MauledAgain

As one of my readers put it, absurd claims about the size of the Internal Revenue Code is one of my favorite topics. Indeed it is. My exploration of this persistent misrepresentation began more than ten years ago in Bush Pages Through the Tax Code?, and continued with Anyone Want to Count the Words in the Internal Revenue Code?, Tax Commercial’s False Facts Perpetuates Falsehood, How Tax Falsehoods Get Fertilized, How Difficult Is It to Count Tax Words, A Slight Improvement in the Code Length Articulation Problem, Tax Ignorance Gone Viral, Weighing the Size of the Internal Revenue Code, Reader Weighs In on Weighing the Code, Code-Size Ignorance Knows No Boundaries, Code-Sized Ignorance Discussion Also Is Growing, The Scary Specter of Code Size Ignorance, and Code Size Claim Shrinks But Not Enough.

Though it disturbs me when someone repeats the misrepresentation about the size of the Internal Revenue Code, it doesn’t surprise me when it comes from someone who isn’t involved with tax policy and taxation. Politicians who repeat this erroneous claim should know better, and are in a position to inform themselves, but very few politicians know much about tax policy or taxation beyond the talking points that their handlers provide them. On the other hand, when those who should know better and who profess to be experts in tax policy speak or write about the size of the Internal Revenue Code, they owe it to themselves and to their audiences to get the facts right.

Why does it matter? If a person with common sense visits a physician and is told to drink a quart of turpentine every evening, that person isn’t going to trust anything else that the physician advises. By now, with at least ten years of corrective explanation available not only from myself but from others, it makes no sense at all that two academics, one a fellow of an economic institute and the other a professor of economics would assert that the tax code, as of 2010, was “nearly 72,000 pages long.” It wouldn’t take much research to figure out that this claim is way off the mark. Perhaps getting a copy of the Internal Revenue Code and counting the pages -- even using a method of extrapolation – would generate something much closer to the correct number than grabbing something off the internet.

It’s unfortunate that these two commentators begin their article with this claim. Usually, when I start to read something that puts forth a serious factual error I set it aside. In this instance, I continued to read, wondering if I would find any other errors. Like the other advocates of the “flat tax,” including a presidential candidate who a few days ago shared his particular version, they claim that complexity is eliminated by setting the tax rate at one percentage and eliminating all deductions. They fail to mention issues of timing, such as cash versus accrual, installment sales, or nonrecognition, make no attempt to consider the application of any tax to partnerships and LLCs, ignore the treatment of cost of goods sold, and make no attempt to discuss basis. As I explained in, among other posts, The Flat Tax Myth Won’t Die, those who understand taxation don’t accept simplistic flat tax proposals as anything even close to solving the complexity problem.

As a consequence, readers who stop reading when they see the 72,000-page silliness miss the valid claims that the authors offer. They point out that politicians buy votes with tax breaks for their “preferred constituencies,” a polite phrase for puppetmasters. Yes, the IRS makes mistakes when answering taxpayer questions. Absolutely, it is better to judge politicians by what they do after being elected than simply by what they say they will do. Indeed, tax law complexity provides cover for hiding tax breaks dished out to those rich enough to buy them.

So I’m left with one conclusion. Though the authors identify the problem – namely, the ownership of Congress by the oligarchy, though they don’t put it in those terms – they go off track when it comes to finding a solution. And that conclusion is reinforced when my confidence is shattered at the outset, after wondering what do they really know and understand, and then realizing the answer is, not all that they need to know and understand.

Sometimes I wonder, when it appears that people exhibit ignorance, if they actually lack understanding and knowledge or simply are pretending to be deficient in order to accomplish some other goal. If it’s the latter, my admiration is withheld because that sort of approach lacks transparency. If it’s the former, I remain baffled at the inability of so many people to understand the use tax. In many posts, such as Taxing the Internet, Taxing the Internet: Reprise, Back to the Internet Taxation Future, A Lesson in Use Tax Collection, Collecting the Use Tax: An Ever-Present Issue, A Peek at the Production of Tax Ignorance, Tax Collection Obligation is Not a Taxing Power Issue, Collecting An Existing Tax is Not a Tax Increase, How Difficult Is It to Understand Use Taxes?, Apparently, It’s Rather Difficult to Understand Use Taxes, and Counting Tax Chickens Before They Hatch, I have tried to explain how the use tax works. It’s rather simple. When a resident of a state with a sales tax makes a purchase in another state and brings the item back into the state, that resident must pay a use tax. Of course, compliance is unsatisfactory. The only items with respect to which states manage to collect most of the use tax that is due are items requiring title, such as vehicles, boats, airplanes, and a few similar items. The rise of Internet commerce has made it even more difficult for states to collect the use tax, because the number of people who crossed state lines to make purchases to bring home is dwarfed by the number of people who can make out-of-state purchases without leaving their home or business. So, of course, states want out-of-state retailers to collect the use tax on their behalf, even if the retailer has no physical presence with the state.

In the latest attempt to deal with this issue, Representative Jason Chaffetz has introduced the Remote Transaction Parity Act (RTPA), which would authorize states to require all retailers to collect the use tax if they sell products in the state. Bricks and mortar stores want this sort of legislation because they consider themselves to be at a disadvantage caused by the online retailer’s ability to refrain from collect the use tax that the brick and mortar stores must collect in the form of a sales tax. It is important to note that this disadvantage existed long before there was an internet, such as in the case of Pennsylvania residents shopping in the no-sales-tax state of Delaware. The Retail Industry Leaders Association (RILA) supports the RTPA because it would “restore basic free market competition for retailers” and eliminate the “free pass” given to online businesses that are “little more than a government subsidy.” RILA argues that they “want everyone to play by the same rules.” In contrast, the Institute for Policy Innovation (IPI) opposes the RTPA because it “opens the gates to an unprecedented expansion of taxation and taxpayer harassment by out-of-state tax collectors,” and fails to “solve the core issue of nexus, or where precisely an electronic transaction takes place.” By eliminating the requirement that businesses must have a physical connection with a state before the state can require it to collect use tax, IPI argues that RTPA would open the door to every state being permit to audit businesses in every other state.

For me, it is easy to see that RILA and IPI are arguing past each other. When IPI argues, for example, that RTPA would require “consumers, [to] pay taxes in the state where the customer resides,” it overlooks the fact that under law that has been around for decades, a consumer living in a state with a sales tax must pay use tax on items purchased in other states and brought into the state. So the issue, as I have repeatedly pointed out, is not a matter of whether a tax exists, but who should be responsible for seeing to it that the tax is paid. The ultimate responsibility is on the consumer, and the imposition of collection requirements on a retailer arises when the retailer avails itself of the state’s services by making itself present in the state. The question of what constitutes presence in the state when a transaction takes place over the Internet is the key issue, and here, IPI makes a good point by noting that RTPA doesn’t address that question. On the other hand, when RILA considers the inability of Pennsylvania to require a Delaware merchant to collect Pennsylvania use tax when selling items in Delaware to a Pennsylvania visitor to be some sort of government subsidy, it ignores the practical reality that the Delaware merchant chose to do business in Delaware and Pennsylvania, and that if there is a subsidy, it is the choice of Delaware not to impose a sales tax.

