MauledAgain

Anyone looking closely at the “Links to Other Tax Blogs” on the left side of this page will notice that I’ve added a link to Due Diligence. Though this blog includes commentary on white collar crime, legal malpractice, and several other areas where the lack of due diligence can get lawyers and others into trouble, it also includes a significant number of tax cases and other tax situations where the failure to exercise due diligence sparked adverse consequences. I’m particularly glad this blog exists because it is something to which I can direct students who respond favorably to my advice that those who find both tax and criminal law to be interesting can carve out a niche occupied by relatively few lawyers and that demands a confluence of analytical skills that transcend those used in tax and those used in criminal law analysis.

The Due Diligence blog runs a series of headlines, from which users can follow links to complete stories. The headlines remind me of the sound bite teasers aired by local television stations that are followed by “news at 11” or, for some, “news at 10.” Those teasers almost always are attention-getting descriptions of crimes, accidents, fires, and other ratings-making catastrophes. Consider not only these headlines but the cumulative impression they provide of the condition of the nation’s business sector:

* More Offshore Indictments – This Time Julius Baer Is Target
* Ed May: A Sentence That Ends a Dour Chapter
* Merrill Lynch Tagged Again – This Time for $800,000
* Merrill Lynch Fined $1mm For Fraud
* Lawyer and Client Indicted in Asset Protection Gone Wrong
* NBA Player Arrested for Alleged Ponzi Scheme
* Stock Traders More Reckless Than Psychopaths? Yes Says Study!
* Edward Jones Brokers Under FBI Scrutiny
* New Charges Against Milwaukee MD For Unreported Foreign Accounts

And that’s just the front page with the news from the past several weeks. Why was I not surprised to learn that stock traders are more reckless than psychopaths?

After reading the stories linked to these headlines, and others on Due Diligence, two thoughts popped into my head. First, those who sing the praises of the private sector might not realize how flat their tunes are when one considers that these headlines are but the tip of the iceberg. It’s a significant factor in my conclusion that the “choice” presented by the “free” market is a false choice, as I noted last week in From Fat Tax to Accountability: The Failure of Choice. Second, the resounding chorus from the anti-government, anti-tax crowd for a reduction and even elimination of laws, rules, and regulations protecting society from the rapacity of those who generate the sort of headlines featured in Due Diligence is another chant that fails to resonate with reality. Imagine how much busier the Due Diligence blog would need to be if the regulation bashers had their way. Sadly, it would be reporting the crimes, rip-offs, and scams but not investigations, indictments, convictions, fines, or sentences. I suppose there are some people who would find that to be a better world. I’m not among them.

Tax professionals, as well as other professionals, will find keeping tabs on Due Diligence to be worth the few minutes they invest. That’s why Due Diligence has been added to “Links to Other Tax Blogs.” Check it out.

In last Friday’s post about The Fat Tax, I commented on a Danish citizen’s concern that taxes designed to influence behavior raise the specter of government becoming “big brother” by pointing out that the private sector is a “big brother” orders of magnitude beyond anything government can construct. I asked “whether the cameras, the information collection, and the laws should be imposed by a non-accountable private sector oligarchy or by a government accountable through the ballot box.”

Joe Kristan over at Tax Update Blog, though accepting of my position on the fat tax, took issue, in Just Try and Fire the IRS, with my suggestion that the private sector is non-accountable and the government is accountable. Though quoting the entire paragraph, including my claim that the private sector engages in more information collection, more regulation, and more camera installations than government, it does not appear that Joe is contesting my assertion that the private sector collects far more data than does the government.

Joe rests his disagreement on two propositions. First, if he is unhappy with what a private sector enterprise or actor is doing, he can take his business elsewhere. Second, his vote is diluted because he is one of hundreds of thousands or millions, and might even live in a jurisdiction where his vote is meaningless because he is outnumbered by those who vote in the opposite way than he does.

Joe’s proposition with respect to the private sector reflects the theory of a free market but not the reality of the market in practice. Joe gives as an example his ability to take his coffee purchasing activities to Java Joes or Timbuktuu if he becomes dissatisfied with Starbucks. From what I can determine, Java Joes and Timbuktuu are local businesses in Des Moines. How long until they are purchased or run out of business by Starbucks? The notion that businesses thrive by providing good service and go under if the service is bad may be true in some instances for short periods of time, but too many good, small, local businesses have gone under while unaccountable international conglomerates foist bad quality on the market place because of predatory and other questionable practices by the giants. For all the complaints that taxes and regulations kill small businesses, which tend to be of a higher quality, what kills small businesses is the overbearing size and activities of the international giants. Joe’s other example, involving grocery stores, will soon be history. During the last five years in my area, one grocery chain bought out another, another went bankrupt, and a third is scaling back in what many would agree is the first step in its disappearance. The big box conglomerates are killing not only small business but even the larger regional outfits. The danger of an oligarchy is that it stands poised on the edge of a monarchy. The choices may exist, but they are diminishing. The trend isn’t very promising.

But aside from the occasional instances of local choice, there remains the practical effect of monopolistic practice. For example, though I have the theoretical opportunity to use an operating system and software other than Microsoft’s, the insistence of those with whom I interact to receive documents in a Microsoft format means that to exercise my theoretical right to use another operating system I must invest time and money in applications to convert things into Microsoft format. Not that Microsoft products are superior, as the tidal wave of complaints about Microsoft software failures, security breaches, and other problems indicate, yet Microsoft dominates the industry. Why? Because it has managed to persuade government to back off from its antitrust responsibilities. How? Money talks.

Yes, there are private sector organizations that do a good job, even a superb job, with the quality of the product and the quality of the service. But their number is few. And, as I’ve noted, they’re likely to be snatched up by an inefficient corporate mega-monster looking to pounce on every money-maker in sight. Unfortunately, the market is riddled with private sector companies that deliver failure after failure, causing death, injury, and destruction. The private sector delivers not only Pintos, some of whose owners never had the information and opportunity to seek and select a safer alternative, but also things like bad pet food, moldy wall board, unsafe environmental impacts, repeated Blackberry service outages, spotty Internet access, and hundreds and thousands of other bad products and flawed services. Interestingly, far more of this comes from the international companies than from the local, hometown businesses, probably because the latter have a more personal relationship with customers and clients and thus see their revenue sources as people and not anonymous numbers.

Joe’s proposition with respect to the government sector rests on the observation that he is one of hundreds of thousands or one of millions. But that’s true for Joe in the private sector as well. His one vote matters, because of its value when combined with other votes. His walking out of Starbucks because of bad service or poor quality coffee is one decision that matters, because of its value when combined with other similar decisions. Just as Joe can leave Starbucks, he can move from Des Moines, he can move within Des Moines to a different district, he can move out of Iowa. If he’s sufficiently unhappy, he can move out of the country, and as extreme as that choice may be, if Joe can find a country whose government is more to his liking, then he has that option. I doubt we will be waving goodbye to Joe anytime soon.

Joe’s proposition with respect to the government sector suggests that government services are worse than those provided by the private sector. In some instances that’s true. But in other instances it’s far from true. Knock on wood, but I’ve never had a problem with Pennsylvania’s Department of Transportation in terms of licensing and vehicle registration. I can’t say that about the insurance companies. I’ve never had a problem with township-provided, tax-funded trash and recycling pick-up, but I cannot say that about the private contractors with whom I dealt when I lived in townships that went with private collection. When I have had difficulties with government services, in most instances it was a consequence of a government law, regulation, or policy adopted at the behest of a large private sector enterprise or actor with the money to wield influence over the government legislature or agency in question.

And that brings me back full circle to the notion that government somehow is a failure. For every failure of government service, there are disproportionately far more failures in the private sector. When government does fail to respond to the needs of the electorate, it’s often because the private sector organizations are devoting too many resources into owning government and insufficient resources into providing quality products and services. That government-imposed monopoly that Joe mentions as the exception to his free market choice model is the product of the private sector co-opting government. The solution is not to punish the captive government but to put the oligarchs and monopolists out of the vote-buying business.

I maintain my position that those who fear governmental big brother are worrying about a threat that is miniscule compared to the threat of corporate big brother. I maintain my opinion that government is accountable through the ballot box in a way that the private sector is not. Joe can leave Starbucks but he cannot vote out its officers or board, and when he wakes up tomorrow and finds that Starbucks bought out Java Joe’s and Timbuktuu, he cannot run for office as he might if he wakes up to find that a candidate not of his liking was elected.

