPLOYEES TO ENFORCE PATIENT PROTECTION AND AFFORDABLE CARE ACT AND HEALTH CARE AND EDUCATION RECONCILIATION ACT OF 2010.

No position within the Internal Revenue Service may be filled, by transfer or any other appointment taking effect on or after the date of enactment of this Act, if the duties and responsibilities of such position include the enforcement of any provision of, or amendment made by, the Patient Protection and Affordable Care Act or the Health Care and Education Reconciliation Act of 2010.

That’s it. The translation is simple: “Even though opponents of health care reform and health care for those without health insurance lost in their attempt to maintain the status quo, they intend to prevent implementation of the legislation so that there is no health care reform and so that those without health insurance coverage continue to suffer.” If the concern of Representative Forbes and his allies was mine, namely, that the IRS is not the appropriate agency to enforce the legislation, the proposed legislation would contain a section 3 that shifted the responsibility to some other federal department or agency. The lack of any such provision makes it clear what Forbes wants to do. His approach is not unlike that of a basketball coach who, after his team loses a game, ignores the meaning of the final buzzer, and tries to prevent the officials from sending the score to the league office.

This tactic is worse than what happens when Congress imposes an obligation or duty on the states but fails to provide funding to the states to pay for implementation. That tactic causes the debate to be one of who pays for enforcement rather than whether the program in question should be undertaken. The Forbes tactic is one in which the losers try to replay the game because they don’t know how to accept decisions made by a majority of legislators elected to the Congress.

Forbes justifies his actions by arguing that “The simple truth is that spending $10 billion for the government to force federally mandated healthcare on families and businesses will not initiate business growth or create lasting career opportunities for Americans. By prohibiting the funding of those new IRS employees, we will allow American taxpayers to keep their money and begin to draw a line in the sand on matters of unnecessary growth in government.” He also argues, “Americans remember an era of IRS overreach and abuse and don’t want that time back. Whether preventing 1,000 new IRS agents or 16,000 new agents as some have predicted, this bill is intended to stem the growth in big government’s control and authority in the lives of American citizens.” How much of this makes sense?

First, there is nothing to support the claim that it will cost $10 billion for the government to enforce the health care legislation. Forbes himself admits that there could be “1,000 new IRS agents or 16,000 new agents.” Surely the overall cost could be anywhere between some amount and sixteen times that amount, though the latter outcome is highly unlikely because the IRS has asserted it will not need 16,000 new agents. Maybe it will cost $500 million (which would permit hiring as many as 4,000 agents), maybe it will cost $1 billion, but $10 billion appears to be more of a number drawn out of thin air to add drama to the issue than it is the product of a cost accountant’s detailed research and analysis. Even if half the $10 billion were used for things other than the cost of paying salary and benefits to health insurance verification form clerks, the other $5 billion would pay for as many as 50,000 employees. That’s triple the extremely high number at the top end of Forbes’ “estimate.”

Second, however many people are hired by the IRS, or any other federal agency, to administer the new legislation, those will be new jobs. Those jobs will take people off the unemployment line and off unemployment benefits. Those jobs will reduce government spending on unemployment benefits. How can Representative Forbes not understand, and like, that outcome? His claim that there will be no career opportunities is unfounded.

Third, the insurance companies will need to hire people to assist them in complying with the legislation. Perhaps they will cut the salaries of their employees who earn more than $1 million a year to find funding sources. No matter how they pay for the new employees, they will be creating more jobs. That’s even more people taken off unemployment or other public benefits, and thus there will be even more reduction in government spending. Representative Forbes’ claim that the legislation “will not initiate business growth” is nonsense.

Fourth, the private sector having had decades to establish a health care marketplace that works for all Americans, does growth in government required to assist those who need health care fall into the category of “unnecessary” or “necessary”? Perhaps it is not necessary to do something about people who go without medical care because they have no health insurance and no independent source of funds to pay for care. All of this presumes that the health care legislation will cause government to grow, when it is quite likely that by making preventative care available to everyone, there will be a huge reduction in the number of people who need far more expensive care at some later date because a disease was not caught in its early stages and who, if uninsured, would require government outlays far in excess of the cost of paying for universal preventative care. One wonders who has the vested interest in the current system. As for the expected argument that people without health care would not be in that situation had they not lost jobs, and that reducing the size of government protects and creates jobs, one need only point to what happened while those opposed to health care reform were calling the shots. Perhaps they would like to put on center stage the reduced regulation of banks, mortgage lenders, and other financial institutions, which permitted reduction in size of certain regulatory agencies, and then explain how the misfeasance and malfeasance of individuals within those industries had nothing to do with people losing their jobs and, concomitantly, their health insurance. Isn’t it amazing how the kids who spill milk start getting so critical of the way in which the parents trying to clean up the milk are going about their remedial efforts?

Fifth, when Forbes refers to “an era of IRS overreach,” is he referring to an IRS that was doing more than it was authorized to do under law? If so, perhaps he ought to check the political party affiliation of the President who ordered the IRS to engage in those activities. When he refers to “abuse,” is he trying to re-open the now-discredited Congressional hearings, brought to the nation courtesy of the same group, that pretty much failed, in the long run, to demonstrate abuse? Is he trying once again to shift onto the IRS blame for the tax complexity and tax compliance nightmares that torment so many people, when in fact these are gifts to the nation from the very Congress in which Forbes sits? This sort of spin might do well in the media, but it falls apart when careful and thoughtful reasoning is brought to bear on the matter.

Sixth, when Forbes decries “growth in big government’s control and authority in the lives of American citizens,” has he considered why the government has needed to become involved in matters such as health care? If the private sector, operating in the so-called free market, was doing a top-notch job with health care, there would not be such a mess in American health care. There would not need to be government intervention if those treating the word “free” in the phrase “free market” to mean “free to do what we want to do” had not made such a mess of so much of the lives of American citizens. Every time something that needs to be regulated is deregulated, calamity befalls Americans, and when attempts are made to repair the damage, the folks who brought us the deregulation jump up and bewail the very thought of restoring some sort of order through government regulation or intervention. As I learned as a child, if you don’t want a poor grade, do what you need to do to learn how to do it properly, and if you don’t want to be reprimanded, do what you should be doing and do it properly.

It is highly unlikely that the legislation introduced by Forbes will be enacted. It is highly likely that he knows this. So why invest time in drafting and introducing the bill? The answer is simple. It will earn Forbes votes. It will bring him votes from people who, because of inadequate education attributable in part to the refusal of some communities to invest in their children’s futures, are unable to understand the reality and are susceptible to catchy-sounding but deeply erroneous, and dangerous, platitudes. Forbes, however, does not lack the ability to understand this. So, though I disagree with the voters who flock to his side, I am sympathetic to their plight. But my disagreement with Forbes is not tempered by any such sympathy. He holds a position of public trust and he should know better.

On Wednesday I learned a new phrase. The phrase is “crop club.” I learned this word from Jeffrey Kacirk's 2010 Forgotten English 365-Day Tear-Off Calendar. Regular readers of MauledAgain may recall that twice during 2009, I shared tax-related words that were brought to my attention courtesy of Jeffrey Kacirk’s 2009 Forgotten English 365-Day Tear-Off Calendar. As I explained in It Could Be Worse Than Taxation, Worse Than Stimulus, “[n]ear the end of [2008], 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.” It was a hit. My friend knows that because each morning, another word or phrase of forgotten English appears, and thanks to the wonders of email, I share almost immediately. So it was not really a surprise when at the end of 2009, my friend bestowed on me the 2010 Forgotten English 365-Day Tear-Off Calendar. And on Wednesday, the phrase of the day was “crop club.”

Like the previous two words that I shared on MauledAgain, “crop club” has a tax-related meaning. Lest they be forgotten, the previous two tax-related forgotten English words were flat-cap, which I discussed in in It Could Be Worse Than Taxation, Worse Than Stimulus, and catchpole, which was highlighted in Tax Day Trivia. Considering that catchpole showed up about tax filing day last year, I don’t think it’s an accident that a tax-related word showed up on Wednesday. Sure, it was two days early, but with my blog writing schedule, the timing was ideal.

