MauledAgain

[republished from 1 Mar 2006 because blogspot archived page length limitations prevents all posts from appearing]

During the 2005 tax filing season, the California Franchise Tax Board (FTB) administered a pilot program for a project called ReadyReturn. A group of taxpayers was invited to join the pilot program. Under the pilot program, the FTB prepared the taxpayer's return, and then gave the taxpayer the opportunity to verify the information, make any necessary changes, and sign and submit the return. According to the FTB report, approximately 50,000 taxpayers were invited to join the pilot program, of whom nearly 9,400 filed the return prepared by the FTB (5,600 by e-file and 3,800 using traditional paper). The ReadyReturn site provides slightly higher numbers: 11,620 participants (5,610 by e-file and 6,010 by paper).

The FTB prepares the taxpayer's return by "using wage and withholding information that is already reported to the state by employers." Accordingly, the taxpayers invited to participate were those "who file the most simple returns."

FTB surveys of the participants revealed that almost all of them considered ReadyReturn easy to understand, almost all of them concluded they saved time using ReadyReturn, and more than 90% also concluded it was more convenient than how they filed the previous year. Roughly 80% reported that ReadyReturn made them "feel less anxious about filing their tax returns." The survey also discovered that 99% of the participants were “Very Satisfied” or “Satisfied” with ReadyReturn, roughly 97% would use it again, and about 90% thought ReadyReturn was a service that the government should provide. Only 5% indicated they believed their personal information was not secure with ReadyReturn. Many of the taxpayers invited to participate who chose not to do so turned down the opportunity because they had already filed their return, though others expressed doubt about the security of using the Internet, were not comfortable receiving a pre-filled-in return, or preferred a non-government e-filing company. The FTB reported that ReadyReturns were less likely to fall out of processing because of errors, that ReadyReturn users were less likely to receive error notices, and that ReadyReturn introduced "thousands" of paper filers to e-filing, with more than half of the ReadyReturn participants who used e-filing having used paper filing for the previous year.

Based on these results, the FTB requested that the program be fully implemented. However, it would be limited to taxpayers who are single, have no dependents, claim the standard deduction, and have income derived solely from wages.

The project, however, is not without its critics. For example, the National Taxpayers Union (NTU) produced an issue brief, California's ReadyReturn Program: Fool's Gold in the Golden State, in which it pointed out numerous concerns. First, the NTU wondered why the FTB should "get into the tax return preparation business," considering that there are more than adequate numbers of tax return preparers available. Second, the FTB provides a free e-file service, which should mitigate concerns about private industry charging taxpayers for that service. Third, there is no guarantee that the FTB would make fewer computational mistakes than other preparers. Fourth, the FTB is unlikely to "scour the tax code for ways to reduce the filer's prepared tax liability." Fifth, changes in the taxpayer's status could change eligibility, posing the risk that taxpayers would not understand the need to switch to a private preparer. Sixth, there is a cost in generating FTB-prepared returns that end up in the trash because the taxpayer became ineligible to participate or otherwise chose to pass up the chance. Seventh, ReadyReturn makes it less likely that taxpayers will understand how much of their income is being withheld or otherwise paid in taxes because they will not look at the return or have a preparer explain it. Eighth, some taxpayers may see ReadyReturn as a new approach to increasing tax collections. Ninth, the service would not be free because its costs are borne by taxpayers generally. Ninth, ReadyReturn could lead to FTB offering bookkeeping services or estimated tax computation advice, and, at the very least, would justify requests by the FTB for more employees and more funding. Concerns from other critics echo these arguments.

The California State Senate Republican caucus has prepared a briefing report on ReadyReturn that devotes far more space to objections than to the advantages touted by its supporters. The Howard Jarvis Taxpayers Association released a commentary in which it called ReadyReturn a "prime example of California's long line of information technology boondoggles," claimed that "[i]n addition to the conflict of interest in having the tax collector also serve as the tax preparer, the program presents a myriad of accountability problems, and suggested "ReadyReturn should be returned to sender with a cancellation notice."

The project also has its supporters. Joe Bankman, a member of the law faculty at Stanford, explains in "Simple Filing for Average Citizens: The California ReadyReturn" that ReadyReturn offers a solution to the trials and tribulations of fling tax returns. He rejects the arguments made by its critics, and rues the effectiveness of those lobbying on behalf of the tax return preparation industry. He concludes with a call for consideration of a similar program at the federal level. A lobbyists for the California Tax Reform Association explained that ReadyReturn was good for taxpayer privacy because taxpayers would "know what kind of information is there. It's simple and straightforward and demystifies the process of filing taxes."

Five months ago, I concluded that ReadyReturn wasn't ready for prime time. In my analysis I weighed the arguments in favor of its use against the arguments that it is not the answer to the problems it purports to ameliorate. Recently, as the FTB's request for full implementation came under attack in the California legislative process, the debate resurfaced. New arguments have been advanced, principally to paint ReadyReturn as a program to save low-income taxpayers from fee-paying and sometimes predatory tax return preparers. After considering these new arguments, my conclusion remains unchanged.

ReadyReturn has been hailed as a "move in the right direction" to deal with increasingly complex provisions that directly affect taxpayers least likely to have the ability to handle them, such as the additional wrinkles added to the earned income tax credit (EITC) by the legislation providing tax incentives for recovery from Hurricanes Katrina, Rita, and Wilma. The concern is that even more low-income taxpayers will be driven to use fee-charging preparers because volunteer preparers cannot compete with the likes of H&R Block. Aside from the fact that California's ReadyReturn cannot do anything for people in the Gulf Coast region filing 2005 federal income tax returns, justifying the implementation of government-prepared tax returns by pointing to government-generated complexity is a bootstrap argument. All that would be accomplished is to make more and more low-income taxpayers wards of the state when it comes to tax compliance. The notion that these taxpayers will review the return "proposed" by a government is impractical. Low-income taxpayers would either accept the government proposal, even if it was incorrect, or go to a fee-charging preparer for help in deciding whether to accept it.

ReadyReturn has been defended because the only "realistic alternative to ReadyReturn is commercial tax return preparation services, which have a vested interest in complexity." Yet ReadyReturn would cement the complexity, because by sheltering taxpayers from its impact, it removes an incentive for taxpayers to press for genuine simplification. What better way to guarantee complexity than to make taxpayers think it doesn't exist because taxpaying has allegedly been "demystified" by letting the government decide what the taxpayer should pay? Simplicity in the form of marching in lockstep to government-dictated tax returns is a dangerously misleading attribute of ReadyReturn, and the theoretical proposition that taxpayers can reject the government's proposed return flies in the face of reality. Low-income taxpayers already are at the mercy of the government, and ought not think they are being befriended by an entity that by law is not set up to be the low-income taxpayer advocate. Consider, for example, the difficulties faced by low-income individuals when dealing with government-controlled child support and custody matters. Incidentally, almost every tax return preparer with whom I communicate abhors the complexity that has turned the tax law into an impenetrable mess. The suggestion, as has been made, that tax return preparers might have been involved in creating the absurd complexities of the hurricane relief EITC, ignores the fact that most complexity arises either from special interests seeking to hide a narrowly focused tax benefit or from theoretical solutions proposed by folks with little or no practical experience in dealing with taxes. Tax return preparers are busy enough and coping with more tax nonsense than they wish than to have encouraged the addition of more mazes into the tax law.

Ready return has been described as a good idea being plowed under by the tax return preparation lobby. That lobby is perceived as inimical to a free market, and as joining forces to conspire against the public. Yet, all things considered, tax return preparers and tax return preparation software don't carry prices that smack of monopolistic or conspiratorial
behavior. Consumer choice when it comes to finding a tax return preparer is orders of magnitude broader than when it comes, for example, to choosing a computer operating system. There is genuine competition among preparers and tax return software developers. The problem with applying market analysis is that it presupposes the government should be a player in the market. How, then, can a government protect the market when it's playing in it? Unless there is a reason for the government to monopolize a market (e.g., national defense), it ought to stay out of it.

ReadyReturn has been characterized as a move toward simplicity on the premise that a government employee has a vested interest in simplicity because it means less work. I disagree. I translate a desire for less work into a temptation to cut corners. And we know whose corner will be cut when that happens. Most government employees have a sense of "protect the revenue" built into their mind set by their training. The folks programming the computer aren't working in algorithms to determine if the taxpayer is claiming the correct number of dependents. Although the FTB request for full implementation would not include taxpayers with dependents, legislators who support the project want to expand it so that it does. All that the FTB could do is to list the dependents claimed on the previous year's return, because it does not have access to information about support, living in the abode, etc. But I wonder if its need for that information would open the door to government collection of even more information about every aspect of the taxpayer's life that affects taxes. Trust me, most things in life affect tax liability.

