MauledAgain

Last week, in So Where Have the Tax Reductions Gone?, I focused on the fact that federal tax receipts, as a percentage of gross domestic product, had fallen to a 60-year low of 14.8 percent. As recently as 2008, the share had been 17.5 percent.

Now comes news that the Administration’s proposed budget would generate a deficit of $1.65 trillion, roughly 10.9 percent of GDP. That would be the highest since 1945, when it reached 21.5 percent of GDP. In 1945, the nation was at war, a war that was declared and a war that was financed, to the fullest extent possible, by taxation representing increases over pre-war levels.

Slightly different numbers emerge from other analysts. For example, the US Government spending web site puts the 1945 deficit as 24.07 percent of GDP, following 1944’s 22.35 percent and 1943’s 28.05 percent. During those same years, according to another chart on that site, government spending as a percentage of GDP during 1943 through 1945 amounted to 46.68, 50.02, and 52.99 percent of GDP. Rough computation tells us that tax receipts accounted for the difference. Thus, in those three war years, taxes represented 18.63 percent, 27.67 percent, and 28.92 percent of GDP.

Comparing those war year numbers with the current situation, using the Administration’s budget as the benchmark, taxes represent 14.8 percent of GDP, spending represents 25.7 percent of GDP, and the resulting deficit constitutes 10.9 percent of GDP. Do these numbers suggest that government spending is out of control, as certain segments of the electorate and of the business world contend? Hardly. Considering that the nation remains at war, in fact a war fought on at least as many fronts as was the war being waged in the 1940s, it makes sense to compare how responsible politicians managed the economy sixty years ago with how irresponsible politicians manage it today. During the last year of the war, government spending had reached 53 percent of the economy and taxation had reached 28.92 percent of it. Now, spending as a proportion of GDP has been cut by 51.5 percent (53 to 25.7), and taxes by 49 percent (28.92 to 14.8). In other words, both taxes and spending have been cut by roughly the same amount, and yet the anti-tax movement wants even more tax cuts.

What gets little attention in the mainstream media, on most blogs, and from most commentators, especially those supporting further reductions in taxation, is the impact on the deficit of not only the refusal of Congress to raise taxes in time of war, as happened in the 1940s and again in the 1960s, but also its foolish move to reduce taxes during a time of war. Not only did the series of resulting and continuing annual deficits contribute to the total accumulated deficit, the interest payments on those deficits have literally and figuratively compounded the problem. Five years ago, in A Memorial Day Essay on War and Taxation, a commentary which not only I have quoted on several occasions but which has been mentioned occasionally by other commentators far from the mainstream media, I explained why the failure of politicians to demonstrate leadership and ask for sacrifice from all citizens, and not just the dedicated members of the Armed Forces, was unwise and destined to create systemic economic and national security problems for the country:

I wasn't around during the last full-fledged, unlimited global conflict. Yet I've listened to as many tales as were shared with me by those alive at the time as I could find, and I've read and watched a lot. So I've heard and read about rationing, double shifts, postponed plans, substituted products, and sacrifice. Every tax practitioner, and every citizen, should understand that during World War Two income tax rates skyrocketed, wage withholding was introduced, and the entire revenue-expenditure structure was altered. War hung as a cloud over every life, and over every dollar. Is that good? I think so. Why? Because war is so serious and so terminal a course of action that it should not be permitted to recede to the background.

Yet the current global war has not been managed in the same manner. Politicians have chosen to fight without increasing revenue, imposing rationing, or deferring projects and activities. In their defense, they argue that none of these things are necessary, that a nation can have its guns without giving up its butter. I disagree, and I happen to think that politicians are reluctant to do what needs to be done because they are more concerned about maintaining their position in office than in making the tough decisions that war requires. So our national leaders have chosen to put the cost of the current war on our children and grandchildren. Those who decry the huge deficits, triggered in part by war and in part by the almost insane concept of decreasing tax revenues (mostly for the wealthy) during wartime, pretty much focus on the economic impact. They ask if, or suggest that, our grandchildren will be facing income tax rates of 80 percent in order to reduce an unmanageable deficit. I think it will be worse. I think our children and their children and grandchildren will become subservient to our nation's creditors. The sovereignty of the United States of America is far from guaranteed, and is at risk. Were these considerations discussed when those in power decided that war can be done on the cheap?

War cannot be done on the cheap. War is not free. War ought not be purchased on a credit card. War is a national commitment. Hiding the true cost of war in order to influence a nation's willingness to engage in war is wrong. Ultimately, the price to be paid will be dangerously high.

Though sometimes when I re-read things that I have written, especially things written years or decades ago, I recognize where I could have used different words that would have made the piece better. Every once in a great while, I realize that I have changed my mind, or would have presented a different analysis. But every time I re-read what I wrote in A Memorial Day Essay on War and Taxation, I wonder what happened that day. Something inspired me. Something made me deeply concerned and almost angry. Perhaps it was the fact that while Americans were dying, and continue to die, most of the nation was rolling along, almost oblivious to the realities of the world. Something, culturally, is very wrong, and it’s not the efforts of a nation to help those who are in need, which is what some people want to eviscerate as the national price for waging war while lowering rather than raising taxes. Something, morally, also is very wrong. Leadership requires something more than gathering votes by telling people the nation asks less of them. Our parents and grandparents responded unselfishly. Can we not honor them by doing likewise?

Long-time readers of this blog, like my students who paid attention and my friends and colleagues who listened, know that I object to the use of the tax law to promote specific social objectives. For example, why should the IRS be the agency responsible for regulating residential energy-saving improvements, adoption of special needs children, or purchases of fuel-efficient automobiles? Ought not the Department of Energy, the Department of Health and Human Services, and the Department of Transportation be dealing with these matters, if at all? I pointed out the ineffectiveness of this approach in "Professor Maule Goes to Washington" and in Not To Its Credit, among other posts. Now another interesting lesson in the futility of using tax as an economic policy scalpel comes from France.

Pierre Cahuc, of the National Institute of Statistics and Economic Studies National School for Statistical and Economic Administration, the University of Paris Pantheon-Sorbonne, the Centre for Economic Policy Research, among other institutions, and Stephane Carcillo, of the International Monetary Fund, have published a paper in which they examine the effect of a French tax law that exempted overtime wages from income tax and social security contributions. In The Detaxation of Overtime Hours: Lessons from The French Experiment, they explain how a law designed to increase the number of hours worked not only failed to attain its objective but provided “highly qualified wage-earners, who have opportunities to manipulate the overtime hours they declare,” a blueprint for reducing the taxes they paid on their non-overtime wages.

Two major lines of questioning present themselves. One deals with the policy. The other focuses on why tax law is not the best tool for advancing the policy.

Presumably, France wanted to increase the number of hours worked because it wanted to improve its economy by increasing worker productivity. Coupled with this goal were concerns that the supply of workers capable of doing the work that needed to be done were in short supply. French law prevents employers from simply telling qualified workers that they must work additional hours, even if compensated. It is unclear whether French law prohibits employers from training people to do the work that needs to be done, whether directly or indirectly through foundation of, or support for, educational institutions providing the training. Perhaps a deeper problem is the unwillingness of people to learn these skills, though arguably people with no jobs or bleak employment prospects because their current skills are no longer desired would jump at the opportunity to re-tool and find employment.

The analysis is complicated by the advantages to employers of getting more hours out of employees rather than hiring additional employees. A good example of this phenomenon can be found in large American law firms, which prefer to hire, say, 10 new associates each earning $160,000 than 20 new associates each earning $80,000. The 10 new associates, in order to make their salaries manageable by the firm, are pressed to bill upwards of 2,400 hours, which translates into 52 weeks of 65 or more hours in the office, whereas 20 associates earning $80,000 would not need to bill anywhere near those numbers of hours, and thus might have a chance of investing some time in life outside of law. There are two factors that push law firms in the direction of hiring fewer associates and seeking more output from each employee. One is fringe benefits, which as a percentage of salary, decrease as salary increases. In other words, the cost of fringe benefits for two $80,000 associates exceeds the cost of fringe benefits for one $160,000 associate. The employer portion of the FICA tax is one example of this phenomenon. The other factor is that it is easier, in many respects, to train 10 new associates rather than 20, because training 20 associates chews up disproportionately more resources than training 10 associates. Though hiring 20 new associates would be a better approach socially, and perhaps even morally, it is economically the less desirable approach, at least in the short run. In the long run, the economic costs of the psychological side effects of demanding upwards of 2,400 billable hours from associates makes hiring 20 rather than 10 new associates the better choice, but business organizations much prefer decisions based on short-term, rather than long-term analysis, and might even lack the ability to engage in the latter.

Thus, it is not difficult to understand that employers in France, persuading or working in concert with the French government, decided to find a way to induce employees to work more hours. They chose to use the tax law to do so. It backfired. That is not surprising. In every instance where the Congress has used the tax law to encourage behavior, all sorts of people have crawled out from under the wood pile to claim that they were engaging in that behavior and thus entitled to the tax break, even though they were not engaging in that behavior. One need think only of the abuses with respect to the credit for new home purchases, the earned income tax credit, the plug-in electric and alternative motor vehicle credits, and the biodiesel fuel credit, to name but a few, to understand the inherent weakness of trying to use tax law to do what should be done through other means.