So what’s a crop club? Is it an association of farmers who grow things? Is it a special device used by golfers? Is it, oh, never mind. According to Trench Johnson’s Phrases and Names: Their Origins and Meanings, 1906, the answer to both questions is, “No.” The word crop has more meanings than simply things that farmers grow. In the context of “crop club,” the word “crop” isn’t derived from its use as a noun. It reflects the use of “crop” as a verb.

The calendar brings a bit of trivia to accompany each day’s word or phrase. According to the calendar, on April 13, 1795, The Times of London carried this item: “A club has been formed in Lambeth called the Crop Club, every member of which is obliged to have his hair docked for the purpose of opposing – or rather evading – the tax on powdered heads.” As soon as I read the trivia, I had a flashback. Surely I had written about this on MauledAgain. Thanks to the efficiencies of google, I did a search for “powder AND wigs” and sure enough, there it was. In May of 2009, in Fashionably Powerful Taxation, I explored the lessons to be learned from the one-guinea tax imposed by Parliament on wig powder in the late eighteenth century. On that occasion, the inspiration came from Michael Quinion’s Gallimaufry: A Hodgepodge of Our Vanishing Vocabulary.

The goal of the wig powder tax was not only to raise revenue to pay for military expenses but also to reduce the use of flour in wig dusting because of a shortage in bread and other foodstuffs requiring flour as an ingredient. These were, of course, conflicting goals. The more successful the tax was in curtailing the use of flour as wig dust, the less revenue would be raised to defray military expenses. In the event, wigs went out of fashion. It seems that unpowdered wigs were not a fashionable alternative to powdered wigs. In Fashionably Powerful Taxation, I noted the effect of the powder tax on wig use but did not explore its further effect on hair length. Not only did people stop wearing wigs, they also cut their hair. Why? Apparently natural hair also was powdered, presumably because of length. Short hair did not require powder, though whether that was the case because of fashion reasons or hygienic reasons isn’t something I’ve been able to figure out.

Not surprisingly, not everyone abandoned their wigs, or, I suppose, long hair. The trivia in the April 13 entry in Jeffrey Kacirk's 2010 Forgotten English 365-Day Tear-Off Calendar explains that reaction to the tax “polariz[ed] the English into wearers and nonwearers -- the former being punningly described as ‘guinea-pigs.’” Apparently the tendency to work tax words into puns is not a recent one.

So in the late eighteenth and the early nineteenth centuries, most of the people of England cut off their hair rather than pay a tax on powder made from flour. What would taxpayers today be willing to cut off in order to avoid a tax? What would YOU cut off to avoid a tax?

On Saturday, April 10, several of my comments shared during an interview with reporter Julie Small were aired on National Public Radio’s Marketplace, in a discussion of California’s Ready Return program and the possibility of something very similar to it being adopted at the federal level. With April 15 just a few days away, attention turns, as it does every year, to the aggravation that filing income tax returns causes for so many people. The aggravation is rooted, of course, not in the concept of filing a return, but in the unjustifiably complicated maze of rules bestowed on the nation by a Congress more concerned with appeasing special interest groups than with crafting an income tax law that best suits the people.

The idea that the income tax would somehow become less aggravating if the government prepared returns for taxpayers is one of those “sounds good” proposals that has gathered support but that, after careful analysis, does nothing more than mask the underlying problems, making it less likely that public pressure would encourage legislatures to fix the tax law. It’s not surprising that California, which proudly or not so proudly owns the most complicated state income tax law in the country, jumped at the idea and presented the Ready Return program. Only three percent of taxpayers eligible to have the state of California prepare their return took advantage of the opportunity. Only 60,000 people out of 2,000,000 were willing to put their tax fortunes in the hands of an anonymous revenue department bureaucrat or its computer. That speaks volumes, even though Ready Return advocates dig up every excuse imaginable to explain what doesn’t really need to be explained. People often vote with their feet, or, in this case, with their pens and keyboards.

Ready Return has been the subject of more than a few MauledAgain posts. In the most recent, Federal Ready Return: Theoretically Attractive, Pragmatically Unworkable, I summarized my previous analysis:

The idea of Ready Return is one of those dangerously great-sounding ideas that just won’t hold up when closely examined.

The notion of having the IRS take an approach similar to the California “Ready Return” experiment is alarming. When the California version was instituted, I criticized it, in in Hi, I'm from the Government and I'm Here to Help You ..... Do Your Tax Return and in ReadyReturn Not a Ready Answer. In those two justifiably long analyses of the defects of the program, I pointed out that conflict of interest permeates the arrangement, noted that the track record of government employees in these sorts of situations is too far from ideal, explained how the idea opens the door to fraud, poses logistical problems, tricks millions of taxpayers into thinking that complicated tax laws are not their problem even though they continue to pose a threat to the national well-being, and puts taxpayer privacy at risk. Joined by many other critics, I tried to explain to the advocates of Ready Return why it was the typical "good idea in theory" that falls apart in the real world of tax practice. Some months later, in Ready It Was Not: The Demise of California's Government-Prepared Tax Return Experiment, I commented on the decision by the California Franchise Tax Board to terminate the Ready Return program. Yet, its opponents continued to lobby against the program, which in As Halloween Looms, Making Sure Dead Tax Ideas Stay Dead, I suggested was the consequence of a fear that it would be resurrected. And, indeed, as I discussed in Oh, No! This Tax Idea Isn't Ready for Its Coffin, I reacted to the restoration of the program, warts and all. What was particularly disturbing was the fact that state administrators restored the program even though the legislature had cut off funding and authorization.

The advocates of Ready Return, both in California and at the federal level, point to the “high praise” received from taxpayers using the program. Stross joins this chorus. But, as I pointed out, few, if any, of those taxpayers knew or know if their returns are correct. In Getting Ready for More Tax Errors of the Ominous Kind, I discussed the revelations in The Report of the Treasury Inspector General for Tax Administration, Ensuring the Quality Assurance Processes Are Consistently Followed Remains a Significant Challenge for the Volunteer Program concerning the high level of errors made by the IRS in dealing with taxpayer’s returns, computing tax, and determining refunds.

I have previously asked who audits the returns prepared by the California Department of Revenue. The Department itself? Who would audit returns prepared by the IRS? Taxpayers would end up taking these “tentative” returns to tax return preparers or using software to see what results it generated, so the alleged efficiencies of a federal “Ready Return” is another theoretical construct that falls apart when put to the test in the practical world. Only the most trusting, and naïve, of taxpayers would do anything less but prepare their own return, or pay an independent third party to do so, even if the IRS had put a proposal on the table. It’s not as though eye-balling a proposed return from the IRS is as simple as determining if the sales tax on a store receipt makes sense. The federal income tax law is way too complicated, even for the taxpayers who supposedly have “simple” returns. There is no such thing as a simple federal income tax return.

The same can be said about California’s tax returns, which might qualify as even more complicated than federal income tax returns.

The opinions I shared during the NPR interview brought one comment, from Alice Abreu, who teaches tax a few miles away at Temple University. She claims:

Jim Maule is just flat wrong in saying that ReadyReturn doesn't save people time, and the taxpayers in CA who love it are proof of that. Even if the return wasn't completely done, just having the form filled in with all of the W-2 information the government already has would be a tremendous time saver. Indeed, that is where the attention on the federal level has moved. If that information was filled in, returns could be done more quickly, and that would be a time and moneysave. Think about it: checking the information against what you have on your W-2 has to be faster than typing it in and then checking it.

Unfortunately, I must disagree with Alice. Checking to see if someone else has done something properly is never a time saver. There's a reason "it's faster if I do it myself," "it would have been faster had I done it myself," or some variant is heard so often, not only in tax return preparation but in other areas of law and life. Banking on a state or federal computer system getting it right is risky, especially when one takes into account all the information that has been released concerning the antiquated state of most government tax computing systems, programming errors, data entry errors, data transfer errors, and a variety of other glitches. Think about the error rates in advice obtained from telephone calls to the IRS. Think about all the mistakes on the information return reporting letters, which are based on the same systems that would be generating these "government prepared" tax returns.