In theory, a free market working as it should requires a small government to protect that market. In reality, we have a market that is free only for those with money to be free to do what they want, and an oversized government trying to keep up with protection of those afflicted by the abuses of the market place, but hamstrung by the opposition to regulation advocated by those who have the most to lose if they were required to obey the rules of a truly free market. When all is said and done, the lack of transparency and accountability in the private sector makes the government look downright benevolent in that regard. It’s not, of course, but when compelled to choose between two things that are broken, it’s best to put one’s repair skills to work on the thing that’s easiest to fix and whose repaired condition will make it easier to fix the other broken item. A repaired government can fix the broken free market. A repaired free market cannot repair the government.

Ever since the Marcellus Shale natural gas boom got rolling, I argued that the Commonwealth of Pennsylvania, as representative of its citizens, needs to impose a user fee to recover from the gas developers the costs that otherwise would be borne by the state government and thus, indirectly, by its taxpayers. I first made that suggestion in Tax? User Fee? Does the Name Make a Difference?. I followed up in Giving Up on Taxes = Surrendering Taxpayer Rights?. A month later, in Life for My Proposed Marcellus Shale User Fee?, I asked, “Have these people been reading my MauledAgain posts?” and answered “Perhaps.” Five months ago, in Revenue: Is It All in The Name? I described an impact fee proposal offered by the President of the Pennsylvania Senate who defended the revenue raiser by noting that it was a fee and not a tax.

Now comes news that the governor of Pennsylvania will propose that individual counties set a per-well fee on the natural gas developers. The fee would be split between the county and the state. The county would use the revenue to recoup the cost of improving infrastructure, repairing roads and bridges, and dealing with the effects of the local population growth that the drilling has sparked. The state would use its share, at the moment pegged at 25 percent, to deal with issues affecting the entire state, such as pipeline safety, environmental effects beyond the counties in which drilling occurs, road and bridge repairs on traffic arteries leading to those counties, health studies, and similar matters.

Not surprisingly, no sooner had the plan been released than the criticism rolled in. Some legislators want the state’s cut of the revenue to be more than what is being proposed. There is concern that counties without wells will engage in “border wars” with counties imposing the fee. The proposed limit on the fee, $40,000 per well, does not have unanimous support, particularly because it will not raise nearly enough revenue to repair the transportation infrastructure or offset the environmental and health damage, and the proposed phasing out of the fee over a 10-year period also does not sit well in some quarters. Still others worry about administrative burdens.

The previous governor pointed out that the fee nonetheless is a tax, and that by shifting its enactment to the county commissioners, the current governor is finding a way to impose a tax without breaking his pledge to prohibit the state from increasing taxes. He has a point. It turns out that the key to getting around the Norquist no-tax-increase pledge is to call the revenue raiser a fee and to have constituent government entities impose the fee. It will be interesting to see, if this plan is adopted and the governor runs for re-election, whether he will claim that he did not raise taxes. It will be even more interesting to see if voters and citizens buy that argument.

As further proof that those who teach learn by doing so, I share a question that arose recently when I was guiding the students in the basic federal income tax course though the technicalities of the section 119 meals and lodging exclusion. We were focusing on the unsettled issue of whether groceries constitute meals, an issue that has the IRS and the Tax Court saying “no” and the Third Circuit responding affirmatively. To get the students thinking about the issue, I ask them to give examples of groceries. Of course, they immediately offer the usual items that are not food, such as plastic wrap, paper towels, and cookware. This semester, one of the students pointed out that grocery stores sell pet food.

Until this semester, I had never given any serious thought as to whether pet food fell within section 119. If groceries are considered meals, pet food would qualify, as would the paper towels, but that surely is not the correct result. Because a person can buy “ready to eat” meals at a grocery store, an employer who provides groceries in the form of “ready to eat” meals surely is providing a meal. What about food items that require preparation? A reasonable reading of section 119 should include those items. Why? Consider the paradigm employer-provided meal, that is, food served to employees at a table or collected by employees at a buffet. Not all of the food in those situations is ready to eat. Bread needs to be buttered. Baked potatoes need to be split open and filled with whatever the diner chooses. Sugar and milk or cream needs, for many people, to be added to coffee. These observations might help refine the definition of “meal” when it comes to food delivered by an employer to an employee other than in a dining room, including food that requires additional preparation, but does it help answer the pet food question?

Section 119 applies to meals “furnished to [the employee], his spouse, or any of his dependents.” At first glance, this rules out the pet food because it is not furnished to the employee, the spouse, or dependents. But, on the other hand, the statute does not say “consumed by” the employee, the spouse, or the dependents. Consider the following situation. The employee resides in employer-provided lodging on the employer’s business premises. For example, the employee is employed by a K-12 boarding school and must reside on campus for the convenience of the employer and as a condition of employment. The employer has groceries delivered to the residence on a weekly basis. Ignore the paper towels. Presumably the value of the foods delivered on behalf of the employer are excluded from the employee’s gross income. Suppose that on one evening, the employee’s brother, who is not the employee’s dependent, stops by for dinner. Must the employee include the value of the food consumed by the brother in gross income because it was not “furnished” to the employee, the spouse, or the dependents? Would that not be administratively burdensome? But is it not possible to argue that the meals were furnished to the employee, who chose to share? If so, is it not possible to argue that the pet food shared with the pet dog or cat of the employee’s family falls within the term meals because the food is furnished to the employee?

In my mind, the matter is not resolved. If there has been a case or ruling on the pet food issue, I haven’t found it. But for those who think tax law is “just numbers” and poses no unanswered questions, I offer this question as yet one more example of why tax law is more than numbers and fixed rules.

No, the fat tax is not a tax on fat cats. Nor is there a typographical error, as the fat tax is not the flat tax. The fat tax is a tax enacted in Denmark, applicable to foods with saturated fat content exceeding 2.3 percent. According to this report, Denmark is believed to be the first country in the world with a tax on saturated fat. It is also reported that Finland and Romania are considering a similar tax. Denmark officials explain that the purpose of the tax is not to curb obesity, as Danes are thinner than average, but to increase life expectancy, a measure on which Danes lag behind.

It is unclear what use is made of the proceeds from the fat tax. Ideally, the proceeds would be funneled into health care, either specifically for research and treatment of diseases caused or worsened by the intake of saturated fat or generally for overall health care. Denmark also taxes soda and candy, but it’s also unclear where those tax proceeds are expended.

Readers of MauledAgain know that I have consistently objected to a tax on soda and sugary beverages. As I have explained in a series of posts beginning with What Sort of Tax?, and continuing in The Return of the Soda Tax Proposal, Tax As a Hate Crime?, Yes for The Proposed User Fee, No for the Proposed Tax, Philadelphia Soda Tax Proposal Shelved, But Will It Return?, Taxing Symptoms Rather Than Problems, It’s Back! The Philadelphia Soda Tax Proposal Returns, The Broccoli and Brussel Sprouts of Taxation, and The Realities of the Soda Tax Policy Debate, my objection rests on singling out sugary beverages as a target when there are many other substances ingested by people that contribute to the rising cost of health care. As I explained in The Realities of the Soda Tax Policy Debate:

The problem with these attempted explanations for why sugary beverages are singled out in the “we need revenue, let’s tax something” version of the defeated proposal is that they rest on erroneous factual assumptions, conflate information, and ignore reality. First, though moderate and sensible use of sugar does not trigger obesity and other illnesses, there is no such thing as moderate use of tobacco because any use of tobacco ramps up the risk of cancer and other disease. Second, sugar is not the only substance that, consumed excessively, causes health problems. Excessive intake of fat, for example, is just as dangerous, if not more so. Even water can be deadly, as evidenced by people who have died in foolish water drinking contests. Where is the logic behind “Sugar is bad, tax it, fat is bad, don’t tax it”? The notion that people will take in more sugar drinking soda because soda is not filling ignores the fact that gulping down a huge amount of liquids will leave a person with less stomach room, and less desire, to take in food. Does it make sense to encourage the ingestion of Twinkies rather than soda because it’s better to fill the stomach with sugar and fat? Finally, the notion that cigarette taxes has cut smoking is debatable, particularly with respect to tobacco use among younger people, who supposedly are the targets of the “tax will teach you a lesson” proponents.

From a health perspective, the target needs to be the items originally indicted by the Yale researcher, namely, high-calorie, low-nutrition substances. The issue isn’t so much the item, other than the true poisons such as nicotine and trans-fats, but the quantities being consumed. Even low-calorie, high-nutrition foods can be dangerous if consumed in excess. The focus on soda, intense as it is on the part of the soda tax advocates, suggests something more is at work. I wonder if we would be seeing “donut tax” proposals offered with the same zealousness had it been donut manufacturers who tossed money at school boards to install vending machines in the schools. I wonder.

Interestingly, according to the report, Denmark has banned the use of trans fats, and thus there is no tax on them. Although saturated fats also contribute to cardiovascular disease and cancer, Denmark has opted not to ban them but to tax them, not unlike what governments in the United States do with tobacco.