My Friday morning email from Law.com brought a story whose headline was alarming. Half an hour later, Paul Caron’s email conveying the morning’s TaxProf Blog posts carried the headline for his post on the topic. The first headline? “Law Professor, a Former Tax Attorney, Convicted for Failing to File Tax Returns.” The second headline? “Tenured Law Prof (Former Tax Lawyer) Convicted of Failing to File Tax Returns.”

Wow.

Professor Robin Kimberly Magee, a member of the faculty at Hamline University School of Law, was convicted by a jury in Minnesota of failing to file state tax returns. She had told investigators when initially questioned, and asserted again at trial, that “she didn’t understand tax law.” According to her on-line biography at the school’s site, “While in private practice, [she] concentrated in the area of criminal, entertainment, and tax law.”

At first, Magee was charged with failing to file returns and pay taxes, which are felony charges, but those were dropped, and she was convicted of the gross misdemeanor counts of failing to file state tax returns. According to the Minnesota Department of Revenue, Magee failed to file returns from 1991 through 2003, so the Department filed returns on her behalf. Magee continued to not file state returns for 2004 through 2007, and for unexplained reasons the state did not file returns on her behalf for those years. Those were the years for which she was convicted of not filing returns. Although state taxes had been withheld from her salary during those years, it is unclear whether she owed additional taxes or was entitled to, and received, refunds.

In her defense, Magee’s attorney claimed that Magee “relied on the state to complete her tax filings.” However, that is not an appropriate approach to dealing with one’s obligation to file tax returns, nor does it necessarily leave the taxpayer in a position of having fully satisfied his or her income tax liability. A taxpayer can, under certain circumstances, request the IRS or a state revenue department to complete a return, for example, computing the tax liability, but to do so, the taxpayer must file a return that contains sufficient information for the government to do so.

Surprisingly, after the conviction, Magee told reporters that “she felt vindicated.” That reaction is difficult to comprehend. How is it possible to interpret the conviction as approval of what she did? According to the story, her supporters, who were not identified, claim that she was “unfairly prosecuted because she has publicly criticized local prosecutors in the past.” Proving unfairness would require some sort of showing that the state does not prosecute other taxpayers who fail to file returns, though the wrinkle in the argument is the unexplained decision by the state to stop filling out returns on Magee’s behalf. Perhaps it was vindictive. Perhaps it was a matter of deciding that after 13 years of communications to the taxpayer informing her of her duty to file, her failure to do so, and the state’s corrective actions, someone decided that enough was enough.

The Dean of Hamline’s law school said the school was “disappointed” and would review the situation to see what steps would be taken. He noted, “Her actions are contrary to the values of our law school where we expect faculty to lead by example in teaching respect for the rule of law.” Indeed. Suffice it to say Magee is not the only member of a law faculty to act contrary to the school’s value and to act inconsistently with the rule of law. I have empathy for the other members of the faculty of Hamline’s law school. It’s not fun discovering what colleagues have done that ought not to have been done.

Ironically, Magee, who has not taught a course since 2009, is assigned to, and has taught, criminal procedure, criminal law, property, police practices, and a seminar on race and law. It could have been worse. She doesn’t teach tax law. Over at Tax Update Blog, Joe Kristan, in Sometimes Those Who Can’t Do, Really Do Teach, opines that the conviction “gives anybody borrowing money to pay the $28,000+ Hamline Law School tuition reason to ponder what they’re getting for their money.” If Magee had been teaching tax courses, I’d share that concern. Fortunately, Hamline students who take tax courses are taught by other faculty. I don’t expect the intellectual property experts or the torts experts or the land use experts to have the ability to teach or practice federal securities regulations, though every now and then someone combines, for example, intellectual property with securities regulations to carve out a valuable academic and practice niche. My question is whether the clients for whom Magee practiced tax law are concerned about her assertion that “she didn’t understand tax law.” Isn’t is late in the day for her to make that claim?

The difficulty is that Magee wasn’t tripped up by some complicated tax provision such as the many that cause taxpayers to file inaccurate returns. Even in those situations, lawyers – and even law faculty who aren’t members of the bar – should know enough to get help so that they avoid negligence penalties. The difficulty is that most citizens know, and all citizens and lawyers should know, that they have an obligation to file income taxes with the state in which they reside. That part of tax law isn’t confusing, and it should be remembered that although tax law is complicated, not every part of it resembles rocket science. Some aspects of tax law are fairly easy to learn and to understand. Magee didn’t struggle with tax technicalities. She practiced tax law, but nonetheless simply didn’t bother to file her state income tax returns, for at least 17 years. Ironically, Magee also practiced criminal law, was teaching courses in criminal law and criminal procedure, and ought to have been aware that failure to file a tax return is within the realm of crimes.

Perhaps the answer lies in Professor Magee’s personal statement in her on-line biography. She writes, “I believe, as the founders of this country espoused, that the greatest threat to law and order, peace and liberty is tyranny, not crime. I, therefore, believe that the highest calling of the lawyer is the call to fight against tryanny [sic] and government-sponsored or tolerated oppression. Thus, I struggle in my classes to instill in my students the knowledge of the law and the critical and analytical skills to hold the government (and everyone else) accountable to the rule of law and the rights of all people." Could her failure to file have been some sort of protest against government? I don’t know. Could her failure to file have been based on some belief that the requirement to file tax returns is tyranny? I don't know. Could her failure to file have reflected her belief that she was not subject to the law? I don't know. Perhaps Professor Magee will enlighten us by explaining why she hadn’t been filing state income tax returns. And I’m sure I’m not the only person who is curious and wants to know if she filed state income tax returns for 2008 and 2009, and if she has filed federal income tax returns.

A TaxProf blog post sent me to an interesting AP article, the headline of which must surely take the wind out of the sails of the “our taxes are too high so let’s cut or eliminate them” crowd: “High Taxes? Actually, They’re at a 60-Year Low.” Wow.

The AP article, relying on a Congressional Budget Office report and scenarios worked out by H&R Block’s Tax Institute, points out that federal tax receipts have fallen to 14.8 percent of the gross domestic product, the lowest since 1951. That compares to the 17.5 percent share of GDP paid in federal taxes in 2008. So much for the rumors and allegations that the current Administration has caused taxes to increase. Interestingly, even though corporations are awash in profits and cash, the CBO reports that corporate tax revenues have fallen by a third. It’s no wonder that the budget deficit is growing and federal debt is skyrocketing.

So if the federal government is taking a significantly smaller portion of GDP, where’s the tax reduction going? Granted, a small portion is heading the way of states that have increased their taxes, though those increases don’t make much of a dent in the amount of tax payment reductions for the private sector. The savings aren’t being used to create jobs, a conclusion that correlates with the huge build-up of cash in corporations and other business enterprises. It’s not being used to buy more things, as consumer spending statistics show reductions in, and at best, steady retail sales.

Could it be that the money representing federal taxation’s decreased share of GDP has been and is heading offshore? Is it being stashed somewhere, as insurance against the looming catastrophic consequences of bloated federal debt? And as for who is doing this, surely it is not the poor who are putting money aside. And it’s unlikely that the middle class, whose real earnings have been dropping during the past decade, can afford to set cash aside in offshore tax havens. That leaves, of course, the folks who we were told would use their tax cuts to create jobs and turn the economy into a robust machine. That hasn’t happened. So what are they doing with their tax cuts? And why?

Several weeks ago, in The Price of Insufficient Tax Revenue, I described how the City of Camden, New Jersey, was compelled to make substantial reductions in its police, fire fighting, and other departments because of insufficient tax revenue. Now comes news that not only reveals the scope of Camden’s budget cuts, but also suggests that something a bit more complicated is involved.

According to the Philadelphia Inquirer story, Camden had no choice but to dismiss both of its animal-control officers. That move has left the city without the personnel required to deal with stray animals, including those with rabies, those posing a threat to adults, children, and infants, those already having bitten people, those that are fighting, those lying dead in the street, and those contributing to a build-up of filth. When one resident had to deal with cats roaming private property and “howling through the nights,” one resident stated, simply, “I would have called somebody, but with all the layoffs, I didn’t know who to call.” Eventually a nonprofit organization showed up on its own initiative and tried to deal with the problem. Multiple 911 calls with respect to several dangerous dogs finally brought a police officer, along with a private animal-control contractor whose initial reaction to the non-profit’s volunteer had been, “I’m not the person to call.”