There’s a reason that a cash-strapped government like California is so eager to prepare tax returns for taxpayers. It certainly isn’t a case of doing penance for the state having inflicted taxpayers with a patchwork income tax system that begs for true reform. Nor is it a desire to have taxpayers save money, because the response of California and the advocates of Ready Return to concerns about errors is that taxpayers are free to consult with independent tax return preparers. In other words, taxpayers would still face expenses, and even though they would be called tax return review fees rather than tax return preparation fees they still would require the taxpayer to reach into his or her pocket. So if taxpayers would be going to independent professionals, why is the state bothering to divert resources into preparing Ready Returns? The answer must be that the state is banking on taxpayers who receive a Ready Return, consider it official because it came from the government, sign it, and do nothing more. Unfortunately, there are taxpayers who will react in that manner. Whether from ignorance, laziness, unjustified trust in government, fear, confusion, or some other distraction, if enough mistakes are made on their returns and go undiscovered, the revenue flow to the state increases. The people who profess that they “love” Ready Return are saving time only because they are putting themselves at the mercy of the California state government, blindly accepting whatever they’re being told, and exposing themselves to risk if California later decides that the returns filed by the state on behalf of these folks are, in fact, erroneous. I wonder when that love will become love lost.

If a government truly cared about the mental health of its citizens during tax return preparation season, it would do the right thing and simplify the tax. For most other taxes paid by individuals, it’s much easier to notice if something is wrong. Ready Return opens the door to making these other taxes more complicated. Too much chicanery can hide behind complicated tax systems. Changes can be made that would slip by taxpayers because they’re no longer working through, or having tax professionals guide them through, what’s going on with their tax returns.

It shocks me how much confidence people have in government when it comes to having the government do a person's taxes. According to this study, "The percentage of Americans who trust the government in Washington plunged from 76 percent in 1964 to 25 percent in 1996." A May 2006 poll indicates that 63% of the people do not trust government. In California itself, according to this recent survey, 29% of those polled "say they trust the government to do what is right just about always or most of the time." And somehow it’s acceptable to put one’s tax life into the hands of government?

In a nation where governance is built on a Constitutional system of checks and balances, there is much to be said about the checks and balances arising from citizens doing their own tax returns and seeing with their own eyes what the legislative and executive branches are doing. Surrendering what is, in effect, a citizen oversight function is too dangerous a step to surrender of control and participation in governance. What’s next, Ready Vote, where the government sends a filled-in ballot to voters?

The conflict between Philadelphia’s mayor and City Council, on the one hand, and the city’s Board of Revision of Taxes, on the other, continues to escalate. According to this Philadelphia Inquirer report, the mayor already has directed his administration to take control of the BRT’s funds other than those earmarked for payroll and a bill has been introduced in City Council to reduce the pay of the BRT members. In Friday’s post, Can Bad Tax Administration Doom the Tax?, I described how the attempt to remove political patronage influence from administration of the real property tax has become a battle between the reformers and those unwilling to step aside so that competence and efficiency can take over the process. Like most battles, the highest casualty rates will be among the bystanders, in this case the tax-paying property owners of Philadelphia. But at least they should get their chance at the ballot box next month, unless somehow the BRT persuades the courts to let the BRT members continue business as usual.

The primary flow in the BRT’s administration of the property tax is its inability to assess properties in a manner that complies with state law, that generates comparable values, that is timely, and that is free of political influence and favors. On Friday, in a letter to the editor of the Inquirer, Bernard J. Nearey suggested that the solution would be a real estate tax based on the size of the lot. He argues that it would be very easy to determine the tax base for each property, and that the only reason for a BRT would be “to send a person out with a tape measure to check the size of your lot if you disputed it.” He also argues that “[t]he idea that your property-tax assessment should turn on the condition of your brickwork, your windows, or how many bathrooms you have is absurd.”

In a comment to the letter, Joshua911, despite agreeing with the idea that “buildings should not be taxed,” noted that “taxing on the size of the lot is illegal in this state and any other state” and that “[t]axes must be assessed on the value.” He points out that similarly sized lots in Francisville – a section of the city that has deteriorated – and in Society Hill – a section that is very upscale – ought not be taxed at the same amount.

Joshua911 is correct, at least to the extent he refers to Pennsylvania. I don’t know what the law in all of the other states provides, and he very well may be correct, but that doesn’t matter all that much to Philadelphia’s problems, because Philadelphia is part of Pennsylvania. Yes, it would violate Pennsylvania law to base the real property tax on the size of the lots. Aside from the legal question, and that’s a big aside, Joshua911’s point about value not correlating to size is important. Basing value on size might make for easy computations but they would be computations irrelevant to the underlying law.

On the other hand, the notion that buildings should not be taxed is much more problematic. Buildings constitute real property, and thus a real property tax must include the value of buildings, and all other items of real property. One might Mr. Nearey’s idea a step further and argue that even if the tax cannot be limited to the land, when it comes to buildings, it should be calculated based on square footage. Yet again, though, the notion that size is all that matters runs into reality. One of the most notable examples of the BRT’s failures was the absurdly low assessment on Vincent Fumo’s residence, as discussed in How to Fix a Broken Tax System: Speed It Up?. It wasn’t just a matter of Fumo’s mansion being of large size in terms of square footage. It was also a matter of the high value features included in the property.

So long as there is a real property tax, limiting the tax to land degrades the tax, and that is one of many reasons I consistently object to real property tax breaks handed out by the city to corporations. Yet, there is a movement afoot to replace the real property tax with a land value tax, as described by the Henry George Foundation that supports the idea. Though there are good arguments for shifting to a land value tax, there also are good arguments for not doing so. Should a corporation that owns a 10,000 square foot parcel in the downtown business district pay only five times the tax paid by the owner of a 2,000 square foot residential property a few blocks away? Contending that the value of the 10,000 square foot parcel would be much more than five times the value of the 2,000 square foot lot isn’t the answer, because taking into account the value of the building that is or could be built on the parcel would be bringing the value of the building into the computation in violation of the principles of a land value tax.

The underlying problem is that taxes based on value lack the precision that characterizes taxes based on sales price, number of bags of trash put out for collection, or number of axles on a vehicle. Granted, there may be other reasons to reject a particular tax that happens to be precise, but lack of precision is not one of them. The income tax suffers from this imprecision when it comes to determining income based, for example, on the value of property received as compensation, but it avoids imprecision when it measures income based on cash wages or a deduction based on the amount paid. User fees, in contrast, when properly designed, are based on the cost of the service provided by the government, and thus rest on cost accounting concepts that are more precise.

In terms of precision, the real property transfer tax is orders of magnitude better than the real property tax. The transfer tax is simply a percentage of the sales price, though when the transfer is in exchange for something other than cash, valuation problems again complicate the matter. The problem with the real property transfer tax, especially if used as a replacement for the real property tax and thus requiring much higher rates, is that it comes at one time and cuts into the net sales proceeds. It also is avoidable by those who can afford sophisticated planning advice.

So I wonder if there is some sort of compromise that can compensate for the valuation errors inherent even in a well-administered real property tax. Consider this idea. Increase the real property transfer tax rate. Then allow a credit equal to a percentage of the real property taxes paid during the ownership period of the seller and any previous owners whose transfers were not taxed when the property was transferred to the seller or the seller’s transferor, and so on. If the real property tax was too high or too low, as measured by the sales price, the credit would compensate, at least in part, for that discrepancy. Consider two property owners who own similar properties but who, as often is the case in Philadelphia, pay varying amounts of real property taxes. Assume that over a five-year period of ownership, A pays $1,000 each year and over an eight-year period of ownership B pays $3,000 each year. A and B each sell their properties, each for a sales price of $100,000. For ease of computation, assume that the transfer tax is $5,000, an amount higher than current law to allow for the credit mechanism to be an adjustment device rather than a revenue loser. For argument’s sake, let’s set the credit equal to 5 percent of the real property taxes paid by the owners. A would be entitled to a credit of $250 against the $5,000 transfer tax, whereas B would be entitled to a credit of $1,200 against the $5,000 transfer tax. It’s not a precise equalizer but it dampens the effect of assessment errors. Whether, and how, the credit should be shared between seller and buyer is open to discussion, though the better position would be to limit the credit to the seller, because the buyer’s real property tax assessment presumably would be more accurate because of the sales price information and presumed re-assessment.