ReadyReturn has also been characterized as a program that would eliminate the business incentive of tax return preparers to understate tax liability in order to generate refunds, especially if being compensated with a percentage of the refund. Tax return preparer misconduct is not a situation running out of control; in contrast, at least one study has found that a "clear majority" comply with the highest tax return preparation ethical standards. That is not surprising, because there are in place sufficient incentives for tax return preparers to be honest. Penalties, prison, professional disbarment, and similar adverse consequences face the unscrupulous preparer. The problem is that the government has a miserable track record enforcing existing penalties against unethical preparers. Perhaps the FTB could stop trying to play tax return preparer and funnel some resources into helping law enforcement police the tax return preparation industry. Making the government the tax return preparer for low-income, and eventually middle-income taxpayers, on account of the misdeeds of the small number of preparers who act illegally is overkill. One question not asked by the FTB was, "Who do you trust more, the revenue department or your tax return preparer?" Somewhere in here I have visions of people being treated by government doctors, having their tax returns prepared by government employees, having their music censored by government bureaucrats, having their hair length set by government barbers, and so on. The words, "I'm from the government and I'm here to help you, uh, take over your life, because, after all, there are some not very nice people out there doing bad things preparing tax returns,." ought to send chills down the spine of every citizen. ReadyReturn increases dependency on government. That simply is dangerous.

Ready Return has been defended as protection against tax return preparers who advance refunds to low-income taxpayers at a very high rate of interest. Isn't usury illegal? Ought it not be? Ought not our government schools teach people not to borrow money at a high rate of interest and to report such transactions to the appropriate law-enforcement agencies? And if we are to worry about protecting taxpayers as consumers, why should revenue departments be presumed any better at protecting their customers (taxpayers) than are businesses in the private sector subject to all sorts of constraints and requirements designed to ensure consumer protection? It is rather ironic that ReadyReturn would be defended as protection against high-interest loans when governments think nothing of paying zero interest on overwithheld taxes that are refunded months after they've been collected. Casting government tax return preparation as the taxpayer's friend in setting appropriate interest rates makes little sense.

ReadyReturn has been hailed as a remedy for the difficulties faced by taxpayers when the preparer is "long-gone when the IRS asks for more information" or disallows a credit or deduction fraudulently obtained by an unscrupulous tax return preparer, because ReadyReturn provides the low-income taxpayer with more information with which to evaluate the analysis of their returns. Yet aren't these taxpayers perceived as needing the assistance of a ReadyReturn program because they cannot read, cannot deal with numbers, and cannot understand taxes? How are they going to do anything with the information supposedly provided by the FTB? How could the FTB possibly have more information than the taxpayer has? Users of ReadyReturn are put in the position of having a tax return prepared by the government that is presumed to be correct, and the burden of fixing an error is shifted to the taxpayer.

ReadyReturn has been described as a cost-savings rejection of "outsourcing" tax return preparation to the private sector, because it takes overhead and profit out of the cost of return preparation. The notion that there are no overhead costs to government programs makes no sense to me. Surely, ReadyReturn and the staff running it use electricity, water, and health plan benefits.

ReadyReturn removes third-party protection from taxpayer-revenue department relationships. Will one branch of the FTB audit the work of another branch? Isn't there a conflict of interest when the auditor is preparing the return to be audited? Absolutely. Has not a lesson been learned from Enron about the importance of independence? Apparently not.

ReadyReturn masks the problem. As I concluded in my October commentary on ReadyReturn, the solution to complexity is genuine simplification. To achieve that goal, complexity must be revealed for the economic and social drag that it is. The legislative addiction to special interests, of which complexity is a major symptom, requires withdrawal. Withdrawal needs to be discomforting. Enablers of complexity need to be identified, and should not be permitted to cushion the consequences of addiction that lull its victims into a false sense of security. Low-income taxpayers have no incentive to learn why the tax law has become such an agony to taxpayers unless they experience some of that agony. Sheltering low-income taxpayers, and eventually the middle class taxpayers the FTB and ReadyReturn proponents want to bring into the project, dampens criticism of the tax system, weakens the tax reform movement, and trims the number of citizens considering the tax law to be a problem.

Yet the advocates of ReadyReturn have a noble purpose. I think they genuinely want to help low-income taxpayers. I think some of them, at least, genuinely think that ReadyReturn is the answer. They mean well, and they have done society a service by bringing much needed attention to the dangers posed to society by tax complexity and to the aggravations afflicting taxpayers when they try to comply with those laws. Yet when reading reports that the taxpayers using ReadyReturn are happy, I wonder how much of that happiness is blissful ignorance? An informed and educated citizenry is essential to a democracy, and so long as the tax law is as it is, keeping citizens insulated from the reality merely guarantees perpetuation of the mess.
The urge to protect low-income taxpayers is not unlike the urge to protect one's child from falling off the bicycle while learning to ride. In the long run, the child must be allowed to fall.

I, too, deplore the increase in the need for paid preparers. The answer, though, is to make independent tax return preparation services available to all taxpayers who cannot afford those services, at least until the true need for tax preparation assistance is removed.

After arguing on a listserve that "The goal of helping low-income taxpayers can be achieved in less risky, more informative, and more effective ways," I was challenged to elaborate, and that if I've "got something better to offer," I should show my hand. Fair enough.

If there is going to be the expenditure of government funds to assist low-income taxpayers comply with the tax law, I'd rather see government pay the bill, thus keeping the third-party intermediary in the picture and thus keeping government honest and unconflicted. My experience with most (not all) state revenue department officials (and some IRS employees) is that they do not have the training or mind-set to prepare tax returns for low-income and middle class taxpayers as an advocate of the taxpayer. Paying the bill for independent preparers to do the job would keep the spotlight on the national disgrace (and threat to economic survival) that the tax law has become over the past three decades.

Therefore, the money and resources being expended by the State of California to program, design, implement, and operate ReadyReturn should be used to finance a "tax return preparation credit" to be claimed by low-income taxpayers (however defined) who pay tax return preparers to prepare their return (and perhaps by those who prepare their own returns though that raises a gross income issue). In this manner, the tax return is prepared by someone or some entity outside of government, which makes it less risky because it puts a second set (or maybe even the only set) of knowledgeable eyes on the return (assuming the low-income taxpayer isn't knowledgeable and assuming, as I do, that the government employees
programming, designing, implementing, and operating the program are insufficiently knowledgeable about the specific tax situation of each taxpayer to know what is best for the taxpayer and in at least some instances are not up to speed on the law). This approach is more informative because it lets low-income taxpayers remain aware of the complexity imposed on them by state legislatures and revenue departments (and if implemented at the federal level, by the Congress and the IRS). This approach is more effective because it would generate fewer situations in which the taxpayer return shows a tax liability higher than (or refundable credit lower than) what an independent tax return preparer would generate. The credit could be disallowed to taxpayers who use a state-funded volunteer tax return preparation service, such as VITA programs that do state returns.

Francine Lipman of Chapman University School of Law considered the tax return preparation credit in her article, "The Working Poor are Paying for Government Benefits: Fixing the Hole in the Anti-Poverty Purse." She rejected the idea because she concluded it "would encourage rather than discourage the use of paid tax preparers with more even benefits being shifted away from working poor families and their communities to paid tax preparers." So stated, that seems true, but from a different perspective the question is whether the FTB should use tax revenue to pay its employees to prepare returns or transfer those dollars to low-income taxpayers so that they can hire independent tax return preparers to prepare their returns. So viewed, the credit removes the conflict of interest, preserves taxpayer choice in selecting a preparer, and decreases the risk that the FTB prepared return would be accepted blindly by taxpayers.

I have as much faith in things working out well for individual taxpayers under any sort of "we'll take over, thank you, sit back and relax" government-run program as I do in things working out for the folks trying to make sense of the Medicare mess. In both instances people theoretically can get third-party assistance, but if they cannot afford it, they don't get it. That's why I prefer the credit. If it means more tax return preparers get more business, that's simply another symptom of the tax complexity mess. The solution is to fix the problem, and not put a leaky band-aid on a symptom.

There is another chapter in the continuing and almost eternal story about Philadelphia’s attempts to fix its broken property tax system. My commentary on the story began in An Unconstitutional Tax Assessment System, and continued through Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, A Tax Agency Rises from the Dead, and Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation, to How to Kill a Bad Tax System That Will Not Die?. The most recent chapter establishes that the title of my last post on the topic was unfortunately too good of a prediction.

A recent Philadelphia Inquirer report reveals that a member of City Council has introduced legislation to postpone reform of the property tax system by keeping the current assessment process and tax rates in effect for another year. The issue has become complicated because the mayor has proposed coupling the assessment reform not with rate revisions that would keep property tax revenue the same, but with permanent adoption of two previous rate increases that were characterized as temporary when they were enacted. Apparently some other members of City Council have been voicing concern about the impact of coupling the assessment reform with rate increases.

There seems to be a consensus that the current assessment process is seriously flawed and that it must be changed. The concern is that the revised assessments, which are being determined by an Actual Value Initiative that is underway, will not be ready for prime time until later in the year. However, the city budget must be approved by June 30. The mayor has proposed a budget that would seek $1.13 billion in property tax revenue, with an adjustment to the rates once the results of the Actual Value Initiative are available.

As a practical matter, once the reassessments are complete, real property tax bills for people living in homes that have significantly increased in value during the past several decades will increase by quite a bit. Though some people would be facing reduced property taxes, many would be dealing with increases. The member of City Council who introduced the legislation represents a district where a sizeable number of properties would be subjected to significant property tax increases.