It turns out that Camden privatized animal control as “a necessary cost-cutting measure.” It has hired a private contractor, whose winning bid of $190,970 is $20,000 more that what the city had been paying annually for salaries and benefits to the two animal-control officers to whom it had given pink slips. Hello? How is that a cost-cutting move? To me, it’s another example of how privatizing what are and should be public government functions end up costing taxpayers more in order to provide the profit margin demanded by the private sector but unnecessary when government handles a public matter. This phenomenon has arisen in connection with such functions as trash and snow removal, recycling, and leaf disposal, as I discussed in Another Tax v. Private Cost Increase Choice, as well as highway maintenance, as I discussed in Are Private Tolls More Efficient Than Public Tolls? and More on Private Toll Roads. As I wrote in Another Tax v. Private Cost Increase Choice:

Shifting public services into the private sector simply puts more money, in the form of profits that don’t exist and don’t need to exist in the public sector, into the pockets of those who are eager to turn public services into their own money-generating machine. That money comes from taxpayers, duped into thinking that “holding the line on taxes” is a good thing. Only when they compare the impact on their own budgets – too often done after the fact than beforehand – do some or many of them realize that they are getting the same or decreased services but paying out much more.

By the time residents of Camden and New Jersey generally decipher the impact of the tax-cut philosophies that at first glance seem so attractive, and realize that in the long run, their financial positions have worsened, it will be too late. Why? Because the remedy will not simply be restoration of the taxes that ought not to have been cut, but imposition of even higher taxes to make up not only the lost revenue but the public resources siphoned into the hands of the select few who benefit from privatization.

Worse, comments from Camden officials suggest that response times will increase, coverage will decrease, efforts to eliminate dog fighting will diminish, and assistance provided to police searching dog collars and doghouses for drugs will disappear. One official pointed out that a study conducted a few years ago revealed “privatization was more expensive.” It still is.

Late last week I received a press release from the Treasury Inspector General for Tax Administration (TIGTA), summarizing a report which disclosed that roughly $33 million in erroneous tax credits for plug-in electric vehicles and alternative-fueled vehicles had been claimed by “at least 12,920 taxpayers through July 24, 2010.” Considering that taxpayers had claimed $163.9 million in credits between January 1, 2010 and July 24, 2010, for these types of vehicles, that means 20 percent of the credits that were claimed were erroneous. That is a high error rate. Too high.

Some of the credits were claimed by taxpayers who were in prison for all of 2009. That impediment to purchasing qualifying vehicles somehow did not get in the way of these prisoners from claiming credits to which they were entitled. Labeling these credits as “erroneous” is way too kind. Presumably, some of the credits indeed were claimed erroneously, because the complexity of the credit provisions makes it easy for a taxpayer to misidentify a vehicle as eligible for the credit, or to make arithmetic or other errors when computing the credit. One error noticed by TIGTA was the claiming of both the plug-in electric vehicle credit and the alternative-fueled vehicle credit for the same vehicle, when in fact a vehicle cannot qualify for more than one credit. It’s not surprising, in light of the complexity of the various multiple vehicle credits, for taxpayers to be confused and make this sort of error.

TIGTA concluded that the IRS was not spotting erroneous credits with sufficient frequency. It concluded that the IRS had “inadequate . . . processes to ensure information reported by individuals claiming the credits met qualifying requirements for vehicle year, placed in-service date, and make and model.” TIGTA also concluded that “the IRS cannot track and account for plug-in electric and alternative motor vehicle credits claimed by individuals on paper-filed tax returns because it has not established processes to capture this information from those returns.” TIGTA made recommendations for fixing these problems, and the IRS agreed. By taking steps to implement these recommendations, the IRS managed to stop another $3.1 million in erroneous claims from generating revenue losses.

The cause of these difficulties rests, of course, with the Congress. During the past two decades, Congress has heaped credit upon credit onto the tax system, putting administration of environmental, energy, health, labor, child care, and all sorts of other matters into the hands of the IRS rather than the federal agencies charged with oversight of these areas. At the same time, the Congress has failed to provide the IRS with sufficient funding to administer these credits. It’s not surprise, then, that the IRS hasn’t developed a full and efficient set of procedures to manage each of the many dozens of credits that it must supervise.

Results such as the ones TIGTA discovered with respect to the two vehicle credits pale in comparison to what awaits us when full implementation of the tax aspects of health care reform is undertaken by the IRS, as I explained in IRS Ought Not Be the Health Care Enforcement Administrator. My reservations about putting almost every aspect of government activity on the shoulders of the IRS pre-dates health care reform, as was noted in the nightmarishly-titled ”Professor Maule Goes to Washington” and in Not To Its Credit. In the latter post, I wrote:

I wonder how many taxpayers benefit from these credits, and whether making tax credits available for the activities that permit the credit to be claimed is the most effective and efficient way of encouraging people to engage in those activities. It's not that I object to the goals. I object to the Internal Revenue Service being turned into a institution that is focused more on the technical requirements of energy production activities than on administering revenue laws. I wonder why financial incentives to produce and conserve energy aren't administered by the Department of Energy. Well, I know the answer. The Congress, though every now and then publicly trashing the IRS and characterizing it as harmful, then turns to the same agency to administer its favorite incentives programs. Which should speak more loudly to America? What Congress says when it grandstands or what it does when it overburdens the tax law and the IRS because it apparently doesn't trust other agencies to administer laws relating to agriculture, energy, employment, or health?

Yet I wonder, if the desire by Congress to encourage the purchase of electric cars and alternative-fueled vehicles had been implemented through a direct rebate program administered by the Department of Energy, whether a similar 20 percent error rate would have been avoided. I don’t know. Is it easier for prisoners to file tax returns falsely claiming these vehicle credits than it would be for them to file rebate claims with the Department of Energy? Would vehicle purchasers be less likely to get confused by the rules if reimbursements were not imbedded in the tax system?

Ironically, these credits exist because Congress wants to encourage Americans to purchase vehicles that operate without, or with less, dependence on non-renewable resources, such as foreign oil. Without the incentives, far fewer Americans would purchase hybrid and electric cars, principally because they are more expensive than gasoline-fueled vehicles. The private sector, without the injection of government programs, fails to achieve this goal. The reason is that the government, at the same time, also skews the economics of the private transportation sector by failing to increase highway fees and fuel taxes to reflect the true economic cost of operating vehicles. The implementation of a mileage-based road fee, which I last discussed in Mileage-Based Road Fees Gain More Traction and Looking More Closely at Mileage-Based Road Fees, might in and of itself trigger a much more significant shift to electric and alternative-fueled vehicles. That outcome would permit abolishing the income tax vehicle credits and make rebate systems administered by the Department of Energy unnecessary.

The travails of the Philadelphia property tax system and the Board of Revision of Taxes that has administered that system are well known. The ever-lengthening story of recent attempts, during the past four years, to reform the administration of the tax has been the subject of a similarly increasing list of MauledAgain posts, starting in An Unconstitutional Tax Assessment System, and continuing in 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, 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, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, A Tax Agency Rises from the Dead, and Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation.

Disaffection with the Philadelphia property tax and the BRT is widespread. The City Council, as discussed in A Citizen Vote on Taxes, put the matter to a vote by the city’s taxpayers. Not unexpectedly, as related in R.I.P., BRT, the voters chose to replace the BRT with a bifurcated arrangement, in which setting property values was separated from the appeals process. And it was only a matter of time before those with vested interests in the way the BRT was doing business sued, and as reported in A Tax Agency Rises from the Dead, they were successful in persuading the courts to put the brakes on reform. Though the property assessment function now resides in its own agency, the BRT continues and has jurisdiction over appeals.

But two can play the same game, and as reported in this recent story, a coalition of property owners and property tax reform advocates has sued the city, asking that the property tax system be declared illegal. If they succeed, the city would be compelled to enact a new system, presumably one reflecting what the voters approved. The plaintiffs also want the 2010 property tax increase to be rolled back, and they want refunds issued to those who have already paid property taxes computed at the new rate. They want a judge to “protect taxpayers from unmanageable increases in their property-tax bills” and to suspend sheriff’s sales arising from tax liens. The plaintiffs claim that the city is dragging its feet, worried that taxpayers will rebel – particularly in voting booths – when properly computed assessments are issued. Ironically, the mayor and his administration have consistently sought property tax reform and took the lead in the attempt to dismantle the BRT. The city’s defense is that it takes time to reassess the roughly 577,000 properties in the city, and that it won’t happen “overnight.” The city claims it will take two years. The plaintiffs are impatient, and claim that two years is too long. The plaintiffs also are sincere, as many of them will face higher property tax bills on their own properties if they succeed with their lawsuit. It’s a rare case of putting public interest above personal status.

Some city leaders think that assessments generated by a flawed revision implemented by the BRT as the reform movement was getting underway ought to be implemented immediately, despite the inaccuracies in the information underlying those assessments. They view the plaintiffs’ case as having merit. They are concerned that city inaction will bring about judicial intervention, forcing the city to do what it could do now. A Carnegie Mellon University professor thinks that most elected officials prefer to be told by a court to implement changes that generate increased property tax bills for some or many taxpayers, because it lets them offer the easy excuse that they were required by a judge to adopt a system that caused property taxes to increase for those taxpayers. There is concern that the process of reassessing properties will end up being administered by a judge, something that has been characterized as a “thankless job.”