Had it not been for Mr. Neary’s letter and Joshua911’s comment, I very well could have ended up not thinking about the idea of a real property transfer tax credit. For sharing their thoughts, I thank them.

The tax world is interesting. Most of the people who are upset with the complexity of the federal income tax law, and who object to the loopholes and special interest provisions found in it, direct the bulk of their anger at the IRS. At the same time, there is a growing aggregation of individuals who object, not to the administrative agency, but to taxation itself. What harmonizes these seemingly discordant approaches is the tendency of people to lay blame in the wrong place. Congress, not the IRS, is responsible for the complexity and loophole corrosion of the federal income tax. In other instances, however, the governmental institution charged with administering a tax indeed deserves to be the object of taxpayer frustration, and yet too often the agencies deficiencies are conflated with analysis of the tax itself.

When it is time to hand out awards for Most Brazen Tax Administrative Agency, there will be more than a few people ready to nominate Philadelphia’s Board of Revision of Taxes. My commentaries on the flawed property tax assessment system go back almost ten years, beginning with An Unconstitutional Tax Assessment System, and followed by 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, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, and How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, and The Tax Price of a Flawed Tax System. As I easily predicted in the last of those, my commentaries “momentarily” ended. The story continues.

The tale of the BRT has become one of a chess game. After City Council decided to put to the voters a proposal to replace the BRT with two separate agencies, and the Mayor persuaded the BRT to relinquish its property valuation duties and restrict itself to hearing assessment appeals, five members of the BRT sued the City, as reported in this Philadelphia Inquirer story from several weeks ago. This news broke while City Council, the Mayor, and others debate how best to deal with the city’s budget gap. Thus, I wrote:

five board members of the Bureau of Revision of Taxes have sued the City of Philadelphia in an effort to derail the reforms that are underway to give the city the opportunity to fix the real estate tax. The board is trying to remove from the May 18 primary ballot the referendum question that asks city voters to decide if the BRT should be replaced with two new entities. If the board succeeds, the current property tax inequities and inaccuracies will continue. In an atmosphere of political bickering and litigious self-interest disguised as, at best, questionable concerns, what are the chances that the city can fix its tax system so that mayors and city councils need not dabble in soda taxes?

Ideally, the city would fix its property tax system, and then adjust rates as part of the process of balancing a budget. However, so much time was lost with political nonsense while attempts were being made to fix the property tax system that the city has run out of time. Its choices are terrible. Either it magnifies the shortcomings of the real property tax system, or it turns to an unwise, administratively inefficient, and possibly legally flawed tax on sugared beverages. It faces this brutal choice thanks to decades of political patronage run amok. Ultimately, failure to design and properly maintain one tax system has opened the door to another that might be impossible to design and maintain, properly or otherwise. Other jurisdictions, including the federal government, ought to heed this lesson, because the tax price of a flawed tax system is orders of magnitude higher than the cost of fixing the flawed system before it fails.

It’s no wonder that objections to raising the real property tax rate as an alternative to other proposals, such as the soda tax, the trash pick-up fee, and changes in the business privilege tax, on which I commented a few days ago in Don’t Like This Tax? How About That Tax?. Why expand something that isn’t working well? The city is between a rock and a hard place, and in no small measure due to the antics of the BRT.

Not satisfied with suing the city to prevent the reform plans from moving forward, the BRT chose to let its agreement with the Mayor to relinquish its property valuation duties expire. According to this story, in what was described as a “surprise,” the BRT decided to take back control of the property assessment process, while continuing to hear assessment appeals. The Mayor’s office claims that there had been a “verbal agreement to extend the memorandum of understanding” that had been signed six months ago. From the Mayor’s perspective, the BRT members acted to preserve the $70,000 salaries they receive for their part-time jobs. This is where the chess game analogy provides some guidance. It has been suggested that if the BRT continued to acquiesce in letting Richard Negrin, a mayoral appointee, run the assessment process, it would weaken its position in the lawsuit, because entering into and continuing to abide by the memorandum of understanding would make it easier for the city to argue that the BRT should be estopped from arguing that its existence is essential to administration of the property tax system, and from arguing that the city has no power to interfere with the BRT. But even if the BRT loses its lawsuit, until the reforms are approved by voters and put into place, the BRT could cause all sorts of problems. For example, it could reverse the freeze on property assessments that Negrin had declared shortly after taking over supervision of the assessment process. The BRT, however, seems unfazed by the fact that the judge who is involved in appointing people to the board, and the City Council member who is leading the effort to increase property taxes in lieu of trash pick-up fees, both roundly criticized its decision. It also appears that, because Negrin chose not to continue supervising day-to-day operations considering the BRT’s action, the BRT has no one exercising managerial control over its employees. Negrin noted that the BRT’s action undercut the progress he had made in getting BRT employees to “embrace” the change he was trying to bring to the “culture and performance of the agency.” According to Negrin, the BRT is “paralyzed now.”

Of course, these antics by the BRT brought a response from the mayor. According to a Philadelphia Inquirer story two days ago, the mayor announced that “he and City Council would immediately attempt to slash their salaries and seize control of their budgeting authority.” That the mayor is angry is apparent from his choice of words. He called the BRT “a rogue board,” and likened them to “pirates.” Claiming that the BRT “appears to be out of control,” and that it is exhibiting “behavior [that ] is bizarre, … irresponsible, … irrational,” and that “undermines our reform efforts,” the mayor is requesting that those $70,000 salaries be reduced to the state law minimum of $18,000. The mayor has other plans, which he did not disclose, to try to convince the BRT to renew the memorandum of understanding. The member of City Council who sponsored the legislation that put the BRT’s future in the hands of the voters has promised to “assist the mayor in reminding [the BRT] that it is City Council and the mayor that make the rules, and the BRT that follows them.”

When a tax agency behaves as does the BRT, not only butchering its responsibilities to assess properties fairly and sensibly, but also plays all sorts of games trying to hang onto power that arises from political patronage, it is difficult for those who defend the existence of taxes to justify calls for compliance when the administrative agency performs and behaves so badly. This is an instance where, however one views the property tax in terms of where it fits on the spectrum of efficient and fair taxation, the flaws arise from the BRT’s inability and refusal to do what the law commands it to do. The backlash among voters against the BRT can too easily become a backlash against taxation. Though the mayor and City Council finally are dealing with the problem, it comes very late in the game, decades and decades after the seeds of inefficiency, irregularities, and incompetence were sown. Legislatures not only need to produce tax laws that are efficient and fair, they also need to set up tax administration that is efficient and fair. One without the other is a recipe for disaster. Just as a bad tax can doom administration of the tax, bad tax administration can doom a tax. Philadelphia has become an object lesson for this proposition.

Philadelphia’s struggles with finding the best way to raise revenue have become even more complicated as another possibility has been tossed onto the table. Several weeks ago, in Picking a Tax Not So Easy, I described the challenges raised by a City Council member’s proposal to raise property taxes rather than enact the so-called soda tax and the proposed trash pick-up fee. Now, according to this Philadelphia Inquirer report, two other City Council members floated a proposal to revamp the city’s business privilege tax. Details are scant, so it’s unclear precisely what the proponents plan to suggest.

The business privilege tax is a strange sort of tax, unfamiliar to most taxpayers other than those doing business in Philadelphia or any other location that has a similar or identical levy. One must wonder, with cities like Philadelphia trumpeting the need to encourage businesses to locate within their boundaries because they bring jobs, why a government would tax a business for the “privilege” of bringing to the government what the government wants and needs. The business privilege tax, at least in Philadelphia, is computed in a manner that suggest the business is being charged for the opportunity regardless of how it turns out. The Philadelphia business privilege tax equals the sum of two amounts. The first equals 0.14 percent of gross receipts. The second equals 6.45 percent of profits. Thus, a business that fails to make money nonetheless is taxed. A business with high gross receipts and high cost of goods sold, thus incurring a low gross profit percentage and profits that are a small fraction of sales, pays a disproportionately higher tax, when compared to profits, than does a business with a high profit margin. For example, a grocery store that has $100 of sales receipts, $95 of cost of goods sold, and $4 of operating expenses, thus making $1 of profit, would pay a business privilege tax of 20.45 cents (0.14 percent of $100 plus 6.45 percent of $1). A law firm with $100 of sales receipts and $60 of operating expenses, would pay a business privilege tax of $2.72 (0.14 percent of $100 plus 6.45 percent of $40). As a percentage of profits, the grocery store’s business privilege tax is 20.45 percent (20.45 cents out of the $1 profit). For the law firm, it is 6.8 percent ($2.72 out of $40). Something’s not quite right when the business with 40 times as much profit pays at a rate that is less than 1/3 the rate paid by the other business. Is it any wonder there are few grocery or similar stores in Philadelphia?

