Friday, March 19, 2004
Capital Gains, Dividends, and Taxes
A friend asked me for some help the other day. He was doing a tax return for a small trust. He's not a "tax guy" but he's a smart, educated fellow who surely would do at least as well, and most likely better, than many or most of the students in the basic federal income tax course that I teach. He's been doing this trust's tax return since its inception, so I asked what's the problem? His reply was that he was bewildered by the tax computation portion of the Form 1041 Schedule D. The trust had a small amount of capital gains distributions and also received dividends qualifying for the lower tax rates.
So I agreed and he stopped by. He laughed and said he figured I could punch the numbers into "that tax program you have." Well, I do have Turbotax. So does he. But the Turbotax we have doesn't do trust tax returns. There is software available from Turbotax to do trust tax returns, but when there's only one return to do and the total income is less than $800 it isn't worth the expense.
The ultimate good news was that because the trust distributed its income and is allowed a $300 exemption deduction, it had no tax liability. The bad news was that at first I forgot to subtract the $300 so I ended up plowing through the tax computation portion of the Form 1041 Schedule D. The good news is that despite that portion of the form not being needed, it wasn't a waste of my time because I had the education experience of making direct contact with a the tax computational portion of a Schedule D other than through Turbotax. Yes, the Form 1041 Schedule D is a bit different than the Form 1040 Schedule D (the one used for individuals), but they're very similar. They share a level of complexity that to most folks looks like a differential calculus exercise.
Sometimes I think this is all part of a vast conspiracy among tax software manufacturers, lobbyists, members of Congress, and the Treasury Department. Then I do a reality check and remember that as long as there are taxes there will be a need for tax software, and that the folks at Turbotax are probably (strange as it may seem) among those in the forefront asking for tax simplification. Why? Because programming this tax complexity isn't easy, and the more chances for mistakes, the more mistakes get made. Issuing updates to fix mistakes is expensive. Early in its history, Turbotax required several updates each tax season to deal with errors, but now it's become almost perfect. The years when I would be on the phone with the Turbotax people educating them and explaining how the software wasn't tracking the tax law have faded into the past. They were always very polite but I should have held out for a lifetime subscription!
So why is the Schedule D of Forms 1040 and 1041 (and others) so complicated? Because the Congress insists that certain capital gains, and now, certain dividends, should be taxed at rates lower than those that apply to salaries, interest, pensions, the taxable portion of social security, book royalties, etc. In other words, stock market and other investing and corporate ownership is seen as more important (or at least, deserving of less taxation) than is earning a living through sweating, being retired, or conducting a business in partnership or LLC form. (To be technical, capital gains are taxed at a variety of lower rates, not just one lower rate. To keep this analysis from getting unduly complex, I'll ignore those complexities upon complexity.)
Someone, a few years ago, wrote a brief article in which they listed the arguments made by the advocates of low (or no) capital gains taxation and the arguments made by those who think capital gains should be taxed as is any other income. There were more than 6 dozen arguments on each side. This is hardly the place to list all of them or to analyze each of them. Let's instead consider the major premises.
The advocates of low (or no) capital gains taxation claim that they are being taxed on "phantom" income because some of the gain represents adjustments in price that reflect inflation. They point out that adjustments for inflation exist in the tax law for a wide variety of items (for example, the personal and dependency exemption amount, the standard deduction, the cut-offs for the phase-out of various deductions and exclusions, etc.) But they overlook the fact that the tax rate schedules themselves are adjusted for inflation. Not good enough, they reply.
The answer, therefore, is simple. Make an inflation adjustment to the basis in the asset being sold. Capital gain reflects the difference between the net selling price and the amount invested ("basis") in the asset. So if T buys stock for $100 and ten years later sells it for $400, T has capital gain of $300. If T is in the 30% marginal bracket, T pays tax of $90 on the gain. But T argues some of the gain reflects inflation. How that justifies taxing T at a rate of 5% or even (as the advocates admit is their goal, zero percent) is impossible to understand, let alone accept. Why should T's tax on the gain be $15 or $0? Let's assume that during the 10-year period in question inflation was 35% (that's roughly 3% a year compounded). What makes sense is to let T adjust the basis from $100 to $135. Then T's gain would be $265 ($400 minus $135). Taxed at 30%, T would have a tax liability on the capital gain of $79.50. That's lower than $90 but not near the unfathomable $15 or $0 that T thinks is "fair."
