MauledAgain

The problem is simple. As related in this Philadelphia Inquirer article, the prices of various commodities and other items are soaring. Most people are keenly aware of rising gas prices, which are moving almost in lockstep with rising crude oil prices. The price of cotton has skyrocketed. The price of sugar has risen roughly 33 percent since last year at this time. The price of Cheese Whiz, used in those famous Philadelphia cheese steaks, is up almost 25 percent in one year. Soybeans are up 48 percent, wheat is up 62 percent, and corn, 78 percent. There’s also the implicit price increase taking place as manufacturers reduce the size of their products without lowering the price. These wholesale price increases have not yet fully hit the consumer, but they will, and soon. Also waiting in the wings are increased prices for products manufactured by Procter & Gamble, for clothing, and for maternity items.

My concern is that politicians, reacting to the already noticeable stream of price complaints that surely will grow into a resounding chorus of demands that something be done, will turn to the tax law and add a pile of credits and deductions in a fruitless (sorry) effort to hold back the tide. The naïve belief that every problem can be solved with tax law amendments is destined to make the situation worse.

The causes of the problem are simple. Demand is increasing. Supply is decreasing. Though the global economic malaise postponed the day when demand outracing supply would become overwhelming, it did not eliminate the inevitable. Demand is increasing because people in China, India, and other rapidly developing nations need and want food, clothing, concrete, electronics, vehicles, and hardware. The rate of demand is accelerating because global population is growing at an unrelenting pace. In the meantime, supply is decreasing for two reasons. Some items, such as crude oil, exist in finite quantities and are rapidly being depleted. Other items have been the victims of political unrest and devastating weather. Until I read the article, I had not known that the wheat crop in Russia, usually an exporter of a crucial global foodstuff, had been significantly reduced by heat and wildfires, or that dry weather had shrunk Argentina’s soybean crop. I knew about the price of oil going through the roof, and I had heard about the cotton shortage. But what else will soon join the list of items in short supply?

This is not the first time I have questioned the wisdom of using tax law to deal with a problem that needs another solution. Three years ago, in Can a Tax Rebate Band-Aid Stop the Economic Bleeding? I criticized use of tax rebates because they do not address the underlying economic problems. My concluding paragraph touched some nerves. I wrote:

The impending shortages of critical goods and materials, including oil, clean water concrete, steel, natural gas, health care, copper, agricultural products, and similar life-essential ingredients, will only worsen the problem. An ever-increasing world population, seeking more and more quantities of these and other items, coupled with the emergence of a small creditor group and massive hordes of debtors, is a recipe for disaster. Somewhere along the way, these conditions will trigger armed conflict, pestilence and pandemics, civil disorder, and breakdowns in societal structures. No one ever promised that the Dark Ages were a one-time event.

Joe Kristan, in a post headlined by one of my favorite captions, Good Morning, We’re All Doomed, explained that ever the optimist, he was confident of human ingenuity coming to the rescue, and not very concerned because similar warnings had been issued for decades, going back at least to Thomas Malthus in the 1830s. In Can Tax Rebates Help Prove Malthus Wrong?, I responded that there are shortcomings in the supply-demand curve theory of economics, argued that government borrowing to finance rebates worsened the situation in the long-term, and suggested that "people and governments [and not just government] mobilize to deal with these issues while there still is time." I then questioned the confidence in market-based solutions because I do not think that the market is a truly FREE market.

Several months later, in If Only It Were Prices Getting Depressed, I revisited the question of supply and demand, motivated by reports of increases in the price of oil, gasoline, and food, and by news of shortages of steel, lumber, timber, polyvinyl chloride pipe, and even, good grief, chocolate, hops, and barley. Joe replied, in Good on Taxes, Not so Good on Economics, taking issue with my supposed advocacy of government direction of markets. In Keeping Free Markets Free, I noted that “I am not advocating government management of the markets,” but seeking government regulation to prevent markets from being “hijacked by speculators, cheaters, shoddy artisans, defective manufacturers, cronyism-afflicted traders, and others whose greed surpasses their respect for the market's consumers.”

Although it is possible that some of the current supply and demand disequilibrium is caused by speculators, it seems to me that it is caused by the confluence of three major trends: political unrest, weather and climate disruption, and excessive population growth. Government intervention with respect to any of these issues sparks deep controversy, aside from the question of whether government of the United States can do much of anything about them on its own. These are global problems. If they are to be solved, they need to be addressed globally. The weather in Russia affects food prices in this nation. Political upheavals in African and middle Eastern nations affects energy and mineral prices here. Rapid population growth in developing countries puts demand-side pressure on the demand-supply balance. Enacting federal income tax law credits or deductions would be much like putting a band-aid on a hemorrhage. Yet I would not be surprised to see a Congress engage in such futility for the sake of obtaining campaign-time sound bites. By the time people figure out that tax law will not fix the wheat crop in Australia, the soybean shortage in Argentina, the demand for steel and concrete in China, the increasing use of oil in India, or the “revolt of the oppressed” in nation after nation, yet another “election cycle” will have passed. And the tax practitioners, though seemingly facing the prospect of even more fees to charge to help clients deal with an over-supply of legislative tinkering, will cringe at the thought of having to muddle through yet more bad legislation. I don’t think I have been wrong about the tension in the supply-demand situation, and yet I hope I’m wrong about the prediction of Congress using tax law to deal with issues it cannot or will not face head-on.

Last week came news, in What Harvey Dorfman did for the Phillies, of the death of Harvey Dorfman. Few people, even most baseball fans, knew who Harvey Dorfman was and what he did. Now many more people do know, thanks to the tributes pouring in from around the baseball world.

Harvey Dorfman was a sports psychologist, and, according to dozens of baseball players, an extremely good one. I understood, as soon as I read this quote from Roy Halladay, one of the Philadelphia Phillies aces, about why Dorfman succeeded. Halladay said, "He made you be accountable to yourself and accountable to him. I don't think you ever got the feeling that he was a psychologist. It wasn't warm and fuzzy, you know, it was 'Let's figure this out.' You didn't feel like you went in and told him all your problems and he gave you a solution. He teaches you to do it yourself."

The sentence, "He teaches you to do it yourself." grabbed my eye, as did the quip, "It wasn't warm and fuzzy." I thought of the many students who complain that they end up teaching themselves, somehow so blissfully unaware that it's precisely learning to teach one's self, to depend on one's self, to be accountable to one's self, is what it's all about. When I wrote about this a few years ago in Learning to Teach and Teaching to Learn, an article for the Gavel Gazette (the now-extinct newsletter of the Villanova University School of Law), I didn't address the "warm and fuzzy" issue, but "warm and fuzzy" sometimes gets in the way of learning, especially learning to teach one's self.