Another problem is that the $1.13 billion figure includes a $90 million increase above current revenue, intended to alleviate shortfalls in the school system budget. Some members of City Council think that this aspect of the mayor’s plan should be split off and subjected to a separate vote. At least one member of City Council argued, “If you want to vote for a tax increase to support the school board then the public should know what we're doing.”

The mayor argues that it would be “irresponsible” and “disrespectful” to ignore the revised assessments. He is opposed to continuing the use of assessments obtained under a system which he described as “broken.” Others in the mayor’s administration view the plan as an opportunity to make up for tax revenues lost on account of current assessments not reflecting property value increases since the last full reassessment.

One member of City Council argued that the implementation should be “as close to perfect as you can,” otherwise “people have a right to turn on you.” Another member of council, one who supports the mayor’s approach stated, replied, “The majority of folks know we need a fair system, not a perfect one,” explaining, “There is absolute no way we are going to do AVI perfectly. The folks who know they have not been paying their fair share – the loud minority – will scream about it because it’s time for them to pay up.”

If asked, I would advise the mayor and City Council to separate assessment reform from tax increases. That would permit people whose properties are woefully under-assessed to understand that the bulk of the tax increases that they face under the mayor’s current plan arises from the repair of an assessment system that has caused them to be under-taxed for many years. It also permits the tax rate increase proposal to be debated independently of the assessment question. Mixing the two together creates the sort of confusion that perpetuates the flaws in Philadelphia’s real property tax system.

It's January. Fast approaching is January 31, the date by which employers must get W-2 forms to their employees' and payors must get Forms 1099 to their payees. For most taxpayers, this signals the beginning of "tax season," a time for preparing and filing their tax returns. Or at least a time for having prepared and then filing their tax returns. For tax return preparers, the season began a few weeks ago, as they turned to installing tax software, running tests, stocking up on supplies, reviewing changes in the tax law affecting 2008 returns, and otherwise bracing for the stream of visitors. Recession or no recession, there are tax returns to be filed and tens of millions of people who need help in doing so.

But for some tax professionals, there's not much special about this time of year. For example, tax planners are busy throughout the year, and often their professional lives become chaotic in December. Tax faculty are busiest when preparing courses, teaching, and grading, and not much more happens in February, March, and April than happens in September, October, and November.

But this particular January brings a different type of tax season. Whichever way one turns, governments at every level are discussing tax issues as they focus on budgets, corporations and individuals are continuing to bring forth every imaginable tax break as "the" solution to the current economic turmoil, and Congress already is beginning to fracture as some insist on sticking to the disproven way of managing government revenue and spending.

Friday morning's Philadelphia Inquirer brought news that the Governor of Pennsylvania intends to hold the line on state sales and personal income taxes even though the state faces $2.3 billion projected deficit that weeks ago was a $1.6 billion shortfall. The Governor expects the federal government to provide stimulus payments to the state. Others have suggested a new tax on the extraction of coal, oil, and gas, which could generate a fair amount of revenue considering that a huge natural gas deposit has been discovered in Pennsylvania, or perhaps it already was discovered and they figured out how to get the gas out of the ground. To the extent the state cuts programs that local governments need to pick up, their budgetary woes will worsen and they will need to look at taxes.

For example, in Philadelphia, suggestions such as this one from a member of City Council, to delay scheduled wage-tax decreases have been circulating. People are debating whether a postponement of a schedule tax decrease constitutes a tax increase. Why argue about a label and then act based on the label? Why not debate the wisdom or lack thereof in delaying a wage tax decrease? Will it generate revenue? Only if it does not encourage businesses and taxpayers to leave the city. Will they? Has anyone done a survey?

Nor is that the only tax item getting attention in Philadelphia City Council. According to a Friday news report, legislation was proposed that would provide a $3,000 tax credit to employers who create jobs during the next two years. This credit is a revision of one enacted in 2002. That credit failed to generate jobs. Is it because the credit is only $1,000? City council is trying to decide why a tax credit predicted to create 3,100 jobs ended up creating 347 jobs. Perhaps for the same reason that brokers promise 31% rates of return only to see the actual outcome be 3.47%? Something about placing expectations that are too high on approaches that don't have a proven track record?

In D.C., Friday also brought news that Republicans in Congress are unhappy with the proposed stimulus legislation. The President has agreed to discuss with them their call for even more tax cuts. Somehow, the argument that cutting taxes will rejuvenate the economy continue to persist, even though a decade or more of tax cuts just didn't do it. Perhaps eliminating all taxes and government services will do the job?

In the meantime, another letter to the editors of the Philadelphia Inquirer keeps alive the idea of raising the gasoline tax so that reduced pump prices don't blunt the enthusiasm for alternative fuel development that had swept the country last summer. This is one of my favorites, a three-in-one plan to fix the economy, the environment, and the energy crisis. I've written about it extensively, with the most recent long analysis in The Return of the Federal Gasoline Tax Increase Proposal, which discussed a proposal that moved along the implementation path in a decision I discussed earlier this month in Whatever a Tax Increase is Called, Someone Needs to Sell It.

Friday's Philadelphia Inquirer was packed with tax issues. In yet another article, a former chair of Delaware County Council, arguing for a change in how state pensions are computed, pointed out that with the upheaval in the markets, the pensions that are promised to state workers and teachers will require "massive increases in taxes, especially property taxes for local school districts" because estimates of the revenue needed [to fund the promised pensions] are in the billions, and they will no doubt grow."

Today someone sent me a report advocating a two-year suspension of federal income tax on the gross income arising when a debtor purchases its debt from the creditor for less than the face amount. The report gives an example of a company that owes $100 but that can purchase it back for $75. We're supposed to agree that somehow the $8.25 tax liability arising from the $25 of gross income stands in the way of the company engaging in this buy-back and that somehow if many companies get this tax break not only will they engage in these transactions but by doing so they will restore consumer confidence and confidence in the free marketplace. My guess is that it would restore confidence in the belief that the system can be worked over by whomever is in a position to push through their favorite "for us and for us first" tax break.

That's not all. Friday's paper brought news that former state senator Vincent Fume lost his appeal of the reassesment of his home by the Philadelphia Board of Revision of Taxes. The last time I had written about this on-going story, in Not the Sort of Tax Loss Taxpayers Prefer, the Board was explaining that it had lost the file for Fumo's case. At that time the Board had voted 4-3 to refrain from reassessing Fumo's 27-room mansion, which had an assessment of $250,000 though it was on the market with an asking price of $7 million. After the file problem was somehow handled, the Board met again, one member changed his vote, and Fumo's mansion was assessed at $953,500. Fumo appealed, claiming that was too high a value. At the hearing, Fumo's appraiser testified that he had never been inside the mansion. The saying about not judging a book by its cover comes to mind. On Thursday, the Board met to consider the appeal. With two members absent for medical reasons, the Board voted to reject the appeal, reportedly by a 5-0 vote. Fumo, in the meantime, collapsed during his corruption trial in Federal court, though it is unlikely the news of the Board's decision was the triggering event. The charges include allegations that Fumo used state money and non-profit organization funds to pay for some of the renovations he undertook at the mansion. The house is on the market, at a reduced price of $5.5 million, because Fumo needs to raise funds to pay for his legal defense. The Board's decision can be appealed. The story isn't over.

Like that last story, the tale of this wild 2009 tax policy season is far from complete. It's just beginning. At every level of government, from Congress down to City Councils and local tax assessment boards, tax issues are coming out of the woodwork. In some ways, I'm glad that tax policy is now center stage, though it's too bad it took an economic catastrophe to get it there and even though it must share the stage with other very important issues, including environmental, energy, national security, and health care concerns. The latter arrangement isn't really an obstacle, because these issues are inter-connected, and tax has played and will play a role in dealing with each of them. People need to let their legislators and public officials know what they want the tax system to be, how they want it administered, how they feel about the activities of lobbyists, their reactions to the parade of special interest groups trying to get their particular tax break enacted, and what each proposal would do in terms of their confidence. Without a restoration of confidence, the tax policy game could end up being window dressing in a house of cards. To make their comments valuable, people need to learn about taxes, to read the proposals and not just the advocate's news release, and to study the analyses that have been published by commentators, tax practitioners, and taxpayers on every side of the issue. An informed electorate is a powerful electorate. That's one reason I write. Surely there is no shortage of material about which to write. I'm going to guess that somewhere there was a tax story on Friday somewhere that I missed. That's bound to happen, because I do not read all of the nation's local papers. I'll leave those stories to others.

Earlier this month, in Better to Tax Gross Receipts, Net Income, or a Combination?, I revisited the question of whether, and if so, how, the Philadelphia business tax structure should be changed, following up on comments I made on the issue in Don’t Like This Tax? How About That Tax?. The core question in the discussion, as framed by the City Council members advocating a change and those supporting the idea, is whether businesses should be taxed on gross receipts, on net income, or on some combination of the two. From my perspective, there exist other alternatives, such as the imposition of user fees to charge businesses for the costs that they impose on the city.

On Sunday, Mark Zandi, chief economist of Moody’s Analytics Inc., published an opinion piece, Philadelphia Business-Tax Code Needs Change, in the Philadelphia Inquirer. The point made in the headline is one with which few people disagree. The city’s business tax structure is antiquated, and does not serve well the city, its citizens, or the businesses operating in it. The challenge is identifying what sort of tax structure would be a worthwhile improvement.