One Danish citizen interviewed by ABC News explained, “Denmark finds every sort of way to increase our taxes. Why should the government decide how much fat we eat? They also want to increase the tobacco price very significantly. In theory this is good — it makes unhealthy items expensive so that we do not consume as much or any and that way the health system doesn’t use a lot of money on patients who become sick from overuse of fat and tobacco. However, these taxes take on a big brother feeling. We should not be punished by taxes on items the government decides we should not use.” These observations demonstrate the tension between individual liberty and societal responsibility. Governments care about the health of its citizens, or, because governments are the citizens, citizens care about the health of other citizens for several reasons. An out-of-shape citizenry is in no condition to defend the nation. An unhealthy citizenry diverts scarce resources from efforts to make progress economically, socially, culturally, and technologically to efforts to repair the damage caused by unhealthy practices. To the extent health care is covered through insurance systems, it is in the interest of every insured to keep the overall risk as low as possible. That goal is enhanced when unhealthy behavior is reduced, either through education and encouragement or through prohibition and penalty. A balance between individual liberty and societal intervention can be reached if responsibility for individual decisions rested solely on individuals. Thus, the person who engages in unhealthy and risky behavior and who is unwilling to participate in societal insurance or to be subjected to societal restrictions must be willing to bear the full cost, without societal assistance, of the consequences of that behavior. What sort of society, though, is willing to tell a person who shows up at an emergency room, “You chose to ignore the speed limit, not wear a seat belt, and not purchase health or accident insurance, so we cannot assist you.” Frighteningly, there are increasing numbers of people who want to take that approach. But there is a flaw in their reasoning. What if the unhealthy behavior brings consequences beyond the person engaging in that behavior? What does a society say to a person who is injured, or whose family member is killed, because another person’s unhealthy behavior led to, for example, a heart attack that triggered a traffic accident?

The Danish citizen’s concern about big brother is real but misplaced. The fear that government is becoming or has become big brother is a distraction. The deeper concern is that private actors in the private sector act as big brother. For every government security camera, there are many more private sector cameras. For every government form that citizens fill out with personal information, there are many more private sector information collection devices doing the same and more. For every government rule or law, there are many more private sector regulations. The question is whether the cameras, the information collection, and the laws should be imposed by a non-accountable private sector oligarchy or by a government accountable through the ballot box. The latter option, of course, is rapidly disappearing as the oligarchy continues to acquire increasing amounts of electoral power disproportionate to the principle of one person, one vote.

There is value in shifting the cost of health care to the practices and substances that jeopardize good health. But that shifting needs to be consistent. Selecting one or two items, such as soda and saturated fat, while ignoring others, is a recipe for ultimate failure. The ideal tax is one that, for the moment at least, cannot be administered. One of the most serious contributors to health issues is excess caloric consumption. Because calories abound across the menu, a tax on all foods accomplishes nothing in this respect. That is why the better approach is education. Again, there is a serious tension between those who think that dietary and nutritional should be delivered by the public sector, for example, schools, and those who think it is a matter for the private sector. But a quick look at this country’s population is visible proof that reliance on the private sector to promote good health and educate people with respect to beneficially healthy practices has been pretty much a failure. That is why some people advocate soda and fat taxes. Though that advocacy is understandable and well-intentioned, it is too narrowly focused, and if focused appropriately, runs into the barrier of impractical application.

It is a basic principle of federal income tax law that gross income includes all income unless an exclusion can be identified that applies to the transaction. Thus, it was surprising to me to discover that a taxpayer had litigated the question of whether a qui tam payment constituted gross income. It surprised me even more that this issue has been litigated more than once.

Before analyzing the federal income tax consequences of a transaction, it is important to understand the transaction. This challenge is one of the significant contributors to the struggles that law students face when trying to learn basic federal income tax law. So what is a qui tam payment? Simply, it is a lawsuit brought by a citizen on behalf of a government. A qui tam payment is an amount awarded to the citizen for his or her efforts in bringing the action.

Once that is understood, it ought to be fairly easy to determine that qui tam payments are gross income. First, there are no exclusions applicable to qui tam payments. Second, there is settled case law that a reward is included in gross income, and section 74 makes it clear that awards are included in gross income, with two exceptions not relevant to qui tam payments. Third, considering that a qui tam payment essentially is compensation for performing a service, it must be included in gross income.

The case that caught my attention was the Eleventh Circuit’s affirmance, in Campbell v. Comr., No. 10-13677 (11th Cir. 2011), of an earlier Tax Court decision in the case (134 T.C. No. 3 (2010)), which somehow I didn’t notice when it was published. The Tax Court concluded, following an earlier decision, that the qui tam award must be included in gross income. That qui tam payments and their tax treatment are no small matter is evidenced by the size of Campbell’s award, specifically, $8.75 million. Campbell, who had been employed by Lockheed, filed two lawsuits under the federal False Claims Act, and Lockheed eventually settled by paying the government almost $38 million. The Justice Department issued a Form 1099 to Campbell to reflect his $8.75 qui tam payment.

The payment was wired to Campbell’s attorneys, who took out their $3.5 million fee, and sent Campbell a check for $5.25 million. Campbell, who prepared his return without consulting anyone, put the $5.25 million on line 21 as other income but left it out of taxable income. Neither the Tax Court opinion nor the Eleventh Circuit opinion explains how Campbell managed to remove the $5.25 million from taxable income. The amount reported as taxable income did not include the amount on line 21.

Campbell argued that a person who brings a qui tam payment acts for the government, and because the government’s recovery is not taxable to it, the qui tam payment is not taxable to the person who receives it. The flaw in the argument is that no one has ever decided whether or not the recovery is included in the government’s gross income, because the government has no need to compute gross income.

Campbell was not the first taxpayer to raise the issue. In Roco v. Comr., 121 T.C. 160 (2003), the Tax Court held that a qui tam payment is gross income. In Brooks v. U.S., 383 F.3d 521 (6th Cir. 2004), the Sixth Circuit concluded that the qui tam payment is a reward, is not within any exclusion, and is gross income. In Trantina v. U.S., 512 F.3d 567 (9th Cir. 2008), the Ninth Circuit reached the same conclusion.

The IRS asserted an accuracy-related penalty against Campbell. The Tax Court upheld that determination. The Eleventh Circuit affirmed. The Eleventh Circuit rejected Campbell’s claim that the payment was disclosed on the return, because disclosure requires more than a mere mention, especially when the taxpayer “incredulously and conveniently ignored or overlooked the amount when it was time to do the math.” The Eleventh Circuit rejected Campbell’s argument that substantial case law authority exists for excluding the payment, a conclusion so obvious that it led the court to consider Campbell’s citations to alleged authority “neither reasonable or persuasive.” Campbell’s claim that of reasonable cause for omitting the payment from gross income also was rejected, in part because Campbell “is a sophisticated taxpayer” and “chose not to consult a professional tax consultant in preparing” the return. Thus, neither exception to the penalty applied.

Though some people think that tax is “just math” with no debatable or uncertain points of law to be resolved, there are more than a few issues with respect to which there is no authority, or there is a split of authority among the Courts of Appeal, or there is some question of applicability or scope. The question of whether qui tam payments constitute gross income is not one of those questions that disproves the fallacy of treating tax as “just math” with no open legal questions to be resolved. Hopefully, the Campbell case is the last one in which government resources need to be expended to hammer home the inescapability of the requirement to include qui tam payments in gross income.

Section 104(a)(2) of the Internal Revenue Code excludes from gross income “ the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.” The flush language to section 104(a) clarifies that “For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care (described in subparagraph (A) or (B) of section 213(d)(1)) attributable to emotional distress.”

Thus, if a person negligently inflicts emotional distress on another person, for example, by yelling “boo” and frightening the person in a traumatic manner, any damages recovered by the victim resting on a claim of negligent infliction of emotional distress are included in gross income. But as Robert W. Wood explains in Post-1996 Act Section 104 Cases: Where Are We Eight Years Later?, “[E]xclusion under section 104 is still appropriate for any damages that are based on a claim of emotional distress attributable to physical injuries or physical sickness.” So if the defendant had grabbed the victim while yelling “boo,” causing bruises and other physical injuries, the victim can exclude from gross income the entire amount of the compensatory damages, including not only those based on the bruises and physical injuries, but those based on the emotional distress.