So the advocates of low or zero capital gains rates turn to other arguments. One is the "lock-in" effect. They claim that owners of assets who do not need to sell will not sell if the gain is taxed at regular rates, because they know that at death their heirs will take the assets with a basis equal to fair market value, thus letting the gain arising during lifetime escape taxation. There are several problems with this argument. First, it relies on ANOTHER BAD TAX POLICY to justify a SECOND BAD TAX POLICY. There is no logic in letting gains go untaxed if the property is held until death. The justification is "we don't know what the decedent's basis is." Hogwash. If the decedent made a lifetime gift of the asset, the donee's basis is the decedent's basis and there are ways of figuring it out. It's done all the time. Basis isn't information that the decedent takes to the grave. (And taxing unrealized appreciation (the technical name for these gains) at death would justify total repeal of the estate tax; of course, it would raise more revenue than estate tax repeal would lose, so it's easy to see how members of Congress would sort themselves out on this one.) The second problem with the "lock in" argument is that it presupposes that non-tax factors compelling or strongly encouraging lifetime sales do not exist. Anyone who makes investment or ownership decisions based SOLELY on the tax law is going to be poor, barring extraordinary luck. Investment advisors are known to suggest that "holding on too long" is a bad thing.
Another major argument dragged out by the low/no capital gain tax crowd is that taxation of capital gains impedes capital formation. Supposedly, if capital gains are taxed at regular rates, people will not invest in capital formation (such as corporations, LLCs, and partnerships). Well, I ask, will they bury their money? Spend it? If they spend it, what will be done with the money by those who receive it? Oh, they'll spend it. Inflation will run rampant. So savvy folks will invest to shield themselves from inflation. And that, in turn, will generate capital investment, and loosen the consumption pressure on the inflation rate. Perhaps people would invest their discretionary income (money left over after paying for the necessities of life) in interest-bearing accounts. Which, of course, means that the banks and other financial institutions would have cash that would be used for (a) making loans to people who would invest in true capital, such as equipment, machines, buildings, etc. or (b) investing in the stock market or other equity arrangements.
I could continue on and on with the dozens of arguments put forth by the advocates of low or no capital gains tax. I could add the dozens of arguments made by the opponents (and I already have outlined some of them). I could dedicate paragraphs of analysis to the question of why, if it is so good to tax capital gains at 5% or 0%, is it not just as good to tax salaries and interest and pensions at 0% or 5%. I could (and I may, in a future post) explore how we will end up with an income tax on salaries and not much else (especially if the proposal to make most contributions to savings accounts deductible). Add in the imposition of social security taxes on salaries (but not capital gains, interest, or dividends) and one quickly begins to see how two economic classes will come to exist in society. That is something that is flat out not healthy for survival of the nation. Am I beginning to sound like Howard Dean? Maybe if I refrain from screaming I'll avoid being mistaken for him. (After all, he is a Maule descendant (as you can see here ) so he must be right about something, and so I'm guessing it's probably in the tax area...)
Now, of course, with tax rates on capital gains having been lowered and then lowered again, to the point where a zero rate is rapidly approaching, the low/no capital gain tax rate folks turned to dividends. So dividends are taxed at these lower rates. Why? Supposedly it will encourage corporations to pay dividends (as to whether it does, see Story Number Five in my earlier posting on that topic. That makes no sense if the concern is capital formation, because under that theory, the corporations should retain cash to invest in additional property acquistion, in more jobs, and in business growth. Why distribute earnings to shareholders?
Easy. So that they can invest in other corporations. And get more capital gains. And have their net worth grow at an after-tax rate that far exceeds (relatively speaking) the net worth growth rate of folks who earn salaries and put their money into bank accounts to insure against next month's job loss. See how the gap between society's owners and society's workers is widening? When I use the phrase "economic slavery" to describe this phenomenon I get a lot of static from all sorts of people, but give it some thought.
