MauledAgain

In an opinion piece on Sunday, George Will made an important point. There is a difference between borrowing to finance investment and borrowing to finance consumption. A person or government who borrows $100 to purchase a $100 asset is neither richer nor poorer. The important issue is whether the asset will be used in a manner that generates income that can be used to pay off the debt and enhance the financial position of the investor. In contrast, a person or government who borrows $100 to fund consumption is $100 poorer, because there is no asset to offset the loan.

Where I differ with Will is in his examples of borrowing to finance investment and borrowing to finance consumption. Will gives two examples of borrowing to finance investment. One is infrastructure. On this example, I agree with Will. Borrowing $100 to build a $100 bridge leaves the nation no richer nor poorer. The same can be said of borrowing $100 to repair a bridge so that its value has increased, arguably, by $100. The issue is if and how that bridge will generate income to repay the debt and to maintain the value of the bridge. Will’s other example of borrowing to finance investment is war. I disagree. A government that borrows $100 to build a bomb that destroys something has consumed $100. In some respects, it has burned a $100 bill. I suppose Will would argue that the $100 is an investment in security or peace, but even from that perspective, investment in war has turned out to be pretty much a waste, with uncountable costs in human lives and materiel and no peace at hand. In contrast, borrowing $100 to build a defense system, such as aircraft carrier groups, anti-missile systems, radar warning devices, whatever, that prevents war is an investment not unlike the purchase of a fence, a lock, or a moat. Perhaps that is what Will meant, by using the term war, though I would prefer he used the word defense.

There is a deeper problem, though, with these examples. The examples assume that a $100 outlay for a bridge or an aircraft carrier brings a $100 asset into the hands of the people through government. It very well may be, and often has been shown to be, different. The bridge or aircraft carrier might be worth $80, with the difference being excess funds winding up in the hands of private contractors. The seriousness of this problem can be debated, with estimates of corruption and overpayments ranging from minimal to significant. Unfortunately, it costs money to ferret out the waste, bribes, and other squandering of taxpayer dollars.

When Will gives examples of borrowing to finance consumption, which he sees as the flaw of the “entitlement state,” he again provides two examples. Again, I differ with his selections. He focuses on Social Security and Medicare. Social Security has not been financed through borrowing. In fact, it has been a source of lending for borrowing to finance other programs. True, without adjustments to reflect increased life expectancies and the resulting lengthening of the average retirement period, Social Security eventually will need to borrow in order to maintain its outlays. But of all federal programs, save a few minor temporary ones, Social Security is the model of how to avoid borrowing. On the other hand, Medicare outlays exceed Medicare premiums, requiring borrowing to “break even.” Is Medicare spending properly classified as consumption? Or is it an investment, an investment in people who, by receiving medical care, live to generate societal benefits?

The same conundrum arise with respect to other spending programs. Is spending on education appropriately tagged as consumption? Or is it an investment in the nation’s future? What about food stamps? Is the borrowing presumably undertaken to finance food stamps borrowing to finance consumption? Or is it borrowing to finance investment in the nation’s future? Put another way, are the people who are saved and nurtured through borrowing to be treated as an asset on society’s balance sheet?

Perhaps the problem is in the measurement of the deficit. Annual deficits are measured by income (tax and other revenue) over expenditures. In typical accounting, only expenses, and thus not the cost of aircraft carriers or bridges, would be included in expenditures. And the result would be called a loss. The cumulative deficit would reflect the excess, if any, of government debt over the value of government assets. If those assets include the value of defense personnel trained by the government, along with physical assets, do not the numbers change?

Ultimately, the worst form of consumption occurs when assets are destroyed. Food is consumed, but is turned into energy that fuels the creativity of the nation’s citizens. When munitions are consumed, they do not create human creativity, nor do they rebuild bridges. This nation has directed a significant amount of borrowed funds into war consumption. To call that a financial investment is, at best, misleading. And if there’s any entitlement in war consumption, perhaps it lies with the defense contractors who have profited mightily from the destruction of assets.

As I pointed out on Friday in Fiscal and Tax Irresponsibility, the recently enacted legislation that postpones the impact of the so-called fiscal cliff can be analyzed in different ways. As I noted, “there are ways of spinning the situation so that it appears to put a slight dent in the deficit.” I concluded, as have many others, that the legislation will generate a $3.9 trillion increase in the federal budget deficit over the next ten years.

The legislation cuts taxes. As I pointed out in Fiscal and Tax Irresponsibility, it does so by restoring most of the Bust tax cuts, adjusting the alternative minimum tax, re-establishing tax breaks for the working poor, and enacting or re-enacting special tax breaks for selected individuals and businesses.

According to this report, it did not take long for the anti-tax crowd to issue not only expressions of disappointment, but also warnings of retaliation, for what it considers to be, in the words of a “tea party favorite,” Ted Cruz, “[A] lousy deal.” Why? According to Cruz, “I think it raised taxes by $620 billion.” Really? Here is what happened. The Bush tax cuts expired. More than a decade of bad tax policy, which brought revenue as a percentage of the economy to its lowest level in decades, came to an end. The Congress then decided to re-enact some of the Bush tax cuts. So why is Cruz complaining? His friends in the top income levels, who for more than a decade have increased their collective share of the economy at the expense of everyone else, didn’t get a tax cut. So Cruz, spinner deluxe, decides that a person who does not get a tax cut has been hit with a tax increase. The fallacy of this logic is no less obvious than the claim of someone who does not get a raise during a time of zero inflation that he or she has been inflicted with a pay cut.

If Cruz is concerned about the federal deficit, he ought to stop campaigning for tax cuts. Tax cuts increase the deficit, and do very little for the economy, despite the propaganda that tax cuts for the wealthy create jobs. It is true, though, that as Cruz and others point out, federal spending needs to be corrected. How that can be accomplished is a challenging puzzle, as I discussed in The Howling Void of Taxes and Spending. What he and others will discover is that there isn’t anywhere near the amount of spending cut savings that he and others seem to think that there is. Despite the floating of theoretical spending cut proposals, the reality is that the only way to balance the budget while conferring the tax cuts Cruz and his friends want is to knock most of the nation into poverty and despair. Imagine a nation dealing with substantial cuts in Social Security, Medicare, Medicaid, education assistance, food assistance, and the loss of progress in energy efficiency, the destruction of the environment in the wake of the elimination of the EPA, and the continued deterioration of the nation’s infrastructure.

What’s alarming about the reaction of the anti-tax crowd is not so much that its ringleaders take the position that they do, for it is understandable that those who benefit from their policies would seek implementation of those policies, but that many of those who stand to suffer on account of those policies root for those policies to be adopted. Considering the nonsense I read on web sites, ranging from mainstream media to social networking outlets, it is not surprising that people are being misled and it is inescapably evident that a significant number of Americans would benefit from some careful study of the facts.

So we’re told that the nation avoided the fiscal cliff. No, the nation did not. The nation backed away from the cliff, by pushing it two months into the future. The Congress made the cliff steeper, because if the nation goes over the cliff it will be a much longer fall.

The absurdity of the last-minute temporary duct-tape and chewing gum solution is evident from two very significant flaws in the failure of the Congress to meet its responsibility. Instead of tackling the problems long before the deadline, Congress waited and put together a patchwork piece of nonsense. First, as reported in this story, the Congress did not address the fact that the nation reached its debt limit on Monday. Second, the legislation adds to the deficit, making the situation worse, even though, as this report explains, there are ways of spinning the situation so that it appears to put a slight dent in the deficit.

The only sensible way of measuring the impact of the legislation is to compare it to what would have happened had the nation gone over the cliff on January 1. Had the nation gone over the cliff, the deficits for 2013 and subsequent years would have been less than what it is under the legislation. The legislation preserves tax rates that would have increased in the absence of the legislation. That adds to the deficit that otherwise would have existed. The cost of this legislation is a $3.9 trillion increase in the accumulated deficit that otherwise would have existed over the next ten years.

Two pieces of the legislation account for most of the $3.9 trillion. By extending the Bush tax cuts for all taxpayers other than those with incomes of more than $400,000 (or $450,000 for married couples filing jointly), the accumulated ten-year deficit is increased by $1.9 trillion. Fixing the alternative minimum tax adds another $1.8 trillion. Of the rest, $134 billion comes from extending tax breaks for the working poor, and $77 billion comes from extending special tax breaks for businesses and certain individuals.