Now comes a Pennsylvania case involving an insurance company’s liability under an automobile insurance policy that adds a wrinkle to the analysis. In this Superior Court case, reported in this story, the court held that a policy covering “bodily injury” extended to emotional distress suffered by plaintiffs who witnessed a family member hit and killed by an automobile, even though the plaintiffs did not suffer physical injury. In reaching this conclusion, the court held that the emotional distress is a “bodily injury” even though there was no physical injury. The policy defined “bodily injury” as “bodily injury to a person and sickness, disease, or death which results from it.” The defendant insurance company argued that the definition in Black’s Law Dictionary should apply, specifically, that bodily injury means “physical damage to a person’s body.” The court explained that although it distinguishes “ ‘bodily injuries’ from purely emotional injuries,” it also rejects “the notion that bodily harm or physical injury necessitates physical impact.” The concurring opinion emphasized that the policy did not require that the person suffering the emotional distress be the person suffering the bodily injury. The court noted that it has not decided whether the family members’ emotional injury claims include a physical or bodily component, pointing out that the usual symptoms of emotional distress “may not involve blunt trauma to muscle, tissue, or bone, but our precedent recognizes them to reflect the significant physical or bodily toll severe emotional distress may take."

Section 104(a)(2), of course, uses the adjective “physical” and not the adjective “bodily.” Given the Pennsylvania approach, these two terms must be treated as having different meanings for tax purposes. In other words, because section 104(a)(2) does not apply to the damages in the Pennsylvania case, the action resting solely on emotional distress grounds, the plaintiffs must be treated as having suffered no physical injury or sickness even though they suffered, for state law purposes, a bodily harm. Does this make sense?

The distinction between physical and non-physical injuries is, to me, rather outdated. When it comes to illness and disease, the distinction between “physical” and “mental” is disappearing, if not entirely gone. Emotional distress causes changes in brain chemistry, which clearly is a physical matter, just as a disease that changes blood chemistry is a physical matter. Perhaps an injury arising from slander or libel is not physical, in the absence of emotional distress symptoms, but the idea that emotional distress damages should be treated differently from those for a broken leg doesn’t make sense in the world of twenty-first century medicine. This is especially so considering that damages for emotional distress arising from a physical injury or illness are excluded.

So the tax adviser to the plaintiffs in the Pennsylvania case will need to explain, “Even though your damages are for a bodily injury, the tax law does not consider them as having been received for a physical injury.” No wonder people think the tax law is bizarre.

It is, of course, time for Congress to fix section 104 by either by repealing it or by tearing it down and building it back up into something sensible, justifiable, and understandable. Taxpayers deserve no less.

The subheadline of a Philadelphia Inquirer article earlier this week caught my eye. “People want improvements, but no one wants to pay for them.” Unfortunately, this disappeared from the online version of the article.

When I saw that subheadline, I immediately thought of various MauledAgain posts in which I had made the same point. I touched in this problem in Funding the Infrastructure: When Free Isn’t Free, in The Price of Insufficient Tax Revenue, in No Tax Increases, No Fee Increases, No Roads, No Bridges?, and in Being Thankful for User Fees and Taxes. The underlying tension between wanting something and not wanting to pay was corroborated by the poll that I discussed in Poll on Tax and Spending Illustrates Voter Inconsistency.

The article in question described, among other things, the frustration faced by regional planners who are trying to fix regional problems, including many that adversely affect the economy. For example, for years there has been agreement that the choked traffic on Route 422 needs to be alleviated in some way. One of the proposals is to impose a toll on that highway. When this proposal first emerged, I explained, in Toll One Road, Overburden Others?, why this is not a good way to raise the required revenue and why, as readers of MauledAgain know, the solution is the mileage-based road fee, a topic on which I have written numerous times, in Tax Meets Technology on the Road, and thereafter in Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, and Is the Mileage-Based Road Fee So Terrible?.

The proposed toll would be used to add lanes to Route 422, widen bridges, install monitoring and signaling equipment, and to restore a commuter rail line that runs parallel to the road. Absent a toll, the executive director of the Delaware Valley Regional Planning Commission predicts it will take decades to come up with the money. He did not, however, mention mileage-based road fees. But perhaps he is just as pessimistic about the prospect of those being enacted.

At the community forum held recently on this proposal, the audience almost universally spoke out against tolls. One question was very telling. Someone asked, “Why should I pay for someone else to ride the train?” The article doesn’t disclose the answer, or if there was an answer. But the answer is simple. The toll not only purchases an improved road, it purchases space on the improved road by making train use economically efficient and attractive to someone who would otherwise be using the road, but who would give up road use if train use was economically more desirable. That’s a far different matter than paying a toll to fund unrelated projects, as I discussed in Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, When User Fee Diversion Smacks of Private Inurement, and Toll Increases Ought Not Finance Free Rides.

Though citizens attending the meeting and most legislators oppose tolling, when asked, “What else are you willing to do to solve the problem,” they are silent. It isn’t very helpful to simply claim that the government needs to do more with less. Unless, perhaps, they advocate going to gravel roads that become rutted tracks because of reduced capital and operating outlays. More lanes, less paving material. There’s some more with less for these people who want to ride free when there is a cost to what they are doing.

The underlying problem is that an increasing proportion of the nation’s citizens are people who grew up accustomed to getting without giving, or at least getting more than has been given. As I explained in Being Thankful for User Fees and Taxes, “Though anti-tax sentiment is popular, it too often is expressed in thoughtless condemnation of all taxes, as well as user fees. At some baser level, perhaps tied into the limbic system, humans simply prefer to get as much as they can get for free. They dislike taxes, but complain no less when paying bills or forking over cash at the checkout counter. Perhaps the trait is acquired and refined during childhood, when life for many people does appear to be an experience of getting things for nothing.”

Sadly, the focus on reducing what is paid in the short-term overlooks the longer term price that will be exacted. Consider Future Mobility in Pennsylvania: The Condition, Use and Funding of Pennsylvania’s Roads, Bridges and Transit System, a report issued by TRIP, a “non profit organization that researches, evaluates and distributes economic and technical data on surface transportation issues.” Lest anyone doubt the nonpartisan character of the organization, it “is sponsored by insurance companies, equipment manufacturers, distributors and suppliers; businesses involved in highway and transit engineering, construction and finance; labor unions; and organizations concerned with an efficient and safe surface transportation network.” As I pointed out, again in Being Thankful for User Fees and Taxes:

After reading the report, I wondered how the yes and no responses would turn out if each motorist in Pennsylvania were to be asked this question: “Would you be willing to pay an addition $1 per gallon in gasoline taxes if the proceeds of that tax were used to improve and repair Pennsylvania highways and bridges?” My guess is that most people would say “No.” I wonder what would happen if people understood that those improvements and repairs, by decreasing congestion, enhancing safety, and reducing vehicle operating costs, would save each motorist an average of $800, to say nothing of creating jobs. Motorists in Philadelphia would save $1,500 each year, while those in other urban areas would save between $900 and $1,000.

This sort of reasoning finds little favor among those who are the first to complain if a public good disappears or is not up to par, but lead the charge opposing taxes, tolls, and any other funding for the things they demand. Somewhere between being an infant, when nothing is paid for what is taken, and reaching the stage of responsible citizenship, some sort of transformation needs to occur. Recently, it hasn’t been happening. As the Inquirer article notes, in bemoaning the lack of public leadership from elected officials and the inability of citizens to understand the true cost of what they demand, former House Speaker Sam Rayburn put it best, “Any jackass can kick down a barn. It takes a good carpenter to build one.” The article concludes, “At this moment in Pennsylvania politics there don’t appear to be many carpenters left.” How true. How sad. How disappointing.

At least when I hear someone complain about traffic on Route 422, I have the option of asking the person’s position on tolls. Or mileage-based road fees. I take education opportunities wherever I can find them. Perhaps one by one, people will have the opportunity to give deep thought and apply reasoning to situations that too often get the simple “take but don’t give” instinctive mentality with which we are born. Instinct without reason does not nurture a civilized society.

The anti-tax lobby is fond of singing the praises of the “free market” and justifying, in part, their aversion to taxation because it provides funds for government “interference” in the private sector. I’m a fan of the private sector when it works well, but I’m also a fan of regulation sufficient to persuade the private sector to work well and to rescue the victims of the private sector when it does not work well. Several years ago, in Keeping Free Markets Free, I rested my criticism of market deregulation on, among other things, this conclusion: “I do think that the market is not providing sufficient quantities of necessary goods.”

Last week, in Drug Shortage Stirs Fears, the Associated Press disclosed that its investigations uncovered at least 15 deaths during the past 15 months attributable to a “severe nationwide shortage of drugs for chemotherapy, infections, and other serious ailments.” Hospital pharmacists, we are told, “are scrambling to find drugs.” Among the reasons for the problem are insufficient profit margins, a near-monopoly in the industry, theft, and an unlicensed “gray market” that is buying up these medications and selling them at “many times the normal price.” There is no way for the medical profession to determine whether drugs moving through the “gray market” have been properly refrigerated or are still within their expiration dates.