What's really going on is the "don't tax you, don't tax me, tax that fellow behind the tree" phenomenon that has afflicted tax law development since the beginning of tax time. (The quote is attributed to former Sen. Russell B. Long.) Who's you? Who's me? Simple. You and me are the folks making the laws, that is, bringing their proposals in for enactment as rewards for campaign contributions. Where do they get all that money to contribute to the soft-money organizations? Hmmm... And who's behind the tree?
One response is to point out that most Americans own stock through their pension plans and thus share in the benefits of lower capital gain taxation. First, for many Americans in pension plans investing in stock, their stock ownership is remote and the benefits subject to the risk that the plan will go under, as has happened. Second, for many Americans, adding a few dollars of capital gains to their income would not push them into the high brackets where the benefits of 5% and 15% capital gains rates generate the most significant savings. Third, because pension plan income is not taxed to the participant until retirement (when it is taxed at regular rates), the existence of a low or zero capital gains rate for those pension plan capital gains is specious. It's like giving a person ineligible for a driver's a preferred appointment time for a driving test.
I began this discourse with a description of the complexity generated by taxing some capital gains and some dividends at lower rates than those applying to salary, pension, interest, and other income. Though the cry "it's too complicated" ought not always win the day (because sometimes there is no choice but complexity, as is, for example, the case with the chemisty applied to design life-saving pharmaceuticals), adding complexity to a system of any kind (including tax law) needs to be justified. The burden needs to be on those advocating the complexity. I submit to you that in this instance, the advocates of lower taxes on certain capital gains and certain dividends have not met that burden.
So I agreed and he stopped by. He laughed and said he figured I could punch the numbers into "that tax program you have." Well, I do have Turbotax. So does he. But the Turbotax we have doesn't do trust tax returns. There is software available from Turbotax to do trust tax returns, but when there's only one return to do and the total income is less than $800 it isn't worth the expense.
The ultimate good news was that because the trust distributed its income and is allowed a $300 exemption deduction, it had no tax liability. The bad news was that at first I forgot to subtract the $300 so I ended up plowing through the tax computation portion of the Form 1041 Schedule D. The good news is that despite that portion of the form not being needed, it wasn't a waste of my time because I had the education experience of making direct contact with a the tax computational portion of a Schedule D other than through Turbotax. Yes, the Form 1041 Schedule D is a bit different than the Form 1040 Schedule D (the one used for individuals), but they're very similar. They share a level of complexity that to most folks looks like a differential calculus exercise.
Sometimes I think this is all part of a vast conspiracy among tax software manufacturers, lobbyists, members of Congress, and the Treasury Department. Then I do a reality check and remember that as long as there are taxes there will be a need for tax software, and that the folks at Turbotax are probably (strange as it may seem) among those in the forefront asking for tax simplification. Why? Because programming this tax complexity isn't easy, and the more chances for mistakes, the more mistakes get made. Issuing updates to fix mistakes is expensive. Early in its history, Turbotax required several updates each tax season to deal with errors, but now it's become almost perfect. The years when I would be on the phone with the Turbotax people educating them and explaining how the software wasn't tracking the tax law have faded into the past. They were always very polite but I should have held out for a lifetime subscription!
So why is the Schedule D of Forms 1040 and 1041 (and others) so complicated? Because the Congress insists that certain capital gains, and now, certain dividends, should be taxed at rates lower than those that apply to salaries, interest, pensions, the taxable portion of social security, book royalties, etc. In other words, stock market and other investing and corporate ownership is seen as more important (or at least, deserving of less taxation) than is earning a living through sweating, being retired, or conducting a business in partnership or LLC form. (To be technical, capital gains are taxed at a variety of lower rates, not just one lower rate. To keep this analysis from getting unduly complex, I'll ignore those complexities upon complexity.)
Someone, a few years ago, wrote a brief article in which they listed the arguments made by the advocates of low (or no) capital gains taxation and the arguments made by those who think capital gains should be taxed as is any other income. There were more than 6 dozen arguments on each side. This is hardly the place to list all of them or to analyze each of them. Let's instead consider the major premises.