Zandi argues in favor of shifting away from a hybrid structure that taxes both profits and sales to a tax based on sales. The existing structure, if left alone, will shift, by terms of already-enacted legislation, from its hybrid form to a tax on profits. Zandi advances several arguments in favor of a tax based on gross receipts.

First, he claims that taxing gross receipts “broadens the tax base,” by spreading the tax burden from profitable businesses to businesses that are profitable and businesses that are unprofitable. Here’s the catch. One of Zandi’s arguments demonstrating the need for business tax reform is the claim that combined with all other taxes, it puts businesses in a position where they “could pay more than half” their profits in taxes. If that’s a terrible thing, then how does one react to a tax that would be imposed on a business with little or no profits? Even if a business with $100 in profits pays $51 in total taxes – with the Philadelphia business tax being a small portion of that – is it better to ask a business with a loss of $20 to pay $5 in sales-based taxes, or to ask a business with $4 in profits to pay $5 in sales-based taxes? The broadened base would quickly disappear as these borderline businesses closed their doors or moved out of the city. Zandi’s goal of “lightening the load . . . for successful firms” would end up increasing the load for those firms as they ended up being the only businesses remaining in the city to be taxed, until, of course, they, too, departed.

Second, in a related argument, Zandi claims that by taxing profits and not taxing sales, the city will encourage successful businesses to leave the city. There’s logic in that argument, but shifting the tax burden in order to kill the chances of barely profitable firms becoming successful merely changes the sequence and timing of continued erosion of the city’s business tax base, as explained in the preceding paragraph. Though Zandi seems to argue that the many businesses that already have left the city did so because of taxes, other factors also entered into those decisions, including the decision to move operations to areas where employees live and customers and clients live and do business. Many suburbanites are reluctant to go into Philadelphia, for reasons other than tax policy, and thus to retain customers from among those individuals, it made sense for businesses to relocate.

Third, Zandi argues that a profits-based business tax is more easily avoided than is a sales-based business tax. He claims that profits are “harder to accurately measure and easier to manipulate than are sales.” It would be helpful to see proof of this proposition, particularly when far more tax dollars are evaded in the federal income tax arena through under-reporting of gross income -- think of the cash skimmed from the register – than are avoided through overstatement of deductions. A sales-based business tax would encourage more of the “pay cash, pay less” schemes. The advantage of a profits-based tax is that the city could let the IRS and state revenue departments do a good chunk of the auditing work. Granted, Zandi’s argument that “[a]nything that simplifies the tax code is likely, therefore, to produce greater compliance and more tax revenue” is valid in a general sense, but the argument carries within its message a suggestion that the answer might lie in something other than sales-based and profits-based business taxes.

Fourth, Zandi argues that profits are “extraordinarily volatile, swinging wildly with changes in the economy,” and thus making revenue based on profits unreliable and difficult to predict. That’s also the case with sales, as Zandi concedes, and though he claims that sales are less volatile, it isn’t difficult to appreciate that profits drop when the economy tanks because revenue declines faster than expenses can be cut. If anything, Zandi is again making a strong case to minimize reliance on both sales-based and profits-based business taxes.

Fifth, Zandi dismisses the impact of a profits-based business tax on small firms by pointing out the $100,000 sales exemption that is included in the most prominent of the proposals to reform the business tax. He also dismisses the impact of a profits-based business tax on less profitable companies by suggesting the concern about the impact “probably is overdone, as such firms also likely have weak sales.” Brushing aside the concern in that manner neglects the principal danger of a profits-based business tax on less-profitable enterprises, namely, these are often the fledgling companies whose rise to success would contribute to the well-being of the city’s economy, but are most at risk of going under if their $4 profit must be used to pay a $5 sales-based business tax.

Sixth, Zandi concedes that shifting to a sales-based tax “would benefit professional-services firms such as accountants, lawyers, and management consultants, along with some manufacturers, information-service companies, and the publishing and broadcasting industries.” No kidding, though I think very few manufacturers and very few publishers would be better off. Zandi also notes that “[h]otels, retailers, and construction firms would be hurt” by a sales-based business tax. His response to this issue is to claim that the companies that would benefit “generally employ educated workers, who bring lots of income and wealth to the city,” and that the businesses that would suffer “are less likely to leave the city even if they face higher taxes.” Is there any evidence suggesting that the “educated workers” employed by the firms that would be shifting their tax burden to the companies that are easy tax targets actually bring income and wealth into the city? Don’t most of these workers live in the suburbs? Don’t most of them spend most of their discretionary dollars outside of the city? Isn’t there something a bit alarming about a tax proposal that shifts the tax burden from highly profitable companies with their highly-paid educated employees to businesses employing lower-compensated individuals and having little or no opportunity to escape?

Zandi argues for a “more rational tax code.” Is it not more rational to determine the costs that a business imposes on the city and to charge it accordingly? Do not general taxes, such as a sales-based or profits-based exaction, skew the relationship between the benefits accorded a business and the amount it pays for those benefits? Don’t businesses have an obligation to bear the costs of their operations? Would it not make sense for the city to identify the services it provides to businesses and to utilize some cost accounting techniques to calculate the cost? Perhaps there is justification to calculate cost for a few services based on sales. For example, jewelry stores have relatively higher sales receipts per transaction, are more in need of police protection – perhaps because of the high-end value of their merchandise – whereas other enterprises are far less likely to be criminals’ targets, and thus dividing some portion of the cost of the police department by total sales in the city and allocating the cost in that manner would make more sense and move the tax system closer to a more rational, fair outcome. Fire protection should reflect the asset value of a business, an amount that may or may not be proportional to sales or profits. Businesses and their employees use city streets, and what an interesting opportunity to impose mileage-based road (or street) user fees. The city provides services that makes it a source of customers and clients, and ought not businesses be charged a user fee for this benefit, best measured by profits, not sales, because profits reflect not only the sales revenue brought by those customers and clients, but also the costs that a business must incur by reason of doing business in the city.

Reforming taxation in the 21st century, whether federal, state, or local, demands more creativity and courage than to kick around the same tired, worn-out, disproven, ineffective, and irrational tax structures that have been in place for more than a century. It is time for tax policy, and the politicians, economists, commentators, and others who are involved in tax policy decision making, to think beyond what they learned in school however many years ago they underwent that experience, to open their eyes and ears to ideas coming from sources other than the traditional power brokering segments of society, and to move past the present. Why? Because the citizens and taxpayers deserve nothing less.

Last September, in Just Because A Tax Involves Arithmetic Does Not Mean It Resembles Quantum Physics, I explained that when a jurisdiction, in that instance Delaware County, Pennsylvania, conducts a reassessment of real property subject to the real property tax, some property owners will see their real property taxes go up, some will see their real property taxes go down, and a few will see no change, or close to no change, in their real property tax bill.

The reassessment conducted in 2020 by Delaware County involved two steps. The first was redetermining the fair market value of each property, a process that included proposed valuations and the opportunity to appeal. The second was redetermining the tax rate so that the total revenue raised by the reassessment could not change. That was separate and apart from any annual increase in the rate, to be determined after the reassessment computation was complete.

The reassessment was ordered by the Delaware County Court of Common Pleas, following a Pennsylvania Supreme Court decision that addressed challenges to the county’s existing assessments and its appeals process. State law requires that taxation be uniform, but that requires reassessing all properties to make certain that the rate of tax applied to properties is the same. That doesn’t happen when one property is assessed at fair market value and another is assessed at the assessed value determined at some previous time. This situation arose because many properties were reassessed only when they were sold. This meant that properties that had been owned by the same person or entity for many years was assessed much more below market value.

Last Thursday, in a letter to the editor of the Philadelphia Inquirer, C. Tom Howes of Havertown complained about the county tax reassessment. There is no link to the letter because the Inquirer apparently no longer publishes on its web site the letters published in its print version, other than the replica edition on the web site that does not permit links to individual articles, letters, or other material.

Howes writes, “While our eyes have been nervously awaiting possible tax increases from Washington and Harrisburg, it turns out that our local Delaware County politicians have managed to pull the wool over our eyes and extracted the green from our purses. Their secret was a 2020 tax reassessment of county properties under the guise of more realistic values with equity and fairness.”

What Howes omits is that the reassessment was required by the Pennsylvania Supreme Court, as applied to Delaware County by the Delaware County Court of Common Please, in compliance with the Pennsylvania Constitution and Pennsylvania law. It was not ordered by, imposed by, or invented by “local Delaware County politicians.” In fact, reassessments have been undertake and are underway in other Pennsylvania counties.

Howes continues, “When they announced this action, they tried to soften the impact by claiming that any increases would be limited by law to 10%. However, as a taxpayer, I was shocked and disappointed when receiving the 2021 tax bills to find those increases failed to follow those assurances. For examples, township taxes have increased by 15.86% while the real estate taxes went up by a whopping 32.31%.”

Howes is conflating two issues. As I described, tax rates would be adjusted so that the reassessment did not change the total revenue raised by the tax. Once that step was taken, as I described, taxing jurisdictions had the option to increase the tax rate just as they had the option to raise rates in previous years. However, this rate increase was limited to no more than 10 percent. The 10 percent limitation has nothing to do with the changes in tax bills generated by the reassessment.