Interestingly, the legislation does not extend the repeal of the itemized deduction and personal and dependency exemption phase-outs. This crafty way of raising rates ought not to have been enacted in the first place, and it ought not to have been revived. Hiding tax rate increases in this manner makes it more difficult for Americans to understand the issues percolating in the tax and fiscal policy debates. However, by not extending the repeal of phase-outs and by not extending the Bush tax cuts for taxpayers with incomes of more than $400,000 (or $450,000 for married couples filing jointly), the Congress demonstrated that it could abandon pieces of the 2001 and subsequent tax legislation. Why, then, extend special tax breaks for businesses? Why continue spending money on the motorsports industry? Why continue lower taxes for some industries and not others? Whatever can be said in favor of special breaks for the motorsports or other favored industries can be said in favor of every other industry. It is this sort of favoritism that makes the entire legislative process tainted, and that creates an atmosphere in which rational and sensible policy decisions cannot be made.

As icing on this cake of irresponsibility is the postponement of any decision with respect to the spending side of the problem. Though the sort of wholesale spending cuts that the anti-tax, anti-government crowd wants are unrealistic, surely there are programs and activities that can be scaled back. It is not unreasonable to expect that the Congress again will do nothing until hours before the new, delayed deadline. Whatever people may think of their own Senators and Representatives – most of whom they continue to send back to Washington – the Congress as an institution has failed miserably. Until Americans insist on a revamping of how Congress does business, the nation is in for an extended period of tax and fiscal irresponsibility.

The debacle over the so-called “fiscal cliff” should compel Americans to re-examine the various claims that government spending cuts will solve the nations’ economic problems. A recent article, Why Republicans Can’t Propose Spending Cuts, explains the phenomenon of reality knocking theory down. As Jonathan Chait, the author, puts it, “The Republican understanding of government spending is based on hazy, abstract notions that don’t match reality and can’t be translated into a workable program.” That haziness percolates in the assorted internet and social media postings that claim cutting this or that program will solve the problem.

Almost two years ago, in Americans Still Don’t Grasp Federal Budget Realities, I examined the quandary in which the nation has been placed by blind acceptance of mistruths spewed by those who use “cut government” as a pathway to electoral success but who then fail miserably when it’s time to balance the budget. I reacted to the results of a poll revealing that Americans grossly overestimated the portion of the federal budget devoted to the right’s favorite scapegoats, such as foreign aid, the Corporation for Public Broadcasting, pensions for federal workers. Even military spending was overestimated. If people don’t know the facts, how can they fix the problem?

Apparently, few, if any, of the people coming up with the wrong answers had taken a look at what I had explained six months earlier in The Grand Delusion: Balancing the Federal Budget Without Tax Increases. Examining the proposed 2011 federal budget, I concluded that balancing the budget on spending cuts would require cutting one-third of federal expenditures. I explained that if military spending, Medicare, Social Security, Medicaid, and interest on the federal debt were untouched, “89 percent of all other expenditures, including veterans’ benefits and health care, the CIA and other intelligence activities, NIH, military retirement, border security, immigration, the FBI, the courts, FEMA, the Coast Guard, federal prisons, and a long list of services that the country surely needs, would need to be axed.” I predicted, correctly, that attempts to cut Social Security would encounter widespread “howls of opposition,” as would proposals to cut military operations. I predicted, again correctly, that advances in space exploration would shift to “China, or perhaps Japan or Russia.”

In Why Republicans Can’t Propose Spending Cuts, Chait pinpoints some of the many flaws in the approach taken by the anti-tax, eliminate-government crowd. He describes the approach taken by “the CEO community and their publicists” who want to “cut deeply into entitlement spending” and who claim that “There’s money to be cut everywhere.” Chait, taking a view consistent with mine, posits that “There really isn’t money to be cut anywhere.” He notes that federal spending on social services lags behind other advanced countries, that Social Security benefits are “quite meager,” and that “infrastructure is grossly underfunded.”

Chait is of the opinion that the Bowles-Simpson plan failed because the panel could not reconcile the “gulf between perception and reality.” In other words, there is no way compromise can be made between delusion and sense. Chait provides a window into understanding the dysfunction of Congress. It is, in part, a consequence of the dysfunction of the nation and the delusion of those who believe fantasy rather than facts.

Chait criticizes the Bowles-Simpson plan as one that “simply pretended the federal government could have everybody do a lot more work for less pay.” That’s, of course, the secret of that “CEO community,” which sees cuts everywhere. That’s a community that enriches itself by firing employees and leaving those who remain to do the work of two or three employees, because it worships the short-term bottom line rather than long-term stability. Oddly, that community hides behind the word “prosperity,” but its philosophy has brought misery to far more people than it has brought any sort of confident financial position.

Ultimately, the anti-tax, cut-spending crew objected to the cuts suggested by Bowles-Simpson. Chait mentions Paul Ryan’s approach, which he characterizes as “kick[ing] the crap out of the poor,” and which would work only if “epic levels of suffering on the very poor” were acceptable. They’re not. And even things such as making Medicare needs-based, or fiddling with the CPI component of Social Security generates a drop in the bucket compared to the spending that must be cut to finance the tax cuts for the wealthy that were made ten years ago and that the anti-tax group wants to continue.

Chait concludes that the anti-tax, cut-spending folks don’t disagree with the inability to find spending cuts that don’t “inflict real harm on people with modest incomes” and that don’t “save small amounts of money.” They simply “don’t seem to understand it.” Thus, he concludes, the failure of Republicans to list specific spending cut proposals “is not just a negotiating tactic but a howling void where a specific grasp of the role of government ought to be,” and that “The spending cuts aren’t there because they can’t be found.”

Federal taxes are at the lowest they have been for many decades. Failure to connect that fact with the existence of a huge deficit, and attempting to pin the deficit on needless spending that does not exist demonstrates a howling void in understanding reality.

Almost ten months ago, in Tax Return Preparation Disaster, I wrote about a tax return business called Mo’ Money Taxes, that had created nightmares for its clients. It has been sued by various state attorneys general, charged with filing inaccurate returns, imposing hidden fees on its clients, withholding client refund checks, distributing checks in amounts less than promised, and distributing checks that could not be chased. Reports circulated that thousands of tax documents related to its clients were found in dumpsters behind its offices. Other reports explained that the owner of the business was involved in a contentious divorce proceeding, replete with claims of physical assaults, adultery, unfit parenting, and drug use.

About a month ago came news, that reached me recently, about the latest undertakings by Markey Granberry, the owner of Mo’ Money Taxes. Although the lawsuits commenced by the attorneys general continue, and although employees of Mo’ Money Taxes have been indicted, Granberry has announced the establishment of a new tax return preparation business called Marquis Taxes. He explained that, with respect to the allegations arising out of the 2012 filing season, “thus far, no charges have been filed against no one regarding issues of last year.”

In Tax Return Preparation Disaster, I concluded:

My advice to taxpayers is that they ought not retain a tax return preparer until they have done due diligence and research, particularly opinions from existing clients, about the reputation and quality of the potential preparer. My concern is that the people most often victimized by the unscrupulous companies are those least able to check out the business. That is why the idea of requiring tax return preparation be done by preparers who have earned an IRS-issued “seal of approval” is so tempting. Given the choice between a bigger government or thousands of victimized taxpayers, I’m compelled to choose the former, even though ideally I’d prefer to purge the marketplace of the perfidious businesses.

Until the litigation underway in several states is concluded, and until the charges against the indicted employees are resolved, the key words are research and caution. Why risk it?

Almost two years, in The Price of Insufficient Tax Revenue, I described how the “success” of tax reduction in New Jersey compelled the city of Camden to lay off half of its police force and one-third of its fire fighters. A few weeks later, in When Tax Cuts Cause Privatization, Taxpayers Pay More, Not Less, I explained how Camden also was compelled to fire its animal-control officers, with their jobs turned over to a private company, at a cost exceeding what it cost to employ the animal-control officers. It’s easy to identify the winners and losers in this tax-cut game.

Now comes news that another city in fiscal trouble, Oakland, California, dealt with the impact of revenue reductions by laying off one-fourth of its police force. Oakland ranks fifth among American cities when it comes to crime rates. Discharging 25 percent of the police force is a foolish thing to do. Oakland police have confessed that someone calling 911 is “looking at an indeterminate amount of time before an officer can respond.” Crime rates in Oakland have soared since the cuts took effect.