History has a strange way of repeating itself. In 1981, a court ordered the city to establish an equitable property tax system within six years. Taxpayers are still waiting. One wonders why those who were ordered to do so but did not do so are not sitting in jail somewhere for their dereliction of duty.

The parade of severe winter weather parading through parts of the country, including the Mid-Atlantic area, have had a devastating effect on the snow removal budgets of states and localities. For example, as of last week, according to this report, New Jersey has spent all of the money allocated for snow removal for the 2010-2011 winter season, and as of last week, the calendar page had yet to turn to February. Running out of budgeted snow removal funds will happen when the actual frequency and intensity of winter storms exceed pretty much everyone’s expectations, and that surely has been the case this winter. The snag is that most states and localities, having used most or all of their reserve funds to cover revenue shortfalls in the last two years, are faced with the difficult choice of suspending snow removal or cutting back on other services, such as trash removal, police protection, fire protection, or pretty much any other expense the cutting back of which will bring no fewer howls of protest than will the suspension of snow removal. I wonder if increased expenditures on snow removal constitutes the sort of “government expansion” that the anti-tax crowd despises so much.

So how do anti-tax-increase advocates propose to get out of this conundrum? By dismissing tax increases as some sort of unholy evil deed, they are left with choices such as suspending snow removal or cutting back on police protection, or worse. But wait! The governor of New Jersey, whose defiant resistance to tax increases has generated proposals that jeopardize the safety of motorists and pedestrians, as described in Cut Taxes? Cut Spending? Cut Safety?, and whose other cutbacks include one that has imperiled the city of Camden, as described in The Price of Insufficient Tax Revenue, has come up with an alternative. According to this Philadelphia Inquirer story, he has requested the federal government to provide $53 million to New Jersey as reimbursement for snow removal costs.

If the request by Governor Christie is approved, where does the federal government get the money? One choice is to take it from an existing program. Does a worker get fired? Does a school get closed because funding is reduced? Does an airport reduce its operating hours because it has fewer air traffic controllers? Does the Department of Defense recall several drones, a few tanks, or a destroyer from wherever they are deployed? Or, wait, does the federal government increase taxes to pay for the increased spending on “snow removal reimbursements” to New Jersey and other states? How would that fly with Governor Christie’s anti-tax-increase, pro-tax-cut colleagues in Washington, some of whom have murmured about the possibility of his seeking the Republican presidential nomination in 2012 (a prospect which, incidentally, Christie has been denying)? Is the secret to claiming success as a tax cutter the ability to foist expenses off on another governmental entity, while blaming that entity for tax increases? Oh, wait, indeed, hasn’t this happened under federal legislation that cut federal taxes while shifting spending burdens onto states by using those wonderful “spending mandates”? Do the politicians and their staff who devise these schemes attend the same courses that were attended by Bernie Madoff, the executives of Enron, and the funds transfers specialists in Nigeria?

And keep in mind, as you slip and slide on roads plowed once but not twice as in former years, or treated with less or no salt, that these deprivations were made necessary by the refusal of certain politicians to undo the unwise state and federal tax cuts enacted for the benefit of the wealthy. Perhaps as you are slipping and sliding, or sitting in one of those eternal weather-induced traffic snarls, you can ponder the impact on business productivity, job creation, national defense, and K-12 education of underfunding snow removal expenditures. Perhaps you can join in delight with those who think that cutting back overtime pay for snow plow operators and spending less money on road brine is a good way of “starving the beast.” The government, of course, is us, and so perhaps the silver lining in this winter of transplanted Arctic climate, is that people will understand that starving the government beast is nothing more than self-starvation.

About ten days ago, in Judge Judy and Tax Law, I shared my reaction to a Judge Judy episode in which tax consequences played a tangential role, demonstrating the maxim that “Taxes are everywhere.” On Thursday, after shoveling snow and slush for several hours, I came into the house, sat down, flipped on the television, and there was Judge Judy. Having missed the first two minutes of the episode, it took me several more minutes to figure out the issue. It was a contract claim resting on a tax return preparation agreement.

According to the plaintiff, a woman whom he knows – possibly the mother of a former girl friend – approached him and said that she understood he could not afford to pay for tax return preparation as he had done the year before. Subsequent testimony revealed that he had been a client of H&R Block. So this woman offered him a deal. Her sister, she explained, was a tax return preparer and charged less than H&R Block. The plaintiff takes her up on the offer. At some point, the woman or her sister suggested to the plaintiff that he claim as a dependent on his tax return the child of a woman – and because I missed the first two minutes, I’m not certain of this – who was the former girl friend. The plaintiff had never previously claimed an exemption for this child, even though his confusing testimony suggested that at some point he thought the child was his but at other times knew that the child was not his. It seems that the child’s mother wasn’t going to claim the child because, having little or no income, she did not need the deduction. So the plaintiff agreed. He also was told that he would be getting a sizeable refund. A few days later, the woman who had initially approached him called him and explained that he would get his refund more quickly if he agreed to have the refund deposited into the woman’s bank account. She promised she would immediately remit the money to the plaintiff. He agreed, but not surprisingly, she didn’t transfer the money to him. So he sued her.

Judge Judy looked at the return in question and noticed that not only was a dependency deduction claimed that should not have been claimed, but that a child tax credit also was claimed. It wasn’t clear how much of the refund was attributable to these two items. The camera zoomed in on a small portion of the return, from which it was impossible to dissect the underlying entries. Judge Judy quickly figured out that the intermediary defendant and her sister were running a scam, and that the plaintiff, knowing he was not entitled to the dependency exemption, was no less complicit. In her questioning of the plaintiff, she used the word “fraud” on at least three occasions. She also, through questioning the defendant, determined that the defendant was not the mother of the woman whose child was being claimed, but was, at best, a foster mother.

Accordingly, Judge Judy dismissed the plaintiff’s case. She pointed out that there are all sorts of doctrines on which she could rely, but that the doctrine of “clean hands” would suffice. The plaintiff had not come to court, she explained, as an innocent victim but as a participant in some sort of scheme. Judge Judy told the plaintiff, “You need to file an amended return. You need to file an honest return.” She added that he knew that he was not entitled to claim the child. She then told both parties that the IRS would be told that the defendant has the refund, that the defendant has money that “belongs to” the IRS, and that the IRS would want to get it back. She also told the parties that the IRS doesn’t like fraud. No kidding.

I wonder what sort of impact on the viewers this episode has made. Has it taught people that it doesn’t pay to commit tax fraud, that the improper filing might be identified even if it is not the IRS that discovers it, that con artists specializing in tax fraud are popping up all over the place, and that one should check out the credentials and experience of a prospective tax return preparer? Or is it putting ideas into the heads of people who figure that with a little more care they can avoid being detected?

There wasn’t any means for me to determine what happened thereafter. Did the plaintiff file an amended return? Did the IRS go after the defendant and recover the refund attributable to the improperly claimed deduction and credit? Did anyone go to jail? Did the tax return prepare sister have other clients? Did she work similar scams with them? Perhaps when “Judge Judy: The Aftermath” debuts, we’ll find out. In the meantime, yes, tax is everywhere.

Edit: Paul Caron of TaxProf blog found video of this particular Judge Judy episode, which he shares on his post Jim Maule and Judge Judy. Thanks, Paul.

Several days ago, the Tax Court overruled one of its existing decisions, and in Mayo v. Comr., 136 T.C. No. 4 (Jan. 25, 2011), held that the limitation in section 165(d) on gambling losses does not apply to a gambler’s expenses that are not wagering losses and that otherwise qualify as trade or business deductions under section 162. The taxpayer drew attention to himself by deducting from gambling gross receipts not only section 162 deductions but also his gambling losses, generating a $22,265 Schedule C loss and deducting it against other income. The IRS, relying on Offutt v. Comr., 16 T.C. 1214 (1951), and on section 165(d), disallowed all of the taxpayer’s deductions.

Though the IRS initially took the position that the taxpayer was not in the trade or business of gambling, it later conceded the point. Considering that the taxpayer wagered almost $131,760 and won $120,463, it would have been difficult to persuade the court, in light of Comr. v. Groetzinger, 480 U.S. 23 (1987), that the taxpayer was not in a trade or business. The taxpayer also incurred $10,968 of business expenses, including travel, meals, telephone, internet, entry fees, subscriptions, and my favorite, ATM fees.

The IRS, however, also took the position that the taxpayer was permitted to deduct only $120, 463 of combined wagers and other expenses. The taxpayer argued that section 165(d) does not apply to professional gamblers. The taxpayer rested the argument on the premise that because section 165(d) does not apply to trades or businesses generally, it ought not apply to the gambling losses of gamblers who are in a trade or business and should be limited to the gambling losses of people who gamble without being in a trade or business. The taxpayer, in effect, was viewing section 165(d) as analogous in this respect to section 183.