The percentage increases cited by Howes are a consequence of the reassessment. Haverford Township, in which Havertown is located, did not increase its tax rate for 2021, as described in this story. Nor did Delaware County increase its real property tax rate, as described in this report, which presumably is the tax described by Howes as “real estate taxes,” a term that includes the township tax that he mentions, as well as the school district tax though those tax bills are not sent until late spring or early summer. Thus, the increases facing Howes are a consequence of his property being under-assessed relative to other properties.

According to the $165,000 assessment on the property had not been increased since sometime before 2000. According to the Delaware County Treasurer, the reassessment has increased the assessment from $165,000 to $397,560. That’s quite a jump and certain accounts for the percentage increases Howes mentions. Though it is understandable that these sorts of increases are shocking, it’s also important to understand that for at least 21 years the property assessment did not increase to reflect fair market value, whereas the assessments on properties purchased during that time did reflect the purchase price, thus creating the lack of uniformity required by Pennsylvania law. So when Howes concludes by asking, “Is this the politicians interpretation of equity and fairness?” the answer is, “It is equity and fairness as required by Pennsylvania law and enforced by Pennsylvania courts."

Last week's Tax Notes carried two articles addressing the current proposals to restore the federal income tax deduction for state sales taxes, which was abolished in 1986 as part of the "deductions and exclusions are removed but rates are lowered" reform that fell to the wayside when rates subsequently were increased. This is a topic on which I previously commented.

After reading these two articles, two more thoughts wandered into my head. The article supporting the deduction restoration argues that the absence of a deduction puts taxpayers living in sales-tax-dependent states that do not have income taxes at a disadvantage. This is true. Both articles address the notion that repeal of the sales tax was an attempt to encourage states to shift from regressive sales taxes to progressive income taxes.

First it's just plain inappropriate and silly for the federal government to try to influence or control how a state raises revenue, other than restrictions intended to prevent states from violating the Constitution. It's inappropriate because if the residents of a state want a regressive tax system, that's their choice and they have a right to make it. It's silly, because, as events show, eliminating the sales tax deduction had no effect on tax decisions made in state legislatures. There's a lesson here for the Congress. If it bothers to read, study, listen, and learn.

Second, resolving the unquestioned disparity in the federal tax treatment between taxpayers living in "income tax states" and those living in "sales tax states" doesn't necessarily require restoration of the sales tax deduction. Resolution also can occur by REPEAL OF THE DEDUCTION FOR STATE INCOME TAXES. Trust me, that one won't sell anywhere, but logic, in contrast to greed, supports such a conclusion.

Here's why. A federal income tax deduction for a state tax shifts a portion of the burden of that tax from the person on whom it is imposed to taxpayers generally. It shifts the burden from taxpayers in one state to taxpayers in another, it shifts the burden among taxpayers in the state, and it can shift the burden from higher income taxpayers to lower income taxpayers (because lower income taxpayers tend to use thed federal standard deduction and forego the state income tax deduction). A taxpayer in the 25% federal income tax bracket who pays a $3,000 state income tax to State A saves $750 in federal income taxes on account of the federal income tax deduction for state income taxes. That means taxpayers across the nation, and not only in State A, pay $750 more in federal income taxes than they would have paid had there been no deduction. But wait! A taxpayer in State B, who pays state income tax, in turn gets a federal income tax reduction, and depending on how much state income tax is paid, comes out a bit ahead, even, or a bit behind as compared to life without a federal income tax deduction for state income taxes. The taxpayer in a state requiring payment of high sales taxes but no income tax loses. But does restoring the state sales tax solve the problem? No, it simply adds to the shifting. With restoration, it means state tax burdens will be shifted from taxpayers in high tax states (whether the tax is income, sales, or as is sadly the case in a few states, BOTH!) to taxpayers in low tax states. Thus, taxpayers who voted to have lower taxes and less government intrustion in life end up paying for the programs operated in states where the taxpayers voted to imitate Sweden. OK, that's a bit simplistic and contrasting the edges, but if I got hypertechnical the reading of this post definitely would stop here.

This debate reminds me of the discussion between two children and a parent that takes place after one child is caught playing with one of dad's power tools. "It's not fair," says the other child, "he gets to play with a power tool and I haven't." Fairness could dictate that both children get to play with power tools. It also dictates that neither child gets to play. It's common sense that helps make the choice between the two avenues to fairness easy to make. Ah, common sense. I haven't seen much of that lately.

Righting a wrong can be done by eliminating the wrong rather than wronging the right.

Thanks to Paul Caron's TaxProf Blog posting, I learned that the GAO had issued a report, "TAX COMPLIANCE Multiple Approaches Are Needed to Reduce the Tax Gap." The report concludes that the tax gap "has multiple causes and spans different types of taxes and taxpayers." Accordingly, "Multiple approaches are needed to reduce the tax gap. No single approach is likely to fully and cost-effectively address noncompliance since, for example, it has multiple causes and spans different types of taxes and taxpayers."

Three major approaches are considered:

1. Simplifying or reforming the tax code.

2. Providing the IRS with more enforcement tools.

3. Devoting additional resources to enforcement.

Minor approaches include "periodically measuring noncompliance and its causes, setting tax gap reduction goals, evaluating the results of any initiatives to reduce the tax gap, optimizing the allocation of IRS’s resources, and leveraging technology to enhance IRS’s efficiency."

The report points out that billions of dollars of the tax gap could be avoided if the tax law were simplified or fundamentally reformed. It explains, for example, that the IRS "has estimated that errors in claiming tax credits and deductions for tax year 2001 contributed $32 billion to the tax gap."

Unfortunately, the report then concludes that "these provisions serve purposes Congress has judged to be important and eliminating or consolidating them could be complicated." Even fundamental reform, in which tax preferences are limited and "taxable transactions are transparent to tax administrators," is "difficult to achieve." The report provides an almost irrefutable axiom, that "any tax system could be subject to noncompliance." Finally, it provides another difficult-to-rebut observation: "Withholding and information reporting are particularly powerful tools."

Two things pop into my head.

First, consider the provisions that add complexity to the tax law and thus feed the tax gap. Is it the Congress that judges this array of complex provisions in the Code to serve important purposes? Does the Congress even know they exist? Individual members might be aware of some, but no member comprehends all of them. These provisions exist chiefly because special interest groups arrange for their enactment. If the item is highly visible, it gets some attention, but many simply wander by the side door, unnoticed by most, while the ruckus at the front door over the appropriateness of some soundbitten proposal gets the attention. The most significant question is whether American taxpayers judge the causes of complexity to serve important purposes. Most taxpayers have a few favorites, and a few taxpayers have dozens of favorites. But should attempts to reform the tax law be diverted simply because of some presumed Congressional attachment to what exists? I don't think so. If Congress were so enamored of what it has created, why does it change it every time we blink? The answer is that Congress is enamored of the process by which tax law provisions become the handouts for electoral support. Is this any way to run a country?

Second, consider information reporting and withholding. Well-designed use of these tools could reduce the tax gap tremendously. So why would anyone object to comprehensive reporting and withholding? Perhaps we can ask those who successfully lobbied for instant repeal of a provision imposing withholding duties on payors of interest and dividends. We can examine the tactics. The payors generated what was at the time the largest "write your member of Congress" campaign by telling their payees that withholding was a "new tax." Withholding is not a new tax. Yet the gullible gobbled up the gobbledy-gook. Congress, conscious of elections, replaced withholding with a backup withholding mechanism that is helpful but far from universal and riddled with shortcomings.

Left to instinct, most people would prefer to pay no taxes, and exist as beneficiaries of others. History teaches that most of those who can grab have done so, and that many who could not exerted themselves to find ways to do so. The tax gap is a reflection of some unintentional errors and lots of intentional evasion. Careful intellectual reasoning, though, teaches us that civilization requires taxation, economic principles tell us that taxation should be efficient, common sense tells us it should be simple, and ethical principles tell us that it should be fair. It takes leadership to persuade the civilized world why it makes no sense, in the long-run, to behave in ways that generate tax gaps. Fraudulent behavior by taxpayers contributes to the tax gap. So, too, does the way in which Congress does business. Ought not the Congress take the first step in leading by example? Until the Congress understands that the way it does business encourages the non-filers, the protesters, the illegal tax shelter promoters, and the rest of the noncompliant population to act in ways that undermine the tax law and fuel the rapid growth in the tax gap, talking about closing the tax gap is not much more than rhetoric. Yes, I talk and write about it, but I've not undertaken the responsibility that members of Congress have sought and accepted. If they don't think they can or want to fix the problem, no one will stop them from returning home.

In my post yesterday about the Congressional agenda for future tax relief, I noted that it wasn't clear to me what was meant by that term.

A regular reader who is also a former student and an adjunct professor in our Graduate Tax Program suggests that what is intended is making permanent the tax cuts enacted in 2001. Thus, the estate tax would be repealed, at least until such time as a Congress intent on its return re-enacts it.

I agree. I'm sure that this is one of the things on the agenda. But I am sure there is more. At his press conference this morning, the President emphasized that he intended to simplify the tax law: "We must reform our complicated and outdated tax code."