The proposal to change the business privilege tax is to repeal the net income component and to increase the gross receipts component. Though it’s unclear by how much the gross receipts percentage would need to be raised to offset the loss of the business profits component and to raise the additional revenue that the city needs, let’s take a wild guess and assume it would need to be raised to 1 percent. What does that do to the grocery store and the law firm? Both would face a tax of $1. For the law firm, this would reduce its business profits tax from $2.72 to $1, and reduce the tax as a percentage of its $40 profit from 6.8 percent to 2.5 percent. For the grocery store, it would increase its business profits tax from 14 cents to $1, and would increase the tax as a percentage of its $1 profit from 20.45 percent to 100 percent. The proposed change would drive every business with a low gross profit margin out of the city. I wonder what that would do to tax revenue.

Conventional wisdom, we are told, is that the gross receipts component of the business privilege tax curtails or eliminates job creation. Of course it does, because when those low-gross-profit-margin enterprises leave, they take their jobs with them. The City Council members advocating the change claim that their idea would “help small businesses, since the majority of their tax liability is on the net-income side.” If by small business, they mean those with low levels of sales, but high profit margins, they may be correct. I wonder, though, how many businesses with low levels of sales, particularly during this economic downturn, have high profit margins. I suspect that the businesses standing to gain from the proposal are those with very high net profit margins, many of which are unlikely to be found among small businesses.

All of this may be moot, because it would be a major challenge to rewrite the business privilege tax law in time for adoption of a budget. That obstacle, though, assumes a budget adopted in time. One must also wonder whether that will come to pass.

Every proposal that has been advanced has been criticized, opposed, and attacked by one or more constituencies, organizations, special interest groups, or commentators. The soda tax proposal has been ripped apart by almost everyone despite a few supporters hanging on to the idea. I joined in lambasting the idea, both on this blog, in Yes for The Proposed User Fee, No for the Proposed Tax, and in a Philadelphia Inquirer editorial. Administration of Philadelphia’s property tax, including property valuation, is in such disarray that even those who propose raising the property tax rate concede that it’s a far from ideal solution. The trash pick-up fee, which I endorsed in Yes for The Proposed User Fee, No for the Proposed Tax, has just about no support in City Council, even though a few people continue to explain the economic, environmental, and political benefits of a per-bag user fee.

If nothing else, perhaps Philadelphia could invite economists, college students, people living in other parts of the nation, members of Congress, tax lawyers, lobbyists, and anyone else interested in, or having a need to learn about, tax policy to come watch City Council debate the revenue issue. Perhaps City Council could charge an admission fee. At $10, it would be worth it for attendees, for it would provide an insight into tax policy development in a real world setting rather than in an isolated and theoretical think tank seminar room. To make it worthwhile for the city, the focus would need to be on high volume attendance, not unlike how those grocery stores and similar establishments try to make money when the gross profit percentage is so low. The odds of City Council going this route are lower than those low gross profit percentages. The odds of City Council coming up with a tax or fee, or some combination, that does not upset a majority of the city’s population, are even lower. Zero, perhaps.

The Washington Post ran another of its polls last week. Question 4 asked, “Do you approve or disapprove of the way the U.S. Congress is doing its job? Do you approve/disapprove strongly or somewhat?” Of those who responded, 54 percent strongly disapproved, and 18 percent somewhat disapproved, for a net total of 72 percent disapproving of the way the Congress is doing its job. Only 24 percent approved, but only 7 percent of respondents strongly approved. There was a small holdout of 4 percent who had no opinion. The disapproval rating is the highest since 1994, when Congress also earned a 72 percent disapproval rating. On several polls in 1992, disapproval ratings of how Congress was doing its job reached the upper 70s. Nothing in the poll suggests that voter approval of the job Congress does with taxes is any different from the overall rating; though a question about taxes was asked, it focused on perceived political party capability and not the Congress.

What is shocking to me isn’t the high disapproval rating, or the fact that it’s the highest in 16 years (or 18 years, depending on how one treats ties). What’s shocking is that a quarter of the respondents approve of the job Congress is doing. It would be much less shocking to me had the approval rating been in single digits. Whether it is tax policy, the implementation of health care reform, immigration laws, whatever it is that Congress handles ends up coming out far less polished and ready for implementation than it ought to be. Members of Congress are too busy being politicians to find time to be legislators. Could it be that the 24 percent who approve of the job Congress is doing admires its work as a body of collective politicians? I doubt it.

After some thought, it occurs to me that perhaps the poll results aren’t all that shocking. Approximately half of the population eligible to vote sits out, on average, most elections. Though there are many reasons for their non-participation, these folks are so unenthusiastic about the electoral process and so dismayed by the poor quality of politicians’ work product that they almost certainly do not approve of the job Congress is doing. So of the 72 percentage points racked up on the disapproval side, one can estimate that roughly 45 are attributable to this segment of the citizenry (after attributing the 4 percent with no opinion as most likely coming from this group). That leaves the half of the electorate that voted. On average, despite some landslides, slightly less than half of these people, give or take, voted for the winner. So perhaps another 20 percentage points in the disapproval column can be attributed to supporters of the candidate who lost and who are not about to check the approval box for a Congress in which sits someone who vanquished their candidate. The rest of the 72 percent probably comes from people who have come to realize that the person for whom they voted turned out not to be what they thought the person would be. What that tells me is that most, if not all or nearly all, of the 24 percent who give a positive approval rating to Congress, though most of them being rather lukewarm about it, are supporters of the successful candidate. Their loyalty, whether based on unbiased evaluation, on self-interest, or on gratitude for special interest accommodation, would explain how Congress manages to get an approval rating several times what I think it would be.

This sort of analysis also explains, I think, another phenomenon. Even though three-quarters of the electorate doesn’t approve of the job Congress is doing, voters keep sending the same people, or their clones, back to the Congress. Incumbents win re-election far more often than they should, considering the low quality of the legislative output that Congress bestows on the nation. The traditional explanation, that people dislike Congress but think their Senators and their representative are magnificent, might not be the answer. The answer might be that to be elected or re-elected, a candidate must obtain the votes of roughly 25.1 percent of the electorate. With roughly half the eligible voters sitting out, electoral choice boils down to a battle over a much smaller pool of voters. So we end up with a Congress that represents roughly one-fourth of the nation, the one-fourth that appears to be supportive no matter what sort of job Congress does. Perhaps treating abstentions as no votes, and requiring a majority of eligible voters to be elected, would solve that problem. Yet it would create another. Hardly anyone would get elected, and the growing fragmentation of the country would be highlighted if not accelerated.

There’s just something about hypocrisy that disgusts me. That’s a problem I’ve had all my life. I’ve lost count of the number of times I’ve offended, annoyed, or even angered someone by telling the truth rather than shoveling out some “spin” to make things seem better than or different from what they are. That’s not to say I’ll breach a confidence, because it’s no lie to tell someone that one has no comment or cannot discuss a matter. I suppose all of this is a reflection on having been raised under rules that set the penalty for lying about something several orders of magnitude above the punishment for the commission or omission under about which I was being questioned.

Hypocrisy isn’t just a matter of saying one thing to one person and the opposite to another, when only one can be true. Hypocrisy, like lies, can involve not only words but deeds. And what has annoyed me this time around are the small bits of information in a New York Times article about Tea Party activists. Keep in mind that the Tea Party membership stands for the proposition that government should be small, perhaps even so small as to disappear, and that taxes should be reduced, if not eliminated. Consistency, the virtue that negates hypocrisy, suggests that Tea Party activists would not clamor for nor accept government benefits financed with those taxes they so hate and sometimes don’t even pay.