The Food and Drug Administration and the health subcommittee of the House Energy and Commerce Committee have held hearings on the issue. Leaving regulation as it is or prescribing less regulation is a recipe for more deaths and disease. Increasing regulation surely will bring howls of protest from those who benefit from the insufficient regulation. Increased regulation will require funding. Funding requires revenue. I wonder if “tax and spend” is a truly horrible thing even if the “tax and spend” is designed to help Americans stay healthy. In Can Tax Rebates Help Prove Malthus Wrong?, I explained why the free market’s supply-demand curve “works well for some things, but . . . becomes very inelastic when dealing with life's basic necessities.” In It Could Be Worse Than Taxation, Worse Than Stimulus, I explained that, “Sometimes the so-called free market doesn’t do what it needs to do because it really isn’t free.” As I pointed out in Keeping Free Markets Free, “The market is unfree because there are biases, there is corruption, there is bullying, there is cheating, there are monopolistic practices, there are all sorts of behaviors, characteristics, and practices that are inimical to the notion of ‘free.’”

Surely the anti-tax lobby will hold to the proposition that any increase in funding for regulating the pharmaceuticals market, assuming that they lose the anti-regulation effort, should come from other programs. This is the approach that they have been taking, for example, with respect to disaster relief funding, as I explained in Storms, Public Infrastructure, and Taxes and in Disaster Relief, Taxes, and Offsets. The absurdity of this position is highlighted by the following questions: Was the government’s protection of citizens against widespread drug shortages hampered by cuts in the FDA’s budget? Were those cuts made to provide funding for other programs? People are dying because of the ideological biases of a small minority holding a nation hostage. But that doesn’t seem to matter to those who detest government, taxes, and regulation.

Last month, in Storms, Public Infrastructure, and Taxes, I criticized the posture of the anti-tax crowd for its insistence that governments should fund disaster relief only through cuts in other programs. I summarized the anti-tax position as follows: “So in the anti-tax world, the county that wants to replace the washed out bridge or the city that wants to restore train service needs to eliminate police departments, lay off fire fighters, close down the sewage treatment plant, or reduce already bare-bone services to the citizenry.”

Now we are getting an opportunity to see how this plays out at the federal level. The Federal Emergency Management Administration (FEMA) and the Army Corps of Engineers, the two agencies primarily responsible for assisting Americans after natural and other disasters strike, are just about out of money. The Congress is now engaged in a drama that rivals the debt ceiling increase circus, but that is getting less attention. Perhaps one reason it is getting less attention is that the process and the debate are so convoluted one needs more than a road map to follow the twists and turns.

A full account of how Congress has been handling this problem can be found in several places, including this story. Additional funding for FEMA and the Corps of Engineers is wrapped into legislation that provides temporary spending that keeps the government running for seven weeks beginning on October 1, when the new fiscal year begins. This stop-gap is required because Congress has failed to approve a budget and enact spending authorization for the fiscal year ending September 30, 2012.

Last Wednesday, the House of Representatives defeated a Republican proposal to authorize $1 billion in disaster funding when the legislation is signed and $2.6 billion for the September 30, 2012, fiscal year. The legislation “offset” the $1 billion with a $1.5 billion cut in a loan program designed to assist car manufacturers increase the production of fuel-efficient vehicles. How did a Republican proposal fail to get through a Republican-controlled House? Forty-eight Republicans voted “no,” not because they were offended with the notion that $1.5 billion in spending was being cut to provide $1 billion in disaster relief money, but because they object to what they see as excessive government spending in the proposal. So the Republican leadership tinkered with the legislation. The bill was amended to cut $100 million from a federal loan program designed to make the nation less dependent on foreign oil. That $100 million cut, a drop in the bucket, somehow convinced 23 Republicans to flip their position on the legislation, which then squeaked by on Thursday.

In the meantime, the Democratic-controlled Senate, in response to a request by the President for $5.1 billion in additional funding for FEMA and the Corps of Engineers, approved $6.9 billion. The legislation passed with bipartisan support, and did not include spending offsets.

After the Republican-controlled House managed to pass the modified Republican legislation, Senate Democrats suggested they could live with the reduced amount of funding, provided the offsets were removed, even though the amount of funding in the House bill is “insufficient.” Nonetheless, Democratic legislators understandably are accusing certain Republicans of taking a “my way or the highway” approach, while Republicans bicker among themselves.

As of Friday, Congress was slated to go on recess for a week. By the time it would reconvene, the new fiscal year will open. Without resolution of this issue, the government is unfunded, and could partially shut down. The House Majority Leader, however, confidently predicted that there would be an agreement. The Senate Majority leader had suggested agreement was possible, but made that comment before the House added offsets to the legislation. He predicted either weekend sessions or a delay in the recess, whereas his House counterpart’s reaction to a weekend session was, “I surely hope not.”

Agreement will happen only if one of three things occurs. First, the Senate gives in to the current House version of the legislation. Second, the House agrees to the Senate version. Third, a compromise is reached. The first two possibilities are possibilities in name only. Compromise is difficult because a significant group of Representatives are opposed to any sort of compromise and have a track record of getting in the way of compromise. The only reason it is not absurd to predict that an agreement will be reached, somehow, is the political impact of subjecting an unhappy electorate to yet another manifestation of governance gridlock.

Opponents of government spending, many of whom, admittedly or not, are opponents of government, period, reminisce blissfully about the way things were a long time ago, so long ago that it was before they were born. Yes, there was a time when government disaster relief did not exist. Is that what these anti-tax people want? Then say so. Stand up and say so. Stand up and tell Americans that you oppose funding of efforts to end reliance on foreign oil. Stand up and tell Americans that you oppose funding efforts to increase the use of solar energy. Don’t wrap it up in some sort of “offset game.” Don’t hold disaster relief and the people in need of assistance as hostages in your anti-government and anti-tax campaign.

Even before the President formally announced his plan to ensure that wealthy individuals did not pay federal income taxes at rates lower than those imposed on less fortunate individuals, the Republicans, as reported in stories such as this one, lambasted the proposal, accusing the President of triggering “class warfare.” In response, when he unveiled his plan, the President succinctly stated, as widely reported, including this story, that “This is not class warfare.”

Guess what? They’re all wrong.

When a class of individuals, even if not joined by everyone within the class, attempts to take away from another class of individuals, even if not everyone in that class is targeted, that constitutes “class warfare.” So take careful note, I am again criticizing the President. Sorry, President Obama, but you are wrong. This is class warfare.

But the Republicans similarly are in error. The President’s proposal is a defensive tactic on behalf of the majority of Americans, an attempt to regain what has been taken earlier in the class war. This particular class war began when wealthy individuals saw an opportunity to make their economic position even more advantageous, by “persuading” their Congressional lackeys and a compliant President to reduce their taxes during wartime, and to gain popular support for a foolish move by tossing several nickel-and-dime tax breaks for not-so-wealthy Americans. The effect of those tax cuts, the overwhelming bulk of which went to the upper class, was to wreck the economy for everyone else. Though some among the wealthy caught the wrong end of the boomerang and experienced asset reduction, it’s much easier to cope with a 30% loss of income or a 20% decline in investment value when one is starting with hundreds of millions of dollars or more of wealth and income than when one has barely $5,000 in assets and a $25,000 salary.

This recent bout of class warfare – something that has been around as long as there have been civilizations – involves far more than taxes. A number of factors are contributing to the rapid speed with which the wealthy are out-distancing, by orders of magnitude, the rest of the population. Consider that the advocates of preserving, and even enlarging, tax cuts for the wealthy are also found among those who are attempting to eliminate unions, scale back or eliminate Medicare, reduce or repeal the social security system, back away from health care reform in a manner that leaves the vulnerable bereft of medical assistance, and cut spending that primarily assists those who are losing the current class war. Casualties from the economic chaos of the past decade include the Medicaid program, the nation’s infrastructure, environmental protection, and public education. It’s not the wealthy who suffer from these national deprivations.

The important question is “Why?” Is it just a matter of using one’s excess wealth to acquire additional, ostensibly to create jobs that never materialized but perhaps to satisfy some sort of addiction? I think not. That could still be accomplished, though perhaps requiring a little more time, without destroying the middle class. The goal is more than just amassing wealth. The goal is to acquire control of the political system. Throughout history, the middle class – whether artisans or scholars, whether craftsmen or small merchants – have posed a threat to the power elite. Royalty, nobility, and peasants is the mix that works best for royalty and nobility. Whenever the middle class has prospered, royalty and nobility have not. Think 1776. Think 1789. It is important to note that democracy flourishes when the middle class prospers, and that when the middle class doesn’t exist, or is marginalized, democracy exists, if at all, in name only. By siphoning wealth to itself, the wealthy class undermines the political power of the middle class, and when it uses its wealth to mislead voters into supporting the very practices that voters profess to resent, it subverts the nation’s existential democratic nature. The poor and the middle class aren’t the ones pouring truckloads of money into political campaigns, often masked through corporate and foreign conduits.