The President also stated, in response to a question about his overall legislative agenda:

And part of that comprehensive agenda is tax simplification.

The -- first of all, a principle would be revenue neutral. If I'm going to -- if there was a need to raise taxes, I'd say, let's have a tax bill that raises taxes, as opposed to let's simpl[if]y the tax code and sneak a tax increase on the people. It's just not my style. I don't believe we need to raise taxes. I've said that to the American people. And so the simplification would be the goal.

Now, secondly, that obviously, that it rewards risk and doesn't -- it doesn't have unnecessary penalties in it. But the main thing is that it would be viewed as fair, that it would be a fair system, that it wouldn't be complicated, that there's a -- kind of that loopholes wouldn't be there for special interests, that the code itself be viewed and deemed as a very fair way to encourage people to invest and save and achieve certain fiscal objectives in our country, as well.

One of the interesting debates will be, of course, in the course of simplification, will there be incentives in the code: charitable giving, of course, and mortgage deductions are very important. As governor of Texas, when I -- some time I think I was asked about simplification, I always noted how important it was for certain incentives to be built into the tax code, and that will be an interesting part of the debate.

So does that mean the President would not sign another special interest giveaway tax bill such as the American Jobs Creation Act? Does he really intend to oppose any more special breaks for specific individuals or entities or small groups of them? Is he ready to stand up to legislators on both sides of the aisle and oppose their special interest group tax legislation ritual? As I said yesterday, it's already messy and it will get interesting.

The President's statement also suggests that simplification, as he sees it, probably would not repeal the charitable contribution deduction or the home mortgage interest deduction. This is probably his way of saying that he understands the political reality implicit in an attempt to repeal a tax break that benefits a wide cross-section of taxpayers rather than a small group. An interesting question is "what else falls into that category?" IRAs? MSAs? Education credits? The section 135 bond interest exclusion?

It also will be interesting to see what happens to the tax breaks that are not repealed. Both the charitable contribution deduction and the home mortgage interst deduction are complicated. These are not reflected in one sentence provisions that allow a deduction. They are loaded with definitions and limitations. Many of these limitations, particularly in the charitable contribution deduction area, are attempts to shut down taxpayer abuse.

See, what makes simplification a conundrum is the "I'm special" mentality of taxpayers who seek not only the enactment of special interest tax breaks but who twist and abuse provisions that people of common sense would not characterize as intended to permit what the "I'm special" person wants to do. Thwarting the "I'm special" person requires definitions, limitations, and other provisions that add to complexity. The President's expressed desire to eliminate loopholes conflicts with his expressed desire for simplicity. Of course, a balance can be struck between the two concepts, but compromises generally leave everyone unhappy and looking for the next opportunity to strike back. It would be easier if everyone behaved "appropriately," especially when dealing with matters where "appropriately" is not something over which reasonable people can differ.

Would a different type of tax make it easier to achieve simplicity while fending off the "I'm special" folks? The types of taxes and revenue generators that hold out that promise tend to lack fairness. Inserting fairness into a tax can generate complexity, not only to prevent regressivity but also to cut down the efforts of the "I'm special" people to redefine fairness as that which ratifies their specialness.

I predict a lot of discussion, a lot of noise, studies, arguments, and much fodder for the talking heads of the 24-hour news channels. Taxes involve money, and discussions about money, especially when it involves how much one pays and how much someone else is or isn't paying, can find an audience (i.e., ratings). Will the Congress find a way to get together and fix the problem? My prediction is no, it will make it more complicated. When the day is done, there will be more credits, more anti-abuse rules, more definitions, more limitations, and more phased-in, phased-out provisions. The impact of the looming financial problem (deficits, Social Security, and Medicare topping the list) will contribute to the collapse of the system.

I could be wrong. I hope I am wrong. I'd be more than happy to post a blog that says "I WAS WRONG" after the Congress cleans up the tax law. Cleaning up the tax law, by the way, isn't a matter of making existing provisions permanent. Cleaning up the tax law means this: cutting down exclusions to the point where gross income is income, eliminating all deductions other that trade or business and income-generating activity deductions, providing for an inflation-adjusted poverty level exemption, scaling tax rates on a progressive basis that applies bracket boundaries at meaningful levels ($100,000, $250,000, $1,000,000, and $10,000,000 for example), limiting credits to genuine "paid on account" credits, eliminating all filing status categories except "taxpayer," and permitting individuals to transfer "unused exemption amounts" to other taxpayers. This approach removes the need to insert "don't tax the poor" phase-out provisions in inclusion provisions and the need to insert "let's add a tax to the rich" phase-out provisions in deduction and exclusion provisions. It means determining income net of production expenses in a manenr that truly measures income, exempting those who are poor from paying an income tax, and creating a progressivity that doesn't treat people with income of $300,000 as in the same tax bracket as those with income in the millions.

I know I didn't say anything about Social Security, the taxes for which fall more heavily on the lower income groups. I'll save that for another time. That, too, needs a lot of fixing. It may require a credit mechanism for the income tax. That might be about as close to merging the two as the system will permit.

So... don't throw away any of your income tax books. Even the old ones. What goes around comes around and perhaps they will be of value in the upcoming debate.

A week ago, in How Difficult Is It to Count Tax Words?, I revisited the pervasive ignorance manifesting itself in absurd declarations of Internal Revenue Code length, in terms of pages, words, or both. A dutiful reader has alerted me to more instances of this dangerous and perhaps intentionally misleading and distracting inaccuracy that suggests tax ignorance has gone viral.

In previous commentaries, such as Bush Pages Through the Tax Code?, Anyone Want to Count the Words in the Internal Revenue Code?, Tax Commercial’s False Facts Perpetuates Falsehood, How Tax Falsehoods Get Fertilized, and A Slight Improvement in the Code Length Articulation Problem, I explained what was wrong with the several variations of Internal Revenue Code length that have been broadcast by those who have contributed mightily to the misinformation parade.

Let’s begin with Hal Hawkins, who in his post attempts to depict what the Internal Revenue Code would look like if printed. He shows a photograph of four stacks of paper approximately six feet in height tagged “Tax Code.” Knowing that the printed Code, even with the text of uncodified statutory provisions and amendment notes, fills two volumes that are about four inches high, I continued reading Hawkins’ post, not to acquire more misinformation, but to detect where his mental process went awry. He relies on the claim of House Speaker John Boehner that the Internal Revenue Code contains four million words. Hawkins then claims that he “found a downloadable TXT file of the entire tax code on the U.S. House website,” downloaded it and then ran it through a word counter. He claims this file has 4.139 million words. I examined the file he downloaded. It’s far more than the Internal Revenue Code. It’s the Internal Revenue Code, along with amendment language, effective date information, amendment annotations, and text of each provision in the Code as it existed before each amendment. So, if a particular section was amended 20 times, there could be at least 20 times as much text to cover the previous versions plus all of the amendment and effective date information that is not codified. Had Hawkins bothered to educate himself or consult with a tax expert, he would have spared himself being highlighted in today’s MauledAgain commentary. Of course, his claim that a flat tax, fair tax, or 9-9-9 would solve the problem merely confirmed my conclusions about his lack of tax expertise.

Next comes Gregory Gwyn-Williams, Jr., of CSNNews, who in Obama Proposes More Taxes - But, Tax Code Is Already 13 Miles Long! decides to go horizontal rather than vertical in his measurement game. Working with the debunked 73,954-page Internal Revenue Code length claim, and using an erroneous 11-inch page height, he concludes that if all the pages were ripped out and placed end to end they would pan 12.84 miles. Of course, the Internal Revenue Code is nowhere near 73,954 pages in length. I know that because I have a copy of the Code sitting next to me. And the paper on which it is printed is not 11 inches in height. It is 9 inches in height. Nor does Gwyn-Williams consider the fact that 2 inches on each page is empty top and bottom margin, so his calculations are erroneous for at least three reasons.

Let’s turn to Paul Nowak, who in his Iris Speed Reading & Information Management Blog claims that it would take 13 days of non-stop reading to get through the claimed 3.7 million words of the Internal Revenue Code. Being one of the very few people in the world who has read the entire Internal Revenue Code, several times, and knowing it did not take me the 308 hours Nowak claims it would take, I dug into his underlying data. Where did he get his starting point of 3.7 million words in the Internal Revenue Code? He puts the blame on “IRS National Tax Advocate Nina Cooper.” The link goes to an editorial by National Taxpayer Advocate Nina Olson. Unfortunately, she gets it wrong, falling into the trap of counting the words in the ANNOTATED Internal Revenue Code rather than the words in the Internal Revenue Code itself. My guess is that she assigned the task to an underling, who had no idea what he or she was doing.

And if these gifts of ignorance about the Internal Revenue Code are not enough, let’s finish today’s survey of tax code ignorance by looking at another widespread piece of tax ignorance. In his The Futurist blog at World Future Society, Thomas Frey, though offering strong and sensible arguments for why the tax code ought not be as complex as it is, shares this nugget of misinformation: “In case you’re thinking this is a ridiculous idea, the IRS is already making changes to the tax code at a rate of more than once a day – 4,680 changes since 2001.” This statement causes my confidence in the entire post to plummet. Folks, the IRS does not, and cannot, change the tax code. It is the Congress that changes the tax code. Yes, the tax code is a mess. Why do American voters let the culprits off the hook every two years, by sending them back for another opportunity to wreak havoc on the nation’s tax laws?