So what’s the answer? I proposed a solution in Tax Collection Obligation is Not a Taxing Power Issue:

Perhaps a better approach is for states to seek voluntary contracts with out-of-state retailers, compensating them for serving as tax collectors. There may be state Constitutional provisions or legislation that prohibits contracting tax collection to out-of-state individuals or entities, though I doubt that is the case. For some businesses, being compensated to engage in use tax collection might help the bottom line.

Taking this route is more consistent with free market principles than is converting out-of-state businesses into involuntary workers.

Perhaps we have been handed another clue in the great mystery of why tax laws don’t get fixed. It’s common knowledge that one reason for tax law complexity is the attempt to disguise a provision aimed at a select few. And it’s no secret that another reason is the entrenched opposition by tax break beneficiaries to removal of what is an overall burden on everyone else. But perhaps a no less significant reason is the inability of politicians to understand how existing tax law functions.

An example of the problem popped up last week, according to this story. New Jersey Governor Chris Christie, who harbors hopes of becoming the next president, claimed that one reason for the nation’s economic troubles is that United States corporations are taxed twice on income earned overseas. His assertion overlooks the foreign tax credit, designed and implemented to prevent the very thing that Christie claims is happening. Christie’s shallow understanding of federal income tax law was corroborated by his pinning the blame for the nonexistent double taxation on the IRS. So common is this misunderstanding – or perhaps so successful has been the campaign by Congress to blame the IRS for the existence of the federal income tax – that the writer of the article made the same error, rebutting Christie’s bizarre claim with the explanation that “the IRS provides a foreign tax credit to prevent double taxation.” With apologies to those who try to excuse away the error, it is the CONGRESS that enacted the foreign tax credit.

Rejections of Christie’s claim, which he has made in multiple speeches, also came from others. The co-director of the nonpartisan Tax Policy Center called Christie’s statement “wrong.” A former Treasury analyst who worked in both the Clinton and Bush administrations was a bit gentler, saying that “Governor Christie appears to be confused.” But confusion is simply one reason for being wrong. Another reason is ignorance, which can generate a wrong answer without any confusion entering the picture.

From my perspective, Christie is not confused. I’m confident he knows very well that what he is saying is wrong, but repeats it because is sound good. It riles up the anti-tax crowd, a group whose support Christie needs to nurture. These sorts of misrepresentations are hallmarks of campaigns that cannot succeed with the truth. When I read or hear this type of inaccuracy, lie, or exaggeration, my first thought is that the person has insufficient confidence in what they are peddling that they feel a need to pump up the hype. It’s a reaction I don’t limit to politicians, as I also invoke it when dealing with advertising and sales pitches. Oh, wait, is there really any difference?

What concerns me most is when someone trying to get a repair job demonstrates ignorance of what needs to be fixed. I’ve listened, for example, to enough support-line technicians tell me things about software to avoid implementing their suggestions. Not that I haven’t encountered ones who knew their craft, or repair personnel who got the job done correctly the first time around. So when I hear someone campaigning and asking to be elected to a job reveal a lack of understanding about a basic principle of federal income taxation, I shudder at the thought of putting that person in charge. It would be too easy for those trying to game the system to game that person.

In a National Review commentary, Tom Giovanetti of the Institute for Policy Innovation proposes that every law and regulation expire after five years and that every agency terminate after ten years. Legislators would then have the opportunity to consider revival.

In theory, there is some merit to the idea. Economies change, nations evolve, culture morphs, people transform. But in practical reality, the proposal is a nightmare. But even some of the arguments Giovanetti offers in support of the theory fail to withstand scrutiny.

He begins by comparing law to milk, which goes bad. Yet anyone who proposes throwing out all of the food and beverages in a home or establishment based on the expiration date of milk not only would be wasting money but also endangering the health of the residents and survival of the business. Just as one should cull beverages and food from the freezer, refrigerator, and pantry based on individual analysis, so, too, laws should be repealed based on individual analysis and not some one-date-fits-all mindless dumping.

Giovanetti compares the situation to the ability of the nation to amend the Constitution. This comparison is badly flawed. The drafters of the Constitution provided for review and amendment, and were not so idiotic as to propose that the Constitution expire every five years. Just imagine how that would play out. The best single-word description is anarchy.

Giovanetti tries to support his proposal with an example, specifically, the expiration date of section 215 of the Patriot Act. Busy praising the fact that the expiration date forced legislative review of the provision, he overlooks another more important fact, which is that for several days, the American intelligence and defense communities were blind. Congress, in its usual dilatory and irresponsible way, failed to deal with the expiration date until after the expiration. Sensible homeowners don’t throw out expired milk and then let the children go unnourished because the stores are closed. Sensible people plan ahead. The United States Congress is incapable of doing that, mostly because those elected are so bound to vote-gathering and fund-raising that they have little time to do their jobs and uphold their fiduciary duties. The track record of state and local legislators isn’t any better.

Giovanetti praises the expiration date of section 215 of the Patriot Act as forcing Congress ‘to actually do something rather than nothing.” But the fact Congress did something is no guarantee that it will deviate from what Giovanetti concedes is its usual pattern, that is, doing nothing. A wonderful case in point is the failure of Congress to deal with the funding of American infrastructure while Americans die, suffer injuries, and incur economic costs exceeding what the nation would pay if Congress did what it ought to do rather than quaking in its boots at the sight of the unelected Grover Norquist gang.

And even with staggered five-year expiration dates, there is no way that Congress could deal with a re-examination of 20 percent of every law and regulation during the relatively few days it is in session. The best that would happen, which is still worse than worst, is the enactment of laws written by paid and unpaid devotees of the oligarchy. The worst that would happen, which is even more catastrophic, is that the nation would descend into chaos. That sort of chaos would encourage and empower those who want to impose an oligarchic dictatorship on the nation, subjecting freedom to monetization by pretending to be advocates of freedom for all yet reserving power unto itself.

Though Giovanetti provides a bad example of how his proposal would work as proof that it would work, he overlooks some of the most egregious instances of using expiration dates in legislation. Of course, I am referring to the federal tax law, so stuffed with expiration dates that extender legislation often deals with dozens and sometimes hundreds of “expiring provisions.” The effect on the economy is nothing less than a drag-down, as the uncertainty paralyzes businesses because entrepreneurs don’t know what the rules are or what they will be. And why does Congress do this? One reason is to circumvent its own requirement that the cost of tax breaks be limited. The other is to provide leverage for fund-raising, by using the threat of non-renewal to extract campaign contributions from the very people who supposedly are being helped by the provision. Sometimes it appears that the tax savings from an extension simply circulate back to members of Congress as campaign contributions. Giovanetti’s proposal simply would give members of Congress a much-longer list of arm-twisting tools, and leverage to hold the nation hostage by delaying extensions until a pet project of the oligarchy is enacted.

One can only imagine what will happen when all traffic laws expire on January 1, 2019, or when restrictions on the private ownership of nuclear weapons expire on January 1, 2018. It might be fun to play theoretical games pondering the consequences of child abuse laws expiring in 2021, or bank robbery statutes reaching sunset in 2022, but the practical realities of life suggest that this isn’t simply nonsense but a threat to civilization.

The task of the Congress should be to review existing laws and regulations and amend those that need repair, while identifying those that work well and that should be permitted to continue without being terminated arbitrarily. Giovanetti argues, “Wouldn’t it be a good idea for every law, regulation, and agency to be forced to justify its existence every once in a while?” Of course, but that is an argument in support of review and revision. One cannot justify one’s existence if one is first killed and then supposedly given the chance to provide justification. Giovanetti has it backwards.