In his explanation of why the President’s attempt to eliminate instances of wealthy individuals paying taxes at lower rates than others, to say nothing of the various phase-out bubbles that place the highest effective marginal rates on the middle class, must be rejected, Senate Minority Leader Mitch McConnell spewed out the same old disproven canard. He offered this declaration: “But we don’t want to stagnate this economy by raising taxes.” Consider that taxes make money available to hire people to fix the nation’s infrastructure, to restore the nation’s civic integrity through public education, and to fund programs that ultimately gave the world microwaves, advanced plastics, the internet, and a long list of technical and scientific advances sourced in government programs, to give but a few examples of why taxes are the price paid for a civilized and democratic society. The claims that cutting taxes for the wealthy stimulates the economy, and that restoring an unwise and unproven tax break for the wealthy will hurt the economy, is nonsense. Someday those beliefs will find themselves on the dust-heap of history along with things such as flat-earth claims and the assertion that the sun rises in the north. What McConnell should have said is, “But we don’t want to stagnate this economy, which is working so well for the wealthy and terribly for everyone else, by letting unwise tax cuts expire.” Of course he won’t say that. It’s not something they want Americans to know.

When reality hits the ideal, the ideal almost always caves in. Consider what has been happening when the anti-tax crowd meets the reality of revenue shortfalls. They increase tolls, perhaps thinking that constituents will be fooled by the absence of the phrase “raise taxes,” and then use the increased toll revenue for purposes other than maintaining the toll road and paying for its wider adverse impacts. Worse, these anti-tax advocates, also staunch opponents of government borrowing, have instructed toll commissions to borrow money to be repaid through increased future tolls. Do they really think they are fooling the citizens who bother to educate themselves about this issue?

Fortunately, I’m not the only person trying to educate people on the “we won’t raise things called taxes but we’ll get you in other ways” anti-tax scam. In N.J., Pa. Tap Toll-Road Funds for General Road Projects, Paul Nussbaum, a Philadelphia Inquirer staff writer, describes how Pennsylvania and New Jersey have been diverting tolls from toll road maintenance to other projects. Those responsible for the toll roads project that over time those roads will deteriorate because of decreased monies available for maintenance.

There are some who argue that tolls should be diverted to other uses. The reasoning is questionable. One advocate claims that because the “transportation network is interconnected, . . . it makes sense to use toll revenue on projects that reduce traffic congestion” on the toll roads. Wait. It makes sense to divert revenue so that revenue can be decreased through reduced usage of the toll road? Why not a fee on train passengers to pay for the bridges that toll roads need to build to go over or under railroad tracks? The silliness of that question demonstrates the weakness of the toll diversion justification argument. When New Jersey’s governor proposed the toll-diversion scheme, I took it apart in User Fees and Costs, and the followup, When User Fees Exceed Costs: What to Do?.

The numbers are not insignificant. According to Nussbaum, last week the New Jersey Turnpike Authority agreed to divert another $324 million to the state. He also discloses that “[s]ince 2007, the Pennsylvania Turnpike Commission has sent $3.1 billion - more than it collected in tolls - to Harrisburg for statewide use.” How did they manage to do that? The legislature planned to impose a toll on I-80. Thinking that this was money in the bank, the legislature, before getting clearance from the Federal Highway Administration, ordered the Turnpike Commission to borrow billions of dollars, and to turn that money over for repairs to other roads and highways. The amount? Nearly one billion dollars a year. The folks who pulled this stunt have committed the turnpike to paying half a billion dollars a year for 47 years, to be funded by annual toll increases on a highway that had only five increases in 68 years. When the I-80 toll proposal was disapproved by the FHA, the legislature mandated toll increases on turnpike users to pay for the money it spent before it actually had that money. Keep in mind who did this. Politicians who have accumulated votes by criticizing deficit spending. Folks, spending money that one does not have and might not ever have, is deficit spending. Can you spell “hypocrite”?

And tolls are scheduled to increase in 2012 for all the toll roads in both states. In New Jersey the increases are at least 50 percent. Yes, you read that correctly, 50 percent. And this from the legislators and governors who claim to be anti-tax because increased government revenue is such a bad thing. Apparently it’s not a bad thing when it provides politicians with dollars to funnel to their pet projects without raising anything with the name of “taxes.” They think they can get away with this because they think citizens are ignorant (and if they are, the politicians are in many ways responsible, from underfunding public education to peppering society with misleading sound bites). In User Fees and Costs, I explained that “Supporters of the [New Jersey toll diversion] plan think that motorists using E-Z-Pass won't object as much as they otherwise would because the don't 'see the actual fees' being paid.” Who has the moral high ground on this point?

I had predicted that the I-80 tolling plan would not work, because it diverted tolls. Had the legislature been paying attention, it would have designed the plan as a true toll arrangement and not as a hidden revenue generator. In Are State Gasoline Taxes the Best Source of Highway Revenue?, I rejected the I-80 toll diversion plan by arguing, “It makes no sense to require drivers using the turnpike or I-80 to subsidize repairs to Routes 1, 3, 320, 252, or 202, to name but a few highways in the southeastern part of the state where I live.” In Raising Revenue Through Tolls Isn't Simple, I explained, “[The FHA] concluded that Pennsylvania's proposal did not adequately meet the threshold for the three-state federal plan. The FHA noted that Pennsylvania did not demonstrate that the tolls would be used only for I-80 improvements. The FHA did not seem to agree that toll revenues used to fund highways and bridges elsewhere in the state constituted operating costs of I-80.” I had that one right from the beginning. Harrisburg, though, was not listening or reading. Had it been sensible with the I-80 toll proposal, it would have generated sufficient funds for maintaining and improving that important road. But by reaching for too much more, the legislature proved once again the saying about bears, bulls, and pigs.

The diversion of tolls to other uses is not a new ploy. For example, for years the Delaware River Port Authority used tolls for all sorts of projects having nothing to do with maintenance and repair of the bridges under its supervision. I explored this in Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, Restricting Bridge Tolls to Bridge Care, Don't They Ever Learn? They're At It Again, A Failed Case for Bridge Toll Diversions, DRPA Reform Bandwagon: Finally Gathering Momentum, and When User Fee Diversion Smacks of Private Inurement. The warning I provided in DRPA Reform Bandwagon: Finally Gathering Momentum is one that should be viewed carefully by turnpike users, other motorists, and legislators, though the latter might not do so until pressure is brought by motorists. I explained:

Some time ago, I criticized the decision of the Delaware River Port Authority to use toll revenues for contributions to the construction of a major league soccer stadium. In Soccer Franchise Socks It to Bridge Users, I pointed out that tolls paid for the use of a bridge should be used for the maintenance and repair of the bridge and not for other purposes, as the DRPA had become accustomed to doing. In a follow-up, Bridge Motorists Easy Mark for Inflated User Fees, I noted the absurdity of the DRPA’s call for increased bridge tolls because it needed money to repair its bridges. Perhaps had money not been diverted to soccer stadium construction and other projects, there would have been funds for the DRPA to perform its stated functions. The criticisms that I, and a few others, offered fell on deaf ears, as a year later, I explained in Don't They Ever Learn? They're At It Again that the DRPA had announced plans to funnel more toll revenues into projects having nothing to do with the bridges and waterways it is charged with tending. Shortly thereafter, in A Failed Case for Bridge Toll Diversions, I lambasted the governor of Pennsylvania for his unwise attempt to justify using bridge tolls for other purposes.

(emphasis added).

What should be funded by tolls? In User Fees and Costs, I explained:

The toll should be based on the cost of building, expanding, improving, repairing, maintaining, policing, and monitoring the road. It isn't difficult for a cost accountant to determine how much it costs to operate the New Jersey Turnpike, the Garden State Parkway, or any other toll road. Tolls should be increased as costs increase, and though it is preferable to recalculate the cost each year, it might be easier to use some sort of inflation index and do the cost recalculation every four or five years. . . .

. . . The analysis I support is one that looks at the impact of the toll road and its use on surrounding residents, neighborhoods, and infrastructure. Traffic volume surrounding a toll road interchange is higher than it otherwise would be, and that generates additional costs for the local government. It makes sense to include in the toll an amount that offsets the cost of widening adjacent highways, installing traffic signals, increasing the size of the local police force, adding resources to local emergency service units, and similar expenses of having a toll road in one's backyard. I understand the argument that because the locality benefits economically from the existence of the toll road and its interchange that it ought not be subsidized by the toll road. It is unclear, though, whether the toll road is a net benefit or disadvantage. If it were such a wonderful thing, why are new roads so vehemently opposed by so many towns and civic organizations?