With all that needs to be done to fix the nation’s problems, there ought not be tolerance for the distraction of people who prefer to argue that the sun does not rise in the east, that the planet is flat, that rape cannot cause pregnancy, that Russia can be seen while standing on the ground in mainland Alaska, that the printed version of the Internal Revenue Code would be 24 feet high or stretch for 13 miles, or that everyone’s child can play left tackle in the NFL. Aside from the fact that the length of the Internal Revenue Code is far less important than what is IN the Code, tax reform requires deep and serious analytical examination of complex issues in a complex society, and not limbic system excitement about some far-fetched myth that takes root and multiplies in the fertile ground of ignorance.

Note: A reader considers the "Russia can be seen while standing on the ground in mainland Alaska" reference as a "swipe at Palin." Palin said, "And you can actually see Russia from land here in Alaska." Later, the statement was repeated in modified form, "They're our next-door neighbors and you can actually see Russia from land here in Alaska -- from an island in Alaska." The reader suggested that my "Russia can be seen while standing on the ground in mainland Alaska" reference is repeating a myth. It is not. The myths were "I can see Russia from my house" and "I can see Russia from my backyard," which I did not repeat, until now, in a context making it clear that those two statements are myths. The reader added that Palin said other ridiculous things, such as the one I highlighted in It's Not a New Tax. I had enough tax ignorance examples in the last paragraph in the original post and wanted to demonstrate that ignorance is no less prevalent in the non-tax world, and that it is not tax law that can be blamed for ignorance.

In a series of commentaries, including The Realities of Income Tax Withholding, Indeed, Check Your Withholding, and Do It Now, and Time Runs Out on Tax Withholding Adjustments, I cautioned people against getting excited about take-home pay increases that will be offset, to a greater or lesser extent, by refund reductions and tax due amounts when filing season rolls around in 2019. And now that we are in tax filing season, people are discovering what is not news to those of us who paid attention. Numerous articles, including this Philadelphia Inquirer report, are sharing the experiences and reactions of taxpayers navigating what is, to them, a surprising and often unwelcome tax filing process.

The IRS reports that total refunds and the average tax refund have both decreased. People are discovering that their refund is not as large as expected, and, of course, many people expect their refunds to be in line with previous year refunds. Not a few are discovering that they owe tax and must transfer funds or write a check to the Department of the Treasury.

Arguments about the impact of the legislation focus on whether people are paying less tax than last year or more tax than last year. The flaw in that approach is that the only time it works is when a taxpayer’s income remains unchanged. A person who experiences a significant increase in income will almost certainly face a higher tax liability, even if rates are reduced. Likewise, if income drops significantly, tax liability will go down even if there were no tax cuts.

The only fair measure of the impact of the tax law changes on an individual is to compare total tax liability to total income. It makes no sense to compare to taxable income, because the tax law changes cause many taxpayers’ taxable incomes to change even if their income doesn’t change. In other words, what percentage of income must be paid as federal income tax?

Estimates of how many people are seeing a reduction in the percentage of income that must be paid as federal income tax are not available. Instead, we get statements such as the one issued by the Department of the Treasury claiming that most people are “seeing the benefits of the tax cut in larger paychecks throughout the year, instead of tax refunds.” But there is no benefit unless that percentage goes down. Does it? That percentage is not computed on the federal income tax return. It must be computed separately. I wonder how many people, and how many tax return preparers, are doing this calculation.

One Senator claimed that because the average refund is down $170 that people experiencing a reduced refund are encountering a tax hike. Some are, and some aren’t. The reduction in a refund does not answer the question. The Department of the Treasury could provide the information, considering it knows each filer’s income and tax liability, but I doubt it has the inclination, the time, or the financial resources to do the computation and publish summaries.

Another Senator cautioned that relying on early season refund statistics is misleading because the refund statistics change from week to week. That’s true, but again, that’s an argument about which set of useless information should be used. Worse, early filers are usually those expecting a refund. What is going to happen when the later filers, many more of whom expect to owe taxes, join the filing parade?

Another Senator claimed, “That big refund they've gotten used to — that's a goner now that Trump's tax changes are the law of the land, and many might owe the government money. It sure looks like the Trump administration decided to put politics first, lowball the estimates of how much tax should be withheld from everybody's paychecks, and lure people into the false sense of security that they'd gotten a big tax cut, courtesy of Donald Trump." Of course, that’s exactly what happened. It’s a technique often used in private sector business deals, with the front end looking fantastic for the consumer and the back end turning out to be an ocean of interest charges.

Those of us who understand these things saw what was happening. People were warned. The IRS repeatedly told people to check their withholding. Not everyone listened. And now, some are paying the price. When the fine print isn’t examined, when projected computations are not done, when careful analysis is omitted, when limbic impulses overwhelm reason, prices get paid. And those who think that a reduced refund or the need to write a check or transfer funds to the Department of the Treasury is the only price they will be paying need to think again, and again. These refund decreases and tax payment increases are just the first installment in the total price that will be paid.

The Ask Marilyn column in last Sunday’s Parade Magazine addressed a tax question. The question was a good one, though technically it could be construed as asking either for a confirmation of asserted black letter tax law or for an opinion. The questioner wrote, “I donated eggs to a fertility clinic and have to pay taxes on my compensation. The funds were intended to offset the effort and the discomfort involved. Do you think this is right?” As a matter of black letter tax law, the information provided to the questioner by whomever told her that her compensation was taxable is correct. See the discussions of the Garber and Green cases in my February 24, 2006, posting, The Taxation of Kidney Swaps, and my September 4, 2009 posting, Tax Consequences of Kidney Sales. As a matter of tax policy, all sorts of arguments can be made, but the better view is that there’s nothing wrong about taxing the egg donor on her compensation.

Vos Savant, allegedly the world’s smartest woman, made several points. A few, such as the claim that fair taxes require complexity and that simplifying taxes might not be wise, make sense. Many, however, are either flat out wrong, or highly questionable.

Vos Savant claims that taxing the egg donor “demonstrates the unfairness of tax laws.” What’s so unfair about taxing a person who is compensated for providing a service, or who makes money by selling something? The fact that the process of providing the service or selling an item involves “effort and . . . discomfort” means nothing in the tax world. Most people who are compensated for providing services, for example, are making an effort. Many of them would suggest that the work they do involves at least discomfort, if not, in some instances, outright pain. Consider, for example, the compensation earned by a stunt artist and the “discomfort” that the person experiences.

Vos Savant also claims that payments for lost wages are not taxed, even if they would have been taxed had they been earned. As a general proposition this statement is wrong. For example, if a person does not receive a paycheck because of a contract breach, sues, and recovers, the payment is included in gross income. When lost wages are a component of a personal injury damage award, they are not taxed, but that fact is taken into account in determining the amount of the award. If, for some reason, compensation for egg donation was excluded from gross income, the going rate for egg donation would drop to reflect that fact.

Vos Savant further claims that “After all, as selling body parts is against the law, and donating eggs is perfectly legal, the compensation can’t be called income or any other kind of gain.” That is total nonsense. There is no principle anywhere that the proceeds from selling body parts, including eggs, are excluded from gross income and do not constitute gain. In fact, the principles established in the Garber and Green cases, discussed in The Taxation of Kidney Swaps, make it clear that the opposite assertion is the accurate one. A person who sells blood, or hair, or a kidney, whether or not legal under state or federal law, has gross income in the amount of the proceeds or compensation, though there may be deductions available to the person, which is a different issue and one not addressed by the questioner or vos Savant.

When vos Savant offers her opinion that an “exemption” for income from donating eggs makes obvious sense, she is making a tax policy argument that in and of itself is not wrong. There are arguments for excluding compensation for egg donation from gross income, but they are outweighed by the arguments against such an exclusion. Presumably, one argument is that an exclusion would encourage egg donation, but if that is something governments want to do, they ought to do so by paying people to donate eggs, rather than complicating the tax laws with special interest provisions. Presumably, another argument is that it is not “fair” to tax the proceeds from selling eggs, but that approach demands excluding from gross income any income that would be unfair to tax, which opens the door to every person receiving income claiming that it is not “fair” to tax them on the income. There are several strong arguments against an exclusion for egg donation. First, the exclusion, to be fair, would need to extend to sperm donation, blood donation, sale of hair, swaps of kidneys, transfers of bone marrow, and so on, which opens the door to an unlimited exclusion once someone demonstrates, for example, that they are “donating” sweat as they work at their job. Second, as pointed out above, an exclusion for income from the sale of eggs would drive down the price, leaving the person selling the eggs in roughly the same economic position. Third, once the door is opened to the idea that certain ways of making money are more highly valued, not only would the tax law be duplicating what the market place dictates, there also would be too high a risk that those with money and influence would persuade the Congress that their ways of making money deserve tax exemptions not justified for others.

Though how smart a person Marilyn vos Savant is continues to be debated, one thing is certain. When it comes to income taxation, she has more to learn. As I have been told since I was very young, perhaps before I took my first IQ test, being intelligent is not enough to get something right.