Oakland, facing a $32 million deficit, did not touch a $17.3 million payment that it makes to the Oakland Raiders and the Oakland Athletics. The Raiders, however, are not content with these payments. Instead, the team threatens to move to Santa Clara unless Oakland forks over support for a $1.5 billion stadium.

Oakland is not the only city that chose private professional sports over police protection for its citizens. Jacksonville fired police and cut other services so that it could repeatedly reduce the rent that it charges the Jaguars for use of the stadium partially funded by taxpayer dollars. Taxpayer dollars support professional sports teams throughout the country. Most of those teams are owned by billionaires.

The anti-tax crowd, oblivious to the harm that tax cuts do to ordinary citizens, backs tax increases when the revenue is funneled into private enterprise. For example, Indiana increased hotel, rental-car, and food and beverage taxes to fund the stadium used by the Indianapolis Colts. Reversing foolish tax cuts to provide revenue to care for the needy is some sort of outrageous sin in the minds of the anti-tax crowd, but jacking up taxes to pump money into the hands of the wealthy seems to be some sort of virtue to these folks.

It is outrageous that the anti-tax crowd casts into a “47 percent net” the people it considers to be “takers.” These folks do this without regard to whether the “taker” is a disabled military veteran, a person disabled by disease caused by private enterprise pollution of air and water, a person unable to work because of the consequences of being the victim of a crime that could not be prevented because a city had to let police officers go, a person disabled when doing a good deed to save the lives of innocent people, or a firefighter injured on the job. Yet when the rich show up, hat in one hand, bully-club in the other, these same opponents of “taking” start handing out taxpayer dollars to wealthy individuals and corporations, justifying their hypocritical decision with every possible baseless excuse available.

The typical justification that it is good for everyone to cut the taxes of the wealthy, or that it is good for everyone to collect taxes from everyone and funnel the proceeds into the hands of private corporations and rich individuals, has been disproven repeatedly. These actions have not generated jobs. They have reduced public safety. They have failed America.

A little more than a month ago, in A Not So Dopey Tax Question, I considered a tax question raised by the operator of New Jersey’s first legal marijuana dispensary. The question is easy to frame. Is medical marijuana sold in New Jersey subject to the New Jersey sales tax? At the time, the dispensary had not received an answer. I examined the New Jersey sales tax statute and concluded that medical marijuana is exempt because it meets the statutory definition of a drug sold pursuant to a doctor’s prescription, citing section 54:32B-8.1(a) of the New Jersey statutes, which provides an exception to the general rule of sales taxation in section 54:32B-3(a).

On November 30, the Regulatory Services Branch of the New Jersey Division of Taxation issued a Technical Bulletin in which it provided its answer to the question. It took several weeks for this publication to reach me.

According to the Division of Taxation’s TB-68, which “is based on current New Jersey law and governing regulations regarding the medical use of marijuana, . . . retail sales of medical marijuana are subject to [sales] tax.” The Bulletin cites section 54:32B-3(a) of the sales tax statute. The Bulletin then addresses the applicability of the sales tax to purchases of equipment used in the production of medical marijuana.

That’s it. Nowhere in the Bulletin does the Division of Taxation mention, analyze, or deal with the applicability or non-applicability of section 54:32B-8.1(a). If a law student writing a paper on this issue failed to mention, cite, analyze, or deal with section 54:32B-8.1(a), he or she would be heading for a rather unpleasant grade. It’s not as though that provision is buried in some other volume or many pages distant in the same volume. Depending on pagination and the publisher, and whether or not the volume in question contains annotations, it’s on the same page or the next page. Law students are taught to look at the entire provision to determine if any exceptions apply. Nothing in the Technical Bulletin reveals whether it was written by someone with a legal education, but even someone without a legal education ought to understand the need to look beyond the general rule.

My point isn’t so much whether or not section 54:32B-8.1(a) applies. I think that it does. My point is that the Division of Taxation didn’t even consider it, or, if it did, chose not to favor the taxpaying public with the benefit of its conclusion. At best, this is sloppiness. It could be worse than that. It’s possible that someone decided that politically, the Division ought not say anything one way or the other about section 54:32B-8.1(a). If that’s the case, it is an outright violation of the fiduciary responsibility vested in the Division of Taxation not only to interpret and administer the tax laws appropriately, but to exercise such transparency as is required to permit taxpayers to understand the tax law so that they can comply. Regulation by fiat is not a cornerstone of a healthy democracy.

When House Speaker John Boehner floated his since-abandoned “Plan B,” he put most Republican members of Congress into a bind. Under Plan B, tax rates on individuals with income above $1 million would revert to the higher rates in effect before the Bush tax cuts were enacted. Though this expiration of a tax cut is simply that, the anti-tax crowd considers it to be a tax increase. Accordingly, the legislators who had signed on to Grover Norquist’s anti-tax pledge had to choose between supporting Plan B and violating the pledge, or opposing Plan B while holding fast to the pledge. As it turned out, informal canvassing suggested to Boehner that it would not make sense to put Plan B to a vote.

According to this report, Norquist conjured up “political cover” for his devotees, telling them that “they could support the Boehner plan B because it adhered to the meaning of their promise to oppose tax hikes.” How can that be? If someone decides to give up smoking, does the occasional cigarette not count because it “adheres to the meaning of their promise”? If a youngster promises his or her parents that they will not drink and drive, is driving after having one drink insufficient to put the youngster over the legal limit “adhere to the meaning of the promise”?

When people make absolute, unconditional promises, they end up trying to wiggle out when they discover that they have painted themselves into a corner. Life is full of anecdotes telling of conversations between a person who makes an absolute statement and who, when questioned about the applicability of the statement to a situation demonstrating the absurdity of the absoluteness of the statement, hems and haws and wiggles and dances in an attempt to defend the indefensible.

An example of this slippery slyness comes directly from Norquist and his allies. About a year and a half ago, in Tax Semantics, I explained the backpedaling that tainted Norquist’s attempts to walk his silly anti-tax tightrope:

First comes news that Grover Norquist described expiration of the Bush tax cuts as not a violation of his no-tax-hike pledge. He said, “Not continuing a tax cut is not technically a tax increase.” Speaker of the House John Boehner countered that allowing the tax cuts to expire would be the equivalent of a tax hike.

Then Norquist’s Americans for Tax Reform issued a statement explaining that failing to extend or make permanent the Bush tax cuts “would clearly increase taxes on the American people” and that “[i]t is a violation of the Taxpayer Protection Pledge to trade temporary tax reductions for permanent tax hikes.”

Is it any wonder that the Congress is so dysfunctional? Infected by absolutists who resist negotiation and compromise because it would demolish the foolish principles underlying their extremist stance, they prefer to defend their silly statements and pledges rather than doing their job of solving the mess they created.

It takes a good deal of courage to confess to having signed a foolish pledge. It takes a good deal of wisdom to understand that the pledge is foolish. It takes a good deal of honesty to explain to America why the foolish pledge is causing so much harm. Will the nation see these qualities coalesce in its Congress?

Eleven days ago, in When Tax Revenues are Short-Changed, What Should Be Cut if Taxes Are Not Raised?, I expressed my continued bewilderment at the lack of logical thinking demonstrated by most Americans when it comes to tax and spending policies. Three years and two years ago, respectively, in Poll on Tax and Spending Illustrates Voter Inconsistency, and A Grander Delusion: Cut Taxes, Don’t Cut Spending, Cut the Deficit, I had explored the deep flaws in the positions taken by the majority of those polled on these questions.

Now comes yet another poll that tells us that although most Americans support raising taxes for people with incomes over $250,000, and think that this is insufficient to solve the budget problem, they also oppose cutting spending for Medicaid, cutting military spending, increasing the Medicare eligibility age, or slowing the increase in social security benefits. If those steps are not taken, there is no way to eliminate or reduce the deficit absent tax increases for many more taxpayers than simply those with incomes over $250,000.

When there is a problem, the cause matters, because the cause provides pathways to solutions. Refusal to identify the cause of a problem slows or blocks the development of a remedy. “Just fix it” is much easier to accomplish when the cause is known. Understanding the cause also reduces the chances of the problem resurfacing.

The so-called fiscal cliff, or budget deficit issue, arises because of two decisions. One was the decision to reduce tax revenue, to the point where total revenue is lower than it has been for many decades. The second was the decision to add trillions of dollars to military and homeland defense spending without raising taxes to defray the cost. The first decision came with the same disproven claim that it would create economic growth and in turn increase tax revenues that failed when previously attempted. Instead, millions of Americans lost jobs, the economy plunged into one of the nation’s worst recessions, and economic growth stagnated. The other decision, regardless of one’s views on the necessity of the actions that were undertaken, added trillions to the budget deficit.