Using toll revenue to maintain and repair roads and infrastructure far from the toll road is more difficult to justify. Other than relying on arguments such as the maintenance of a high quality state-wide road network that would attract more tourists and business ventures, proponents of siphoning toll revenue to distant areas have a, sorry, tough road to hoe. A better approach would be to impose tolls on heavily used roads in those distant areas.

I reiterated this analysis, more succinctly, in Timing, Quantifying, and Allocating User Fees, by explaining, “Tolls should be used to pay for the costs of building, repairing, maintaining, and operating the toll road, and to defray the economic burden that the road imposes on the surrounding neighborhoods. Tolls should not be used for programs unrelated to the road.”

The toll diversion arrangement rests on the erroneous claim that because most roads cannot be tolled because there’s no feasible way of installing toll booths and limiting access, the only solution true to fuel tax increase opposition is to jack up the tolls on whatever toll roads exist, and divert the excess to other roads. That approach, of course, opens the door to the DRPA misuse of tolls, by diverting the excess tolls to other purposes, a ploy now being used in New Jersey. There is of course, a viable and sensible alternative. As I wrote in Toll One Road, Overburden Others?:

Yes, it’s the mileage-based road fee. I’ve written about this approach many times, beginning in Tax Meets Technology on the Road, and thereafter in Mileage-Based Road Fees, Again, Mileage-Based Road Fees, Yet Again, Change, Tax, Mileage-Based Road Fees, and Secrecy, Pennsylvania State Gasoline Tax Increase: The Last Hurrah?, Making Progress with Mileage-Based Road Fees, Mileage-Based Road Fees Gain More Traction, Looking More Closely at Mileage-Based Road Fees, The Mileage-Based Road Fee Lives On, and Is the Mileage-Based Road Fee So Terrible?

Will politicians figure this out before it’s too late? One can only hope.

In Are State Gasoline Taxes the Best Source of Highway Revenue?, I observed, “It doesn't help when a leading state legislator describes tolls as the 'wave of the future,' because in doing so, what he demonstrates is a surprising ignorance about the actual wave of the future that already is in the present, namely, mileage-based road fees.” Now I understand why state legislators like tolls. It would be much more difficult to pull off the diversion stunt with mileage-based road fees. Which is even more the reason to push for the replacement of tolls with mileage-based road fees.

On one thing, almost everyone can agree. The economy is a mess, as evidenced by the number of people lacking employment. On something else, almost no one can agree. Specifically, what is the recipe for fixing the economy?

President Barack Obama has proposed a plan that continues, expands, and extends to employers the existing payroll tax cut for employees, extends unemployment benefits, funnels money for hiring construction workers, police, firefighters, and teachers, continues and expands the 100 percent equipment purchase deduction, and adds credits for hiring workers. Republicans have a different solution. For example, according to Speaker of the House John Boehner, the solution is lower corporate tax rates and a roll back of environmental and labor regulations.

They’re all wrong. They parade out failed strategies and unsuccessful tactics. Albert Einstein’s definition of insanity is well known. When it comes to choosing between politicians and Einstein, I’m for Einstein.

Aside from one proposal, the linchpins of the President’s plan not only have a failed track record but also pose the risk of counterproductive consequences. The payroll tax cut did little, if anything, to fix the problems, because the economy is no better at this point than it was when that cut was enacted, and it might even be, by some measures, worse. As a short-term band-aid, it was worth the attempt. As long-term surgery, it fails. It costs too much. It undermines funding for the Social Security program. As I pointed out in Two Types of Tax Increases, “The answer might not be an extension of the social security tax cut.”

It should be obvious that extending unemployment benefits does not create jobs. The better thing to do is to exchange benefits for services, not unlike what happened in the 1930s when America, similarly burdened with a failing economy caused by the risky games of the wealthy, needed to get its financial position restored to its potential. This is why the proposal to spend money to fix America’s crumbling infrastructure, makes sense. I explained why this is so, four years ago, in Funding the Infrastructure: When Free Isn't Free. Four more years of rot and rusting only makes the situation worse.

The idea of continuing and expanding the section 179 expensing deduction for equipment purchases a senseless one. It may have been a worthwhile bandage a few years ago, but the economy continued to hemorrhage despite that provision. If anything, it benefits businesses that would have made purchases in any event. A business with no need to make a purchase will not make a purchase simply because the cost is deductible in the year of purchase rather than over a three or five year period. Among my several posts attacking this giveaway to those least in need is If At First It Doesn’t Work, Try, Try, Try Again, not my first criticism of the current President’s tax proposals (a point I make in response to those who consider my economic analysis to focused on criticism of one side of the partisan divide).

Tax credits for hiring people have been in the tax law for a long time. Congress has tinkered with those credits numerous times. Almost every year, the credit has been renamed, duplicated, fine-tuned, and expanded. Those efforts do no good. Why? A business with no need of an employee does not hire someone simply because a fraction of the salary will generate a tax reduction. A business with need of an employee possessing a particular skill needed by the business cannot simply hire just anyone who walks in the door, even if that person brings along a tax credit. Throughout the recession, the employment classifieds have continued to run, and to contain numerous listings. The problem is that too many Americans do not have the skills that businesses seek.

The Republicans’ position fares no better. The consequence of lower corporate tax rates would be retention by corporations of even more cash. Corporations already are drowning in cash. Corporations are not spending that cash, even though most corporate spending would bring reductions in taxable income and thus reductions in tax liability. Corporations are not spending cash because they are self-insuring against the next fiscal fiasco, while waiting, perhaps hopelessly, for the Congressional merry-go-round of continual tax and spending changes and battles to come to an end.

The desire to roll back, translate, and eliminate environmental and labor regulations is understandable once the philosophy of the advocates of this backwards move is understood. Labor regulations are all that stand between the greed of the multi-billionaires and the safety and wage security of workers. When left to their own devices, for example, in the nineteenth century, the barons of industry exploited the working class. Only after someone in authority -- translate, government -- stepped in to protect the downtrodden did the middle class begin to emerge. And only after the middle class emerged did this nation come to prosper in the second half of the twentieth century as the world’s leading economy and a nation to which people across the globe looked for inspiration and economic opportunity. Until, of course, the downtrodden barons of industry started dismantling it. Environmental regulations are all that stand between the greed of the multi-billionaires and the health of the citizenry. Repeal of environmental protection surely means reduced expenses, and thus increased profits, for the barons of industry. Before there was environmental regulation, the air in most cities was a health hazard, rivers were flowing with sewage and industrial pollutants, toxic waste dumps proliferated, and natural resources were ravished. Rolling back these regulations will create jobs. For morticians, undertakers, and grave diggers.

The answer, as I’ve explained for years, is to undo the cause of the economic mess. The Bush tax cuts need to expire. The Bush tax cuts were enacted in response to a promise that they would create jobs. They did not create jobs, at least not in this country. They created pools of money that were either stashed abroad, for example, in Swiss banks, or were invested in bad deals designed to extract up-front fee income while bundling bad loans into packaged investments that poisoned pension plans and small businesses. That, in turn, brought the Bush TARP boondoggle, which added economic insult to economic injury.

Though the defenders of low or even repealed taxes for the ultra-wealthy claim that they should be permitted to “keep what they earned,” the reality is that few of the ultra-wealthy earned what they have through physical or intellectual labor. As I predicted long before there was this or any other blog, the proliferation of Crummey life insurance trusts among the wealthy had the effect of creating an entire class of super-wealthy who had done nothing to attain their economic status other than by chance being born to the right parents. Even those who generate wealth through their own efforts benefit from the activities of others. A doubling of the world’s population doubles the demand for a product or service, and at least doubles the profits, without the provider of the product or service lifting so much as a fingernail to move up the economic ladder.

All of this could be excused if the outcome was beneficial across the board. Perhaps the middle and lower classes would not begrudge the “success” of the wealthy if the economic benefits indeed trickled down. But that’s not what trickled down. During the era of the Bush tax cuts, the rich got much richer, the poor barely held their own, the middle class began to disappear, jobs vanished, infrastructure corroded, and the nation’s international reputation as an economic dynamo went down the tubes. That is why more of the same, including the bulk of the President’s proposals and the bulk of the Republicans’ proposals are nothing more than insanity. Is it not time for rational thinking to trump the politics? Sadly, I doubt that will or can happen.