Dorfman drove home the point in an interview, reported in this story: "It's not like in school, where you get high grades for what you know." For all those students whose focus is on the acquisition of knowledge, here's yet another reason that properly taught law school courses – and those in other disciplines – focus on much more than knowedge. It's not what you know. It's what you do with it. It is, as Dorfman said, "what you do."

I never met Harvey Dorfman. I'm pretty sure I would have liked him. Our conversations would have been fun. Those will need to wait until the life beyond.

This morning came news of the death of Cynthia Holcomb Hall, who served on the Ninth Circuit Court of Appeals since 1984, and had served as a Tax Court judge from 1972 through 1981. I knew Judge Hall, whose chambers were directly below those of Judge Herbert L. Chabot, for whom I served as attorney-advisor from 1978 through the end of 1980.

During the 1980s I learned that one of my ancestral lines included the Holcomb family (with the details in this chart). Curious, I invested a few minutes this morning trying to determine if Judge Hall also belonged to “my” Holcomb family. My copy of Elizabeth Weir McPherson’s The Holcombe Family: Nation Builders, a hefty tome not only in terms of weight, did not include any information on Cynthia Holcomb. Next stop, google, which led me to a Wikipedia page that provided her birth date but not the names of her parents. Next, it was time to search the 1930 census, and I found her, with her mother, aunt, grandmother, and brother, in Hawaii, where, apparently, her father, a Navy Admiral, was stationed. From the census entry I determined that her mother’s name was Mildred Gould Kuck, so back to google! That led me to a genealogy page for the descendants of Thomas Holcombe of Connecticut. Following the links, I traced Judge Hall’s ancestry back to Gilbert Holcombe, who is known to be the brother of Christopher Holcombe, from whom I descend. Although it has not been definitively proven, many Holcomb researchers have concluded, by piecing together the evidence, that Gilbert, Christopher, and their siblings were the children of Thomas Holcombe and his wife Margaret Tretford (or Threthford). Even if that conclusion is erroneous, it does not undo the relationship between Gilbert and Christopher.

It then took only several minutes for me to set up my descent and Judge Hall’s descent from Thomas Holcombe (or whoever might be the father of Gilbert and Christopher if it turns out not to be Thomas, which is unlikely). I am her eleventh cousin once removed (she being an eleventh cousin to my father, who was roughly 6 years older than she).

My collection of “people to whom I am related” continues to grow, though I’ve yet to arrange and publish the information, aside from my My Cousins the Presidents venture. I shared a few in Relatively Speaking, Is It That Big A Deal? (fifth cousin four times removed to James Longstreet, the Confederate General, eighth cousin once removed to Georgia O'Keeffe, ninth cousin to Loudon Wainwright III, ninth cousin to Buster Crabbe, ninth cousin to Birch Bayh, Jr., and fifth cousin three times removed to Theodore Vail, founder of AT&T, ninth cousin once removed to Birch Bayh III, and ninth cousin twice removed to JonBenet Ramsey). There’s also Maxfield Parrish, Thomas Edison, Robert E. Lee, and William Butler Ogden, the first mayor of, and in many respects founder of, the city of Chicago (much to the delight of my son who presently lives there), to name but a few.

Judge Cynthia Holcomb Hall was an accomplished lawyer and judge, and also a superb ornamental garden designer. She will be missed.

Edit: Mary O'Keeffe, a public policy economist teaching -- among other things -- tax courses and blogging on tax and related issues (as well as from time to time providing comments and feedback to MauledAgain posts), noted that I had spelled Georgia O'Keeffe's name with one f. Oops. A quick google check explains how I went wrong: almost 500,000 hits using "O'Keefe" and 1.1 million hits using "O'Keeffe." Mary, who thinks she is not related to Georgia -- but I think with enough digging she may discover she is -- has several most interesting anecdotes that I hope she gets a chance to share. And, yes, I fixed the spelling in this post, but not the one from several years ago.

On the heels of the spending cuts, affecting chiefly the impoverished and the lower ranks of the middle class, paraded out last week by the spending cut advocates, as I inventories in Spending Cuts, Full Disclosures, Hearts, and Voices, comes yet another, in some respects the most absurd of them all. The wizards who surely must be trying to dismantle government, and reintroduce the culture of the wild, wild West, now seek to cut the IRS budget. According to this Philadelphia Inquirer story, even though the IRS brings in $10 of tax revenue from noncompliant taxpayers for every $1 that is spent, House Republicans want to cut the IRS budget by $600 million in 2011 and by even more next year. Translated, according to the IRS Commissioner, this amounts to a reduction of at least $4 billion in annual tax revenues, giving the spending cut advocates yet more excuses to cut even more federal spending, other than, of course, spending that benefits their own districts and their campaign fund contributors.

Inadequate funding of the IRS has plagued this nation for decades. A significant portion of the accumulated federal budget deficit, also known as the national debt, consists of taxes that should have been paid under existing law but that have not been paid by tax scofflaws, some openly defying their obligations to function as responsible citizens and some, with the assistance of the tax shelter and tax evasion industry, wiggling through loopholes and sometimes flouting the law in order to shift their public duty onto the rest of the nation’s taxpayers.

For years, I have lamented the short-sightedness of the Congress. Seven years ago, in Getting It Right, I asked, in connection with complaints about the high rate of erroneous answers provided by IRS employees, “Does the IRS have enough funding to handle the millions of calls that it receives?” Just last month, in The Problem with Income Tax Vehicle Credits, I criticized the failure of Congress to provide the IRS with sufficient funding to administer the dozens of tax credits enacted by the Congress to deal with matters under the jurisdiction of other executive departments and agencies.

Several years ago, in Taxing High-Income Individuals, I advocated, among other things, a way to reduce the federal deficit without raising tax rates. I explained what Congress needed, and still needs, to do: “Increase funding for the IRS so that it can track down and deal with tax shelter promoters, offshore schemes, fraudulent returns, and other gimmicks used to make a person with high income pay taxes at rates lower than those imposed on the middle and lower income echelons.”

How serious is this problem? How much more serious would it be if those lacking a wide perspective on public finance have their way? Tax evasion arrangements will grow, and eventually only the foolishly honest will be paying the taxes that they should be paying, as success or even perceived success at tax avoidance and evasion by others tempts those not yet playing the tax cheat game to jump in. In Triple Tax / Tax Times Three, I analyzed the growing success of tax evasion schemes:

Who creates this stuff? To paraphrase Cal Johnson, who teaches tax law at Texas, it's a bunch of very bright people paid big bucks to outsmart IRS employees. The IRS, not permitted nor funded to pay big bucks, can't compete. The IRS is being out-brained. And it's being out-numbered.