I have explained the arithmetic several times, in posts such as A Memorial Day Essay on War and Taxation, Peacetime Tax Policy While Waging War = Economic Mess, Some Insights into the Tax Policy Mess, What Sort of War is the “Real Budget War”?, and
Borrowing Money to Fund Tax Cuts. I have pointed out that war requires sacrifice, that sacrifice for the sake of war means giving things up to finance military expenditures, that the idea of having both guns and butter has been tried and disproven numerous times, and that the nation would have collapsed had the Bush era approach to fiscal and budget policy been followed during World War Two. Several readers have commented that I am wrong because “this isn’t 1941.” Unless someone can prove otherwise, cutting $100 of revenue from a balanced budget while adding $900 in expenditures generates a deficit, now, in 1941, in 2001, in 2003, and in any other year. Every attempt to prove that it is possible to cut revenue, add expenditures, but not create a deficit relies on what a Republican president aptly called “voodoo economics.”

The first cause of the problem can be fixed by taking two steps. Although the first seems to be facing less political opposition, the second would generate howls of protest. The first step is to repeal the Bush tax cuts. For everyone. The second is to collect the revenue that would have been collected had the Bush tax cuts not been enacted. Of course, that isn’t going to happen. Translation: the problem isn’t going to be solved unless the second cause of the problem generates a solution.

The second cause of the problem can be fixed in one or both of two ways. The first way is to cut back military spending to adjust for the deficit spending of the past decade. That, according to the poll, is unpalatable to the majority of Americans. The second way is to find revenue to pay back the debt incurred to finance expenditures that were undertaken without a supporting revenue base. But that brings us back to the first cause of the problem and the inadequacy of the solutions reflecting that cause.

This is why the folks who created the problem try to divert attention to solutions that do not reflect the cause of the problem. Cutting social security, whether by slowing increases, changing eligibility ages, or otherwise, is a scapegoat approach. It is a diversionary tactic designed to take Americans’ eyes off of the actual causes of the problem. Social security did not cause the problem, and in fact it financed part of the Bush era deficit. Social security will pose budgetary issues in the future, and things need to be done to cut those problems off at the pass, and may include slowing increases and raising eligibility ages, but that ought not be something used to pay for foolish tax cuts and deficit military spending of the past decade. The same can be said of Medicare, which faces future problems very soon. Other programs, such as food stamps, educational assistance, veterans’ benefits, and similar social net expenditures, not only are not the cause of the problem, but are symptoms and by-products of the underlying causes. For example, the increased spending for veterans’ benefits is an additional cost of the two wars. The increased spending for food stamps is a direct consequence of the economic collapse spawned by foolish decisions in the early part of the last decade, including not only unwise tax cuts and deficit military spending but unfettered bad behavior by too many unregulated actors in the so-called free market. In any event, cutting every federal expenditure aside from military spending, interest on the debt, social security, Medicare, and Medicaid will not balance the budget or even come close.

The solution to the budget deficit will be painful. It is the pain that should have been felt by all Americans, and not just members of the military and their families and friends, while the nation engaged in war. It is postponed pain, and it is inevitable. If the budget deficit is not solved, and the nation goes over the fiscal cliff, there will be pain. There is no escaping the economic pain. To quote another Republican president, “I don’t like it but there it is.”

In some areas of this country, the words “beach tag” can spark intense discussions and even arguments. For some people, the thought of being charged to use a beach is as repugnant as the thought of being charged to breathe. For others, the idea of requiring people to pay for the maintenance, repair, and security of what they are using makes all the sense in the world.

Last year, in Free, Freedom, Fees, and Taxes, I commented on a proposal by the town of Wildwood, New Jersey, to cut more than half of its police force and some of its firefighters because of budget shortfalls, even though Wildwood remained one of the few towns in New Jersey that did not charge a beach tag fee. During the summer, the population of the town increases from 5,000 to 300,000, and yet the opponents of beach tag fees somehow think that the 295,000 should enjoy themselves while letting the 5,000 bear the burden of the cost of maintaining the beaches, and providing security, rest rooms, clean-up, and other services. Though the anti-tax crowd often points to the inequity of asking a few to pay for the many, in this instance the anti-tax crowd asks for the few to pay for the many. Why? Because it has nothing to do with consistent and coherent tax policy, and everything to do with where people live. For the most part, the 295,000 visitors don’t want to pay beach tag fees.

Last June, in Limiting User Fee Use: Beach Tag Fees, I criticized the opposite situation, one in which towns were collecting more revenue from beach tag fees than was necessary to maintain the beaches and using the surplus to offset local taxes. In this situation, figuratively speaking, the 295,000 were being asked to pay for benefits accorded the 5,000.

Now, comes another story about beach tags. This time, two New Jersey legislators, one from each side of the aisle, are co-sponsoring a bill that requires elimination of beach tag fees by any town that accepts state or federal aid to rebuild its beaches. One of them claimed that a beach fee is just “another word for tax.” His argument is that if federal and state tax revenues are used to rebuild the beaches, it is unfair to charge him to use the beach because he has already paid for it. The absurdity of his argument is easily in this parallel proposition: “I bought my house for cash. It is unfair to make me pay for electricity and water for my house because I’ve already paid for the house.” Beach fees deal with annual operating costs of a beach. Disaster relief payments from the state and federal governments are capital investments, in contrast to annual expenses.

One of the legislators proposing the beach tag fee repeal defended the idea with a typical theoretical gloss that lacks practical sensibility. He explained that beach towns could be more efficient, pointing out that these towns have a police chief, an administrator, and a public works director. So what’s his idea? That one person do all three jobs? Perhaps he thinks that the 8-hour workday should be replaced by a 24-hour workday? Even aside from the fact that these individuals often work 16-hour days, especially in the summer, his comment indicates a total lack of understanding of what these people do and why few people would be qualified to do all three jobs.

The mayor of one beach town explained that if beach fees were eliminated, there would be less money for lifeguards and beach clean-up. So, those brilliant legislators ought to consider that if they succeed, they will be permitted free access to a filthy beach with no lifeguards. You get what you pay for.

The mayor of another beach town pointed out an interesting twist in the situation. Its agreement with the Army Corps of Engineers is that if the dunes were damaged, they would be replaced at no charge to the town. This mayor expressed a belief that the proposed legislation would not apply. I have a hunch that the legislators would take the opposite position.

As the mayor of yet another beach town explained, if beach fees are eliminated, the cost of maintaining the beaches will fall on the town’s taxpayers. If the federal and state governments want to pay for lifeguards, rest rooms, beach clean-up, and the other services provided by beach tag revenues, elimination of beach fees could be justified. Yet taxpayers who do not use the beach understandably would object. It’s one thing to use general taxes to repair dunes to preserve barrier islands that in turn protect the mainland, benefitting those who live there no matter whether they use the beach or not. It’s another thing to eliminate beach fees on the pretext that general funds were used to restore the capital, because it leaves the beach towns without revenue to pay for annual operating costs.

A little more than a year ago, in Infrastructure, Tolls, Barns, Jackasses, and Carpenters, I explained why the anti-tax and anti-toll forces have it all wrong. I pointed out that without taxes or tolls, highways would become, at best, rutted gravel roads. Five years ago, in Funding the Infrastructure: When Free Isn't Free, I pointed out that failure to repair and replace infrastructure will cause an economic collapse far worse than the supposed economic misery falsely offered by the anti-tax and anti-toll forces as the outcome of undoing the tax policy foolishness of the Bush tax cuts.

Last Friday came news that the Southeastern Pennsylvania Transportation Authority (SEPTA), a government agency that oversees public transit in the greater Philadelphia area, will close the bridge that carries Norristown High-Speed Line trains over the Schuylkill River. The reason is simple. The wooden ties on the bridge are rotted. The steel spikes holding the rails are coming loose. It is rusting. Its concrete piers are cracking. About the only good news is that SEPTA has had the sense to figure out there is a problem and to close the bridge before anyone is killed or injured, unlike what has happened in the past, continues to happen, and will happen with increasing frequency as the price society pays for the self-centeredness of the anti-tax crowd comes due.