The Tax Court noted that it had on several prior occasions rejected the proposition that the Groetzinger decision absolved professional gamblers from the restrictions of section 165(d). The court repeated what it had explained in a prior case, Valenti v. Comr., T.C. Memo 1994-483, namely, that section 165(d), the more specific provision, trumps section 162(a), which is more general. Thus, the taxpayer’s attempt to deduct more than $120,463 of his wagers of $131,760 was stymied.

However, when the Tax Court turned to the question of the other expenses, the taxpayer fared much better. The court decided that the term “losses from wagering transactions,” which is what section 165(d) limits, does not include the other expenses. The court noted that it had to work through the analysis without a benefit of the phrase in the statute, the regulations, or the legislative history. In fact, its own precedent on the point, the Offutt case, “offered no reasoning to support the conclusion that ‘Losses from wagering transactions’ should be interpreted to cover both the cost of losing wagers as well as the more general expenses incurred in the conduct of a gambling business.”

In reconsidering its position, the Tax Court relied on several strands of analysis. Each relied on analyses in prior case law.

First, it determined that because “gains from such [wagering] transactions” was limited to “proceeds from a wager by the taxpayer where the taxpayer stands to gain or lose on the basis of chance” and does not include a taxpayer’s other income, even income based on shares of a casino’s house fees, the term “losses from wagering transactions” should be limited to amounts lost on a wager. In other words, because income that is in connection with, but not a consequence of, placing a wager is excluded from the section 165(d) limitation, expenses that are in connection with, but not a consequence of, placing a wager should not be subject to the limitation.

Second, the court noted that in Comr. v. Sullivan, 356 U.S. 27 (1958), the Supreme Court cast doubt on the appropriateness of treating a professional gambler’s expenses other than wager costs as a loss subject to section 165(d). The Supreme Court treated a gambler’s wage and rent expenses were ordinary and necessary business deductions allowable under section 162(a). Because the taxpayer in Sullivan had gains from wagering transactions that exceeded the total of his wagering losses combined with the other expenses, the Supreme Court did not reach the section 165(d) issue, but its dictum suggests that it would have held that the limitation did not apply.

Third, the court noted that the Court of Appeals for the Ninth Circuit, in Boyd v. U.S., 762 F.2d 1369 (9th Cir. 1985), had distinguished, in dictum, between wagering losses and “expenses incidental to gambling,” characterizing the latter as not subject to section 165(d). The Ninth Circuit’s observations did not constitute a holding because the issue was precluded by the taxpayer’s failure to raise the matter in the refund claim the denial of which had led to the litigation.

Fourth, the court identified a series of cases in which the IRS itself had conceded that section 165(d) did not apply to expenses that were not wagering losses, or had failed to raise the section 165(d) limitation in the notice of deficiency. In fact, in Chief Counsel Memo AM 2008-013 (Dec. 19, 2008), the IRS announced that it would no longer follow the Offutt decision.

Aside from the obvious lesson to be learned from the case, namely, that the Tax Court takes the position that section 165(d) does not apply to expenses otherwise deductible under section 162(a) that are not wagering losses, there are other lessons to be learned. For example, though many people who are not tax practitioners might think otherwise, the Tax Court is no different from other courts in overruling its earlier decisions if and when careful analysis determines that it is appropriate to do so. Another lesson is the need to look carefully not only at what appears to be a rule extracted from a case, but at administrative issuances and the procedural history of other cases. Knowing that the IRS had conceded the issue and failed to raise the issue in some cases, while litigating the point in other cases, suggests that its original position was not as airtight as might otherwise appear.

Several days ago, the headline of a Philadelphia Inquirer article caught my eye. It stated, simply, “Philly-area traffic not so bad, study finds.” Having driven in New York, Washington, D.C., Baltimore, Chicago, Los Angeles, Dallas, St. Louis, Kansas City, Pittsburgh, Boston, Houston, and many other cities, I figured perhaps there had been a tremendous influx of cars and drivers into most of those cities. True, congestion in New York, Chicago, Los Angeles, Boston, Dallas, and Washington, D.C. resembles budding gridlock, but there are numerous times when traffic not only in downtown Philadelphia but in its suburbs reaches the choking point. Whatever one’s impressions, formed by sitting through multiple cycles of badly timed traffic signals or stuck in traffic stopped by the consequences of another “I can text, do my hair, and read the newspaper while driving” wizard, traffic congestion can be measured. And so it has been. Again.

The article told me that, according to a Texas Traffic Institute study, motorists in my home metropolitan area wasted 39 hours each year sitting in traffic. For motorists in the fifteen largest cities, the average is 50 hours. The list of cities where drivers encounter the most delays included Washington, D.C., Chicago, and Los Angeles, three of the cities I would have nominated for the “honor.” But the other two cities in the top five were Houston and San Francisco. My visits to San Francisco were on the BART system, and my one drive through Houston came during a torrential thunderstorm, so I’m not surprised that I did not include them among the worst. The prize goes to Chicago and Washington, D.C., where drivers waste 70 hours a year sitting in traffic queues.

The good news is that congestion eased a bit in the Philadelphia area during the past three years because the economy slowed. Of course, compared to 1982, when only 12 hours were lost each year to the consequences of more demand for highways than the supply, that’s not the best of good news. The bad news is that any improvement in the economy will bring even more traffic snarls. What then?

Assuming the economy improves, ought not the nation compel the improving economy to pay for its own costs? Put another way, the choice between doing nothing to improve the roads and bridges and finding revenue to pay for required improvements probably appears to most people as a choice between the fire and the frying pan. In the long run, doing nothing will dampen the economy, as delivery delays and increased transportation costs caused by congestion digs into business profits and personal disposable income. Increasing taxes to pay for necessary improvements also reduces business profits and disposable income, but it provides something in return, namely, a better transportation system that in the long run makes the arteries of commerce more free flowing.

Mass transit seems to be a nice alternative but for two problems. Surface mass transit, such as a bus, is no less bottled up by inadequate highway capacity. Rail has its benefits but it’s very expensive, particularly with so many rights-of-way having been abandoned to the private sector. The mass transit option poses the question of where resources should be funneled, but it doesn’t deal with the underlying question of where the resources will be found.

Even aside from the predicted increase in traffic congestion, consider the impact of current transportation deficiencies on the economy. Surely, having workers lose the equivalent of one or two full-time work weeks to the consequences of highway capacity not keeping up with population increases rips into business profits and disposable income at least as much, and almost surely, much more than would increasing taxes to pay for what is needed.

Most of the solutions required by the report require additional resources. It costs money to redesign intersections, to synchronize traffic signals, to remove damaged and broken-down vehicles from travel lanes, to build and label high-occupancy and bus lanes, to enforce limited-use lane rules, to add more roads, to widen roads, to build mass transit lines, to purchase mass transit vehicles, and to relocate housing developments. The one proposal that on its face appears to impose little or no cost, though it might when applied to particular business enterprises and employees, is to stagger employee commuting by permitting workers to begin and end work at times other than “peak hours.” The problem with this proposal is that “peak hours” now run from five or six in the morning until six or seven in the evening.

Ultimately, if paying for increased capacity doesn’t sell, the alternative is to cut demand. However, mechanisms designed to cut demand also bring the same howls of opposition as do proposals to pay for increased capacity. Though the mileage-based road fee, particularly as a replacement for gasoline and other liquid fuels taxes, would solve the financing problem and bring equity to the funding of highway use, as described in previous posts such as Making Progress with Mileage-Based Road Fees, Tax Meets Technology on the Road, Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, and Change, Tax, Mileage-Based Road Fees, and Secrecy, it, too, encounters severe resistance from those who benefit from current road funding practices. Perhaps while they’re sitting in stalled traffic, they might want to read the various reports and studies cited in those posts and reconsider whether principled opposition to replacing one source of funding with another is worth yet another few hours a week going nowhere.

Two weeks ago, in Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?, I concluded:

The consequences of a default by the federal government on its debt would begin to appear before it actually “ran out of money.” Even if the default was short-lived, the catastrophic economic consequences would, according to the Secretary of the Treasury, “last for decades.” A protracted stalemate would make the Great Depression look like a walk in the park.

And yet the Republicans, and far too many Americans, carry on as though there is no catastrophic tidal wave building up out at sea. Those who raise the alarm are viewed as the Reincarnation of Chicken Little, as alarmists who don’t understand that it is possible – according to the wizards of tax reduction and elimination – to cut taxes, cut spending, and eliminate the budget deficit without actually identifying and cutting the spending for any specific federal program. Wow.

Nine days later, in a Wall Street Journal op-ed, Republican Senator Pat Toomey, after declaring that all should agree that “Under no circumstances is it acceptable for the U.S. to default on its debt,” claimed that “even if Congress doesn't raise the debt ceiling, a default on our debt need not follow when our borrowings reach their limit in the next few months.” He also claimed, “In fact, if Congress refuses to raise the debt ceiling, the federal government will still have far more than enough money to fully service our debt. Next year, for instance, about 6.5% of all projected federal government expenditures will go to interest on our debt, and tax revenue is projected to cover about 67% of all government expenditures. With roughly 10 times more income than needed to honor our debt obligations, why would we ever default?” Toomey explained that he plans to introduce legislation that would require the Treasury to make interest payments on our debt its first priority in the event that the debt ceiling is not raised.” He argues that, “This would not only ensure the continued confidence of investors at home and abroad, but would enable us to have an honest debate about the consequences of our eventual decision about the debt ceiling.” Toomey adds, “If we do not raise it [the debt ceiling], the government's tax revenue will enable us to fund roughly two-thirds of projected expenditures, including interest payments.”