Five-year plans were the policy linchpin of the Soviet Union, and goodness, how well did that work? It doesn’t make sense to base American legislative policy on that model.

Readers of this blog know that on my list of pet peeves – a list that keeps growing – is the foolishness of letting the nation’s infrastructure crumble while the anti-tax and anti-government crowd stands in the way of maintaining the arteries through which the economy circulates. I’ve written about the short-sightedness of this strategy in posts such as Liquid Fuels Tax Increases on the Table, You Get What You Vote For, Zap the Tax Zappers, Potholes: Poster Children for Why Tax Increases Save Money, When Tax and User Fee Increases are Cheaper, Yet Another Reason Taxes and User Fee Increases Are Cheaper, When Potholes Meet Privatization, When Tax Cuts Matter More Than Pothole Repair, Back to Taxes and Potholes, and Battle Over Highway Infrastructure Taxation Heats Up in Alabama.

Now comes news that heavy vehicles, including tour buses, have been banned from Memorial Bridge, which connects popular tourist attractions on either side of the Potomac River. Why? The bridge is corroded, and it won’t take much to bring it down. The bridge is under the jurisdiction of the Park Service. The problem? The cost of fixing the bridge is bigger than the Park Service’s entire bridge and road budget.

To drive home the seriousness of the nation’s decaying economic underpinnings, at about the time the bridge was being closed to heavy vehicles, a water main near the Capitol broke. It generated even more traffic jams in a city afflicted with constant traffic problems because of infrastructure deficiencies, and left an office building with no water. Bringing in bottled water doesn’t make the restrooms functional.

There are more than 60,000 structurally deficient bridges in this country. Do you drive on any of them? Most people surely cross at least one, if not every day, perhaps every week or month. Do you think you might win the “on the bridge when it collapsed” lottery?

In the meantime, Congress adjourned without dealing with the problem. Held hostage by legislators elected by citizens who seem intent on winning the bridge collapse lottery, these individuals with a fiduciary duty owed to the nation’s citizens cower in fear of the unelected Grover Norquist and his gang of fiscal bullies. These fools, who claim to act in the interest of America, have left the nation falling further behind other countries, such as China, which spends four times more than does the United States, in terms of percentage of GDP, and which now has 19,000 miles of high-speed rail. The Norquist cabal is pushing legislation that forbids the use of federal funds to build high-speed rail. Most of these geniuses are up front when it comes to harping about the threat allegedly posed by China to the national security of our nation.

The “starve the beast” mentality that makes for a good sound bite or tweet, is a Trojan horse that hides the true deprivation. It ought to go by its real name of “starve the non-oligarchs.” It’s not a matter of a nutrition shortage. There are, and have been, more than enough resources, but those have been wasted on needless war and funneled into the hands of greedy oligarchs through tax cuts and loopholes that hide tax breaks.

Those unfortunate enough to be in a vehicle caught on a collapsing bridge probably aren’t thinking about this. But their survivors, at some point, will wonder why they stood by and did nothing while the nation was being destroyed. How many people will need to die before the nation wakes up?

Perhaps more breakdowns in the nation’s capital will catch the attention of legislators. Perhaps when it hits close to home it might wake them up.

Almost two years ago, in Lap Dance Tax?, I first wrote about the attempt by Philadelphia to impose its amusement tax on fees paid for lap dances. I continued the saga in Tax Review Board Strips City’s Lap Dance Tax Attempt, Philadelphia Lap Dance Tax Effort Bumped Up to Court, Which Grinds It Down, and The Lap Dance Tax Dance Marathon. Ultimately, the city of Philadelphia lost.

A few days ago, a reader alerted me to reports out of Albany, New York that a judge has issued a split decision on New York’s attempt to impose its sales tax on revenues collected by a strip club. According to the judge, the sales tax, which does not apply to amounts paid for “a dramatic or musical arts performance,” did not apply to proceeds paid to observe pole dancing because pole dancing is artistic. But, the judge held, amounts paid for lap dances are subject to the sales tax because lap dances lack “artistic merit.” The judge’s opinion, though long, is well worth reading.

Despite having a fairly good grasp of tax law generally, and a passable understanding of sales taxation, I would have struggled with this case because, as others can attest, I don’t quite understand art. That is to say, I don’t understand why something is or is not art, and have concluded, perhaps erroneously, that in some sense everything is art. According to the opinion, lap dancing did not qualify as art because they were not choreographed, the performers did not select the music, the room in which they were performed was not a stage, the performers were limited in what they were permitted to do, and the goal of management and performers was to maximize revenue. I am puzzled by any sense that art requires a stage, or that a person performing art cannot be restricted in what is said or done. Performers who follow a playwright’s script are no less constrained, and yet their performances are accepted as art no matter the definition. And though most artists and artistic venues struggle to make money, there are plenty of unquestionably artistic performances that generate enormous amounts of money.

Yet the best part of the New York case is the revelation that an undercover tax investigator “paid at least 15 visits to the club in the line of duty and received one or two lap dances each time.” I suppose now when I people ask me about my law specialties, my answer will need to qualify the word “tax.” And when I tell people, including my students, that tax law is fun, I will probably need to add yet another qualification.

When debate turns to federal income tax policy, one of the issues focuses on the acceptability of the progressive nature of the tax. Those who see income and wealth inequality as a menace to democracy, as I do, consider progressivity to be a good mechanism for stopping the otherwise inevitable spiral into someone winning all the money in life’s grand game of economic Monopoly. Those who see tax and government as something to be curtailed or even eliminated try to gain support by arguing that no one should pay a higher percentage of tax than anyone else does.

But one of the underlying premises of this discussion turns out to be flawed. The federal income tax is not progressive. This isn’t just a matter of Mitt Romney and his secretary. It’s a matter of ascertaining whether income and wealth inequality ought to be tagged as the 99 percent versus one percent. It turns out that the nation’s economic divide is not so simple.

According to newly-released statistics for taxable year 2012 from the IRS, the average federal income tax rate is skewed in a manner that makes it both and neither progressive. The average federal income tax rate is total income tax divided by adjusted gross income. According to the IRS, in 2012 the average tax rate for income categories was as follows:

Top 50 percent 14.33%
Top 40 percent 14.98%
Top 30 percent 15.81%
Top 25 percent 16.35%
Top 20 percent 17.04%
Top 10 percent 19.21%
Top 5 percent 20.97%
Top 4 percent 21.44%
Top 3 percent 21.97%
Top 2 percent 22.52%
Top 1 percent 22.83%
Top 0.1 percent 21.67%
Top 0.01 percent 19.53%
Top 0.001 percent 17.60%

See the problem? The average tax rate goes down as the income of taxpayers in the upper income brackets increases. But it’s even worse, because the IRS is computing average tax rate by comparing tax liability with adjusted gross income. Adjusted gross income does not include a variety of income items that are excluded because they fit within an exclusion. Though exclusions are available to all taxpayers for all sorts of things, some of the most significant exclusions are of much more use to taxpayers with higher incomes. For example, interest on tax-exempt bonds is not included in adjusted gross income because it is excluded from gross income. I suspect that if these exclusions were taken into account, and the average tax rate were computed using total economic income rather than adjusted gross income as the denominator, the average rates for all categories would go down, but would go down by proportionately greater amounts in the upper categories. In other words, the skewing demonstrated by the information from 2012 tax returns would be worse.