One of the benefits of writing this blog is that it gives me the opportunity to learn. Last week, in Does the IRS Issue Forms 1099? Should It?, I asked whether the IRS is required to issue Forms 1099 when it pays interest, whether it does so, and whether it ought to do so. Two days later, in More on the IRS and Form 1099-INT, I shared one response that came my way. Mary Lew Kehm, a CPA and PFS (personal financial specialist) reported that she has had clients who received Forms 1099-INT from the Treasury Department. Like me, she could not figure out why the taxpayer in Megibow v. Comr., T.C. Memo 2011-211, the case that triggered my questions, did not receive a Form 1099 for interest paid by the IRS. After doing a bit more research, I shared my discovery that the Treasury Department issues Forms 1099-INT with respect to some, but not all, discounts on, and redemptions of, Treasury obligations. That there is inconsistency seems an inescapable conclusion.

Two more replies have arrived. A practitioner in upstate New York reports that “most” of his clients do receive Forms 1099-INT in connection with interest paid to them by the IRS. He suggests that but for those forms he might not otherwise know that the clients had received interest. James Brower, a CPA with a Masters of Science in Taxation who practices not far from me, also reports that Forms 1099-INT are issued with respect to interest paid by the IRS, though he does not think the IRS is required to issue those forms. He explains:

IRC §6049 spells out the rules regarding when payments of interest need to be reported to the IRS. However, IRC §6049(b) has its own definition of “interest” which is much narrower in scope from that of IRC §163. If you read through IRC §6049(b) you will see what payments constitute “interest” for purposes of 1099-INT reporting, and you won’t find interest paid on tax refunds listed there.

Also, if you look at Treasury Regulation §1.6049-5(b)(4) you will see that for purposes of 1099-INT reporting, interest does not include “interest that a governmental unit pays with respect to tax refunds.” I think that the Regulation pretty much answers the question.

Mr. Brower suggests that the IRS – and some states – issue the Form 1099-INT, even though not required to do so, because it encourages taxpayers to report the interest income. Perhaps, he surmises, the lack of the Form 1099 in Megibow caused the taxpayer not to report the interest income. Mr. Brower also suggests that “based on my 20+ years of dealing with the public in preparing tax returns, I’d say that a good segment of the population of this country honestly believes that income is taxable only if it gets reported to the IRS on a 1099, W-2 or other information return.” I agree. More than one student in my basic federal income tax over the past 20+ years has commented, not in these exact words, “If the IRS doesn’t know about it, is it really income that needs to be reported?”

In my reply to Mr. Brower, I said:

Thank you for your analysis. I agree with you. The lack of a requirement combined with the sending of Forms 1099 raised the same question for me. I think your answer makes sense. What continues to puzzle me is (1) did the IRS issue a Form 1099 to Mr. Megibow? (2) if not, why not? (3) if yes, why did the IRS not contest his assertion that it had not sent one?

When he in turn replied, Mr. Brower shared his guess that we will never know the answer to my first two questions. That’s frustrating. I’m confident I’m not the only one who wants to know. Those questions are at the heart of what inspired the initial post on this issue. As for the third question, his guess is that IRS counsel did not think it was necessary to contest Megibow’s claim that a Form 1099 had not been sent. The interest is includable in gross income whether or not a Form 1099 is sent or received, and thus the IRS can win – as it did – without that evidence. Yet, would it not be sensible to introduce proof that the Form 1099 was sent? Would that not chip away somewhat at the taxpayer’s factual presentation, gross income concepts aside? Could it be that IRS counsel tried to obtain a copy of the Form 1099 sent to Megibow, but was unsuccessful because someone on the Commissioner’s side could not find it? But if it cannot be found, ought one assume it was sent?

How many other taxpayers who receive interest from the IRS fail to receive a Form 1099 and then in turn do what Megibow did? Does anyone know? Yes, the IRS could cross-check its record of interest payments with the copies of the Forms 1099 it has sent. This sort of self-audit would be useful to the IRS, to taxpayers generally, and to the nation. So now my invitation is to someone at the IRS to enlighten the rest of us. We remain curious.

A practitioner pointed me in the direction of an H&R Block Press Center Newsroom Story Ideas posting, titled, “Renting Your Vacation Home: What Are the Tax Breaks?” The article points out the sort of expenses that qualify as deductible because of the rental activity, and correctly notes that if the property is rented for fewer than 15 days during the taxable year, those expenses cannot be deducted and the rental income is excluded from gross income. The article proceeds to define what constitutes a personal use day for purposes of determining whether the section 280A limitations apply.

The article provides an example of how to pro-rate rental expenses between personal use days and rental days. In the example, there are 90 days of rental use and 225 days of personal use. The taxpayer in the example has $4,500 in “mortgage insurance” – by which I assume is meant “mortgage interest” because there is no other item tagged as “mortgage interest” and there would not be “mortgage insurance” without “mortgage interest” – along with $3,000 in real property taxes and $17,200 in expenses deductible only on account of rental activity, such as cleaning, insurance, repairs, utilities, and depreciation. According to the example, the taxpayers are permitted to deduct 90/225 of this amount.

There are two errors in this example. The first is the use of a fraction 90/225. The total days of use equal 315 (90 + 225). Thus, the rental portion is 90/315, not 90/225. The second is the lumping together of the deductions allowable in any event (mortgage interest and real property taxes) and the deductions allowable only on account of the rental use. This approach is the position taken by the IRS, but it is a position rejected by taxpayers and by the courts.

Understanding the second error requires a bit of background and an exercise in statutory interpretation. Section 280A(e) provides as follows:

(e) Expenses Attributable to Rental.--
(1) In general.--In any case where a taxpayer who is an individual or an electing small business corporation uses a dwelling unit for personal purposes on any day during the taxable year (whether or not he is treated under this section as using such unit as a residence), the amount deductible under this chapter with respect to expenses attributable to the rental of the unit (or portion thereof) for the taxable year shall not exceed an amount which bears the same relationship to such expenses as the number of days during each year that the unit (or portion thereof) is rented at a fair rental bears to the total number of days during such year that the unit (or portion thereof) is used.

(2) Exception for deductions otherwise allowable.--This subsection shall not apply with respect to deductions which would be allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was rented.

Thus, it is appropriate in the example to multiply $17,200 by the rental use fraction (90/315, not 90/225). However, the mortgage interest and real property taxes are not subject to the section 280A(e) fraction. Instead, when computing the limitation on the total deductions attributable to the rental activity, as provided in section 280A(c)(5), the taxpayer must reduce rental gross income by “the deductions allocable to such use which are allowable under this chapter for the taxable year whether or not such unit (or portion thereof) was so used.” Translated, the means the reduction equals “the mortgage interest and real property taxes allocable to the rental use” because those deductions are allowable whether or not the property is used as rental property. Thus, the question is, “What is the meaning of ‘allocable to such use’?” The IRS takes the position that the allocation is computed using the rental use fraction, and in the case of the example, by using 90/315. Thirty years ago, a taxpayer took the position that the appropriate fraction was 90/365, arguing that a portion of the interest and taxes relate to each day in the year, and pointing out that if Congress wanted to use the section 280A(e) fraction it would have used the section 280A(e) language in section 280(c)(5), something it did not do.

The taxpayer, in Bolton v. Comr., 77 T.C. 104 (1981), prevailed. The IRS appealed to the Ninth Circuit. It lost. See Bolton v. Comr., 694 F.2d 556 (9th Cir. 1982), aff’g 77 T.C. 104 (1981). In the many cases that have since arisen dealing with this issue, the taxpayers have prevailed, including a decision in the Tenth Circuit that followed the Ninth Circuit reasoning. Yet the IRS persists, perhaps hoping that another appellate court will decide in its favor, leading to a decision by the Supreme Court to resolve the dispute. Unfortunately, the IRS position is flat-out wrong, it has been consistently and uniformly rejected, and it puts taxpayers in the unfortunate position of choosing between an adverse tax outcome or the risk and cost of an IRS audit and litigation.

For a commercial tax return preparer to provide an example that makes no mention of the Bolton case or its progeny is appalling. How many taxpayers will end up paying more in taxes than current law requires? I’m told by the practitioner who alerted me to this web page that the same article appeared a year ago, the practitioner called and explained the errors, and the page was taken down. Now it has reappeared. The practitioner noted that another phone call this year is very unlikely.

Teaching section 280A in the shadow of Bolton and the IRS refusal to concede makes the basic tax course even more challenging, for me and for students, than it otherwise needs to be. The only silver lining in the cloud is that it provides an opportunity to help students think about the advice they would give to a client or tax return preparer who faces the issue. How should the tax return be filed? What are the advantages and disadvantages of using the Bolton approach? What are the benefits of following the IRS approach and ignoring the Bolton line of cases? Someone who relies on the H&R Block Press Center Newsroom Story Ideas posting would not be asking those questions because they are not being asked those questions. They would be living in an artificial tax world in which Bolton and its progeny do not exist. That’s not a good way to practice tax.