The advocates of low (or no) capital gains taxation claim that they are being taxed on "phantom" income because some of the gain represents adjustments in price that reflect inflation. They point out that adjustments for inflation exist in the tax law for a wide variety of items (for example, the personal and dependency exemption amount, the standard deduction, the cut-offs for the phase-out of various deductions and exclusions, etc.) But they overlook the fact that the tax rate schedules themselves are adjusted for inflation. Not good enough, they reply.
The answer, therefore, is simple. Make an inflation adjustment to the basis in the asset being sold. Capital gain reflects the difference between the net selling price and the amount invested ("basis") in the asset. So if T buys stock for $100 and ten years later sells it for $400, T has capital gain of $300. If T is in the 30% marginal bracket, T pays tax of $90 on the gain. But T argues some of the gain reflects inflation. How that justifies taxing T at a rate of 5% or even (as the advocates admit is their goal, zero percent) is impossible to understand, let alone accept. Why should T's tax on the gain be $15 or $0? Let's assume that during the 10-year period in question inflation was 35% (that's roughly 3% a year compounded). What makes sense is to let T adjust the basis from $100 to $135. Then T's gain would be $265 ($400 minus $135). Taxed at 30%, T would have a tax liability on the capital gain of $79.50. That's lower than $90 but not near the unfathomable $15 or $0 that T thinks is "fair."
So the advocates of low or zero capital gains rates turn to other arguments. One is the "lock-in" effect. They claim that owners of assets who do not need to sell will not sell if the gain is taxed at regular rates, because they know that at death their heirs will take the assets with a basis equal to fair market value, thus letting the gain arising during lifetime escape taxation. There are several problems with this argument. First, it relies on ANOTHER BAD TAX POLICY to justify a SECOND BAD TAX POLICY. There is no logic in letting gains go untaxed if the property is held until death. The justification is "we don't know what the decedent's basis is." Hogwash. If the decedent made a lifetime gift of the asset, the donee's basis is the decedent's basis and there are ways of figuring it out. It's done all the time. Basis isn't information that the decedent takes to the grave. (And taxing unrealized appreciation (the technical name for these gains) at death would justify total repeal of the estate tax; of course, it would raise more revenue than estate tax repeal would lose, so it's easy to see how members of Congress would sort themselves out on this one.) The second problem with the "lock in" argument is that it presupposes that non-tax factors compelling or strongly encouraging lifetime sales do not exist. Anyone who makes investment or ownership decisions based SOLELY on the tax law is going to be poor, barring extraordinary luck. Investment advisors are known to suggest that "holding on too long" is a bad thing.
Another major argument dragged out by the low/no capital gain tax crowd is that taxation of capital gains impedes capital formation. Supposedly, if capital gains are taxed at regular rates, people will not invest in capital formation (such as corporations, LLCs, and partnerships). Well, I ask, will they bury their money? Spend it? If they spend it, what will be done with the money by those who receive it? Oh, they'll spend it. Inflation will run rampant. So savvy folks will invest to shield themselves from inflation. And that, in turn, will generate capital investment, and loosen the consumption pressure on the inflation rate. Perhaps people would invest their discretionary income (money left over after paying for the necessities of life) in interest-bearing accounts. Which, of course, means that the banks and other financial institutions would have cash that would be used for (a) making loans to people who would invest in true capital, such as equipment, machines, buildings, etc. or (b) investing in the stock market or other equity arrangements.
I could continue on and on with the dozens of arguments put forth by the advocates of low or no capital gains tax. I could add the dozens of arguments made by the opponents (and I already have outlined some of them). I could dedicate paragraphs of analysis to the question of why, if it is so good to tax capital gains at 5% or 0%, is it not just as good to tax salaries and interest and pensions at 0% or 5%. I could (and I may, in a future post) explore how we will end up with an income tax on salaries and not much else (especially if the proposal to make most contributions to savings accounts deductible). Add in the imposition of social security taxes on salaries (but not capital gains, interest, or dividends) and one quickly begins to see how two economic classes will come to exist in society. That is something that is flat out not healthy for survival of the nation. Am I beginning to sound like Howard Dean? Maybe if I refrain from screaming I'll avoid being mistaken for him. (After all, he is a Maule descendant (as you can see here ) so he must be right about something, and so I'm guessing it's probably in the tax area...)