So perhaps it’s not a matter of 99 percent versus one percent. Perhaps it’s more like 99.9 percent versus 0.1 percent. Does it matter? For me, it foretells what happens once the 99 percent is reduced to poverty and turned into serfs economically dependent on the one percent. At that point the 0.1 percent will turn to eliminating the economic position of the bottom 90 percent of the top one percent. And then the top 0.01 percent, and in turn, the top 0.001 percent will seek to eliminate everyone else. And then? Eventually one person will own the one corporation that owns everything, including people, nations, and nominal governments. What is worrisome is that there are too many people who think that they, or one of their descendants, can win this “game.” That’s why they vote against their own economic self-interest, and support those who, in the long run, care nothing for them. But the “game” is rigged, and the losers have lost even though they don’t know yet that they have lost. If they want to win something, realizing that the grand prize isn’t there for them to take, they will support the elimination of a grand prize and vote for policies that unrig the game.

According to a recent news report describing efforts by the Philadelphia School Reform Commission to deal with the underfunding of city schools, “There is little appetite for a tax increase to help Philadelphia schools.” The point was rephrased by another speaker who explained, “There’s no appetite in this city for raising taxes.” No kidding. In this country, there is no appetite whatsoever for tax increases of any kind to fund anything. It is a widespread and fatal malady.

Of course human instinct is to resist paying taxes and to grab whatever can be grabbed. People face a choice. They can push beyond instinct and permit rational analysis to prevail, recognizing that to receive one must give. Or they can invent falsified reasoning, grab while condemning those who grab, and find every which way to get without giving.

It’s not just taxes. It’s everything. I hear people complain about paying for food, gasoline, theater tickets, clothing, tuition, health care, lawn maintenance, and every other service or merchandise one can list. And it’s not about price. True, there are people who claim that they don’t mind paying $5 but find $8 to be too much. That reaction has been around for a long time. But now there are increasing numbers of people who ask, “Why should I pay for this?” And it is to this limbic system dominance that the merchants of hate direct their efforts, subtly and not-so-subtly fertilizing the philosophy that crops should be picked by people who are not paid and whose choice is nothing more than to find another plantation on which to work.

It would not surprise me to discover that the connection between expecting to receive without paying has its roots in how a person is raised. Someone who goes through the first few decades of life being handed anything and everything find the world a difficult place in which to live when the world is a place where one must pay in order to receive. Resentment against those who take without giving – and that group includes people in every economic stratum – fuels the attempt by takers to point the finger at other takers.

What’s missing isn’t something that can be found in tax policy, economic decisions, or rules and regulations. It’s something that requires an adjustment to the nation’s culture. The “me generation” – a term that I first met in the waning weeks of the American Civilization course at Penn many decades ago – has turned out to be everything that it was foretold to be, and worse.

Developers and investors who like to use public funds for private enterprises often try to justify their grab by claiming that the enterprise in question will generate economic benefits for the public that otherwise would not accrue. This argument relies on theory that has been disproved by reality, though there’s no shortage of underpaid economists willing to conjure up “evidence” that the predations of these takers is good for those who end up worse off in the long run.

One example of this approach gone wrong involves the soccer stadium built in Chester, Pa. As I explained in Putting Tax Money Where the Tax Mouth Is, the cost of the stadium, used for a private sector professional sports team, was defrayed in part by a combination of toll revenues diverted from use on the bridges on which they were collected, state funding, and tax breaks. The justification was that the stadium would bring people into Chester, where they would spend money, thus revitalizing the city. The economic development did not materialize. Surprise? No.

Now comes yet another story of the promised trickle-over failing to appear. According to the report, people who attend games at the stadium arrive, watch, and leave, never “venturing beyond the I-95 ramp” that leads to the stadium. And now it is blame time. The mayor says that the owners of the park “have not done enough to boost the city’s economy or residents.” A state senator says that the “relationship between the park and the city” is “hostile,” while the owners hesitate to “characterize the relationship as outstanding.” The team’s chief executive and operating partner said, “Revitalizing the city isn’t what we ever promised.” Really? Too bad this wasn’t publicized when the public resources were being grabbed by the private sector. The amount paid by the team in lieu of property taxes is less than one-half of what the city must pay to redeem the bonds used to finance part of the stadium cost, at public expense. The team claims that it created 162 jobs for city residents, although most of them are part-time jobs. Most people know that a part-time jobs equals a job without benefits. The team also claims that its non-profit foundation is doing wonders for the city.

It is worth repeating what I wrote in Putting Tax Money Where the Tax Mouth Is:

Certain taxpayers are in the habit of trying to obtain public funding for private sector enterprises through tax breaks. The gist of the argument is that the private sector activity for which they seek a tax break is good for the public. The problem with that argument is that pretty much every private sector activity, aside from criminal behavior, is good for the public. Carried to its extreme, the argument supports a conclusion that every private activity ought to be the recipient of tax breaks. As a practical matter, the private activities that benefit from this feeding at the public trough are those with sufficient funds to hire lobbyists to push for advantages unavailable to most entrepreneurs.

Here’s the problem. Private enterprise, which for the most part rejects taxation and government regulation, is quick to find ways to tap into public funding that is financed by the very tax systems that private entrepreneurs detest. Though the argument that a particular private enterprise is good for the public gets transformed into a plea for public funding, what’s missing is evidence that the public funding is necessary. And, if the public funding is necessary because the private enterprise otherwise is not economically viable, ought not the private sector not pursue an uneconomical proposal? Ought not the question be whether the private enterprise is necessary for the health and welfare of the public? It’s one thing to seek public financing for a private enterprise that puts out fires, prevents river flooding, and improves public safety. It’s a totally different animal to seek public funding for the construction of a stadium that is important to the small fraction of the public that cares about the sport in question.

Here are two solutions. The first is easy. When a private enterprise seeks government funding, just say no. If it’s an economically viable project, it will survive in the free market on its own. The second solution is an alternative, to permit flexibility in cooperation between the public sector and the private sector. When the private sector entrepreneurs offer promises that their project will increase government revenues, hold them to that promise. Compel them to offer a number. Compel them to guarantee that if the revenues do not materialize, they will make up the difference. If they truly believe their project will do what they promise it will do, they ought not hesitate to agree, because the guarantee rarely if ever will need to be met. I doubt, though, that the private sector handout seekers will agree to such a guarantee, because they know the reality of these sorts of deals. The promised tax revenue benefits rarely, if ever, show up.

As distressing as it is to see yet another failure of the “trickle-over” theory, as I call it, because it means more people are added to the list of those who are suffering economically, at least it makes the failure pile bigger. In turn, perhaps it will make the flaws of the theory more visible to more people, and perhaps they will stand up and say, “Enough is enough.”

Once upon a time, a person, or even a corporation, prepared to engage in business or engaging in business, estimated or measured revenue, estimated or measured the cost of doing business, and determined whether there would be an excess of revenue over expenses, and, if so, whether it would be sufficient to make the effort worthwhile. Taxes came into play as a cost of doing business, either as part of cost of goods sold, labor, supplies, or other expenditures, or as a percentage of profits. Those who were embarking on a successful enterprise got underway, and those whose businesses thrived kept on going, unless they wanted to retire, or encountered a difficulty such as getting ill. In that event they sold their business or shut it down.