So, the IRS wants more money to do this enforcement. They're asking a Congress that annually REDUCES the IRS budget. What fools. There has been a cadre of politicians who earn votes by running for election and re-election on an anti-IRS platform. It plays well to the crowds who don't realize that they're being persuaded to vote for someone whose chopping of the IRS ultimately will shift the tax burden from the tax cheats to these voters. Except that polls show a majority of Americans are willing to cheat on their taxes. Big surprise. Honesty isn't exactly king (or queen) in this nation anymore (and no political party is free of responsibility).

During the past 8 years, the number of IRS revenue officers is down 27%, the number of special agents (who investigate criminal tax fraud), down 13%, and the "tax gap" is officially $311 billion. Unofficially it's surely twice that or more. Budget deficits? Why blame enacted tax cuts when most of the deficit arises from "self-appointed tax cuts." How do you react to the idea of paying a higher bridge toll to offset bridge toll losses from people driving through the EZPass lane without paying, while the bridge revenue authority fires all its toll takers and police officers? Well, that's where things have been headed. What's really outrageous is that the IRS bashing that led to the funding cuts were orchestrated by hearings at which witnesses presented what is now admitted to be fraudulent testimony about alleged IRS abusive treatment of taxpayers. Not only did most of the stuff not happen, but there are clowns in Congress who think it is abusive for the IRS to send a letter to someone who owes taxes and to ask for payment. How DARE they ask someone to pay a bridge toll? Amazing.

If the House Republicans succeed in cutting IRS tax law enforcement, what will flourish in its place? I answered this in Triple Tax / Tax Times Three:

Let's have some fun. Here's a list of the sort of stuff the tax evaders get into (and note that no one would do any of this but for the saving of taxes with schemes that aren't economically feasible other than the tax evasion and avoidance effect): In the area of reducing taxable gain, they use arrangements with names like Tempest, InsureCo, Basis Importation, 79-21, BLAST, B-FLIP, Asset Monetization/Asset Protection (Triple By-Pass), 501(c)(15) Co., LADD, Leveraged Disposition, Othello, Prepaid Lease, Mixing Bowl, Enhanced Mixing Bowl, CPLS II, Basis Leap, Busted 351, Venture Capital Planning, Leveraged 704(c), PIF, SC2 Gain Mitigator, and PERX. To avoid or evade taxes in the international arena, they resort to things with names like U.S. Withholding Tax Eliminator, A&M Base Shifting, Alhambra, Pathfinder, and Short Option. To jack up losses and deductions, there's CCB, 172(f), Mitigation, 382, FEIGHT, CLC, Dot-Bomb-Monetization, and PALS (partnership allocating loss strategy) -- Income Absorption. Or how about Insureco, 501(c)(15) Captive, PINSCO (Personal Insurance Company), Captive Tune-Up, 21% Solution, WITS, E Replacement (WITS for Homebuilders), and Employee Benefits Captive? They take S corporations and use them for what they weren't intended to do, with things like SC2, SC2 Variation #1, SC2 Gain Mitigation, SC2 CLAS, S-corp Basis Enhancer, and SC2 Redemption Strategy. And then there's the finance and leasing stuff: AF-EXO (Alternative Financing for Exempt Organizations), Dot-Bomb-Monetization, Enhanced Venture Leasing, Inbound Cross Border Leasing, LIFT, PERX, PIF (Partnership Investment and Financing Structure), SLOTS (Sale Leaseback of Tenant Improvements), TAT. Or they go the accounting strategy route, with Bad Debt Reserve Acceleration Strategies, Inventory Methods Review, Contested Liability Acceleration Strategy, California Franchise Tax Acceleration, MEALS, Acceleration of Prepaid Expenses, Service Company Strategy, and IBNR: Incurred But Not Reported. These things sound like Pentagon weaponry, cleaning products, and video games. But it's no game. The last one says it all: "incurred but not reported." The last time I jumped on tax avoiders (namely, the tax protest crowd), I got all sorts of email from people who had fancy ways of telling me I was wrong to criticize them for wanting a free ride from the rest of us.

And that, I contend, is what all of this is about. Some people think that they deserve to pay less and get more, even if it comes at the expense of those lacking the political power, the economic clout, the cerebral understanding, or the firm conviction to learn about, expose, and oppose this arrogance.

The Administration wants to increase IRS funding. Why? Aside from the creation of jobs, it would cut the deficit and restore moral balance to the revenue system. Think of it. Every dollar brings back ten. What advocate of the free market would walk away from such a deal? One dollar brings back ten. The private sector wouldn’t toss that opportunity aside, and neither should the fiduciaries of the public trust. America deserves no less.

So what’s a state to do when it faces a budget deficit, with revenues trailing expenditures? One choice is to raise taxes, but that approach brings howls of protest from those who oppose taxes and the common weal to which they are directed. Another choice is to cut spending, but that approach brings howls of protest from those who understand both the short-term and long-term adverse consequences to individuals and to the state of putting an economy into reverse. The worse thing to do would be to increase spending or to cut taxes, especially when the tax cut is not an across-the-board rate decrease but a credit targeted to a special interest group in what amounts to the equivalent of increased state government spending. That is why it boggles the mind of anyone who understands public finance to learn, as reported in this Philadelphia Inquirer story, that tax credit applications approved by the state’s previous administration and put on hold by the new governor would be processed and approved. Did not Wisconsin get itself into a fiscal mess – converting surplus into deficit in a non-miracle reminiscent of a similar switch-a-roo at the federal level ten years ago – by enacting tax credits and other tax breaks targeted toward a certain preferred group, as described in this article? Is this the path the governor of Pennsylvania intends to follow? Is it a path that Pennsylvania may end up following unintentionally?

I have previously explained why tax credits for the film industry are contrary to best public finance practices. In You’ve Gotta Give 'Em (a Tax) Credit?, I questioned the assumption that without the credit, film companies would go elsewhere, considering that Pennsylvania has nothing to offer companies wanting Rocky Mountain backdrops but has all sorts of features that should attract film companies in any event. I questioned the role of tax credits as incentives. Most important, I questioned why film companies were getting tax breaks not available to other businesses that do as much, if not more, for the state’s economy. An disheartening example of this special treatment occurred in 2007, when the then-governor of New Jersey vetoed legislation that would have extended to producers of digital content the benefits of a tax credit in place for the film industry, highlighting the inequities I criticized in Do Profitable Companies Need Tax Breaks?. Unfortunately, the legislative process did not and does not give that governor the opportunity not only to block expansion of the tax credit, but also to revoke its availability to the film industry.