Now, of course, with tax rates on capital gains having been lowered and then lowered again, to the point where a zero rate is rapidly approaching, the low/no capital gain tax rate folks turned to dividends. So dividends are taxed at these lower rates. Why? Supposedly it will encourage corporations to pay dividends (as to whether it does, see Story Number Five in my earlier posting on that topic. That makes no sense if the concern is capital formation, because under that theory, the corporations should retain cash to invest in additional property acquistion, in more jobs, and in business growth. Why distribute earnings to shareholders?
Easy. So that they can invest in other corporations. And get more capital gains. And have their net worth grow at an after-tax rate that far exceeds (relatively speaking) the net worth growth rate of folks who earn salaries and put their money into bank accounts to insure against next month's job loss. See how the gap between society's owners and society's workers is widening? When I use the phrase "economic slavery" to describe this phenomenon I get a lot of static from all sorts of people, but give it some thought.
What's really going on is the "don't tax you, don't tax me, tax that fellow behind the tree" phenomenon that has afflicted tax law development since the beginning of tax time. (The quote is attributed to former Sen. Russell B. Long.) Who's you? Who's me? Simple. You and me are the folks making the laws, that is, bringing their proposals in for enactment as rewards for campaign contributions. Where do they get all that money to contribute to the soft-money organizations? Hmmm... And who's behind the tree?
One response is to point out that most Americans own stock through their pension plans and thus share in the benefits of lower capital gain taxation. First, for many Americans in pension plans investing in stock, their stock ownership is remote and the benefits subject to the risk that the plan will go under, as has happened. Second, for many Americans, adding a few dollars of capital gains to their income would not push them into the high brackets where the benefits of 5% and 15% capital gains rates generate the most significant savings. Third, because pension plan income is not taxed to the participant until retirement (when it is taxed at regular rates), the existence of a low or zero capital gains rate for those pension plan capital gains is specious. It's like giving a person ineligible for a driver's a preferred appointment time for a driving test.
I began this discourse with a description of the complexity generated by taxing some capital gains and some dividends at lower rates than those applying to salary, pension, interest, and other income. Though the cry "it's too complicated" ought not always win the day (because sometimes there is no choice but complexity, as is, for example, the case with the chemisty applied to design life-saving pharmaceuticals), adding complexity to a system of any kind (including tax law) needs to be justified. The burden needs to be on those advocating the complexity. I submit to you that in this instance, the advocates of lower taxes on certain capital gains and certain dividends have not met that burden.
Wednesday, March 17, 2004
Hidden Taxes
Tom Ferrick, a columnist for the Philadelphia Inquirer, had an interesting column in today's paper about the financial woes of the Philadelphia Gas Works. He took a close look at the PGW's proposal to raise rates to cover the revenue losses from people who don't pay their gas bills.
PGW has a long history of mismanagement, a problem that was recently addressed in a series of operating and personnel changes. PGW is owned by the city of Philadelphia, and contributes $18,000,000 to the city's budget. PGW faces a series of problems.
First, the cost of natural gas has skyrocketed, which has compelled PGW to increase its rates. Second, at least one-third of its customers live at or below the poverty level, so they end up not paying their bills (or paying only a portion) when their winter gas bills arrive. As Ferrick points out, a person working 40 hours a week earning $7 an hour finds it tough to pay a $500 monthly heating bill. Ironically, federal and state heating assistance isn't available to the "working poor." I thought that problem had been dealt with, but apparently there still exist programs that tend to encourage unemployment.
Third, and this is the big one, there are folks who can pay the bills but who don't, knowing that PGW is forbidden by law to shut off gas service in the winter months. Ferrick quotes and paraphrases a PGW official who calls these people "gamers" because they are gaming the system. Half of the PGW's 500,000 customers do not pay their bills on time, one-third of the customers live at or below the poverty line, and PGW intends to cut off service in April to 35,000 "severe" delinquent. Do the math. There are 80,000 customers living above the poverty line who aren't paying their bills, and at least 55,000 aren't going to lose service in April.