But somewhere along the line, making a profit sufficient to support one’s self and one’s family became a matter of trying to grab every possible dollar of profit. One of the techniques that came into play was to get government officials to take money from taxpayers and hand it to businesses. One doesn’t hear very much complaining about this form of taking. But, of course, when government takes money from taxpayers to keep other citizens from dying or becoming so ill that a pandemic ensues, all sorts of “hate the takers” sloganeering runs rampant, much of it financed by those “business” operatives who themselves are sucking tax dollars out of the public system.

So it was no surprise to read the news that Philadelphia’s city controller has come out in support of a tax break for the developers re-working the Gallery at Market East. The Gallery is a shopping mall that, once thriving, has fallen on hard times to the point of being almost vacant. People vote with their feet. Has it occurred to anyone that one of several reasons business fell off is that the typical customer has fewer and fewer dollars to spend because wealth is flowing abundantly into the pockets of, and only into the pockets of, the oligarchy?

The argument in favor of diverting tax dollars into the hands of private investors is that, in the long run, the city will collect more taxes. This argument is nothing more than a variant of the long-discredited claim that cutting taxes for the ultra-wealthy would increase overall tax revenues. We know how that turned out. Very badly is how it turned out.

If the re-developers of the Gallery are able to do so without an infusion of city tax dollars, excellent. That means they have found a good investment and a worthwhile enterprise. Of course, they have not shared their financial projections, so for all we know they’re going to do quite alright even without the tax infusion and simply are playing the “grab more dollars” game. On the other hand, if the project won’t fly without the infusion of city tax dollars, then they should give it up. Tax dollars should be infused into an enterprise only if the enterprise is essential for public safety or welfare, is operated on a no-profit-for-the-private-sector-basis, and is supported by the public. Thus, fire protection, police protection, building safety, public transportation, maintenance of clean air and water, treatment of sewage, and similar undertakings deserve tax dollars, together with tolls and user fees.

But that might leave the Gallery as an empty shell. Of course, that isn’t good for the public welfare. So the answer is to compel the owners to maintain the property, and failing to do so, should allow the city to seize it and sell it to another private operation that can figure out how to make its use profitable without taxpayer financing. Surely, among all those b-school graduates wandering the country claiming to know the secrets to making money quickly and easily, there is at least one person who can make a go of it without relying on taxpayer dollars. That’s the way it once was, and that’s the way it ought to continue to be.

For whatever reason, some people seem to think that being required to pay an existing tax amounts to the creation of a new tax. In a recent news story about an IRS proposal to reduce the reporting threshold for gambling winnings from $1200 to $600, a casino client who had hit the jackpot – of more than $1,200 – complained that the proposed rule was unacceptable because “Everything else is already taxed enough.” But the flaw in that argument is that the jackpot, no matter the amount, is and always has been subject to the federal income tax. In most states, it also is subject to state income tax.

The main focus of the story is the complaint by casinos that lowering the reporting threshold will cause tax revenues to decline. The complaint rests on several assertions. First, taxable income of casinos will fall because fewer people will gamble as a result of the reduced reporting threshold. Second, taxable income of casinos will fall because casinos will need to hire more people and purchase more equipment to comply with the reporting requirements. Third, it takes 8 to 10 minutes to fill out the tax form for withholding. Fourth, each month, at one casino, 8,300 people win jackpots between $600 and $1,200.

Aside from the fourth assertion, which in general terms – that there will be people subject to withholding who currently are not – is undeniable, the other assertions are paper tigers. Existing technology permits casino clients to file a tax form one time, just as employees do not need to file a withholding form for each paycheck. Considering that most casino clients have, or can easily acquire, preferred customer or similar cards, it is very easy to use their identity information from that card to trigger the withholding. People will still flock to casinos, because the lure of the big jackpot, or even a smaller one, is far more powerful than the supposed inconvenience of filling out a form, assuming that a form would need to be completed. Existing technology, which across a wide swath of industries has contributed to a reduction of employees, makes it highly unlikely that more employees would need to be hired to handle casino clients filling out forms, especially considering most of those clients would have pre-filed the information on their preferred customer cards. Whatever equipment is used for the process, unless it is used for 25 minutes at a time for each jackpot requiring withholding under existing laws, there should be sufficient spare capacity for transactions that probably require fewer than a minute or two.

The American Gaming Association is rallying opposition to the proposal, which simply would bring casinos into line with the $600 reporting threshold that applies to other transactions. The opposition reminds me of the time when banks and other financial institutions opposed withholding on the payment of interest and dividends, generating what was at the time a record number of complaints to the Congress. They pulled this off by providing stamped, addressed, pre-printed postcards in customers’ banking statements, with a note telling customers that Congress was imposing a new tax. It’s indicative of the collective ignorance of American taxpayers that millions of them believed the lie. It’s indicative of the national culture that people with fiduciary responsibilities did not hesitate to lie.

Of course, withholding would not be necessary if people lived up to their civic obligations. But that doesn’t happen, for the same reason some people go straight from the left-turn lane, some call people trying to dupe them into sending money to collect non-existing prizes, some pretend to be the IRS, and some create false stories and rumors to circulate on social media. Paying taxes on gambling winnings, net of gambling losses, is not a new tax. People ought not be told that it is. A nation built on lies is a nation with very little time remaining.

An image making the rounds on facebook has this to offer about federal taxation:

Government Handouts That the Rich Get, But Fox “News” Will Never Mention:
1. Mortgage interest deductions for big houses and second homes
2. The yacht tax deduction
3. Rental property deductions
4. Fancy business meal deductions
5. The absurdly low capital gains tax rate
6. The absurdly low estate tax rate
7. Gambling loss deductions
8. The low cap on taxes subject to Social Security taxes
9. Retirement subsidies for gilded retirement plans
10. Tax deductions for fancy tax preparation
But Tell Me Again Who the Real Welfare Queens Are!

This list appears to have come from a Washington Post blog commentary.

One of the worst ways to make a point is to offer arguments some of which are flawed. It creates the impression that if some of the arguments are flawed, all of them are flawed.

Several of these claims are valid. There is no question that the special low tax rate for capital gains and the current state of the estate tax, to say nothing of its proposed elimination, benefit the wealthy far more than they benefit the poor or the middle class. The low cap on wages – which is what I suppose the author of these 10 claims intended to write – subject to Social Security taxes benefits the upper middle class and the wealthy, but certainly no one with five-digit salaries.

On the other hand, though mortgage interest deductions for “big houses and second homes” benefit the wealthy, they also benefit the middle class, particularly with respect to second homes, for which the overall loss deduction is limited if adjusted gross income exceeds $100,000 and disappears if adjusted gross income exceeds $150,000. In any event, the mortgage interest deduction is capped for all taxpayers. The so-called “yacht tax deduction” is nothing more than a reference to yachts maintained as second homes, which provides tax benefits similar in character, though perhaps larger in scale, than second homes maintained by middle class individuals. Similarly, allowing deductions for maintaining rental property isn’t a tax break but simply part of measuring how much net income is generated by the property. What the commentators seem to be describing is the exclusion from gross income of rent received for leasing out a home for 14 or fewer days, a benefit that is available to any taxpayer who owns a home.

The “fancy business meal deductions” apparently refers to the deduction allowable for half the price of a business meal. The example that is given refers to a $1,600 dinner and drink invoice for 10 executives. This deduction is available to all businesses, and benefits the wealthy only to the extent that they presumably spend more on business meals than do other business entrepreneurs. Though surely there are wealthy business owners who open up their wallets for business meals, there also are those whose desire for money accumulation generates restricted spending on meals. In the same vein, gambling losses are deductible, but only to the extent of gambling winnings, a benefit available to all taxpayers who gamble. There is no indication that wealthy individuals hit the casinos more frequently than, or gamble away more money, than individuals of more modest means. Gambling addiction does not respect monetary boundaries.