Mentioned in the article is one Tea Party activist who did not hesitate to ask his Congressman for help in getting government health care when he lost his job. The article notes that “The Tea Party vehemently wants less [government involvement] though a number of its members acknowledge that they are relying on government programs for help.” In defense of their willingness to feed from the hand of the government that they want to stop providing benefits, members of the Tea Party claim that when they “receive government benefits like Medicare and Social Security,” they are “getting what they deserve” because “they paid into those programs.” Nonsense. Other than those who die prematurely leaving no one to take survivor benefits, most Social Security recipients receive far more than they put into the system. For decades, that has been possible because more money was being put into the system than was being paid out, with the surplus used to finance deficits in the federal budget. Similar analyses, though on a different time line, applies to Medicare. There’s something bogus about using the “what [we] deserve” argument while objecting to government programs that assist others who have paid their taxes, perhaps even quietly and without loud protest, over the years.

Whatever one might think of the person who withdraws from society, refuses to pay taxes, doesn’t apply for government benefits, and holes up in some remote cabin, at least that person isn’t campaigning against the very government and very tax system that the person is using to the person’s advantage. Granted, even the rebellious hermit benefits from the government to the extent the remote cabin is protected from attack by a foreign nation, and government-enforced clean water laws make it possible for the fish that the hermit catches to thrive and not sicken the hermit. But the audacity of those opposed to government benefit programs who eagerly take whatever they can get, even if it exceeds what they “paid in,” can be explained only by the unspoken underlying motivation. “Don’t tax you, don’t tax me, tax the man behind the tree” has evolved into “Don’t cut my dole, put it in my hand, cut off benefits to the folks we can’t stand.” As the writer of the New York Times article put it: “[This Tea Party member] and others do not see any contradictions in their arguments for smaller government even as they argue that it should do more to prevent job loss or cuts to Medicare. After a year of angry debate, emotion outweighs fact.“ Indeed, it is a matter of emotion pushing aside reason, overwhelming education and analysis, and fueling irrationality, all symptoms of a deeper hypocrisy.

Here’s the irony. One Tea Party activist was quoted as saying, “If you quit giving people that stuff, they would figure out how to do it on their own.” If that’s the case, why don’t the Tea Party activists who are collecting government benefits teach by example? Why don’t they refuse to apply for or collect these benefits and show the rest of us “how to do it on their own.”? The answer is simple. They can’t. It would expose the core flaw in their approach. So long as they can take on the one hand, and object to giving with the other, they can live the “take without giving” philosophy that has increasingly come to dominate society. Somewhere along the line they didn’t learn that nothing, individual or societal, survives if “take without giving” dominates.

What if they gave a tea party and no one brought any tea, sugar, cups or spoons?

It seems I’m not the only one wondering how the IRS is going to administer the additional responsibilities foisted on it under the health care legislation. In addition to my position that responsibility belongs elsewhere, as discussed in IRS Ought Not Be the Health Care Enforcement Administrator, there also is my concern about the impact on the IRS and the tax law of relying on the wrong agency to deal with the reporting and insurance purchase requirements, as discussed in Health Care: Enlarging the Code and Stressing the IRS. Now, from a long-time reader of MauledAgain, comes another practical problem.

According to this reader, the system put in place by the legislation to enforce the health care insurance purchase requirement is deeply flawed, for reasons that have little to do with the selection of the IRS as the administering agency. I agree with my reader. The problem is best illustrated by an example, and I’ll use the one my reader shared. X is a healthy, 25-year-old individual who does not have health insurance in year 1. Though my reader asks, “When is that reported to the IRS?,” it seems to me that it’s not. Instead, the IRS will need to figure out that X exists, and that no one has filed any information returns with the IRS indicating that X is covered by a health insurance plan. Those information returns are due early in year 2. So the question should be, “When does the IRS figure out that X does not have health insurance for year 1?” My reader suggested that the answer to his question is “Sometime late in Year 2 (or later)?” I think that the answer to the question as I formulate it is “Perhaps late in year 2, but more likely, during year 3.” The IRS notifies X, and demands payment. If X has an income tax refund in the works, the IRS can divert some or all of it to payment of X’s year 1 penalty for not having health insurance coverage. As an aside, I suspect this puts X on the “watch out for this person” list and might speed up the process when year 2 comes to a close, and during year 3 the IRS figures out who did not have health insurance coverage for year 2. But if X does not have an income tax refund in the works, what does the IRS do? As pointed out in Health Care: Enlarging the Code and Stressing the IRS, the IRS is not permitted to file a lien against X’s property or to pursue a levy on X’s wages or other income.

Now, continuing with the example, let’s turn to X’s perspective. At the beginning of year 1, or at some time before year 1, X faced a choice. Purchase health insurance or don’t purchase health insurance coverage. To purchase the health insurance, X would be required to pay something in the vicinity of $5,000, which is the average cost of coverage for an individual. The odds of X needing health care, in X’s mind, are surely very low. Actually, even though healthy, X does need preventative care, such as teeth cleaning, eye exams, and a general physical check-up. Those services won’t come close to costing $5,000. So, from X’s perspective, most of the $5,000 premium is the cost of getting coverage for some extraordinary health problem. X probably has some medical coverage on his auto insurance policy, which deals with the most likely cause of X needing serious medical attention during year 1. On the other hand, from X’s perspective, failure to purchase health insurance coverage poses two risks. One is that the IRS figures out that X does not have coverage, and if caught, X is subject to a penalty that starts at $95 and eventually reaches $750. Even if there is a 50 percent chance of X getting caught – there is, after all, a bit of an “audit lottery” at play here – it still is much less a price than the health insurance premium. The other risk to X is that if X does need medical care, X shows up at the hospital as an uninsured individual. Under existing law, which remains unchanged, X cannot be denied emergency care. And, at this point, X will purchase health insurance coverage, but because the law prohibits insurance companies from denying X on account of an pre-existing condition – whatever it is that brought X to the hospital – X can now obtain coverage without paying the premiums for earlier years.

So, as structured, the new legislation encourages healthy young people to continue on their pattern of not purchasing health insurance coverage. It might even encourage those who had been purchasing coverage to stop, because there is so little incentive to purchase the coverage. Even older people who seem, at least to themselves, to be healthy will find it tempting to play the health care coverage purchase lottery that they cannot lose but for one caveat. If someone playing this game also foregoes self-financed checkups, they may end up with a serious health problem, even death, from a condition or disease that could have been treated easily had it been caught sooner. But one can play the health care insurance coverage lottery without giving up on preventative check-ups. One supposes that free blood pressure, diabetes, eyesight, hearing, and other screenings will continue to be available.

In the meantime, Congress has concluded that by having the IRS determine who is not covered and billing them for some amount ranging from $95 to $750 will encourage everyone to acquire health insurance coverage. Congress needs to sit through a course in economics, a course in statistics and probability analysis, and a course in health care management, with an exemption only for members of Congress who can prove they have degrees in these areas. A sensible incentive is a penalty equal to some sort of average health care coverage premium, provided that the penalty is enforceable in ways that make it likely that it will be collected. The proceeds collected by enforcing the penalty should be transferred into a fund available to health care providers and insurers, including the Medicare and Medicaid systems, that are paying for the care of uninsured individuals. Otherwise, the entire enforcement structure set up under current law is, as my reader notes, “a fool’s errand.”

Here’s the irony. If the people protesting the health care legislation realized how toothless it is, they wouldn’t be investing so much energy into trying to kill a paper tiger. Of course, the health care legislation is nothing more for those folks than a surrogate for the true object of their intense anger. Purposeful anger would be better directed at a Congress that has enacted something other than what is advertised to be, namely, legislation that will reduce health care costs. To accomplish that goal, one does not vote for a bill that makes it so easy to continue decisional behavior that has contributed to the health care crisis. Americans deserve better, but asking Congress to get it right might be asking too much.

The ongoing battle in New Jersey with respect to taxes and state spending is heating up, providing lessons in tax policy not only for students in a tax course but also for citizens generally. In November, after a candidate promising tax cuts won the gubernatorial election, I noted in New Jersey to Follow in California’s Tax Footsteps? that in order to keep the tax-cut promise, the new governor would be compelled to cut back on state services. I also predicted that his election did not guarantee tax cuts because the legislature would have a say in what happened. Not surprisingly, the early stages of this highly-charged debate is playing out as expected.