So, facing an anticipated $5 million loss, PGW is asking the utility commission to let it increase rates on the customers who do pay to cover the revenue shortfall from those who don't pay. What is that?
WHY, IT'S A HIDDEN TAX. It makes PGW, as Ferrick puts it, in part a social welfare agency.
Wouldn't it be better to increase taxes and use that revenue to subsidize the genuinely poor (and to hire law enforcement officials to call time-out on the gamers?). At least the tax would be deductible for federal income tax purposes, whereas increased gas bills are deductible only for businesses.
Ferrick also reports that PGW has asked Philadelphia to release it from contributing $18,000,000 to the city budget. If that happens, then the city's budget takes a shot, and it either raises taxes or cuts expenditures (i.e., services).
What a mess. When what PGW pays to acquire gas triples, there's a problem. The age-old argument about energy sources rears its head again, pitting advocates of renewable energy (solar heating) against those who posit that there's enough natural gas in the ground to last for hundreds of years. Well, then why has the price skyrocketed? There's no OPEC embargo to blame this time. Gas producers blame the government for policies that discourage or make expensive exploring and drilling for gas, the government blames the gas producers for bad planning, and I suspect that somewhere somebody sitting in an office, not getting their hands dirty, is making a lot of money moving someone else's gas around.
Even though it wouldn't end the problem, it does seem outrageous that people can game the system. People who can afford to pay, but who think they are so special that they deserve to avoid paying gas bills (so that they can acquire something else), are essentially telling the rest of us that we need to shoulder their share of the burden. PGW's reaction isn't unlike most other businesses. What you and I pay for a product covers the cost of employee pilferage of inventory, shoplifting, and the retailers' and manufacturer's bad debt expense. So who can blame PGW for doing what other businesses do? True, PGW's proposal is in the spotlight because it is regulated by the utility commission whereas most other businesses just make price adjustments. Other businesses also take steps to eliminate bad debt (by refusing to deal with deadbeats) and to eliminate theft. PGW, however, is constrained by a series of government interventions designed to protect the very poor that are in turn exploited by the gamers.
The gamers are everywhere. The problem needs to be addressed in a way that transcends PGW. The gamers are inflicting hidden taxes on all of us. The gaming isn't just the gas-bill-payment-avoidance play. It shows up whenever someone fails to do what he or she should do, and shifts the burden to the rest of us. Sometimes it's money, as in the PGW situation or in the shoplifting situation. More and more, it's time. A company ships software that hasn't been fully tested, and the consumers invest hours trying to fix it. Imagine buying a car, arriving at the dealership to discover it has four flat tires, and being handed a jack while being told to fix it yourself.
These corporate gamers have figured out that they can foist shoddy products on us and let us invest our time dealing with it. Same thing with telemarketers. We need to invest OUR time listening to them or trying to get onto a do not call list. Someone figured out that it pays to treat us this way (just as someone figured out it's cheaper to pay for deaths caused by defective products than to pay for the correction of the problem (a lot has been written about this theory and I'll leave the discussion to the experts (look at this explanation and be sure to scroll down to "Quality Cost Analysis"))). Sarcastically, I add that it's usually not a question of economic survival for the company, it's often a question of a highly paid CEOs, executives, and upper management not wanting to cut their salaries a bit so that the company can hire a few people to get the job done right in the first place.
Don't mind me. I spent four hours yesterday installing an update of Quicken that was supposed to be seamless. Even though my data was supposed to transfer over, I ended up having to enter manually all the categories (because they didn't carry over and could not be copied and pasted). There were all other sorts of problems. Who designed this thing? Who checked it? Who used it before shipping it? When the program failed, it told me to call the bank, the bank connected me with a third party servicing company, then I was transferred to a Quicken person, who wanted to send me back to a phone call with the bank, but I ended up back with the third party person. The third party technician was helpful; the person at the bank was sympathetic, as apparently I was the umpteenth person to call. Ultimately, as is usually the case, I figured a lot of it out myself. I am tempted to send Quicken an invoice for my time. But I don't have the time to continue playing the game.