The complaint about retirement subsidies is simply a reference to the fact that wealthier individuals tend to have better financial ability to put money into tax-advantaged retirement plans than do the poor, and the fact that low-income workers tend to hold jobs with employers who do not contribute to retirement plans on their behalf. The flaw is not so much the tax law, but the inadequate wages paid to low-income workers. Restricting retirement contributions is counter-productive, because one of the major problems with the American economy is the inadequacy of retirement savings among the population generally. Finally, the complaint about “fancy tax preparation” misses the mark. The deduction for income tax preparation is reduced by 2 percent of adjusted gross income, so most high-income individuals don’t get the benefit of the deduction.

The unfortunate aspect of this image making the rounds is that it makes it easy to cast off the point it is making as being supported by inadequate arguments. There are many examples of how the economic elite benefit from federal income tax advantages, but they are far more difficult to fit into tweets and buzz slogans. How does one explain, in a four or five word quip, tax subsidies for oil and gas drilling, for coal mining, for off-shore corporate subsidiaries, for trust funds, for corporate tax shelters, and for carried interests in partnerships that benefit highly-compensated hedge-fund managers? These don’t have quite the marketing appeal of phrases such as “yacht tax deduction, “fancy business meal,” or “gilded retirement plans.”

The economic elite and their corporate structures surely do reap huge benefits from the federal tax system. But rather than parading out a list of 10 examples, only 3 of which robustly support that reality, it would be better to give Americans the opportunity to be educated about the gimmicks and loopholes that generate those huge benefits. True, it probably takes some effort to explain how the lobbyists for the economic elite use smoke and mirrors to keep their particular sort of welfare out of the public eye, but in the long run everyone benefits from shining an educational spotlight into the dark caverns of the modern American political game.

No, I’m not referring to the tax exams that stand between a student’s coursework and practice experience. What has been pulled from the back burner of this blog is something I’ve discussed many times, though not recently. It’s the mileage-based road fee, which I first discussed in Tax Meets Technology on the Road, and analyzed again 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, Is the Mileage-Based Road Fee So Terrible?, Defending the Mileage-Based Road Fee, Liquid Fuels Tax Increases on the Table, Searching For What Already Has Been Found, Tax Style, Highways Are Not Free, Mileage-Based Road Fees: Privatization and Privacy, Is the Mileage-Based Road Fee a Threat to Privacy?, and Are the Bells Tolling for Highway Infrastructure Chaos?

Thanks to an alert reader of MauledAgain, I’ve become aware of exciting news from Oregon. That state is going to enroll volunteers in a program, under which drivers, instead of paying a fuel tax, will pay a mileage-based road fee. Oregon is testing the transition from twentieth-century highway funding into twenty-first-century highway funding. Logistically, drivers will receive a credit for fuel taxes paid at the pump, which might leave them with a balance due or might generate a credit. Steps have been taken to minimize intrusions on privacy, by giving the volunteers a choice between a GPS-based system and a GPS-free system. Volunteers also receive a credit for miles driven out of state or on private property.

More than 4,000 comments have been posted in reaction to the story. Several amuse me. One complaint is that the test program is nothing more than an attempt to increase taxes. That conclusion suggests that the driving public will be paying more for nothing more. Yet in reality drivers will be getting road repairs and road improvements, which in turn will lower tire and front end alignment costs, save lives, prevent injuries, and economize time. Another complaint is that “the new tax would be unfair” to electric and hybrid car owners because the “program targets hybrid and electric vehicles.” That makes no sense. The fee is imposed on vehicles, which no matter their type of propulsion, use highways, wear out road surfaces, and contribute to traffic jams. Fortunately, an advocacy group for the electric-vehicle industry has come out in support of the test program “because every driver should pay for road repairs.” Yet another complaint is that the fee discriminates against people living in rural areas. The flaw in that perception is that the fee discriminates no more and no less than does a liquid fuels tax. If someone living in the countryside drives, on average, three times as much as someone driving in the city, that person would pay a mileage-based road fee three times what the city driver pays. That is no different from using three times as much fuel and thus paying three times as much in gasoline taxes.

Three other states – California, Washington, and Indiana – are studying the possibilities of adopting a mileage-based road fee. Oregon has administered two earlier tests, though on a very limited basis. This test encompasses many more drivers and is, in many ways, a big deal. In that sense, it is like a tax exam.

Sometimes, in trying to help people understand the facts beneath tax policy issues, I wonder why many have difficulty grasping the essentials, and thus being misled or even duped by the sound bit and buzz phrases tossed about by politicians and lobbyists. The inability of so many people to understand why flattening tax rates does just about nothing to simplify tax law, or to comprehend how phase-outs cause tax rates on middle incomes to be higher than those on high taxable incomes, probably correlates with deficiencies in arithmetic understanding.

A recent article on housing sales in the Philadelphia area provides an example of how easy it is to be confused. The article quotes the chief economist at Meyers Research, who also is a senior fellow at the Lindy institute for Urban Innovation at Drexel University. Referring to the 23 percent average drop in value of area homes during the housing bust that began in 2007, he noted that because the typical area home has recovered only 5 percent of that 23 percent, values “must appreciate an additional 18 percent to recover the loss completely.”

Consider this example. Assume that before the housing crash, a home was worth $100,000. A 23 percent drop in value brings the home’s value down to $77,000, because the drop in value is $23,000, that is, 23 percent of $100,000. Now assume that the home recovers 5 percent of its value. That means the home’s value increases by $3,850, as $3,850 is 5 percent of $77,000. The home is now worth $80,850 ($77,000 plus $3,850). To reach $100,000 the home needs to increase in value another $19,150 ($100,000 minus $80,850). $19,150 is 23.7 percent of $80,850, not 18 percent. If the home’s value increased an additional 18 percent, as suggested by that chief economist, its value would increase by $14,553 (18 percent of $80,850 is $14,553), bringing its value to $95,403. That outcome would not cause the property “to recover the loss completely.”

I’ve seen a similar analysis, and have had to bite my tongue, when someone claimed that an increase in a success rate from, to use easy numbers, 20 percent to 30 percent was a 10 percent improvement. It is a 10 percentage point improvement but a 50 percent increase (because the increase of 10 percentage points from 20 percent to 30 percent is 50 percent of 20 percent). This “percentage of a percentage” challenge stumps a fair number of students studying corporate taxation when they encounter section 302(b)(2)(C). That provision requires a determination of whether a shareholder’s percentage of stock ownership after a transaction is less than 80 percent of the shareholder’s percentage of stock ownership before a transaction. In other words, a student or practitioner must consider whether, for example, 58 percent is less than 80 percent of, for example, 70 percent. It’s not, because 80 percent of 70 percent is 56 percent.

The sort of thinking in which a brain engages to do these analyses is not unlike the sort of thinking in which a brain engages in order to do all sorts of other things, such as reading and playing music, programming computers, or figuring out how many gallons of paint to purchase in order to paint a room. Years ago, when one of my sisters, then in elementary school, was trying to persuade my parents to find a way to get her excused from arithmetic classes, my mother pointed out that no matter what she did in life, she would need to understand numbers. My sister said there were things she could do that did not require understanding basic arithmetic. I sat back, quietly to the surprise of some, enjoying my mother’s refutation of every possibility that was offered. Think about it.