Four years earlier, in Using Taxes to Rescue a Non-Drowning Film Industry?, I had lambasted the California legislature for handing out tax breaks to the film industry, something it felt compelled to do because other states had started dishing out tax credits to the film industry. I noted that “Economic growth isn't nurtured by states fighting with each other for a piece of the existing pie.” Perhaps there’s a clue in this analysis to yet another factor in the economic malaise gripping the country. I argued that to have “growth in the film industry.” There need to be “more people [who] want to see films,” and better films. I also noted that, “Tax incentives have nothing to do with [the] growth [in movie attendance] because no state has “enacted a tax credit for going to the theater or for watching a movie on cable.” Finally, I pointed out that, “The film industry is rolling in money[, and] can afford to pay outrageous salaries to its ‘stars’ and if times get tight, those ‘stars’ ought to take pay cuts.” Surely they are in a better position to absorb those cuts and are of less importance to the future of this nation than are school teachers and skilled workers.

It is possible to argue that the tax credits had been enacted, and that the governor should simply have accepted the decisions that had been made by the previous administration. However, the spending process permits the governor to examine those expenditures. Unlike the former governor of New Jersey, who could veto expansion of tax credits but not revoke those available to the film industry, Pennsylvania’s governor had an opportunity to show by action what he has been preaching in terms of cutting state expenditures. Tax credits for a narrow group of taxpayers are simply disguised spending increases, and it’s well known that Pennsylvania’s governor wants to decrease, not increase, state spending. So why did he permit these credits to go forward? One plausible explanation is that that they were already authorized, and he had no choice. I don’t think that is the case. I don’t think that is the case because, during the campaign, the advocate of shrinking state government had supported the tax credit for the film industry. Why? What is so special about the film industry? Fortunately, representatives of the governor have declined to confirm that the credit will survive the next budget proposal, and though some members of the governor’s party, who had opposed the credit, now support it, others continue to question the wisdom of having taxpayers finance a private enterprise. Other states, including New Jersey under the leadership of a new governor, have suspended credits or are tackling legislation designed to suspend or terminate film credits, in the face of large state budget deficits.

In Using Taxes to Rescue a Non-Drowning Film Industry?, I explained:

In order for the tax burden of the film industry, for example, to be reduced, the tax burden of other taxpayers must be increased. Or, state tax expenditures on health, safety, education, and other essential and legitimate government services need to be cut, shifting the cost to the population generally, particularly through increases in local taxes. This puts upward pressure on the wage demands of workers in the state, it puts upward pressure on prices charged by other entrepreneurs in the state, and it puts upward pressure on interest rates as localities increase borrowing to cope with the impact of the state income tax incentive. Though the arrival of a production in the state brings a temporary boost to that state's economy, particularly that of the area in which the production exists, it isn't necessarily sufficient to offset the negative impact of the true cost of the specialized tax incentive. After all, the decision to bless one industry, thus shifting costs to another industry, may encourage those other industries to leave the state.

Advocates of the credit claim that the credit creates jobs, and that terminating the credit will cause jobs to disappear. Is not the deduction for compensation paid sufficient to reduce tax liabilities for film producers? Apparently not. Is the film industry incapable of surviving without the credits? Perhaps we will find out, and soon. One advocate for the handout to the film industry claims that ending the tax credits would “wreak havoc on the industry.” So the better choice is to wreak havoc on the taxpayers who foot the bill, or on the school teachers and other public sector employees who will lose their jobs so that the credit can continue to be financed with public dollars, or on the school children whose programs will be cut because the money is needed to fund the credit, or on the impoverished who will go without food and health care so that state money can finance an industry that pays salaries to “stars” that dwarf the allegedly “excessive pay” that permits a skilled worker or school teacher to barely make ends meet?

Anyone who has explored the world of sales tax exemptions knows that the distinction between taxable and non-taxable items often is a fine line so thin and delicate that it requires an electron microscope to detect the boundaries. Two recent rulings, from two different states, provide an interesting glimpse into a world that many tax practitioners and most taxpayers have not entered. It’s worth the visit.

In New York, §1105(a) of the Tax Law subjects all retail sales of tangible personal property to the sales tax. An exemption is provided by §1115(a)(3) for “[d]rugs and medications intended for use, internally or externally, in the cure, mitigation, treatment or prevention of illnesses in human beings … and products consumed by humans for the preservation of health but not including cosmetics or toilet articles notwithstanding the presence of medicinal ingredients therein….” The New York Sales and Use Tax Regulations, specifically 20 N.Y.C.R.R. §528.4(b)(1) defines drugs and medicines as “articles, whether or not a prescription is required for purchase, which are recognized as drugs or medicines in the United States Pharmacopeia, Homeopathic Pharmacopeia of the United States, or National Formulary, and intended for use in the diagnosis, cure, mitigation, treatment or prevention of disease in humans.” They also provide that “[t]he base or vehicle used (oil, ointment, talc, etc.) and the medium used for delivery (disposable wipe, syringe, saturated pad, etc.) of a drug or medicine will not affect its exempt status.” In examples of drugs and medicines exempt from taxation, the regulations list “antiseptics.” The regulations, in 20 N.Y.C.R.R. §528.4(d) define “cosmetics” as “[a]rticles intended to be rubbed, poured, sprinkled or sprayed on, introduced into, or otherwise applied to the human body for cleansing, beautifying, promoting attractiveness, or altering the appearance, and articles intended for use as a component of any such articles are subject to tax.” Finally, they define “toilet articles” as “[a]ny article advertised or held out for grooming purposes and those articles which are customarily used for grooming purposes, regardless of the name by which they may be known,” and give soap, toothpaste, and hair spray as examples of are taxable toilet articles.

In Virginia, as in New York, retail sales of tangible personal property are subject to the sales tax. Similarly, §58.1-609.10(14)(a)(i) of the Virginia Code provides an exemption for “[a]ny nonprescription drugs and proprietary medicines purchased for the cure, mitigation, treatment, or prevention of disease in human beings.” Section 58.1-609.10(14)(b) provides that “The terms ‘nonprescription drugs’ and ‘proprietary medicines’ shall be defined pursuant to regulations promulgated by the Department of Taxation.” and also provides that “The exemption authorized in this subdivision shall not apply to cosmetics.” Virginia Tax Bulletin (VTB) 98-4 (5/15/98) defines nonprescription drugs “as any substances or mixtures of substances containing medicines or drugs for which no prescription is required and which are generally sold for internal or topical use in the cure, mitigation, treatment, or prevention of disease in human beings.” Tax Bulletin 98-4 also provides that cosmetics, toilet articles, devices, food products and supplements, or vitamins and mineral concentrates sold as dietary supplements, other than those sold pursuant to a written prescription by a licensed physician, are not within the exemption. The bulletin defines cosmetics as “articles applied to the body for cleansing, beautifying, promoting attractiveness or altering the appearance (includes makeup, body lotions, cold creams, and hair restoration products),” and toilet articles as “products advertised or held out for sale for grooming purposes (includes soaps, toothpastes, hair sprays, shaving products, colognes, deodorants, and mouthwashes).”