Toomey’s goal of curbing the federal budget deficit is laudable. Though he complains about increased spending as a cause of the deficit, he makes no reference to the tremendous increase in military spending during the past decade that not only was funded through money borrowed chiefly from overseas investors and foreign nations, but that was incurred in the face of continuing and increased tax cuts. But that’s not the worst flaw of his reasoning.

Toomey leaves out of his analysis the psychological element. If the Congress refuses to increase the debt ceiling, investors will react by dumping their holdings in U.S. debt, long before the government misses an interest payment. This dumping won’t be a matter of investors selling off the debt. It will take place as investors decline to re-invest in Treasury obligations when they receive the proceeds of the obligations coming due within the next few years. Fear of being the “last investor in the game” will deter the reinvestment. Consider that during the next year almost $2.5 trillion of Treasury obligations will come due, as summarized in this chart, for reasons explained in this prescient warning with respect to the shortening of maturities on Treasury obligations. In other words, not only must the government pay interest on the outstanding debt, it must also come up with cash to pay off the maturing obligations. Usually, it does so by issuing new obligations, but will it be able to raise $2.5 trillion if the Congress has frozen the debt ceiling? Even if some investors decide to “roll over” their investments, the reverberations through world stock, commodity, and other markets if even one-quarter or one-third of the required cash cannot be raised will be tremendous. And it’s likely that what does get raised will demand higher interest rates, thus wedging even more spending into future federal budgets.

Worse, Toomey not only fails to take into account the need to repay principal, he tosses out facts that don’t survive scrutiny when examined closely. Toomey claims that there is “roughly 10 times more income than needed to honor our debt obligations.” The arithmetic belies this claim. The total debt is roughly $14 trillion, whereas estimated total federal receipts for 2010 is about $2.5 trillion. A good chunk of those receipts “belong” to the social security and related trust funds. Even if those receipts were available to “honor our debt obligations,” how can the government pay the $360 billion it owes in interest, plus pay the $2.5 trillion that is due in principal repayment, when it has $2.5 trillion of receipts? Basic arithmetic tells me that “roughly 10 times more income” means Toomey thinks federal receipts top $28 trillion per year. No wonder he and his comrades think taxes are too high. Even I would cringe at the sort of taxation level that would generate $28 trillion in receipts. It takes just a moment to identify the flaw in Toomey’s facts. He views the nation as honoring its debt obligations if it pays the interest that is due. Well, sort of. For the income to be “roughly 10 times” more than the interest that is due, government receipts would need to be roughly $3.6 trillion a year. Oops.

By equating interest payment obligations with “debt obligations,” Toomey ignores principal repayments, and appears to think that when these obligations become due the nation’s creditors necessarily will pony up cash to pay for replacement obligations even though the debt ceiling has not been raised and debt principal hasn’t been paid down. Investors will NOT be racing to the Treasury seeking to put their cash into more debt. Why not? Consider a corporation that borrows money, continues to spend beyond its income, refuses to increase its income, and eventually gets to the point where it can borrow no more money (either because of the market or because of some state or federal law regulating the amount of debt the corporation can incur). It’s true that the corporation can make payment of interest on the debt a priority, but it’s going to start defaulting on other payments, and long before it gets to a point of failing to pay principal, the credit markets are going to write off or sell off the corporation’s debt, and it will plummet into insolvency and bankruptcy.

So what happens if the debt that is due within the next year is not repaid because investors fear the consequences of a frozen debt ceiling? The entirety of all federal receipts would be required to pay off the investors holding the obligations that have come due. I’m not sure where the government would find $360 billion to pay interest. Not only would nothing be put into the social security and Medicare trust funds, those funds would not be able to make any payments, because their “assets” are tied up in Treasury debt which would not be convertible into cash because the Treasury would not have the resources to redeem that debt. There would be no money to finance the military, to staff and operate Homeland Security, the FBI, the CIA, the Center for Disease Control, the Food and Drug Administration. Taxes would be paid, but all federal government services would stop. Perhaps the Federal Reserve could churn out dollar bills, but the resulting inflation would dwarf that of the late 1970s and inject hyperinflation into the economy.

The nation is approaching, more and more quickly, the point of no economic return. I wonder when someone will make it clear to the entire nation, and not just to the few readers of this and a few other blogs who understand the maxim, a nation is doomed when it spends trillions on war while simultaneously continuing and increasing tax cuts that especially benefit the wealthy. I wonder when someone will succeed in persuading the nation that the only hope is a reversal of the mistake, even though it cannot be fully reversed. Even a partial reversal poses the possibility of redemption. Toomey wants “concrete steps toward fiscal sanity.” Would not undoing the fiscal insanity of the past decade be the place to start?

On Tuesday, while getting ready for dinner, I happened upon Judge Judy’s television courtroom show. The litigants were a divorced couple. The former husband was suing his former wife, seeking financial contributions to help offset the amounts he had paid for their 23-year-old child’s master’s degree education. Though Judge Judy tried to get the plaintiff to focus on, and provide evidence of, the former wife’s alleged agreement to contribute funds for the child’s education, the plaintiff insisted that one of the reasons his former wife should pitch in was that she had the money to do so. When asked how he knew that, the plaintiff pointed out that he had paid her $3 million at the time of the divorce as her share of the property. Judge Judy reacted by asking, “And you deducted that?” The plaintiff replied that he didn’t think so. Judge Judy replied, to the effect of, “No? You didn’t get a tax break from that? And your ex-wife didn’t report it as income and pay taxes? She took all of it free of tax?” She asked these questions in a tone that suggested she considered the payment to be taxable to the defendant wife and providing a tax deduction to the plaintiff husband. Not that it had any impact on the plaintiff’s inability to prove his former wife’s agreement to share the education costs, but apparently Judge Judy was trying to deflate the plaintiff’s claim that his former wife had $3 million available to her. The plaintiff responded by confessing that he did not know the tax consequences of the payment.

At first, I thought I could use this as an exam question. But then I decided it was too good to let it wait. On an exam, I would prefer to provide a transcript of this particular episode, but I’ve been unable to find transcripts of the Judge Judy Show.

Any student who has taken the basic tax course and has paid attention knows that there is no deduction for the transferor in a marital property settlement, and that the property received by the transferee spouse is not included in gross income. Section 1041 tells us that. The deduction/gross income treatment applies to alimony, not property settlements. That’s what we learn from section 71. Even if the one-time $3 million payment had been treated by the parties as alimony, the alimony recapture rules would have offset almost all of whatever tax break the plaintiff would have had, as well as giving the transferee spouse a deduction almost equal to the $3 million.

Tax is everywhere. It shows up even in television courtrooms where tax cases surely are rejected by the producers. It didn’t occur, and I would not have expected it to occur, to the plaintiff to bring his tax returns for the taxable year in which he made the $3 million payment to which he referred. Perhaps he didn’t realize he was going to mention it until he started explaining his case. Perhaps he didn’t realize he was going to be asked a tax question about it. Had someone told him to bring a tax attorney with him, he would have been bewildered by the idea. Surely had someone told Judge Judy to have a tax lawyer on call, she or the show’s producers would have been incredulous. And yet, once again, the pervasiveness of tax and the continuing need to have tax practitioners within close reach take center stage.

EDIT: Of course it's section 1041, not 1014. Typo. Thanks to the readers who pointed it out.

A little more than a year ago, in New Jersey to Follow in California’s Tax Footsteps?, I asked this of now governor, then governor-elect, Chris Christie’s plan to lower taxes: “If the governor-elect succeeds in lowering taxes, what will happen?” I noted that lessons could be learned from the California experience, where the anti-tax folks persuaded a majority of voters that they could have tax reductions, while those same voters rejected a tax on government spending. I pointed out that, ultimately, California ended up with one-day-a-week furloughs for state employees that caused traffic jams, and that the price to be paid for reductions in education funding would not be seen “for at least a decade” (though recent reports of plummeting performance by U.S. students and educational institutions, as summarized in this story suggests that the day of reckoning may be sooner than I expected). I also pointed out that “Essential infrastructure projects are left unfinished, bridges are falling apart, cuts have been scheduled for in-home services to the elderly and disabled, income tax refund checks no longer are being issued, and useless IOU notes are being issued to those owed money by California.” Finally, because of insufficient funding to expand or repair the prison system, California was ordered to release 27% of its prisoners.