All sorts of things are being tried to help students learn arithmetic. I’ve seen some of the Common Core examples. I understand what its advocates are trying to do, but I’m not persuaded that it is working. The best way to learn something is to immerse one’s self in it. Has that been happening? I don’t think so. And so we end up with a nation of taxpayers, too many of whom don’t understand the underlying arithmetic when faced with tax and other policy issues. It gives the edge to those who understand arithmetic, know how to use that understanding in nefarious ways, and lack the polished conscience that deters the ego from doing so.

A recent case, Rolle v. Comr., T.C. Memo 2015-93, illustrates the dependency tie-breaker rule. The taxpayer married Raina in 2006. During 2011, the taxpayer, Raina, and their children lived together from January 1 through July 31. On or about July 31, the taxpayer and Raina separated. The children were in Raina’s sole custody from August 19 through December 31. The facts do not disclose where the children were from August 1 through August 18. The taxpayer filed a federal income tax return for 2011, claiming head of household status and claiming the children as dependents. Raina filed a separate tax return for 2011, and also claimed both children as dependents. The IRS issued a notice of deficiency to the taxpayer, changing the filing status to single, disallowing the dependency exemption deductions, and making other adjustments.

The Tax Court determined that each of the two children was a qualifying child of the taxpayer and of Raina. Accordingly it turned to the tie-breaker rule. Under the parental tie breaker rule in section 152(c)(4)(B), if the parents claiming a dependency exemption deduction for a qualifying child do not file a joint return, the child is treated as the qualifying child of the parent with whom the child resided for the longest period of time during the taxable year, or if the child resides with both parents for the same amount of time during the taxable year, the child is treated as the qualifying child of the parent with the highest adjusted gross income.

Because both children resided with Raina for at least 347 days, and with the taxpayer for no more than 230 days, the Tax Court held that the taxpayer was not entitled to dependency exemption deductions for the children. Presumably, the IRS did not challenge Raina’s dependency exemption deductions for the children.

Stanley Druckenmiller, a billionaire hedge fund manager, has reacted, according to this story to “proposals to tax the rich to pay for more social service for the poor.” According to Druckenmiller, “That’s not where the money is.” So where’s the money? Do the poor have it? Is it buried somewhere?

Perhaps the kindergarten teachers have it. Oh wait. This story explains that the top 25-income-earning hedge fund managers earn more than all of the nation’s kindergarten teachers put together.

And if that isn’t disturbing, keep in mind that those teachers pay federal income taxes at ordinary income rates. The hedge fund managers, using a loophole called “carried interest,” manage to pay taxes at the much lower capital gains rates. Yes, special low rates defended as necessary to encourage the sale of property, a rather questionable claim, apply to income earned from performing services, but no kindergarten teacher dare have the audacity to use or request special low rates in computing federal income taxes on the income they earn from performing services.

Yes, where’s the money?

In a recent decision, Hyler v. Comr., T.C. Summ. Op. 2015-34, the Tax Court held that a taxpayer’s casualty loss deduction claimed in 2012 was not allowable in that year because during that year, and even as late as 2015, the taxpayer was continuing to pursue reimbursement from those alleged responsible for the loss. The taxpayer lived with his wife in a rented house. On June 2, 2012, while they were away visiting friends, a fire destroyed the house and all of its contents. The taxpayer’s personal property was insured but the insurance company paid only $60,000 because that was the policy limit. The taxpayer and his wife sued the landlord, in 2014 that case was set for trial, and by February 2015 meetings had been scheduled to mediate the matter.

The Tax Court explained that under Regs. Section 1.164-1(d)(2)(i) a loss is not sustained until it can be ascertained with reasonable certainty whether reimbursement will be received. Citing Hudock v. Comr., 65 T.C. 351 (1975), the court noted that a casualty loss is not recognized in the year of occurrence if there exists at that time a reasonable prospect of recovery on a reimbursement claim, and that settlement, adjudication, or abandonment of the claim is the event that renders the loss “sustained” for purposes of section 165. According to the court, because the taxpayer’s claim for reimbursement was very much alive and active in 2015, and had been so since shortly after the fire, the loss was not sustained in 2012.

What particularly caught my eye when reading the opinion were these two sentences: “The Woodside Fire Protection District reported that the fire likely started in the kitchen but did not state a specific cause. Petitioner believes that the fire may have started because of rodents and/or faulty electrical wiring.” Long-time readers of MauledAgain may recall that more than nine years ago, a house fire supposedly started by a burning mouse triggered four posts:

Why Tax Law Can Fire Us Up
Follow-Up Report Extinguishes Blazing Mouse Tale (but not the tax issues)
Tax Law and Rodents Afire
The Flaming Rodent Tax Trilogy Gets a Sequel

They also may remember that ten months later, in Animals, Fire, and the Tax Law, I wrote about the issues arising when a cat started a fire by knocking over a candle. It’s unclear from the Hyler case whether mice were once again at work or rats need to be added to the list.

A recent case, Cowan v. Comr., T.C. Memo 2015-85, required the Tax Court to decide when the relationship of a foster parent to a foster child ends for federal income tax purposes. The taxpayer was the guardian of a child, who was placed in the taxpayer’s home from 1991 through 2004. In 2004, the child attained the age of 18 and the guardianship ended. In 2006, the child had a child. The taxpayer had continued to support the child, and after the child’s child was born, the taxpayer supported both the child and his child. Not surprisingly, on her 2011 income tax return the taxpayer claimed dependency exemption deductions for the child and the child’s child, along with an earned income tax credit, a child tax credit, and head of household filing status.

The IRS issued a notice of deficiency denying the dependency exemption deductions, the credits, and the head of household filing status. Thereafter, the IRS conceded that the child was a qualifying relative of the taxpayer and that the taxpayer was entitled to a dependency exemption deduction with respect to the child.

The Tax Court rejected the taxpayer’s argument that the child’s child was a qualifying child. One of the requirements that must be satisfied in order for a person to be a qualifying child is a relationship test. To satisfy that test, the claimed dependent must be a child of the taxpayer, a descendant of that child, or a brother, sister, stepbrother, or stepsister of the taxpayer or a descendant of that sibling or stepsibling. To be a child, a person must be the taxpayer’s son, daughter, stepson, stepdaughter, or eligible foster child of the taxpayer. Because the child that had been placed with the taxpayer was not the taxpayer’s child, stepchild, sibling, or stepsibling, the taxpayer’s claim would prevail only if the child was an eligible foster child. An eligible foster child is “an individual who is placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction.”

The taxpayer argued that the child remains her foster child because they continued their relationship and hold each other out as parent and child. The Tax Court, however, determined that the taxpayer’s guardianship terminated in 2004 when the child attained majority. At that point, the child no longer could be said to be someone who “is placed” with the taxpayer.

The taxpayer then argued that the tax law permits other relationships created by law to persist despite the cessation of the legal circumstances that created them. She pointed to Regulations section 1.152-2(d), which provides that “The relationship of affinity once existing will not terminate by divorce or the death of a spouse.” Thus, for example, once a person becomes an in-law by virtue of marriage, that person remains an in-law even if death or divorce ends the marriage, at least for purposes of the dependency exemption deduction. The Tax Court rejected the argument, concluding that a foster relationship is not a relationship of affinity because it is not based on marriage. The Tax Court also concluded that there was no basis for extending a principle applicable to marriages to foster situations because the former are “by default perpetual, lasting (absent divorce0 until the death of one of the spouses,” whereas foster relationships “are by definition temporary.”