The revenue departments in both states were asked to consider the status of antibacterial soap, antibacterial hand gel, antibacterial hand spray, antibacterial hand lotion, antibacterial hand wipes, hand gel sanitizers, conditioning hand sanitizers, hand sanitizers, and antibacterial hand foams. The antibacterial soap considered by the New York Department of Taxation and Finance was described as follows:

Each of the products’ drug facts label lists an active ingredient of either alcohol, between 68% -72%, or triclosan 0.3%; identifies its purpose as “Antiseptic;” and describes its use as “to decrease bacteria” on hands or skin. The product labels variously indicate that the products leave hands “feeling clean and virtually germ-free;” “clean, soft and virtually germ-free;” “clean, lightly scented and virtually germ-free;” “deeply cleansed and feeling smooth and soft;” “clean and conditioned;” “gently cleansed and conditioned;” “lightly scented, feeling moisturized and looking younger, while effectively fighting germs;” “lightly scented, deeply cleansed and feeling smooth and soft, while effectively fighting germs;” and “lightly scented, gently cleansed and conditioned, while effectively fighting germs.” Many of the products also tout their skin nourishing and softening effects.

The petitioner in New York was either the same entity or one working in concert with the petitioner in Virginia, because the Virginia Department of Revenue explained:

Each of the product's drug facts label lists an active ingredient of either alcohol, between 68%-72%, or triclosan 0.3%. The label identifies the product's purpose as "antiseptic;" and describes its use as "to decrease bacteria" on hands or skin. The product labels from the different categories indicate that the products leave hands "feeling clean and virtually germ-free; "clean, soft and virtually germ-free; "clean, lightly scented and virtually germ-free." Many of the products also advertise their skin nourishing and softening effects.

In both instances, the petitioner argued that alcohol and triclosan are treated by the FDA as over-the-counter drugs, and has proposed to include them in products that help mitigate the risk of disease and infection. In Virginia, the petitioner also pointed out that Public Documents (P.D.) 99-32 (3/18/99) and 05-135 (8/10/05) provide that the Department of Revenue “considers” FDA guidelines when classifying products, and that Tax Bulletin 98-4 specifically treats rubbing alcohol and antiseptics, which are contained in the antibacterial products under consideration, as exempt from the sales tax. The petitioner claimed that the products are marketed for their antibacterial products, and that customers purchase the products to avoid illness.

In its ruling, the New York Department of Taxation and Finance decided that if the antiseptic ingredient were removed from the products, they would be classified as cosmetics or toilet articles, because in that condition they would be “expressly designed to cleanse, beautify or promote the attractiveness of a purchaser, or for grooming purposes.” The Department concluded that adding the antiseptic ingredients did not transform the products into drugs or medicines, because the regulations state that cosmetics and toiletries are not exempt “notwithstanding the presence of medicinal ingredients therein.” The Department cited previous rulings in which it concluded that lotions are taxable but antiseptic gel is not if its sole purpose is treatment of minor burns, scratches, cuts, insect bites, and other minor skin conditions.

In its ruling, the Virginia Department of Revenue explained that “only those nonprescription drugs and proprietary medicines purchased for the cure, mitigation, treatment or prevention of disease in human beings qualify for the nonprescription drugs exemption. Cosmetics and toiletry items, except those that contain medicinal ingredients and that are principally used for medical purposes, are taxable. A product that is a cosmetic is not a medicine even though it may have medicinal properties.” The Department decided that if the antiseptic ingredient were removed from the products, they would be classified as cosmetics or toilet articles, because in that condition they would be “expressly designed to cleanse, beautify, or promote attractiveness of the purchaser, or they are used for grooming purposes.” Clearly, the staff at the Virginia Department of Revenue had read the ruling issued three months earlier by the New York Department of Taxation and Finance.

The Virginia Department of Revenue elaborated on its position by giving an example from its Nonprescription Drug Exemption Question and Answer Summary. That document distinguishes between a cosmetic containing an acne treatment and an acne treatment product intended solely for use in treating or preventing acne. It also cited a previous ruling in which it concluded that toothpaste containing a nonprescription drug is not exempt because toothpaste is generally sold for grooming purposes and that the nonprescription drug added to help prevent gingivitis was a secondary function to the intended use of the product. The key point, according to the Department, is that the “primary purpose of a product” is controlling.

The conclusions, and the reasoning, in these rulings are questionable. Do not most people purchase toothpaste in order to prevent cavities, and not simply to whiten their teeth? Would not a person without gingivitis or the risk of that disease purchase a toothpaste that does not contain the medicine? Very few people purchased antibacterial soaps and gels until outbreaks of assorted influenzas generated advice from government agencies to use those products for the purpose of fighting the spread of disease. Even Fairfax County in Virginia, in this publication was among those jurisdictions that recommended the use of antibacterial soaps and gels in order to prevent the spread of disease. Under these circumstances, is not the primary purpose of these products the prevention of disease? A consumer interested only in cosmetic purposes would purchase the cheaper, non-medicinal product. If asked, “What is the reason you switched to antibacterial soap?”, would not the answer be, “Because I wanted to reduce my chances of picking up a disease” or something similar? The fact that sales of these products soared after government agencies and public health officials – and probably individual physicians – recommended their use in face of threatened influenza outbreaks disproves the assertion that people have been purchasing them primarily for cosmetic or grooming purposes.

These rulings, however, illustrate a more serious problem than simply disagreement over the question of why people purchase antibacterial products. That question arises because there is a sales tax that has exemptions requiring retailers, shoppers, and revenue departments to distinguish between medicines and cosmetics. The existence of products that are both compel revenue departments to issue regulations or other guidance, and many chose to rely on a “primary purpose” test. The difficulty with a primary purpose test is that it ultimately requires exploration of the mental state of consumers, a task that not only is daunting and impossible to administer efficiently, but also alarming when one things of technology on the horizon that will permit reading people’s thoughts. Understandably, a test that looked simply to the presence of medicinal ingredients would invite manufacturers of all sorts of products to inject antiseptic or other pharmaceutical substances into the product. As horrible as it sounds, might not the solution be a repeal of all sales tax exemptions, which would permit a reduction in the overall rate and the streamlining of revenue department sales tax divisions? A quick scan of exempt and non-exempt items for each state’s sales tax reveals not only inconsistencies between states – something that adds to the cost of retailing in multiple states – but also hundreds of these “fine line” definitional conundrums that distract taxpayers, their advisors, retailers, and revenue department employees from other, more productive, activities.

Finally, for those who think tax is “nothing but numbers” or “all about numbers,” even those who think – often wrongly – that they are mathematically challenged and cannot “do tax” should be surprised and delighted that there are tax experts focused not on computations but on whether antibacterial soap is a medicine or a cosmetic, whether Clearasil is a medicine or a cosmetic, whether gingivitis-fighting toothpaste is a medicine or a cosmetic, whether, oh, never mind, there’s no point in trying to list all of them. That would take the “fun” out of it for those yet to discover the secrets of sales taxes.