New Jersey, like California and many other states, and like the federal government, is reeling under the impact of tax reductions enacted at the insistence of voters who object to every possible spending cut aside from the magical “reduce fraud” solution that they foolishly think accounts for the totality of budget deficits. In the case of the federal government, I have repeatedly asked the tax-cut advocates to identify the spending cuts they wish to make. I did this most recently in The Grand Delusion: Balancing the Federal Budget Without Tax Increases. Though I did not ask this question specifically with respect to New Jersey’s fiscal crisis, I should have done so, though holding up California’s experience as an indicator made, and continues to make, sense.

Now comes news, news that very likely would have had an impact on voter decisions had it been released before, rather than after, the election. New Jersey’s governor insisted that one way of balancing the state budget was to reduce or eliminate state payments to local governments. And so the cuts were imposed. Faced with reduced state assistance, Camden City Council, as explained in numerous reports, such as this one, has voted to cut up to one-fourth of the city work force, including almost half of the city’s police officers and one-third of its firefighters. Some residents claim that they will be “buying weapons” because they will “have to defend ourselves [and] our families.” The head of the City Council put the blame on the state’s decision to reduce city funding. In response, according to this report, the governor essentially replied, “Don’t blame me.” He claims that the council is at fault, because “they’re the ones who have been managing the city for all these years.” Christie supported the notion of having the city of Camden “spend less.” And so it will. Christie justified his decision in part on corrupt city politicians that he had helped, in his former position as U.S. Attorney for New Jersey, put in jail. However, barring evidence that these politicians absconded with tax receipts equal to the budget shortfalls in Camden’s past and present fiscal years, the existence and eventual removal of corrupt politicians does nothing to solve the problem. Camden, like New Jersey, California, almost every other state, most other cities, and the entire country, has insufficient resources to protect its citizens, to maintain the infrastructure that the citizens wish to have, and to defend the rights of its residents.

How long until severe reductions in police and fire fighting departments sweeps across the nation? How long until bridge and tunnel collapses, sinkholes, water main breaks, and other infrastructure failures begin to occur at a rate too rapid for even 24-hour cable news to keep pace in reporting? How long until public health systems collapse? How long until voters realize what’s in offshore tax haven accounts, who put it there, and what a difference would have been made had the evaded taxes been paid when they should have been paid? Some people in the anti-tax crowd continue to hide income and assets, even while their precious rate reductions are enacted and extended, because deep down inside, they want a totally free ride. An early installment of the price for that ride is being paid in the form of the looming crisis for people Camden, and later installments eventually will reach far beyond the city that sits across the Delaware River from Philadelphia.

The title of the post on Paul Caron’s TaxProf Blog froze my eyeballs in their tracks. It simply said, Pay Your Taxes or We’ll Kill Your Dog. Living in an area that has me rooting for a team whose starting quarterback had been sent to prison for doing such a thing, and having a friend who is very active in dog rescue work, I wondered, “To what could this possibly refer?” Surely, I thought to myself, this must be something going on in an undeveloped or developing nation, where the culture accepts this sort of threat. But, no, I was wrong.

According to the Time Magazine article cited by Paul, this “tax arrangement” exists in Switzerland. Switzerland! The municipal council of the town of Reconvilier, frustrated by increasing numbers of dog owners failing to pay the $48.50 dog ownership annual fee, announced that it would take steps to collect the unpaid taxes, including enforcement of a 1904 law permitting seizure and killing of dogs with respect to whom the tax has not been paid. What made matters worse is that the head of the council, in describing actions taken 30 years ago, stated, “A lethal injection is sentimentality. We took them to a knacker’s yard, shot them in the head, and it was done . . . Euthanasia is for humans, and in our era, we’re not going to dilute the truth.” In reaction to the not unexpected expressions of outrage and dumbfoundedness, the council head explained that the unpaid taxes could be paid in installments and that killing dogs would be an extreme and unlikely outcome. He added, “This isn’t about eliminating all the little doggies! We don’t even have an extermination worker – our police forces aren’t even armed!”

A reader of TaxProf Blog pointed out that there are jurisdictions within the United States that have similar laws on the books. A reader named “US Law” quoted section 19-20-2 of the West Virginia Code:

It shall be the duty of the county assessor and his or her deputies of each county within this state, at the time they are making assessment of the personal property within such county, to assess and collect a head tax of three dollars on each dog, male or female; and in addition to the above, the assessor and his or her deputies shall have the further duty of collecting any such head tax on dogs as may be levied by the ordinances of each and every municipality within the county. However, no head tax may be levied against any guide or support dog especially trained for the purpose of serving as a guide, leader, listener or support for a blind person, deaf person or a person who is physically or mentally disabled because of any neurological, muscular, skeletal or psychological disorder that causes weakness or inability to perform any function. Guide or support dogs must be registered as provided by this section. In the event that the owner, keeper or person having in his or her possession or allowing to remain on any premises under his or her control any dog above the age of six months, shall refuse or fail to pay such tax, when the same is assessed or within fifteen days thereafter, to the assessor or deputy assessor, then such assessor or deputy assessor shall certify such tax to the county dog warden; if there be no county dog warden he or she shall certify such tax to the county sheriff, who shall take charge of the dog for which the tax is delinquent and impound the same for a period of fifteen days, for which service he or she shall be allowed a fee of one dollar and fifty cents to be charged against such delinquent taxpayer in addition to the taxes herein provided for. In case the tax and impounding charge herein provided for shall not have been paid within the period of fifteen days, then the sheriff may sell the impounded dog and deduct the impounding charge and the delinquent tax from the amount received therefor, and return the balance, if any, to the delinquent taxpayer. Should the sheriff fail to sell the dog so impounded within the time specified herein, he or she shall kill such dog and dispose of its body.

West Virginia is not alone with this tax enforcement approach. Under section 17-526 of the Nebraska Revised Statutes, the approach is similar:

Second-class cities and villages may, by ordinance entered at large on the proper journal or record of proceedings of such municipality, impose a license tax in an amount which shall be determined by the governing body of such second-class city or village for each dog or other animal, on the owners and harborers of dogs and other animals, and enforce the same by appropriate penalties, and cause the destruction of any dog or other animal, for which the owner or harborer shall refuse or neglect to pay such license tax.

In Utah, section 10-8-65 of the Municipal Code states, “They may license, tax, regulate or prohibit the keeping of dogs, and authorize the destruction, sale or other disposal of the same when at large contrary to ordinance.” There probably are similar provisions in the statutes of other states. So before fingers are pointed at Switzerland, it would be prudent to engage in some self-examination of laws in the United States. There is something absurd about inflicting punishment on the dog, who hasn’t done anything wrong, rather than on the owner. Fortunately, there are some states that do not take out the tax nonpayment on the dog, but instead look to the imposition of fines on the deadbeat owner, at times classifying the failure to pay as a misdemeanor.

Though statutes providing for the killing of dogs with respect to whom their owners have not paid applicable taxes have been on the books for quite some time, there is something not only immoral but also illogical in the killing aspect of the remedy. If a person does not pay a vehicle registration fee, do states confiscate the vehicle and then send it to the car smashing machine at the junkyard? No, the state auctions the vehicle in an attempt to raise revenue. If a person does not pay real property taxes, the state or local government files a tax lien and eventually can end up owning the property. Does it burn down the house or other structures on the property? No, again, it sells the property at a tax sale. If a person fails to pay an occupation tax, the state might shut down the person’s business, but it doesn’t put the person on death row. If a person does not pay a per capita tax, does the local government cut off the person’s head? Hardly.

The only good thing to come out of the Switzerland story is that it makes people aware of something formerly unnoticed and might trigger movements to take these laws off the books. Sometimes, the best way to teach a lesson to others is to set a good example. Are you listening, state legislators?

To be precise, Julian Block isn’t so much talking with the married and divorce, but sharing explanations of pretty much every sort of issue couples will encounter, beginning with a set of questions and answers that he has constructed to put the issues into realistic contexts. He does all of this in “Julian Block’s Tax Tips for Marriage and Divorce.” The range of topics and the folksy way in which Julian defuses the anxiety that accompanies tax questions for most people are impressive considering he had a mere 120 pages in which to tackle puzzlers such as joint returns, tax traps for same-sex couples, property settlements, dependency exemptions for children of divorced parents, taxation of social security benefits, withholding, and even the tax consequences of having an affair. It’s not surprising that Julian moves through these topics with clear explanations written for taxpayers rather than tax professionals. In my reviews of his earlier books, I noted the same strengths in his writing. "MARRIAGE AND DIVORCE: Savvy Ways For Persons Marrying, Married Or Divorcing To Trim Their Taxes - And They’re Legal" was reviewed in Tax and Relationships: A Book to Read and Give (Feb. 2006), "THE HOME SELLER’S GUIDE TO TAX SAVINGS: Simple Ways For Any Seller To Lower Taxes To The Legal Minimum," in A New Book on Taxation of Residence Sales: Don't Leave Home Without It (Aug. 2006), "TAX TIPS FOR SMALL BUSINESSES: Savvy Ways For Writers, Photographers, Artists And Other Freelancers To Trim Taxes To The Legal Minimum," in A Tax Advice Book for People Who Write and Illustrate Books (Dec. 2006), "Year Round Tax Savings" in Another Tax Book for Tax and Non-Tax People to Read (Feb. 2007), "Travel and Moving Expenses: How To Take Maximum Advantage Of Every Tax Break The Law Allow" in Tax Travels and Tax Moves: Book It with Block (Sept 2007), and "Ultimate Tax-Saving Resource '08" in Helping Tax Clients Understand Taxes (June 2008).