It gets worse. The underfunded SEPTA expects more bridges and other infrastructure to be shut down, for the same reason. To get an idea of how bad the problem is, consider that the cost of fixing the bridge in question is $30 million. SEPTA estimates that it needs $5 billion to eliminate the backlog in infrastructure repair. That’s a lot of bridges and other things that will shut down if politicians fail to exercise their fiduciary responsibilities in a mature manner. Last year, the Congress blocked the Administration’s plan to infuse money into infrastructure repair, which, by the way, would create more jobs than have been created by the tax cuts that were guaranteed to create jobs.

It gets worse than worse. So how will SEPTA deal with its customers who need to cross the river, if there is no bridge? It will unload passengers from the trains, put them on busses, and drive the busses across the river. Three things will happen. First, passengers will waste time because of the longer commute, which in turn hurts the economy. Second, at least some, perhaps many, of those passengers will abandon public transportation and take to their vehicles, putting more stress on the highway infrastructure, and increasing commuting times for others, which in turn hurts the economy. Third, the busses that SEPTA adds to the highway bridge traffic also will have the same effect.

My prediction is that the anti-tax forces will rise up and yell for their favorite solution, the usurpation of government functions by their private sector heroes. The private sector does two things when it takes over government. First, it factors in a profit for themselves that government does not seek. Second, it uses bullying techniques to cut wages and drive the middle-class public servants into the ranks of the impoverished. Focused on the short-term instant profit effect, and oblivious to the long-term detriment to the economy, the private sector can engage in these tactics because it is immune from the ballot box. I have previously explained this problem in posts such as How Do Toll Road Lessees Make a Profit?, Are Private Tolls More Efficient Than Public Tolls?, More on Private Toll Roads, and When Privatization Fails: Yet Another Example.

One must wonder whether the attempt to shrink government by denying it the revenues necessary for it to do its job is part of a larger plan to privatize government and return society to the days of nobility and peasants, in which government was nothing more than the whim of the king and his elites. Perhaps they think that as the bridges close and collapse, the highways fall apart, the public education system continues to deteriorate, and the quality of life for all but the elites continues to decline, that frustrated and unhappy people will voluntarily dance to the tune of the privatized pied piper. Perhaps their confidence in their piper’s siren song is well-placed. Perhaps not. But if the people’s representatives in legislative bodies throughout the nation don’t step up and do what needs to be done, the consequences of collapsing infrastructure is not going to be pretty.

The first-time homebuyer credit has again been litigated. Three weeks ago, in When the IRC Defines a Term, It Trumps Other Definitions, I explored a case in which the Tax Court rejected the taxpayer’s argument that the definition of a term found in the Internal Revenue Code should be set aside in favor of a definition from another federal agency. Proving that taxpayers will do almost anything to grab a social-policy tax credit, the taxpayers in the most recent first-time homebuyer credit case, Morales v. Comr. T.C. Memo. 2012-341, raised a rather bewildering argument.

On April 27, 2006, the taxpayers sold their principal residence. The title company filed a Form 1099-S, Proceeds from Real Estate Transactions, with the IRS. On March 17, 2009, the taxpayers purchased a property on which there were two separate houses. Each of the taxpayers moved into one of the houses and used it as his or her separate personal residence. Each taxpayer filed a 2008 income tax return, and each claimed an $8,000 first-time homebuyer credit.

The Tax Court easily determined that the taxpayers were not entitled to the credit. One of the requirements for a taxpayer to claim the credit is that the taxpayer must not have had a present ownership interest in a principal residence during the 3-year period ending on the date of the principal residence for which the credit is sought. The petitioners purchased the new principal residences on March 17, 2009, which meant that if they owned a present interest in a principal residence at any time between March 18, 2006 and March 17, 2009, they did not qualify for the credit. The taxpayers owned a principal residence from March 18, 2006 through April 27, 2006, and thus they were not entitled to the credit.

The taxpayers argued, however, that the IRS was estopped from asserting that they were not entitled to the credit because “an ordinary examination of the relevant tax documents,” presumably the Form 1099-S, would have indicated that the taxpayers did not qualify for the credit. The Court rejected the argument for two reasons. First, it would place an undue burden on the IRS. Second, it would undermine the effective administration of the tax laws. I would add a third reason. The argument is total nonsense. Examination of the Form 1099-S, together with the 2008 return, would indicate to the IRS that the taxpayers were not entitled to the credit. It is quite probable that the IRS did examine that form, and that’s how the taxpayers’ return was pulled for an audit. The taxpayers’ idea that if the IRS can determine there is an error on a return from looking at the relevant tax documents it is estopped form doing anything about it is absurd. Using the taxpayers’ argument, if a person failed to report wages that showed up on a W-2 filed with the IRS, the IRS would not be permitted to require that person to report the wages. Though it may have been a matter of judicial tact to state the reasons for rejecting the argument in the manner that the court did, there are times, I think, when calling nonsense what it is, nonsense, is valuable. Otherwise, the producers of the nonsense will generate even more nonsense. If one thing is clear, it is that the world doesn’t need more of this sort of nonsense.

High on my list of unacceptable revenue policies and practices is the diversion of revenue from the purpose for which it is collected to some other project or activity. Whether it is a designated tax, a user fee, or a toll, those who pay deserve to get what they are paying for and to be charged no more than is required for the designated purpose. As I explained in The Revenue Diversion Problem, “I take a dim view of governments diverting user fee revenue to purposes unrelated to the reason for imposing the user fee.” I have examined this growing trend of revenue diversion in posts such as User Fees and Costs, When User Fees Exceed Costs: What to Do?, Soccer Franchise Socks It to Bridge Users, Bridge Motorists Easy Mark for Inflated User Fees, Timing, Quantifying, and Allocating User Fees, Limiting User Fee Use: Beach Tag Fees, and Using Tolls to Fund Other Projects.

Now there is good news from Ohio. Technically, the news is old, and what is new is a recent case from the Supreme Court of Ohio that brought to my attention a provision in the Ohio Constitution, adopted in 1947, that specifically prohibits the use of motor fuels taxes for anything other than fixing roads, bridges, and other transportation infrastructure. In Beaver Excavating Co. v. Testa, (Dec. 7, 2012), the Court held that diversion of commercial-activity-tax (CAT) revenues derived from the gross receipts of motor vehicle fuel sales to non-highway purposes violates Article XII, Section 5a, of the Ohio Constitution. One of the interesting aspects of the case is that the plaintiffs included not only businesses paying the tax in question but also county engineers complaining that the diversion was impairing their budgets for transportation infrastructure projects.

The Court pointed out that the Constitutional provision in question was enacted specifically to limit the use of motor vehicle fuels taxes to transportation purposes. The provision was enacted to put an end to the then-existing practice of using motor vehicle fuels taxes for other purposes. The description of the Amendment is more proof that some things just don’t change: “This Amendment simply says you want your automobile license and gas tax money to go for better roads and streets. * * * Ohio originally promised that automobile license and gas tax funds would go for roads, streets, and related purposes. But
temptation was too great and millions of these special tax dollars have been and are being spent for other purposes.” One must wonder why, with the Amendment having been adopted by the voters, there was need for litigation in 2012.

In 2005, the Ohio General Assembly enacted the CAT to replace the corporate franchise and personal property taxes. The CAT is imposed on business gross receipts. Gross receipts do not include amounts paid by licensed motor-fuel dealers, licensed retail dealers, or licensed permissive motor-fuel dealers in state and federal motor fuel excise taxes with respect to motor-fuel receipts. CAT revenues are deposited in the state’s general fund. The Court concluded that the CAT is a tax that relates to motor vehicle fuel sales, and that to the extent that it does so, the revenue it generates from those sales must not be used for non-highway purposes.

The Court concluded that it was not improper for the state to collect the tax, but that it was a violation of the Ohio Constitution to spend it other than in accordance with the transportation-purposes-only requirement. The plaintiffs did not seek a refund, but an order requiring compliance with the expenditure limitation. Nor did they ask that revenues already improperly spent be restored to the transportation fund. Accordingly, the Court applied its decision prospectively.

The Ohio Constitution provides a model for provisions that protect those who pay taxes, user fees, and tolls from seeing their payments diverted to improper uses. Similar provisions might exist in other states; I haven’t looked because whether or not they do, they ought to exist in every state. I wonder how many state legislators and state employees making spending decisions have read the provision. If they haven’t, it’s time to do so and, while they’re at it, to look at this recent Ohio Supreme Court decision.