The attraction to the private sector of the revenue stream generated by certain public sector activities, such as tolls from toll roads, continues unabated, as do attempts by the private sector to hijack the public trust. Though private operation of public sector function has been an abject failure for centuries – think of the ineffectiveness of private sector fire protection in colonial Philadelphia and the collapse of the privately-owned and operated Lancaster Turnpike – the advocates of corporate expansion from the private sector into the public sector continue to press for government surrender of its commonwealth role. Emboldened by the successes of, and reaping the benefits of funding and backing from, the anti-tax and anti-regulation crowd, these privateers demonstrate that the lure of ostensibly easy cash never loses its luster when viewed by those addicted to money (or the power that money buys).

This is not my first attempt to explain to citizens and voters the dangers of letting the private sector take over, among other things, highways. If left unchecked, by the time most people realize that they’ve been taken for a ride, it will be too late to undo the deals. Unlike government, where there is at least a chance for dissatisfied citizens to exercise their right to vote to make changes, the corporate world is impervious to the unhappiness of the electorate, because its decisions are made by an oligarchy to which 99.9 percent of the nation’s population does not, and cannot, belong. Unfortunately, most people go numb when they read the fine print, and thus become no less vulnerable to being conned than they are when they are propositioned by the world’s small-time versions of Bernie Madoff and those of his ilk.

Among the various posts that examine and de-bunk the myth of private sector superiority when it comes to dealing with public assets are Selling Off Government Revenue Streams: Good Idea or Bad?, Are Citizens About to be Railroaded on Toll Highway Sales?, Turnpike Cash Grab Heats Up, Selling Government Revenue Streams: A Bad Idea That Won't Go Away, Turnpike Lease: Bad Policy and Now a Bad Deal , How Do Toll Road Lessees Make a Profit?, The Pennsylvania Legislature Gets It Right, Killing the Revenue Idea That Won't Die, Are Private Tolls More Efficient Than Public Tolls?, and More on Private Toll Roads. In those posts I explained, among other things, why the alleged economics of these deals don’t add up, why the argument that presumed but unproven private sector efficiencies more than justify the private sector profit extracted from the public good doesn't survive careful scrutiny, and why the fable of the golden goose is a lesson still worth learning. Most important, I directed attention to the failed private sector toll road experiments in places like San Diego, Orange County, and South Carolina, and warned that these demonstrations of a theory going bad when put into practice provide more than sufficient reasons to reject any more attempts to siphon public revenue into a small segment of the private sector.

Now comes another article by Joe DiStefano, Builders Extolling Private Highway Projects, in which he points out plans to put tolls on existing toll-free highways to permit private companies to take over these roads. According to DiStefano, the movers and shakers behind this plan are “using the antitax, spending-cut mood gripping voters” to “push for” this privatization. The irony is that voters would be sucked into a deal by which taxes are cut, say, $10, collectively contributing to the public sector’s inability to maintain roads, but making citizens happy, only to be met with tolls of $15. What a trade-off. Pay less in taxes so that the tax savings, and more, can be diverted into the hands of the oligarchy. The public sector does not need to include a profits component in taxes or tolls, and the argument that the private sector can make up the difference through efficiency fails because the folks at Enron, Adelphia, Goldman Sachs, AIG, Worldcom, et al have demonstrated that inefficiency, waste, and fraud are not the monopolies of government as the “free enterprise means free to do what I want without limit” philosophers would have people believe.

The irony is that the advocates of so-called “public-private transportation partnership boards,” according to DiStefano, “acknowledge this could cost more, over time, than having the government borrow the money and build the projects through tax-free bonds.” No kidding. It would cost more because it puts more money into the hands of the oligarchy than it would acquire if the public sector retained ownership, control, and guardianship of public assets. Advocates claim it is better to have “the driving public” pay tolls, rather than to have “cash-strapped governments” pay for the roads. The lack of logic in this assertion is appalling. The driving public would be paying, one way or the other, either through tolls, gasoline taxes, or even the mileage-based road fee. Not only is the driving public no less “cash-strapped” than are governments, they would, as explained in the preceding paragraph, be paying more. Why? Because they would be shifting even more wealth to the oligarchy, who are, of course, responsible for governments being cash-strapped, considering the oligarchy’s persistent campaign to reduce, and eventually eliminate taxes. With taxes eliminated, all government functions would be shifted to the oligarchy, in a quiet revolution too few have been noticing.

Advocates also admit that states could become more efficient by contracting out the design and construction planning phases of highway improvement and repair projects. But we are told that “public-private projects are expected to be more profitable for builders.” Why should citizens rally around something more profitable for builders if the alternative is to let the process be more profitable for the state, thus permitting reductions in tolls and taxes? Because, we are told, shifting profits from the state to the private sector “will help attract more private investors.” And who will those private investors be? Low-income drivers? Middle-class union members? Folks in the swelled ranks of the unemployed? Seriously, who has the money to invest in a money-making privatized road deal? In fact, when “typical” citizens invested in these deals, they ended up being the ones “holding the bag” when the projects in San Diego, Orange County, and South Carolina tanked.

In the meantime, DiStefano tells us, the legislation introduced in Harrisburg to permit this encroaching takeover of government by the oligarchy, stands to be amended so that politicians can sit on the “public-private transportation partnership boards” notwithstanding their lack of expertise in transportation planning, highway design, road construction, street maintenance, or much of anything else that is required. The private sector has always made money doing contract work for state highway departments, sometimes using contacts to get selected, so what’s at issue isn’t so much the influence of politicians on the selection process, but the reinforced indebtedness of politicians to the oligarchy that benefits from the privatization process.

And for those who think that I’m being an alarmist about the doors being opened by this takeover of highways, consider what one of the advocates has promised. “ ‘In a couple more years we’ll be looking at these [to put] courthouses and state colleges’ and other public facilities, and their funding, in private hands.” At least this advocate is being open, perhaps more open than his clients prefer. Folks, the oligarchy wants to buy state highways, courthouses, public schools, police forces, and just about everything else that government does. Corporations owned by the oligarchy will run those things, unhappy citizens will have no one to turn out of office during an election in response to being gouged while getting bad service highlighted by needing to make 911 calls to some foreign country, unions will be broken, wages for the most people will be lowered, for those fortunate enough to have jobs, and the nation, no, the world, will be at the mercy of the handful of wealthy people who have bought the world. And when those who consider these people as heroes and their positions on tax policy to be the Holy Grail of opportunity discover that they have been had, there won’t be any place to find redress, because the oligarchy will own the courts, the police, every form of travel and communication, everything. The planet will have become one big plantation. Alarmist? If you think so, wait. Wait a few years. Then decide. If, of course, you’re willing to stand aside while this public asset grab moves into high gear.