The folksy style pops up early, when in the preliminary chapter, Julian replies to the question, “It pays for me to file jointly. But I don’t want to reveal my income to my wife. Suppose I have her sign a blank return and then fill in the figures?” with a quick, “Don’t bother.” He follows up with an explanation that the taxpayer’s wife would be able to get a copy of the return from the IRS. We’re not told why the taxpayer wants to hide his income, but perhaps Julian doesn’t know. He also deals with more mundane question, such as shifting from married filing separately status to joint returns, and vice versa, the prohibition against one spouse itemizing and the other claiming the standard deduction, the tax treatment of a surprise “additional alimony payment . . . not required by our divorce decree,” and deductions for contraception and gender change surgery. He also gets into the deductibility of payments to girlfriends hired to manage rental properties or to do office work for the taxpayer.

Part 1 focuses on filing status, and includes discussion of when status is determined, amending returns, the scope of joint liability on joint returns, and the advantages and disadvantages of filing separately. Julian alerts those immersed in wedding preparations that they ought not ignore the tax issues. He explains the marriage penalty and the marriage bonus, and how the scheduling of weddings planned for near the turn of the year provides tax planning opportunities. He also explains the tax treatment of surviving spouses, and tax traps for same-sex couples. Julian’s summary of how the Defense of Marriage Act affects unmarried couples, how it came to be enacted, and what would happen if it was repealed or declared unconstitutional is itself worth the price of the book.

Part 2 deals with the tax consequences of divorce, which can bewilder couples who are going through personal upheavals and encountering an array of financial and property decisions. Among other topics, the tax treatment of the legal fees, the effect of invalid divorces, and the difference between the tax consequences of an annulment and a divorce, and the determination of which parent claims the dependency deduction for children get close attention. Part 2 concludes with a section as interesting as its title suggests, “Unearthing Hubby’s Hidden Assets.” It is a good introduction to forensic accounting, as it explains what sorts of information can be derived from the information appearing on a joint return.

Part 3 explores the tax consequences of home sales by married couples, divorcing couples, divorced couples, and unmarried couples. It concludes with a look at the tx consequences of leaving property in both names while one of the two live in the house.

Part 4 untangles the taxation of social security benefits. Julian explains the computation of modified adjusted gross income, and provides examples to help readers understand what is one of the more complicated elements of individual federal income taxation. Part 4 includes some planning advice with respect to the impact on the computation of taxable social security benefits of filing jointly or separately, and concludes with some reminders about the use of social security numbers in connection with tax returns.

Part 5 is titled “Oddball Situtations,” a title that makes sense when one examines the subtitles within Part 5. What’s discussed in “Having an Affair Can Be Taxing” is obvious and well worth reading. Several of the cases, and most of the issues, have inhabited my basic federal tax course for many years, because they are, as I tell my students, simply too good to pass by. More than a few taxpayers will be interested in “Dependency Exemptions for Live-in Lovers,” for reasons that should be readily apparent.

The book concludes with two short segments. Part 6 examines changes in withholding that might be necessary when taxpayers marry or divorce. Part 7 discusses amending returns.

This is a book worth reading. Someone needing or wanting to make a small gift to a friend or relative who has announced an engagement or shared the unsettling news of a divorce should consider giving the person a copy of Julian’s book. It might not be a glamorous present, but it’s a useful one, and one for which the recipient will be appreciative. The book is published by PassKey Publications.

A reader directed my attention to a New York Times article analyzing the economics of attending law school, and to a response to the story. As I pointed out to this reader, this is a topic that has been getting a good bit of press in practice-oriented publications (e.g., ABA Journal), law -related blogs -- including those focused on law students, such as abovethelaw.com -- and in discussions among law school deans, law faculty, ABA committees, and others. Perhaps the significance of the New York Times article is that the discussion is going to expand into mainstream media and grab much wider public attention.

The author makes several assertions which are not quite accurate, but these misunderstandings don’t detract from the basic points, which is that students need to take into account employment prospects, the risk of defaulting on loans, and other economic factors in addition to whatever other information they consider, and that they need help from law schools in doing so by having full disclosure of the relevant, and accurate, employment, salary, and other information. For example, the author claims, “Those huge lecture-hall classes — remember ‘The Paper Chase’? — keep teaching costs down. There are no labs or expensive equipment to maintain.” This may be true at some law schools, but law schools that maintain clinics providing services to the needy while giving law students an opportunity to experience law practice in an environment other than a classroom not only are burdened with what amounts to the cost of operating a public-interest law firm but also are constrained in terms of the number of students who can be permitted to enroll. Clinics are important but they aren’t money makers. The huge lecture-hall classes are disappearing, as more and more law schools limit class size to improve students’ educational opportunities. This change is being reflected in law school construction, as, for example, Villanova’s new law school building has only one classroom that can accommodate more than 100 students, whereas the old building had four. The author also confuses the issue when he highlights a student with $250,000 of student loans in a manner that suggests undergraduate education had nothing to do with the size of the debt.

So though there are a few things in the article with which I disagree, the author is calling attention to concerns not unlike those I have made in the past. For example, in Law Schools, Teaching, Legal Scholarship, and the Economy, where I stated, “What law schools, and their parent universities, need to do is to become honest.” In How A Transformative Recession Affects Law Practice and Legal Education, I predicted that “When prospective law school students begin to realize that the chances of getting a job upon graduation have fallen to the levels faced by college graduates with degrees in those majors that have persistently not been rewarded by the economy, even some of the more idealistic of them will view a J.D. degree as an over-priced ticket for admission to what at best is an employment lottery. When they learn that fewer and fewer law firms are hiring law school graduates because clients are not willing to pay for what little law school graduates bring to the table, some will turn away from the idea and others will join in the increasing chorus to reform legal education.” I also suggested that there will be “some combination of a reduction in the number of law schools and a transformation of what transpires at those that survive” and that “[e}nterprising practitioners, perhaps law firms joining together in collaborative and creative efforts, will form schools focused on preparing people to practice law,” and that [p]roperly operated, they need not charge the tuition rates currently being charged.

The focus of the criticism has been an emphasis on the need of law schools to disclose the realities of job opportunities. It has been proposed that law school applicants should be told that very few law school graduates earn those highly publicized $150,000 salaries when they graduate. It has also been proposed that applicants should be told, and in too many instances are not being told, that significant numbers of law school graduates are not finding law-related jobs when they graduate. Eventually someone will propose that law schools disclose why, after three years of law study, law school graduates are not in a position to practice law, are not near the stage of progress that their peers coming out of medical school have attained, and that some law firms refuse to hire new J.D. graduates for this reason.

Even though I agree that law schools should disclose information such as their graduates’ employment record, and that the information should be specific and free of manipulations such as law schools hiring recent graduates for make-work positions so that the employment numbers can be inflated, I also think there are other disclosures that need to be made by other segments of the legal profession. Why not require legal practitioners to offer full disclosure about the practice of law? Why not require law school applicants to read explanations of how the exciting scenes they see on television dramas and in the movies – cited by more than a few law students over the years as the inspiration for their decision to attend law school – are, like $150,000 entry-level salaries, a fairly rare situation? Why not require lawyers to disclose to law school applicants that there is a good chance they will be confined to small offices, for as many as 16 hours a day, reading through box after box or DVD after DVD of documents and other evidence? Why not require law firms and legal departments to disclose that a specific percentage of their associates or legal employees have concluded their jobs are tedious, stressful, and unfulfilling? Ought not law firms disclose how many newly-hired associates don’t “make partner” and how many choose to leave or are asked to leave after one or two years with the firm? Might not this sort of information cause potential law students to think again about their career decisions? Perhaps law firms ought to be required to explain why some law graduates are offered salaries that are four or five times those offered to other graduates even though all those graduates share a common characteristic, namely, little or no experience. Perhaps someone should explain why there are so many people in need of legal assistance and yet so many lawyers unable to find jobs? Perhaps someone should explain why the connection between those needing legal assistance and the lawyers who could provide it hasn’t been made. Considering that the ratio of lawyers to population is 1:300, and the ratio of lawyers not employed by government, corporations, or tax-exempt organizations, etc. to the population is more like 1:400 or 1:500, ought not each lawyer have 400 or 500 individual clients? Has the legal marketplace failed in this respect? Who is responsible for making these disclosures? It makes sense to require law schools to disclose information about their activities, but the legal profession in its entirety has no less an obligation to be transparent about itself.

The discussion will continue. It will be interesting. It will be contentious. From time to time, it will get sidetracked into other legal education and law practice issues. Whether it will trigger meaningful changes remains to be seen.