Could I have avoided the update? Noooooooo. The bank and Quicken will cease supporting, or letting me use, the older version, as of sometime in April. Clever. The new version isn't any better nor is it more functional for what I want (a checkbook tracker and an on-line banking service). Instead, Quicken wants to advise me on taxes (hahahahahaha), make loans, issue me a credit card, ... why not mow my lawn, too? So I paid for what I already had, cluttered with other unwanted features that had the effect of denigrating the performance and efficiency of what I had. Why? Because of a corporate mentality that the corporation must dominate its market and all related markets. Find your niche, Quicken, and stick to it. Resist the temptation to imitate Microsoft.
Lest you think I'm simply ranting, do this: sit down and add up all the hours you spend doing something because someone else failed to do so or did something in the wrong way. Don't count hours expended taking care of children or ill family members. That's different. Think of the people to whom you've paid money only to get a product that requires you to invest more money or valuable time to fix it (want to hear the story about the peel and stick floor tiles that don't have enough glue and that turn out to be made by some company in Taiwan that is unreachable? Nah, I'll save that one for some other time). Surely, as things I've read recently indicate, it's a widespread problem. It is having and will continue to have, an erosive impact on the security, economic success, and well-being of our nation and our society.
The upshot is that we are paying people for the privilege of doing their work. We're paying extra to cover the misdeeds of others. We're paying extra to cover the costs imposed on society by the gamers. That's just flat out wrong. Most of us do not (and should not) object to paying to help the truly needy and unfortunate, especially those who suffer because society failed them in some way. It is difficult to believe that clamping down on the gamers without hurting the genuinely afflicted is a task that cannot be done. There are times I think that it's not a question of whether it can be done, but whether there is a desire to have it done. So long as the gamers win, they will keep gaming. Software virus writers, PGW gas bill avoiders, sloppy product manufacturers, intentionally incomplete software releases, no-show contractors, and the rest of gaming crowd need to be put in the penalty box.
Otherwise, we will continue to pay these hidden taxes. Thinking of them in this manner, it may change our approach to dealing with those who are benefitting at our expense and who don't deserve to do so. And if steps aren't taken to put an end to the hidden tax phenomenon, it will grow until it chokes the economy and corrupts our standard of living.
Oh, do go read Ferrick's column. He's a good writer, he tackles interesting topics, and today he resonated very well.
PGW has a long history of mismanagement, a problem that was recently addressed in a series of operating and personnel changes. PGW is owned by the city of Philadelphia, and contributes $18,000,000 to the city's budget. PGW faces a series of problems.
First, the cost of natural gas has skyrocketed, which has compelled PGW to increase its rates. Second, at least one-third of its customers live at or below the poverty level, so they end up not paying their bills (or paying only a portion) when their winter gas bills arrive. As Ferrick points out, a person working 40 hours a week earning $7 an hour finds it tough to pay a $500 monthly heating bill. Ironically, federal and state heating assistance isn't available to the "working poor." I thought that problem had been dealt with, but apparently there still exist programs that tend to encourage unemployment.
Third, and this is the big one, there are folks who can pay the bills but who don't, knowing that PGW is forbidden by law to shut off gas service in the winter months. Ferrick quotes and paraphrases a PGW official who calls these people "gamers" because they are gaming the system. Half of the PGW's 500,000 customers do not pay their bills on time, one-third of the customers live at or below the poverty line, and PGW intends to cut off service in April to 35,000 "severe" delinquent. Do the math. There are 80,000 customers living above the poverty line who aren't paying their bills, and at least 55,000 aren't going to lose service in April.
So, facing an anticipated $5 million loss, PGW is asking the utility commission to let it increase rates on the customers who do pay to cover the revenue shortfall from those who don't pay. What is that?
WHY, IT'S A HIDDEN TAX. It makes PGW, as Ferrick puts it, in part a social welfare agency.
Wouldn't it be better to increase taxes and use that revenue to subsidize the genuinely poor (and to hire law enforcement officials to call time-out on the gamers?). At least the tax would be deductible for federal income tax purposes, whereas increased gas bills are deductible only for businesses.