Last month, in Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?, I noted the dilemma presented by candidates who espouse spending cuts but refuse to identify the programs that would be cut. This coy approach survives after the candidate is elected, until, hopefully, the electorate no longer connects the vague promises with the actual realities of the actions undertaken by the candidate turned legislator. The challenge to the advocates of spending cuts is to avoid losing votes by being forthcoming with their hit lists, as I explained in Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?:

So perhaps it would be helpful to learn what spending items the Republicans wish to eliminate. After all, they want to use their opposition to an increase in the debt limit as leverage to compel spending cuts. According to this report, when asked which programs could be cut, Boehner replied, “I don’t think I have one off the top of my head. But there is no part of this government that should be sacred.” Aside from the continued refusal to identify spending cuts, surely out of fear that lobbyists for those adversely affected by such cuts would descend on their Capitol Hill offices in a stampede, the Republicans are being boxed into a corner by their leader. When Secretary of Defense Robert Gates announced plans for a very small increase in the military budget for next fiscal year, plans that include shrinking the size of the Army and Marine Corps and cutting two major weapons systems, as explained in this story, Republicans objected, suggesting that the proposal puts the nation at risk. Is it possible to imagine how Republicans would respond to a proposal to decrease total defense spending when they go ballistic over smaller than expected increases? Do they truly think nothing in government is sacred? In The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I invited “the advocates of using spending cuts as the sole solution to the budget deficit crisis to identify sufficient cuts to bring the budget into balance.” I’ve had no replies from those advocates that identify specific cuts or even general spending reduction ideas. I’m not surprised.

I’ve been trying to get answers for quite some time. More than a year ago, in Some Insights into the Tax Policy Mess, I warned:

The deficit cannot be eliminated merely by cutting spending, unless Congress wants to strip the military down to pretty much nothing, eliminate Social Security and Medicare, and put an end to a variety of other programs. The nation faces huge deficits not only because tax rates on the wealthy are lower than they need to be, but also because the deficit reflects eight years of taxes that should have been collected but that were forgiven by a Congress anxious to reward the economic elite and ballooning interest payments on the debt undertaken to finance the deficits generated by trying to finance a war while cutting taxes.

A few months later, in June of last year, I challenged politicians and commentators from every spot on the spending-taxation spectrum to nominate their candidates for program reduction and elimination. In FICA, Medicare, and Payroll Taxes, I wrote:

Advocates of continued and increased spending need to identify the tax increases that will permit that to happen in the absence of a deficit, and it will take more than the return to the pre-2001 rates and the elimination of capital gains preferences that I support. Advocates of tax cutting need to identify the cuts they would make to balance the budget, and if they don’t touch defense, Medicare, Social Security – and they’re stuck with the interest payment on the debt – there’s not enough to cut.

The response was overwhelmingly quiet. No spending-cut advocate candidate had the courage to make his or her axe list public, because getting votes is much more important than getting honest. Having failed to get the specifics onto the table during the election, in November of last year, anticipating the continued stonewalling in response to requests for specific identification of programs on the chopping block, I challenged spending cut advocates, including but not limited to candidates and legislators, to step up and let Americans know what they planned to do. In The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I explained the fallacious reasoning and misperceptions that cause Americans to think that by cutting waste and aid to foreign nations the federal budget can be balanced. I also explained why cutting spending would be insufficient to eliminate the budget deficit.

Finally, the spending cut advocates who have taken control of the House of Representatives have had to put their cards on the table. In GOP Bill Pairs Budget Cuts, Regulatory Rollbacks, we learn not only which programs are the targets of the spending axe wielders, but also that they intend to eliminate all sorts of rules that protect ordinary citizens from predatory wheeler-dealers, who find taxes and government regulation to be annoyances that get in the way of their objectives. I suppose they’re not unlike the folks who found the newly-arrived sheriffs in Wild West towns to be an annoyance.

So what does the House majority want to cut or eliminate? Check out the list, which is based in part on a Center on Budget and Policy Priorities report:

• A 15% reduction in Head Start funding, in addition to the expiration of funding provided by 2009 legislation, requiring the dismissal of 157,000 children from Head Start education, health, and nutrition services.
  
• A 6% reduction in funding to assist K-12 education, including termination of Mathematics and Science Partnerships and Educational Technology State Grants, reductions in assistance to special education, funding for literacy programs, Special Olympics, and a long list of initiatives designed to help American’s future generations learn what they need to know and understand in order to compete globally with the future generations of places like India, China, Korea, Germany, and Brazil, to name but a few countries whose students are performing better than are America’s children.
  
• A 24% reduction in Pell Grants, which will compel at least some of the 9.4 million college students receiving grants to drop out of college, and forcing unmeasured millions to decide not to attend college.
  
• Cuts in programs that assist high-school dropouts to become contributing members of the economy, including elimination of the Tech-Prep and Workplace and Community Transition programs.
  
• A 6% reduction in funding for community mental health services block grants and substance abuse and treatment block grants, reducing assistance for the mentally ill.
  
• Reductions in the special supplemental nutrition program for women, infants, and children, which, until now, has been able to provide women, infants, and children under age 5 with necessary food and health care that has reduced infant mortality and improved birth outcomes and diets.
  
• A 43% reduction in the Public Housing Capital Fund, thus removing almost half the funding required to make emergency and other repairs to public housing units primarily occupied by low-income senior citizens and disabled individuals.
  
• A 10% reduction in the HOME Investment Partnerships program, which assists local governments develop, acquire, and rehabilitate low-income housing.
  
• A 30% reduction in block grants to assist low-income Native Americans and Native Hawaiians living on reservations, tribal areas, and home lands.
  
• A complete termination of the Low Income Home Energy Assistance Program.
  
• A complete termination of the low-income Weatherization Assistance Program.
  
• A 56% reduction in funding for the EPA’s clean water and safe drinking water programs.
  
• A 19% reduction in funding for local law enforcement, courts, prisons, crime victim and witness initiatives, and other initiatives designed to reduce crime.
  
• A 10% reduction in funding for the Centers for Disease Control and Prevention, the agencies that deal with pandemics, food poisoning outbreaks, and other serious public health matters.
  
• A 10% reduction in funding for the Food and Drug Administration, the agency charged with protecting the quality of the nation’s food and drug supply, which already is suffering from insufficient funding to deal with the significant increases in food-borne illnesses.
  
• A 9% reduction in funding for the Food Safety Inspection Service, which is the agency charged with inspecting farms, food factories, and other components of the nation’s food supply.
  
• A 4% reduction in funding for the National Institutes of Health.