A recent poll has reinforced the inescapable conclusion that Americans, as a group, are illogical when it comes to tax and spending policies. When asked whether budget deficits should be reduced by raising taxes or by cutting government spending, 46 percent chose spending cuts and 30 percent chose tax increases. As described in this summary of the poll, in February 2012 the spending cut option found favor with 56 percent, and in March 2011, 62 percent preferred spending cuts.

But when asked to choose which programs should be cut, poll respondents did a collective about face. Raising the eligibility age for Medicare found favor with only 40 percent, in contrast to 48 percent who opposed the idea. Slowing the growth of Social Security benefits was rejected by 70 percent of respondents. Military and defense budget cuts were opposed by the majority of those polled. Spending on those three programs constitutes a little more than one-half of total federal expenditures, although Social Security, standing alone as a separate trust fund, actually generates a surplus at the moment which is used to fund deficits in other areas of federal spending.

These poll results do not surprise me. More than three years ago, in Poll on Tax and Spending Illustrates Voter Inconsistency, I described the outcome of a similar poll in New Jersey:

According to the poll, 68% of the respondents favor cutting programs and services, whereas only 23% advocate increased taxes. Of those answering the poll questions, 75% support a wage freeze for state workers, and 61% advocate laying off state workers. Not one of several state programs nominated for reduced state funding gathered the support of a majority of the poll's respondents. Only 41% wanted to cut economic development spending, 30% would vote for reduced social services funding, a mere 11% favored cuts in education spending, and a scant 7% stood up for reduced health care expenditures.

This lack of unified focus shows up in how New Jersey residents dealt with specific questions. With respect to state spending for local government and schools, 60% want it to remain the same, 20% want an increase, and only 16% favor a reduction. Though 54% oppose school vouchers and 55% do not want to expand charter schools, 51% want increases in state spending on early childhood education.

These results prompted me to write:

The poll reinforces my contention that the underlying problem is the continued demand for government spending on programs that benefit state residents coupled with a continued resistance to the idea of paying taxes in order to fund those programs. The results of the poll suggest the extent to which various programs benefit residents. That explains the support for maintaining or increasing tax rebates even though it requires higher taxes on someone in order to do that. It also explains why so few favor cuts in health care, education, and social services funding, why gasoline tax increases aren't preferred, and why so many were quick to target state employees for pay freezes and furloughs.

This sort of entitlement mentality, a vision that grows out of the "I want, I got, I will continue to get" experience of too many people, suggests that finding a common ground to resolve the tax and spend debate in New Jersey, and elsewhere, will be difficult if not impossible. It's amusing to see that almost everyone understands there is a problem, almost half think it will get fixed, but fewer than half can rally around any specific solution to the fiscal mess.

A year later, in A Grander Delusion: Cut Taxes, Don’t Cut Spending, Cut the Deficit, I examined a poll taken in California:

When asked about ways to cut the state’s budget deficit, respondents preferred spending cuts to tax increases, but they also rejected spending cuts for programs constituting 85% of the state’s spending. The notion that “trimming waste,” as some suggested, can balance the budget when deficits are gargantuan is, as has often been demonstrated, nonsense.

This discrepancy between the desire to pay little or no taxes but yet to benefit from government programs is at the core of the current fiscal crisis in Washington. Things were working well until some geniuses decided, early in the last decade, to cut taxes and to increase federal spending at the same time. Is not the solution to un-do the behavior that caused the problem? What would be the status of the federal budget and the deficit if taxes had not been cut in 2001 and in 2003? What would be the status of the federal budget and the deficit if the increased spending during the past decade had been financed with taxes rather than debt? What would be the status of the federal budget and the deficit if the taxes had not been cut and the spending had been financed with taxes? The answer is obvious, but discussion tip-toes around it, because too many of those responsible for solving the problem had their hands in creating it, and lack the courage to admit their mistakes and to make amends. Political reputation and re-election appear to be more important to these folks than is the overall welfare of the nation.

According to this story, calls for increases in gasoline and other liquid fuels taxes are being put forth by those who understand the need for transportation infrastructure repair funding and who appreciate the declining value of existing fixed-amount taxes that do not reflect the impact of inflation since the taxes were last established. Support for, or at least willingness to consider, the increases is coming not only from the expected people and organizations but even from some who subscribe to anti-tax-increase philosophies. For example, Pennsylvania’s Governor Corbett, no fan of taxation, has admitted to “mulling an increase in one component of Pennsylvania’s gas tax.” New Jersey’s Governor Christie, another critic of taxation, is being pressured to increase gasoline taxes to fund restoration of highways and bridges damaged by Superstorm Sandy. The Republican chair of the House Transportation Committee expressed a “need to explore” the possibility of increasing the federal gasoline tax.

The gasoline tax is an inefficient way of funding the transportation infrastructure. Because it is set as a fixed number of pennies per gallon, decreases in sales – due to fewer miles being driven, more efficient vehicles, increases in the use of alternative fuels, or other causes – translates to a decrease in funding, even though there is not a concomitant decrease in the deterioration of roads and bridges. Add to that the impact of inflation, which increases the cost of repairs, but which is not reflected in adjustments to the fixed per-gallon tax amount. The federal gasoline tax was last adjusted 19 years ago. New Jersey adjusted its gasoline tax 24 years ago, and Pennsylvania’s last reset was 15 years ago.

Last year, in the Philadelphia area, only $1.4 billion was spent on a system that needs $2.5 billion a year to remain safe and functional. Which anti-tax advocate wants to be on the bridge that collapses because there was no money for repairs? One of the proposals being examined by Governor Corbett would increase the gasoline tax by 22 cents per gallon, though phased in over five years. At present, this tax is capped at a per-gallon price that is roughly half the current market price. In New Jersey, advocates of an increase are trying to sell a 10 cent increase, which would still leave New Jersey with one of the lowest gasoline taxes in the country.

Leaving gasoline taxes at their current levels guarantees more bridge collapses, and pothole-caused front-end alignment repair costs that will take more out of motorists’ pockets than the proposed tax increases. The best approach, of course, is to implement the mileage-based road fee, which I have discussed over an eight-year period, in Tax Meets Technology on the Road, 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, Is the Mileage-Based Road Fee So Terrible?, and Defending the Mileage-Based Road Fee. If governors and legislators cannot bring themselves to step into the twenty-first century when it comes to maintaining the common weal, then they at least need to summon the courage required to raise the gasoline tax and prevent an ever-increasing parade of catastrophes.

The other day, a reader alerted me to a New York Times story that resonated with some positions I’ve taken with respect to federal, state, and local tax breaks for private companies, and Paul Caron picked it up in his Monday TaxProf blog items.

The point made by the story in its extensive analysis of private company tax breaks is a simple one. Governments give tax breaks to companies because the companies promise economic advantages to the government and the people within its jurisdiction, but far more often than not the companies renege on their part of the deal and the governments end up in a worse economic position than they be absent the tax breaks. A similar conclusion was reached in a Oregon Public Interest Research Group report on Oregon tax credits. The conclusion reached in these and similar reports is not a surprise, as it is something that I’ve been suggesting for quite some time. In posts such as Tax Breaks, Politician Takes, Using Taxes to Rescue a Non-Drowning Film Industry?, Do Profitable Companies Need Tax Breaks?, You’ve Gotta Give ‘Em (a Tax) Credit?, When Spending Exceeds Revenue, Hand Out Tax Credits? Really?, and Are State Tax Incentives Worth It?, I criticized special tax breaks because they are unwarranted government spending that benefits private companies and that provide an insufficient economic return on the expenditure. I argued that profitable companies do not need tax breaks, and unprofitable companies ought not be kept afloat with tax dollars because those companies either are engaging in activities rejected by the market or are engaging in de facto unprofitable but necessary activities that belong within the scope of government activity subject to public ownership rather than private inurement.