The governor proposed a bundle of tax cuts, which drew my attention in Tying Tax Revenue to Voter Responsibility. I pointed out the inconsistency between the desire for reduction or elimination of taxes with the desire for maintained or expanded state services. This syndrome of wanting something for little or nothing had been the subject of a poll that I discussed in Poll on Tax and Spending Illustrates Voter Inconsistency. It was inevitable that the pressure for tax reduction would collide with the pressure for government services.

According to a Philadelphia Inquirer report, New Jersey’s legislature, controlled by Democrats, has told the Republican governor that it will not approve the proposed budget unless the state income tax continued to include three tax brackets applicable to taxable income exceeding $400,000. Those brackets were enacted last year, effective for 2009. The governor has promised a veto of any legislation that maintains the higher tax rates on incomes exceeding $400,000. The highest of the three brackets applies to taxable income exceeding $1 million.

The first lesson involves the semantics that get tossed about when dealing with taxes. Should failure to reduce a tax be called a tax hike? Should extension of an existing tax be called a tax hike? The answer depends on the baseline. Should a proposed tax rate for 2010 be compared to 2009? To 2010 as it would exist if 2009 had not existed? To 2008?

The second lesson involves the susceptibility of voters to campaign rhetoric. How many people in New Jersey are subject to the tax brackets applicable to incomes exceeding $400,000? Not very many. How many people oppose those tax brackets? Enough to have elected a tax-cut advocate as governor. Considering that failure to maintain those tax brackets means $800 million to $1 billion in cuts to education funding, assistance for the needy, and other public services, and that those programs benefit most people, why are people voting for a philosophy that benefits the wealthy and jeopardizes the poor and middle class? Some of the staunchest defenders of low taxes for the wealthy do not come from the ranks of the wealthy but from those who face increased burdens – in the form of higher taxes, increased government debt, or reduced government services – in order to pay the price of those low taxes for the wealthy. I suspect that most people see themselves as being wealthy some day and want to make certain that the tax-comfortable environment now in place remains in place when they arrive. Unfortunately, so few will attain that status that it’s the equivalent of using lottery-playing rationale to determine tax policy.

The third lesson involves the distributive nature of tax cuts. Is the governor’s objective simply the reduction of state revenue by $800 million to $1 billion? Or is the governor’s objective the reduction of taxes on the wealthy? If his objective is the first, why not reduce income taxes for the middle class? The argument that the wealthy pay a substantial portion of the income tax is the most frequently offered justification for cutting taxes on the wealthy. Using data from the federal income tax, which is a progressive tax not unlike the New Jersey income tax and because comparable information about the New Jersey income tax isn’t readily available, it is clear that the wealthy are not over-taxed. For example, although it is true that the share of income tax paid by the top 1 percent of income earners increased from 37.42 percent in 2000 to 39.89 percent in 2006 (the latest year in the information), it is important to note that the top 1 percent’s share of total adjusted gross income increased during the same period from 20.81 percent to 22.06 percent. What gets overlooked is the fact that the top 1 percent’s share of national income continues to increase. That means that the bottom 99 percent’s share has decreased. The same trends apply to the top 5 percent. Yet, a Tax Foundation blogger puts focus on the fact that the tax burden of the top 1 percent exceeds the tax burden of the bottom 95 percent, and points out that 20 years ago, the bottom 95 percent paid a larger share of total federal income taxes. According to the same federal income tax data, the bottom 95 percent’s share of adjusted gross income fell from 75.89 percent in 1986 to 63.34 percent in 2006. Of course the bottom 95 percent’s tax burden will decrease as a percentage of the whole if the bottom 95 percent earn a smaller share of national income. The logical corollary is that the top 1 percent’s share has increased at the expense of the bottom 95 percent, yet the top 1 percent, or more precisely, people not in the top 1 percent but advocating on behalf of that group though belonging for the most part to the bottom 95 percent, object to, or at least complain about, the increase in tax burden that goes along with increases in income. If the numbers can be ascertained, it is almost certain that the same phenomenon holds in states with nominally progressive income taxes, such as New Jersey. Interestingly, according to Ira Stoll, some prominent economic and tax policy experts and political advisors, characterized as “center-right” are “signaling openness to federal tax increases,” suggesting that at least some lessons are slowly being learned, unless the they are envisioning tax increases on the poor and middle-class.

The fourth lesson involves lessons. If people understood tax law and tax policy as it needs to be understood, there would be a lot less success by those who take advantage of the public’s ignorance about taxation. People need to learn about tax law and tax policy, but the opportunities to do so are limited. Though there are courses and other educational programs designed for tax professionals and those learning to be tax professionals, there’s almost nothing in place for those who do not want to be experts but need to know something. Where are the K-12 tax courses, particularly in publicly-funded schools, considering that one justification for a system of public education is to nurture an informed electorate? Is it ironic, accidental, or deliberate that when it is time to cut spending, many politicians and governments, joined by a chorus of badly informed taxpayers, call for reductions in education? Is it any wonder that students in many other nations out-perform American school children? Though calls for improvement in reading, arithmetic, history, and other typical subjects get attention, has anyone figured out that so long as the politicians keep Americans in the dark with respect to taxation that it is easier for them to manipulate the masses? As I pointed out in Tax Illiteracy as a Threat, a gleam of hope can be found in efforts such as Prof. Marjorie Kornhauser’s Tax Literacy Project, designed, as she puts it, to “use popular media to informally educate young adults about basic aspects of taxation.”

So, however the situation in New Jersey plays out, people throughout the country will have the opportunity to learn about tax law and tax policy. How many choose to take advantage of that opportunity remains to be seen.

Earlier this week, in IRS Ought Not Be the Health Care Enforcement Administrator, I criticized the Congress for dumping onto the IRS the responsibility for administering the requirement that all individuals, save for a few who area within very narrow exceptions, be covered by, or purchase, health insurance. Now that the bill has been signed into law, it’s worth exploring in more detail the scope of this responsibility.

Section 1502 of the Patient Protection and Affordable Care Act adds a new section to the Internal Revenue Code. Section 6055 requires every person “who provides minimum essential coverage to an individual during a calendar year” must file an information return. Ths return must contain the “name, address and TIN of the primary insured and the name and TIN of each other individual obtaining coverage under the policy,” the dates during which those individuals are covered, and if the minimum essential coverage includes health insurance coverage, information on its status as a qualified health plan offered through an exchange and the amount of any advance payment of any cost-sharing reduction or premium tax credit. The return must also include “such other information as [it] may require.” If the minimum essential coverage is provided through an employer, then the return must also include “the name, address, and employer identification number of the employer,” the portion of the premium paid by the employer, and information with respect to the plan’s status as a qualified health plan offered through an exchange, and whatever other information the IRS requires to deal with the new section 45R credit for employee health insurance expenses of small employers. Without getting into a detailed discussion of what terms such as “minimum essential coverage” and “qualified health plan” mean, it’s easy to see that not only must providers generate more reports, the IRS is going to be receiving many more mailbags or email arrivals once this requirement goes into effect. Who is going to sort through this? Who is going to figure out what to do with the information and how to match it up against some sort of list of the nation’s citizens to see who is and is not mentioned on one or more of these returns. The new section 6055 requires that any individual whose name must appear on one of these returns must be given a statement showing the information on the return that pertains to the individual, together with “the phone number of the information contact” for the person filing the information return.

Section 1502 also amends existing Code provisions. It amends section 6724(d)(1) and (d)(2) to include the required returns within the section 6721 penalty for failure to file correct information returns, and the section 6722 penalty for failure to furnish correct payee statements. The first penalty is $50 per return, capped at $250,000 for any one calendar year. The second penalty is $50 per statement, capped at $100,000 for any one calendar year. Both penalties are subject to a variety of exceptions, increases in the event of intentional disregard, and reductions if corrective action is taken within a specified time. Without getting into the details, the point is that the IRS will need resources to sift through returns, and through data that reveals that returns and statements were not filed, in order to determine whether an penalty applies, to assess the penalty, and to deal with the inevitable appeals and other dispute resolution procedures.