These are the sorts of outcomes that are difficult to explain to clients. There is a good bit of sense in the argument advanced by the taxpayer, and it fails because of the technical nature of the “everlasting affinity” regulation. That regulation, in many respects, is unwise, particularly with respect to the impact of divorce. It comes as a surprise even to students in the basic federal income tax course to learn that for purposes of the dependency exemption deduction, a person’s brother-in-law or sister-in-law remains a brother-in-law or sister-in-law even if the person becomes divorced from the spouse. For some, it’s even worse, as it means a father-in-law or mother-in-law remains so despite divorce. As a practical matter, though, one would not expect an individual to be supporting his or her former sibling-in-law or parent-in-law, though it can happen.

The regulation should be amended to provide that divorce ends a relationship by affinity. Might that ever disadvantage a taxpayer? It would only if a taxpayer was supporting a former sibling-in-law or parent-in-law, who attained that status through divorce in contrast to death, and that sort of situation would be rare. When I teach the basic tax course, I ask students to give me a set of facts where that plausibly could happen. As an aside, students dislike those sorts of questions, as they prefer “tell me the facts and I’ll give an answer” challenges whereas I am convinced that their thinking skills are sharpened by my “I’ll tell you the answer now give me the facts” puzzles. One answer is a guy whose best guy friend has a sister. The guy marries his friend’s sister, perhaps in disregard of his friend’s advice. The marriage fails, and the guy remains best friends with his now former brother-in-law. Years pass, the best friend falls on hard times, and the guy supports him. If he moves the friend into his household, the best friend would be a qualifying relative, provided the income and support tests are met. If not, there’s no dependency exemption deduction. Is that a terrible outcome? No, because there would be no dependency exemption deduction if the guy had not married his best friend’s sister. In other words, someone supporting his best friend, who also happens to be a former brother-in-law, should not be treated differently from someone else who is supporting his best friend who never became a brother-in-law.

When people ask me why I sometimes say that tax law is “fun,” this is one of the examples I provide. What really is fun, and I don’t usually confess this, is watching the looks on their faces when I take them through the “once a sibling-in-law, always a sibling-in-law” tax principle. Perhaps they are thinking, “once a tax geek, always a tax geek.” Perhaps.

Readers of this blog know that I think it is silly to reject fixing potholes with tax increases because of the “no taxes” meme, when that means drivers will be facing much larger outlays to replace tires, wheels, and vehicle parts, to pay for front-end alignments, and to finance the costs of accidents, injuries, and deaths.

Those who haven’t had a chance to explore my thinking on this issue can check out Liquid Fuels Tax Increases on the Table, You Get What You Vote For, Zap the Tax Zappers, Potholes: Poster Children for Why Tax Increases Save Money, When Tax and User Fee Increases are Cheaper, Yet Another Reason Taxes and User Fee Increases Are Cheaper, When Potholes Meet Privatization, When Tax Cuts Matter More Than Pothole Repair, Back to Taxes and Potholes, and Battle Over Highway Infrastructure Taxation Heats Up in Alabama.

Last week, Michigan voters rejected a proposal to fund road repairs with an increase in the sales tax and replacement of the sales tax on fuel sales with an increased fuel tax. So Michigan returns to the drawing board, while its drivers continue their demolition derby encounter with some of the worst roads and bridges in the country.

The usual suspects claim that the solution is to cut spending on other programs in order to fix the roads. These anti-tax advocates have persuaded almost 40 percent of Michigan voters to support the “cut programs” alternative. Yet when asked in a poll what programs should be cuts, according to this story, 88 percent did not want cuts to K-12 education, 86 percent did not want cuts in health care assistance for the poor, elderly, disabled, and children, 76 percent disliked cuts to public safety, and 63 percent rejected cuts to colleges and universities. So what to cut? Apparently, nothing. From the theoretical concept of “cut programs to avoid taxes at all costs” to the practical reality of finding programs to cut, the failure of federal and state governments to protect their citizens is a disgrace to democracy, and an unfortunate deference to the oligarchy and their misguided fan club. Remember that next time you hit a pothole and start complaining. Hopefully those who vote against fixing the roads are the only ones who have that experience, though reality promises to spread the pothole damage far more equally than most other things in monetized America.

Two weeks ago, in An Immoral Tax?, I explained, as I have done previously in Capital Gains, Dividends, and Taxes, As I Expected, Tax Deform(ity), and The Rich Get Richer: The Tax Law’s Role?, that repeal of the estate tax makes sense and has its advantages provided unrealized appreciation does not escape taxation at death. In response, a reader directed me to William G. Gale’s Adjusting the President’s Capital Gains Proposal.

Although Gale describes the proposal to tax unrealized appreciation at death as “a welcome change that would close a huge loophole,” he points out “a serious flaw,” namely, the challenge of keeping records so that unrealized appreciation can be computed at death. That computation requires two facts. One is the fair market value of the asset. The other is the adjusted basis of the asset. Because fair market value must be computed not only for the few taxpayers who are subject to the federal estate tax, but also for purposes of taxpayers who are subject to state estate and inheritance taxes, as well as those who sell inherited property, determination of fair market value does not pose significant challenges. The value of most assets can be determined from market quotes, appraisals, and similar information.

Determining the decedent taxpayer’s adjusted basis in property can be problematic. Many taxpayers do not keep track of their adjusted basis in property, particularly property that is not publicly traded or that was acquired many years previously. This conundrum is what caused the failure of carryover basis to stick. Carryover basis would give the heirs the decedent’s adjusted basis rather than a basis equal to fair market value at death.

What doesn’t get much attention is the fact that when the taxpayer gives property to another person during lifetime, the donee’s adjusted basis is the decedent’s adjusted basis. If determining the taxpayer’s adjusted basis is as impossible as the defenders of the basis step-up at death loophole claim, then why has it endured in existing tax law for almost as long as the federal income tax has existed?

Gale proposes that taxpayers be permitted to compute adjusted basis by allowing them to claim a “standard basis,” a concept derived from the standard deduction. Just as the standard deduction provides an alternative to computing actual itemized deductions, the “standard basis” would provide an alternative to computing actual adjusted basis.

Gale suggests, as an example, setting standard basis at 20 percent of fair market value. He explains that by keeping the percentage low, taxpayers would be encouraged to keep basis records. That might make sense going forward, but there are trillions of dollars of existing assets for which at least some taxpayers have not maintained records.

Gale’s idea makes sense, though I would modify it. I would scale the percentage based on how long the taxpayer held the property. Perhaps "standard basis" should equal the fair market value of the asset multiplied by the standard basis percentage. The standard basis percentage would equal 100 percentage points reduced by 2 percentage points for each year the property has been held, but would not be less than 10 percent. Because the gain would be reported on the decedent’s final income tax return, two special adjustments should be provided. First, to the extent that ordinary income rates apply to unrealized gain, after computing that portion of the tax liability, it would be cut in half to offset the impact of income bunching. That reduction would not apply if the tax rate were a flat rate, such as the rate applicable to capital gains. Second, all taxpayers would be permitted to reduce unrealized appreciation by a standard amount, perhaps twice the exclusion applicable to sales of a principal residence, in order to avoid imposing taxes on principal residences and very small estates.