These tax breaks are nothing more than welfare payments to private enterprise. Opponents of social welfare spending defend these outlays with as much passion as they bring to their attempts to end government assistance for individuals in need of help. One of their favorite arguments is that these tax breaks do not constitute spending because they simply permit a taxpayer to keep the money that belongs to it. This argument is raised in commentary such as Education Tax Credits Are Not Government Subsidies. The reason the argument is wrong can be illustrated by an example. Assume that a government imposes an income tax equal to 20 percent of income, however defined. Taxpayers have income of $100,000,000 and pay $20,000,000 in income taxes. Along comes a special interest group that lobbies for an income tax credit equal to 10 percent of the cost of filming a movie within the jurisdiction of the government, and that the credit will bring $10,000,000 of movie making business into the jurisdiction. The group claims that the $1,000,000 credit will generate more than $1,000,000 of additional tax revenue for the government because of the economic activity triggered by the movie making activity. What the reports are telling us is that these predictions, not unlike those about trickle-down economics and job-creating tax cuts for the rich, are bogus. What the credit requires is one of three things, or some combination thereof. First, all taxpayers other than the movie company must collectively fork over $1,000,000 to make up for the lost revenue. Second, the government must borrow $1,000,000 and incur a deficit. Third, the government must cuts vital services to prevent a deficit from being incurred, thus depriving other taxpayers of $1,000,000 of services for which they have paid. As I explained in Using Taxes to Rescue a Non-Drowning Film Industry?:

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.

Even if one accepts the idea that this sort of government spending isn’t spending but a mere tax reduction, providing tax breaks to one group of taxpayers but not to another means that taxpayers not getting a special tax break are paying taxes at a higher rate that are those feeding at the tax break trough. One would expect the anti-tax crowd to express deep indignation about this sort of hidden tax burden, and although some who subscribe to the anti-tax philosophy do criticize this inequality, many, too many, say nothing. Why? Perhaps because a transparent direct subsidy to the special interest group would be seen for what it is, would be less defensible in terms of the deceptive “keeping their own money” nonsense, and would be more easily understood as an outlay that harms society both in the short-term and in the long-term when it comes to the promised, but unfulfilled, economic payback. For those who want to cut government spending, try starting with the hidden expenditures deceitfully tagged as tax breaks and providing an advantage to particular private sector entities while putting other taxpayers at an economic disadvantage.

At the end of October, news stories, including this one, reported that hackers had managed to obtain millions of social security numbers, bank account data, credit card numbers, and business records by breaking in to South Carolina Department of Revenue computers. It isn’t difficult to imagine the far-reaching scope of the potential damage that has been done. A report released by investigators explained that the hacking was made possible by a Department of Revenue employee falling for a phishing email and providing username and password information.

Last week, the governor of South Carolina, according to this story, blamed the Internal Revenue Service. The governor’s reasoning is appalling. According to the governor, the IRS does not require South Carolina to encrypt social security numbers. So what? Is the South Carolina Department of Revenue incapable of figuring out on its own that sensitive taxpayer information should be encrypted? It’s not rocket science. Of course, South Carolina has now decided to encrypt social security numbers, but closing the barn door after the horses escape is too little, too late. According to another report, the Department had explored encryption on at least two previous occasions but for unknown reasons did not pursue the proposal.

According to this report, the intrusion would have been prevented had the South Carolina Department of Revenue installed a $25,000 dual password system. The IRS, on which the South Carolina governor is trying to put the blame, uses the dual password system. It’s interesting that the governor wants to blame the IRS for not requiring encryption, but does not explain why South Carolina did not imitate the IRS when it comes to dual password systems.

The Director of the Department resigned. There is no news as to the fate of the employee who responded to the phishing message.

It is a good guess that the failure to adopt the encryption proposals in the past was an attempt to save money. The same explanation probably accounts for the failure to purchase the dual password system. And to the extent that the Department’s use of forty-year-old equipment was a contributing cause of the problem, as mentioned in the official report, it’s also a good guess that failure to update the equipment was an attempt to save money. Just as Congress underfunds the IRS while heaping additional responsibilities on it while it tries to keep up with technological change, one must wonder whether the South Carolina legislature was adequately funding the Department of Revenue. So now the state is spending at least $14 million to fix the damage, including $12 million to purchase credit bureau protection for the affected taxpayers, is taking $5 million from other purposes to install encryption, and probably will spend much more before the entire mess is resolved. I wonder if the folks running the show, including those in other states and in Washington, D.C., ever heard the expression penny-wise, pound-foolish.

In the flurry of news reports about some members of Congress who made the Norquist anti-tax pledge backing away from that promise, such as this story, the discussion of how that may come to pass has received far less attention than it should, though it has received some attention in articles such as this report and this analysis. One avenue of escape from the pledge is the notion that the pledge requires opposition to rate increases but does not require opposition to revenue increases. The reason this distinction exists is because revenues can be increased without raising rates. One way of doing so is to eliminate or reduce exclusions from gross income. Another is to eliminate or reduce deductions. One way of reducing deductions is to subject them to a cap. As Senator Lindsey Graham explained, “I will not raise tax rates to do it. I will cap deductions.” Of course, imposing deduction caps to raise revenue constitutes a tax increase.

The idea of increasing revenue without raising rates is not new. It was implemented years ago when Congress placed a phase-out, which is a type of cap, on the personal and dependency exemption deduction and on select itemized deductions. The reason was an amazing bit of political manipulation. In Objections Raised to Elimination of Legislative Tax Deceit, I explained the background of this maneuver:

These two phaseouts [on itemized deductions and the deduction for personal and dependency exemptions] were enacted in 1990 as part of a Congressional subterfuge, or deceit, foisted upon the American citizenry. When public officials deceive citizens, problems arise. In this particular instance, Congress wanted to raise taxes without raising tax rates, because it concluded that it could tell Americans that it did not raise taxes by pointing to unchanged tax rates. However, "clever" minds figured out that if deductions, in this case itemized deductions and the deduction for personal and dependency exemptions, were reduced, the effect would be an increase in tax revenues. In other words, Congress "discovered" that it could raise taxes without raising tax rates and thus trumpet a self-serving proclamation that it had not raised taxes. The simple word for this is lying.

I revisited the issue in When is a 15% Tax Rate Not a 15% Tax Rate?, in which I noted:

I wrote about this problem 16 years ago, in Getting Hamr'd: Highest Applicable Marginal Rates That Nail Unsuspecting Taxpayers, 53 Tax Notes 1423 (1991). It has been cited and quoted almost a dozen times. I doubt, though, that anyone in Congress has read it. That's too bad, because repairs could be made if members of Congress understood the wool that was pulled over their eyes and the eyes of the citizenry by the folks who shoved phaseouts into the tax law as a way of raising taxes without raising rates.

When comparing the two approaches, I see only one advantage to the use of phase-outs, including deduction caps. Deduction caps permit legislators to claim that they have not raised tax rates, hoping that people interpret this claim as equivalent to not raising taxes. It is a misleading approach.

In contrast, I can identify more than a few disadvantages to using deduction caps. Each one by itself outweighs the seeming advantage. Because deduction caps are like phase-outs, the disadvantages of phase-outs that I examined in detail in Objections Raised to Elimination of Legislative Tax Deceit are no less applicable to deduction caps. I highlight these disadvantages, and others, in the following list.

First, deduction caps, like phase-outs, distort the progressivity of the income tax by creating higher average marginal tax rates for taxpayers not at the top of the income pyramid than apply to those at the top of the income pyramid. If nominal marginal tax rates have as much impact on economic decision making as tax-rate reduction advocates claim, average marginal tax rates have at least as much impact, and the skewing of those rates by the use of deduction caps is not beneficial.

Second, deduction caps, like phase-outs, complicate the tax law. The complication is unwarranted, detrimental, and cost-ineffective. The complication increases the chances of errors on tax returns.

Third, deduction caps, like phase-outs, do not increase tax revenue from all high-income taxpayers. Caps only affect those high-income taxpayers who claim the deductions that are subject to a cap.

Fourth, deduction caps, like phase-outs, do nothing to close the many loopholes used by high-income taxpayers to reduced their effective income tax rates, because most of those loopholes do not involve deductions.

Fifth, a deduction cap on the charitable contribution deduction probably will cause a reduction in charitable contributions by high-income taxpayers. In the long run, this outcome is much more harmful to the economy than raising tax rates.

Sixth, deduction caps, like phase-outs, exacerbate the marriage penalty. There are enough challenges with trying to eliminate that penalty without creating a penalty on unmarried individuals without making the task even more daunting.

Seventh, a deduction cap does absolutely nothing to stop the revenue losses arising from absurdly low tax rates on capital gains and qualified dividends. The current capital gains rates are much lower than they need to be to offset the inflation impact that serves as the justification for the lower rates.

About a year and a half ago, in A Foolish Tax Idea Resurfaces, I criticized the President for including a deduction phase-out in his fiscal year 2012 budget proposal. Apparently the President has seen the light, and according to this story, is rejecting deduction caps in favor of the much more transparent tax rate cut expiration. Two years earlier, in a Tax Change Ought Not Be Tax Redux, I criticized the President’s fiscal year 2010 budget proposal for suggesting that the itemized deduction and personal and dependency exemption phase-outs ought to be restored.