But it wasn’t enough to slash spending in ways that will increase costs in the future and that will increase class sizes in K-12 education, cause mortality rates among low-income individuals to increase, and leave the next generation less prepared to compete in a global economy. The House majority also took the opportunity to block the EPA from curbing greenhouse gas emissions, to negate EPA rules designed to prevent the growth of algae in Florida’s lakes and streams caused by excessive use of fertilizer and other pollutants, to stop the EPA from implementing a plan to clean up the Chesapeake Bay – putting fishermen, crabbers, and others who make their living in the Bay at risk of going out of business so that farmers and others who in making their living dump all sorts of waste and poisons into the Chesapeake Bay watershed – and to terminate plans to remove hydroelectric dams from the Klamath River. The House majority also acted to let mining companies that slice off the tops of mountains continue to do so even if it increases water pollution.

The Economic Policy Institute claims that, if enacted, the legislation would cause a loss of 800,000 jobs. Not surprisingly, leaders of the House majority attacked the Institute’s methodology, and in a response, the Institute not only defended its analysis, but noted that close to one million jobs would be lost.

Most observers doubt that the House-passed legislation will be enacted, because it is likely to face sufficient opposition in the Senate to fail to get to the President’s desk. And if did get to the President, there is almost unanimous consensus that the bill would be vetoed. So, perhaps, knowing this, the House majority is having its moment in the sun, grandstanding for the benefit of its backers who want at least a show of support for the “let me do whatever I want” philosophy. That will permit them, during the next campaign, to argue, “I tried, but the evil people who want clean water, safe food, nutrition for starving children, health care for at-risk infants, education for students who the hope of tomorrow, and all other sorts of ‘bleeding heart’ nonsense outnumbered us and stopped us, so join with us to take over the Senate and the White House so that we can cut spending to the point where Americans will need either to pay more state and local taxes or watch the quality of life for all but the wealthy go down the tubes.” Oh, wait, their campaign managers will take out that last part, and replace it with “so join with us to take over the Senate and the White House so that we can make America a wonderful place the same way the tax cuts we advocated made the economy roar.” Oops. That won’t work, either, will it? So perhaps, “join with us to take over the Senate and White House so that we can do all sorts of wonderful things,” leaving out the “which will have effects we won’t share with you, just as we didn’t tell you what programs we would be cutting until after we extracted your vote back in 2010.” I wonder what the 2010 election results would have been had, during the fall, candidates announced they were in favor of a polluted Chesapeake Bay, more crowded K-12 classrooms, termination of low-income energy and weatherization assistance, reductions in Head Start, Pell Grants, food for starving children, and funding for the agencies charged with protecting an already endangered food supply system. I wonder what would have happened had the candidates been forthcoming. Perhaps the outcome would have been different. Or perhaps we would have learned that a majority of Americans prefer polluted waters, starving children, more homeless low-income people, tainted food, worsening education, and increased illiteracy and innumeracy. Perhaps there are fewer and fewer “bleeding hearts” because there are fewer and fewer people with hearts. I doubt it. I think Americans with hearts need to find their voices. And soon.

Last week, Paul Caron’s TaxProf Blog published Maule: The Tax Consequences of Congressional Sleepovers, in which I explained that additional factual analysis was required before any conclusions could be reached concerning the tax consequences of members of Congress sleeping in their offices. It is not uncommon for people to seek conclusions before all the requisite facts are known. Recently, for example, a tax practitioner posed a question to a tax listserve, and in my response I identified facts that needed to be resolved before an analysis could be undertaken that would lead to a conclusion. I encounter this problem frequently, when I get calls and emails from lawyers who want “the answer” but who are dismayed when I ask questions that in the aggregate constitute an inquiry as to “what, really, is going on here?” Otherwise, discussion is restricted to a discussion of the, for example, 81 possible analyses arising from the application of law to three possible factual determinations with respect to four key questions. I use the term “restricted” not because the discussion is constrained – to the contrary, it is 81 times as long as it would be had the necessary facts been determined – but because the discussion, though useful intellectually, does nothing for the client who needs an answer, and who is likely to balk at paying for 81 times as much discussion as is necessary.

That is why it is even more offensive to listen to people jump to conclusions, that is, proclaim outcomes without knowing the facts. In many instances they don’t even realize that there are facts they need to know, because they haven’t bothered to do the analysis. That’s probably because they don’t realize that there is analysis that needs to be done.

A brilliant example of the “speak without knowing what you need to know” nonsense has emerged in connection with the debate over members of Congress catching shut-eye in their offices. On Thursday, Paul Caron’s TaxProf Blog published a link to a “conversation” between MSNBC commentator Lawrence O’Donnell and Representative Jason Chaffetz of Utah. In MSNBC Calls Congressmen Who Sleep in Their Offices “Tax Criminals”, the lack of tax law knowledge was alarming, not merely because lack of tax law knowledge often is per se dangerous, but because the two people involved are in positions that demand they not speak unless they understand what they are describing. A commentator who, for whatever reason, lacked any sense of sections 119, 132, or 162 of the Internal Revenue Code, made accusations against a member of Congress who is entrusted with the responsibility of being a lawmaker. Chaffetz, who before agreeing to the interview, ought to have brushed up on the applicable law, or at least consulted with a tax professional, made absolutely no attempt to raise the issue of excludable fringe benefits or the principle that criminal tax fraud charges won't stick when there is doubt about the applicable outcome (the latter being something to which O’Donnell, too, should have paid attention). O’Donnell made a big deal of Chaffetz’ failure to request tax advice from the IRS, though he didn’t bother to ask whether Chaffetz had sought advice from some other professional source. I suppose I could ask O’Donnell whether he had obtained any information about the applicable tax law, for example, by having an MSNBC intern do some research, perhaps even taking a look at Maule: The Tax Consequences of Congressional Sleepovers. At least O’Donnell vowed to ask the IRS for an opinion. It will be interesting to learn if he followed through, if he obtained any sort of answer, and what the IRS says.

One of the reasons so many bad decisions have been made with respect to this nation’s tax law, economy, national security, and other concerns is that far too many people choose to issue proclamations without taking the necessary steps to be informed about the information that needs to be known in order to issue a proclamation that is sensible and correct rather than nonsense. It’s one thing when two people in a bar toss about silly assertions with respect to the local professional sports team. If they’re both full of nonsense, so what? But when a national cable news commentator, viewed here and abroad, and a member of Congress toss about silly assertions and demonstrate ignorance, it’s not only an embarrassment, it’s also dangerous. Why? It adds to the national culture of ignorance that has become frighteningly pervasive. Somehow, in the effort to score faux debating points and rile up “the base,” commentators and politicians neglect their obligation to speak from an informed perspective. Their fiduciary duty to the citizens of this nation demands nothing less.

And in the meantime, too many politicians are trying to cut funding for education, goaded by a significant segment of national commentators. One wonders who benefits from these efforts? Could it be that widespread ignorance is useful to a select few? Truly, ignorance, including tax ignorance, is frightening.

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.