Section 1502 also requires the IRS to send a “notification to each individual who files an individual income tax return and who is not enrolled in minimum essential coverage.” That’s more work, and given the condition of the IRS computer system, the answer isn’t the glib “let the computer do it” response. IRS employees will need to invest substantial hours in designing programs and setting up database entry systems to deal with this task.

Section 1514 of the Act also adds a new section to the Code. Section 6056 requires every “applicable larger employer required to meet the requirements of section 4980H with respect to its full-time employees” to file an information return. This return must contain the “name, date [address?], and employer identification number of the employer,” along with “a certification as to whether the employer offered to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan,” and information with respect to that opportunity and the plan. The return must also include information with respect to the employees, including the “number of full-time employees for each month” of the year, the “name, address, and TIN of each full-time employee,” and whatever other information the IRS might require. So hiring or finding employees to handle the information flowing in under section 6055 won’t be enough, because section 6056 will cause that inflow to increase significantly. Keep in mind that there will be individuals for some months are included on returns filed under section 6055 but who, after changing jobs, will end up on returns filed under section 6056. Following the same pattern as section 6055, section 6056 requires that any employee whose name must appear on one of these returns must be given a statement showing the information on the return that pertains to the employee, together with “the phone number of the information contact” for the person filing the information return.

Section 1514 also amends existing Code provisions. It amends section 6724(d)(1) and (d)(2) to include the required returns within the section 6721 penalty for failure to file correct information returns, and the section 6722 penalty for failure to furnish correct payee statements. The first penalty is $50 per return, capped at $250,000 for any one calendar year. The second penalty is $50 per statement, capped at $100,000 for any one calendar year. Both penalties are subject to a variety of exceptions, increases in the event of intentional disregard, and reductions if corrective action is taken within a specified time. Without getting into the details, the point is that the IRS will need resources to sift through returns, and through data that reveals that returns and statements were not filed, in order to determine whether an penalty applies, to assess the penalty, and to deal with the inevitable appeals and other dispute resolution procedures.

Section 1513 of the Act adds yet another new Internal Revenue Code provision. Section 4980H imposes “an assessable payment” on “any applicable large employer” that “fails to offer to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan . . . and . . . at least one full-time employee of the applicable large employer has been certified to the employer . . . as having enrolled . . . in a qualified health plan with respect to which an applicable premium tax credit or cost-sharing reduction is allowed or paid with respect to the employee.” The assessable payment equals the applicable payment amount multiplied by the number of the employer’s employees. Another assessable payment is required if the employer has a waiting period exceeding 30 days, and this one is a fixed amount based on the length of the waiting period. Yet another assessable payment is imposed if the employer “offers to its full-time employees (and their dependents) the opportunity to enroll in minimum essential coverage under an eligible employer-sponsored plan . . . and . . . one or more full-time employee of the applicable large employer has been certified to the employer . . . as having enrolled . . . in a qualified health plan with respect to which an applicable premium tax credit or cost-sharing reduction is allowed or paid with respect to the employee.” This payment equals the applicable payment amount multiplied by the number of the employer’s employees, multiplied by 400 percent. Without getting into the definitions of applicable payment amount, applicable large employer, the exemptions for certain employers, the determination of whether an employee is full-time, and other issues, it is clear that the IRS will need yet more resources to determine if one or more of the assessable payments should be imposed. Section 4980H provides that the assessable payment “shall be paid upon notice and demand by the [IRS], and shall be assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68.” Subchapter B of section 68 includes sections 6671 through 6720C, which cover several dozen penalties. Section 6671 states that the “penalties and liabilities provided by this subchapter shall be paid upon notice and demand by the [IRS], and shall be assessed and collected in the same manner as taxes.” Once someone determines that assessable payments should be imposed, even more resources will be required to send the notice, demand payment, initiate collection procedures, deal with appeals, and litigate penalties that the taxpayers decide to challenge in court.

There’s more. Section 1501 of the Act adds a still another new Internal Revenue Code section. Section 5000A imposes a penalty on any “applicable individual” who, for any month, fails to ensure that the individual, and any dependent who is an applicable individual, is covered under minimum essential coverage for that month. The penalty “shall be included with the taxpayer’s [income tax] return . . . for the taxable year which includes such month.” The penalty for each month equals 1/12 of the applicable dollar amount for the calendar year. That amount phases in, starting at $95, until it reaches $750. There is a special rule for individuals under the age of 18. For taxpayers responsible for more than one individual, the penalty is capped at 300 percent of the applicable dollar amount. There are five categories of individuals who escape the penalty, including those who cannot afford coverage, taxpayers with income less than the poverty line, members of Indian tribes, individuals who fail to have coverage for short gaps, and those who can demonstrate hardship. The definition of applicable individual reaches all individuals other than those satisfying a religious exemption exception, those who are in the country illegally, and those who are incarcerated. Without getting into a detailed discussion of the scope of these various exceptions, and without getting into a closer look at the definition of minimum essential coverage, it is clear that the IRS will need even more resources to determine if an individual should be subject to the penalty. It will need to match information on the returns filed under section 6055 and section 6056 with returns that are filed, and somehow deal with matching information with respect to individuals not required to file returns to ascertain whether the penalty should apply. It is going to be a complicated endeavor.

Section 5000A also provides that the penalty “shall be paid upon notice and demand by the [IRS], and except as provided in paragraph (2), shall be assessed and collected in the same manner as an assessable penalty under subchapter B of chapter 68.” Subchapter B of section 68, as noted above, includes sections 6671 through 6720C, which cover several dozen penalties. Section 6671 states that the “penalties and liabilities provided by this subchapter shall be paid upon notice and demand by the [IRS], and shall be assessed and collected in the same manner as taxes.” It’s the exceptions in paragraph (2) that demand attention. The first exception states that “[i]n the case of any failure by a taxpayer to timely pay any penalty imposed by this section, such taxpayer shall not be subject to any criminal prosecution or penalty with respect to such failure.” Wow. So what happens when people come up with ways to make it appear that they have coverage when they don’t, such as having their names falsely included on information returns or through some other deceptive means? The second exception provides that the IRS shall not “file notice of lien with respect to any property of a taxpayer by reason of any failure to pay the penalty imposed by this section,“ and the third exception provides that the IRS shall not “levy on any such property with respect to such failure.” So when the IRS does get around to determining that someone is subject to the penalty, what does it do after it sends notice and demands payment if the taxpayer fails to pay? Presumably it can let the matter work itself out in the judicial system, but isn’t that inefficient? What’s the point of imposing a requirement, putting enforcement responsibility in the hands of a federal agency, and then restricting the agency’s ability to enforce the requirement?

These aren’t the only responsibilities imposed on the IRS by the Act, nor are they the only additions to the Code. They simply are some of the highlights of what Congress wants the IRS to do, enough to give some sense of the wide scope of the additional work that the IRS must undertake. It is essential to understand that unlike the enactment of a new credit that might apply to one percent, five percent, or even 15 percent of the taxpaying public, these are provisions that apply to all, or almost all, individuals, and to all, or almost all, employers. It’s equivalent in some respects to doubling the IRS workload.

Aside from the inappropriateness of dumping all of this responsibility on the IRS, rather than, for example, HHS, there is the more serious question of whether Congress will authorize the IRS to spend additional money to hire and train new employees, to train existing employees who are transferred from tax work to health insurance enforcement work, to hire and train replacements for those employees, to purchase or develop additional computer hardware and software, to obtain assistance in re-tooling systems to deal with the flood of information returns under sections 6055 and 6056, and to find space in which to house all of the additional employees, computer hardware, and other resources required to comply with the Congressional mandate that the IRS become the Health Insurance Enforcement Agency. Considering the IRS-as-enemy mentality among so many on Capitol Hill, who take that position because it can generate votes on election day, is it unreasonable to worry that the IRS will find itself trying to do more with the same, or even fewer, resources? Will it then cut back on tax compliance enforcement in order to handle health insurance enforcement? Will that not have an adverse effect on federal revenues? Does the Act contain within itself the seeds of its own failure? Only time will tell.