As explained in Objections Raised to Elimination of Legislative Tax Deceit, I successfully campaigned against the phase-outs and they were recently phased out of the tax law. It would be a step backwards to reinstate them, to let them be reinstated through inaction, or to adopt their deduction cap surrogates.

There are better solutions. Replacing deductions with credits is one. Repealing the special capital gains rates and indexing adjusted basis for inflation is another. Restoring progressivity to the tax law to undo a decade’s worth of economic damage caused by the discredited “trickle down” theory is yet another. Repealing special interest deductions is still another. It is time to start talking about genuine cures rather than playing around with attempts to hide the problems and mask the solutions. As I wrote in Tax Change Ought Not Be Tax Redux, “Let's face it. The days of using Pease and PEP to hide tax increases are long gone. Everyone knows the score. Aside from the impropriety of raising taxes using clandestine gimmicks, there's no need to do so. There's no genuine impediment to doing what needs to be done in the way it needs to be done. The bleating from the privileged few that taking away their capital gains break or their special dividend rate will destroy the economy should fall on deaf ears. The special interest groups have cried wolf too many times.”

Students in basic federal income tax courses throughout the country encounter the questions, what is income and what is gross income, early in those courses. By the time that topic has been explored, students have learned that the answer to the first question isn’t easy to define, and that the answer to the second question is complicated and not something that a computer program can resolve. This point is one that seems to sail by those who offer the flat tax or one of its many variants as a solution to income tax complexity.

Recently, Robert Smith of NPR, in a report brought to my attention by a faithful reader, explored how the Mormons define income for purposes of their church’s teaching that each member should tithe 10 percent of income. Though the 10 percent tithing principle is rock-solid, the church does not define income. It leaves that to individual members.

Two economists surveyed 1,200 Mormons. They learned that most would tithe on the amount of a cash gift. But few would tithe on the value of a gift of property. Most would tithe on money taken out of a retirement fund even though they had given 10 percent of the income from which the money was taken to put into the fund. In the tax world, this would be considered double taxation. Yet when asked about proceeds from a garage sale, it appears that no tithe is computed because the items sold “has already been tithed.” Most Mormons who find money would transfer 10 percent to the church. Though Mormons tithed on gain from the sale of stock, most did not offset gains with losses from stock sales. Most Mormons do not reduce income by deductions. Smith tells of a married couple who used different rules before they were married. The husband tithed on gross income, and the wife tithed on income net of taxes. Eventually the husband persuaded his wife to his definition of income.

It appears that Mormons react to cash. It does not appear they tithe on employer fringe benefits such as contributions to health care plans or the use of a company vehicle. One reason may be the lack of information sufficient to permit computation of a tithe. But the difference between the reactions to cash gifts and gifts in kind goes deeper than simply the availability of information.

When asked about the lack of an income definition, a Mormon bishop noted that “all this soul-searching about what you owe God is kind of the point.” Would this approach work with income taxes? I think the answer is no. The relationship between a faithful member of a church – and Mormons are not the only ones who require or recommend tithing – is very different from the relationship between a citizen and a government. People don’t soul-search what they owe to society. Churches can function even if members are not using the same definition of income, and even if members are not giving at uniform rates of contribution. Rarely, if ever, do members of a church get into a dispute with each other because someone contributes at 9.5 percent rather than 10 percent, or someone treats something as income that someone else does not. Surely they seek to enlighten each other, as the two spouses in the anecdote managed to do. In contrast, when it comes to financing society, people bring a very different agenda into the discussion. Unhappiness prevails when someone seeks to gain an advantage with respect to taxation.

Not only is soul-searching absent from tax law discussions, the seeming absence of complexity in a tithing system becomes an avenue for game playing in the tax world. Taxation of cash gifts but not in-kind gifts would trigger a rush to substitute property for cash in the gift-giving world. Would a gift card be treated as cash? Do Mormons tithe on the value of a gift card? I don’t know. What seems clear, though I may be wrong, is that Mormons generally do not rearrange their dealings in order to gain a tithing advantage. I can’t imagine someone saying, “Give me property and not cash so I can avoid tithing.” In the world of taxation, requests and planning along those lines is rampant.

The lack of a definition of income for tithing purposes does not appear to be an impediment. The lack of a definition of income for tax purposes would be fatal to any income tax system. The world of tithing and the world of taxation are two different places, as they ought to be. Though it would be nice if the generosity of tithing and the reluctance to, as one person put it, to get “petty with God,” spilled over into the world of government and taxation, it isn’t going to happen.

Readers of MauledAgain know that I am not a fan of Grover Norquist’s anti-tax-increase pledge tactics nor of the influence this unelected, self-appointed anti-tax activist wields over federal and state legislators. In posts such as Food for Tax Thought?, Tax Semantics, Debunking Tax Myths, Tax Policy, Elections, and Money, If the Government Collects It, Is It Necessarily a Tax?, and When Privatization Fails: Yet Another Example, I have, as noted in Debunking Tax Myths, “explored the unwarranted and excessive influence that the unelected Grover Norquist holds over federal, state, and local tax policy and decision making,” and, “[b]ased on Norquist’s own words, . . . concluded that his anti-tax stance is simply part of his strategy to destroy government.”

Several days ago, in this Huffington Post opinion piece, Norquist offered two “protections available to the American people” to avoid previous experiences of watching legislators rush into adoption of economic or tax programs designed in private and put up for a vote without sufficient time for examination. Norquist suggests that negotiations on dealing with the impending fiscal cliff be aired on C-SPAN and not conducted in back rooms. He also proposes that once an agreement has been reached, it should be reduced to legislative language and then put online for 7 days for all Americans to read.

My first reaction to Norquist’s proposals was a positive one, which is rather surprising considering how adamantly I object to his dogma and tactics. Long before Norquist was pondering taxes, I was bemoaning the back-room approach to politics generally and to tax specifically. And long before Norquist turned his attention to legislative matters, I was also bemoaning the “last minute rush” process that generated legislation with flaws, omissions, and inconsistencies, and that raised more unanswered questions than good legislation ought to present. My students have been listening to these criticisms for all the years that I have guided them through the tax law that has emerged from this inefficient legislative process.

But the more I thought about Norquist’s proposals, I came to see two major concerns. Neither one causes me to object to Norquist’s proposals, but both cause me to look at them more closely.

The first is that the idea of requiring a 7-day period for examination of the legislation presumes that the legislation would be ready in time to permit that examination to take place, and enactment to occur, before the December 31, 2012, fiscal cliff event. The reason for the rush to enactment is that legislatures leave things go until the last minute. Though many people, including students, tend to do this is no excuse for public leaders to emulate bad practice. Instead, they need to learn and apply time management principles. Norquist does not address this underlying cause for the “rush to enact” problem that he seeks to remedy. Perhaps legislatures should be required to begin work on an issue a certain number of days before the deadline and should be prohibited from taking a break or doing anything else until the job has been completed. How that sort of solution can be implemented is not as easy to design as might first appear.

The second is that the idea of moving policy decisions out of the back rooms is not one I would have expected Norquist to make. Six years ago, in Food for Tax Thought?, I commented on a story, about the relationship between lobbyist Jack Abramoff and White House Political Director Ken Mehlman, who by 2006 was serving as chair of the Republican National Committee. One of the conversations in which Abramoff and Karl Rove addressed Abramoff’s efforts to obtain benefits for his clients took place at a "Tax Policy Dinner" hosted at Grover Norquist's home. To this, I reacted by writing, “So, wrapped up in this morass of favors, endorsements, deals, and other shadowy transactions is a thing called a ‘Tax Policy Dinner.’ Hosted, no less, by one of the staunchest opponents of taxation to come along in a long time.” I then added, “It is simply wrong for tax policy to be worked out at a private dinner to which only a select few are invited. When the deal is done before the vote is tabulated, what's the value of the vote?” I am confident that if I had requested this dinner to be broadcast on C-SPAN, Norquist and his cronies would have refused. Now, Norquist criticizes back-room dealing. Does this mean he would open his dinners to public view? Or stop doing public business in private? How does he reconcile his past practices with his most recent proposal? What he says, and how he says it, will be important, if he says anything at all. What he does, and how he does it, will be much more instructive.