Now that the summer sojourn is over, and I've returned from journeys in places where Internet access is neither as available or as inexpensive as it is here, I can turn my attention to a variety of topics that made their way into my consciousness even though I was far away. I'm taking them in no particular order, neither alphabetical nor chronological.

Today I turn to an issue that brings out the worst in the tax law. It's the tax treatment of so-called carried interests. To put that in English, it's the question of what tax rate should apply to the money that someone earns for performing services, when that money is paid in the form of a partnership interest that can be "cashed out" at some time after the services are performed. Because of quirks and disjointness in the way partnerships and partners are taxed, people being paid to provide services to hedge funds, investment services enterprises, and similar operations are being taxed long after they are compensated with partnership interests and at those special low tax rates applicable to capital gains. In the meantime, people performing services for factory owners, service station owners, hospitals, fire and police organizations, fast food outlets, and other enterprises are taxed when they paid and at regular tax rates. Even the service station owner, fast food entrepreneur, and factory mogul are taxed at regular tax rates on the profits they generate from running a trade or business. I wonder how many of them know what is going on, and understand the realities that lie underneath all the arguments and spin being offered in defense of an unjustifiable situation. So I add one more item to the list of reasons that some basic tax policy ought to be taught in high school.

The outcry over this discrepancy has climbed to a crescendo during this past summer. Critics have made their voices heard, and proposals for "fixing" the problem, chiefly the flaw in the partnership taxation structure, have been advanced. For example, several members of Congress introduced this proposed legislation. Defenders of the status quo, initially caught off guard, have marshaled their resources and are lobbying the Congress most furiously, throwing time and money into preservation of a totally unjustified tax break. Even a few folks who seemingly have no stake in the matter have spoken or written in favor of special low tax rates for hedge fund managers. Oh, if you haven't figured out by this point where I stand on the matter, I'll give a hint with a question. What is it that hedge fund managers and others of that ilk do that entitles them to being taxed on compensation at rates far lower than those applicable to the compensation of other workers and sole proprietors?

To be fair, hedge fund managers and their advisors aren't doing anything legally or technically wrong. The tax law is flawed, and it leaves open an opportunity for what the hedge fund managers and their advisors have done and are doing. That flaw was not created by the hedge fund managers or their advisors. It exists because Congress tried to make everyone happy when it enacted, and continued to amend, the partnership taxation structure, without thinking through to the end the consequences of what it put into the statute. Surely the hedge fund managers and their advisors should get high grades for detecting the opportunity and taking advantage of what Congress carelessly provided. But now that the tax defect has been identified, it's time to fix it.

Congress, to its credit, has been holding hearings on the issue. It took testimony on July 12 and on July 31. In fact, more testimony is scheduled for tomorrow. Statements by some witnesses and by a few members of Congress suggest that they don't truly understand the justifications for the existence of special low tax rates on capital gains or, more importantly, why those special low rates ought not apply to a person's compensation income. A very good explanation of the "sentimental sophistry" in their reasoning can be found in the testimony of Professor Darryll K. Jones, a rising bright star in the world of partnership taxation.

The arguments raised by supporters of this unintended tax break range from the erroneous to the misleading. A helpful summary has been presented by the Citizens for Tax Justice in "Myths and Facts about Private Equity Fund Managers — and the Tax Loophole They Enjoy".

Consider this argument from the National Venture Capital Association (NVCA): "But the reality is this is always the way it's been. We basically say, It's worked for years, so why change it?" The answer is simple. Because it's wrong. It wasn't intended, it isn't the sort of activity that comes within the protective mantle of capital gains taxation, even if one is to accept, arguendo, that there should be special low tax rates on capital gains.

The NVCA also claims that taxing compensation at regular tax rates would discourage innovation. Really? If that's true, then ought not scientists, medical researchers, space shuttle engineers, highway bridge designers, and just about everyone else whose creativity and intellectual skills contribute to society, often contributing far more than some fund manager sitting at a desk shuffling other people's money does, get a similar tax break? Are we somehow to conclude that those folks aren't innovative and that the only innovation taking place is whatever it is that investment services advisors and hedge fund managers are supposedly contributing, when in fact it's their clients who are coming up with the few truly good ideas that have come out of the tens of thousands of wild ideas that have been financed with venture capital?

Then there is the old chestnut, the "changing our good deal will destroy the economy" argument. Used almost annually by the real estate industry to justify such things as depreciation of appreciating buildings and treatment of nonrecourse debt as recourse debt for at-risk purposes, the not-so-veiled and pipe-dream threat often succeeds in getting members of Congress to cave in to some special interest. Eventually every special interest will get special low tax rates, leaving the bulk of the tax burden to fall on the not-so-special interests. Of course, since (and I say this sarcastically) all of us are special, there won't be anyone left to tax at regular rates. The reason the "economy will suffer" argument is such nonsense is that the taxation of ALL compensation at regular tax rates will not stop the planet from rotating and will not stop people from doing their jobs. In other words, life will go on and the economy will continue to function. It is interesting how special interest groups not only consider themselves deserving of special treatment but somehow conclude that their presence on the planet is the sina qua non of everything good that happens to anyone. What nonsense.

Another argument, that fixing the flaw and taxing the compensation of hedge fund executives at regular rates would damage pension plans, has been refuted by the pension funds themselves. One would think that, for all their alleged brilliance, these super-special low-taxed employees would have touched base with the pension fund experts.

Two other arguments are suggested in this Wall Street Journal article. One is that there's not much revenue involved and the other is that Congress has other, more important things to do. To the first, I respond that every bit helps, and that the message sent by a Congress countenancing special low tax rates on the compensation of a select few further distances itself from an increasingly frustrated population. To the second, I respond that all of us have long "to do" lists and the Congress is quite capable of getting its work done if the members truly wish to do so. The second argument isn't very different from one that advocates letting bank robbers run wild because the police have too many homicides to handle.

What do these selected special few do with their tax savings? Apparently they contribute to the campaigns of members of Congress. These are partisan supporters. They send money to politicians of every party and every persuasion. They don't care who protects their tax break, and they're willing to pay. Considering the Administration's reluctance to support reform, the President being "very, very hesitant" to make changes, I wonder if this is the sort of political atmosphere that it prefers and that it is trying to export abroad.

Very little of what I've written is ground-breaking, and perhaps none of it is. While I was away, more than a few tax faculty chimed in on the issue. As Victor Fleischer points out in "The Academic Consensus on Carried Interest ", there is an "academic consensus" on the question. I find myself in agreement with a group of faculty whose perspectives are all over the tax policy spectrum, including some with whom I sometimes disagree on other matters. When the academic tax community is this much in agreement, it speaks volumes about the need for reform. As Victor points out, there's no unanimity in the mechanics of the reform, but once the competent put their minds together it ought not take long to work out the details. I would require inclusion in compensation income, taxed at regular rates, of the value of what is received, and if it cannot be valued, I'd require that the taxable year be held open until the interest is sold, liquidated, gifted, or passed at death, at which point I'd have the tax for the earlier year recomputed, and then paid, with interest, by the recipient or the recipient's estate.

But the academics are not unanimous in calling for reform. One academic who has come out in favor of the current special low tax rates on hedge fund managers, obtained funding for the research from the Private Equity Council. Another academic, a person I know and hold in high regard, points out that he addressed the subject in "The Taxation of Carried Interests, 116 Tax Notes 183," in which he addresses the "practical difficulties" that reform would generate. He notes that communication between tax academics and tax practitioners has declined significantly, an observation with which I agree, asserting that "these academics really don’t know much about what lawyers do." Yet the fact that some tax practitioners are, as he points out, "intellectual and curious" doesn't mean that the deals they cook up are appropriate or deserve a Congressional imprimatur. The proposal that I offer in the preceding paragraph deals with the practical problem of valuation in a manner not unlike that used in other areas of the tax law where valuation might otherwise be an obstacle. I'm simply not persuaded that there are any insurmountable practical problems, and if there is a challenge in making a transition to appropriate taxation of compensation, that's a small price to be paid for an unwarranted tax break that has been enjoyed for far too long. What might be impractical is going back and collecting the taxes that would have been paid had the compensation been taxed all along at regular compensation rates, so perhaps the advocates of this unjustifiable special tax break ought to consider seriously the risk of facing truly impractical legislative reactions.

Of course, all of the reform proposals, including mine, merely deal with a symptom. The issue would not exist if there were no special low tax rates for capital gains. To its credit, the Wall Street Journal article calls for the same genuine reform that I've advocated for more than three decades. Abolish the special low tax rates on capital gains. Those rates account for almost one-third of the Internal Revenue Code, as the Congress has had to apply piecemeal fixes to a bad idea gone very wrong. It is true, as some defenders of the tax break for hedge fund managers claim, surely some other arrangement will be structured that uses some other flaw in the tax law to turn ordinary income into capital gains. In the long-run, until and unless Congress repeals special low tax rates for capital gains, we will continue to learn about new and improved mechanisms for giving a select few an unintended tax break, we will continue to read and write about the outrage and the call for reform, we will continue to listen to the defenders of the unintended tax break hail its importance to the economy and all that is good, and we will continue to ride a never-ending tax circle. So I doubt this is the last word I will have to say on the issue.