Ferrick also reports that PGW has asked Philadelphia to release it from contributing $18,000,000 to the city budget. If that happens, then the city's budget takes a shot, and it either raises taxes or cuts expenditures (i.e., services).
What a mess. When what PGW pays to acquire gas triples, there's a problem. The age-old argument about energy sources rears its head again, pitting advocates of renewable energy (solar heating) against those who posit that there's enough natural gas in the ground to last for hundreds of years. Well, then why has the price skyrocketed? There's no OPEC embargo to blame this time. Gas producers blame the government for policies that discourage or make expensive exploring and drilling for gas, the government blames the gas producers for bad planning, and I suspect that somewhere somebody sitting in an office, not getting their hands dirty, is making a lot of money moving someone else's gas around.
Even though it wouldn't end the problem, it does seem outrageous that people can game the system. People who can afford to pay, but who think they are so special that they deserve to avoid paying gas bills (so that they can acquire something else), are essentially telling the rest of us that we need to shoulder their share of the burden. PGW's reaction isn't unlike most other businesses. What you and I pay for a product covers the cost of employee pilferage of inventory, shoplifting, and the retailers' and manufacturer's bad debt expense. So who can blame PGW for doing what other businesses do? True, PGW's proposal is in the spotlight because it is regulated by the utility commission whereas most other businesses just make price adjustments. Other businesses also take steps to eliminate bad debt (by refusing to deal with deadbeats) and to eliminate theft. PGW, however, is constrained by a series of government interventions designed to protect the very poor that are in turn exploited by the gamers.
The gamers are everywhere. The problem needs to be addressed in a way that transcends PGW. The gamers are inflicting hidden taxes on all of us. The gaming isn't just the gas-bill-payment-avoidance play. It shows up whenever someone fails to do what he or she should do, and shifts the burden to the rest of us. Sometimes it's money, as in the PGW situation or in the shoplifting situation. More and more, it's time. A company ships software that hasn't been fully tested, and the consumers invest hours trying to fix it. Imagine buying a car, arriving at the dealership to discover it has four flat tires, and being handed a jack while being told to fix it yourself.
These corporate gamers have figured out that they can foist shoddy products on us and let us invest our time dealing with it. Same thing with telemarketers. We need to invest OUR time listening to them or trying to get onto a do not call list. Someone figured out that it pays to treat us this way (just as someone figured out it's cheaper to pay for deaths caused by defective products than to pay for the correction of the problem (a lot has been written about this theory and I'll leave the discussion to the experts (look at this explanation and be sure to scroll down to "Quality Cost Analysis"))). Sarcastically, I add that it's usually not a question of economic survival for the company, it's often a question of a highly paid CEOs, executives, and upper management not wanting to cut their salaries a bit so that the company can hire a few people to get the job done right in the first place.
Don't mind me. I spent four hours yesterday installing an update of Quicken that was supposed to be seamless. Even though my data was supposed to transfer over, I ended up having to enter manually all the categories (because they didn't carry over and could not be copied and pasted). There were all other sorts of problems. Who designed this thing? Who checked it? Who used it before shipping it? When the program failed, it told me to call the bank, the bank connected me with a third party servicing company, then I was transferred to a Quicken person, who wanted to send me back to a phone call with the bank, but I ended up back with the third party person. The third party technician was helpful; the person at the bank was sympathetic, as apparently I was the umpteenth person to call. Ultimately, as is usually the case, I figured a lot of it out myself. I am tempted to send Quicken an invoice for my time. But I don't have the time to continue playing the game.
Could I have avoided the update? Noooooooo. The bank and Quicken will cease supporting, or letting me use, the older version, as of sometime in April. Clever. The new version isn't any better nor is it more functional for what I want (a checkbook tracker and an on-line banking service). Instead, Quicken wants to advise me on taxes (hahahahahaha), make loans, issue me a credit card, ... why not mow my lawn, too? So I paid for what I already had, cluttered with other unwanted features that had the effect of denigrating the performance and efficiency of what I had. Why? Because of a corporate mentality that the corporation must dominate its market and all related markets. Find your niche, Quicken, and stick to it. Resist the temptation to imitate Microsoft.
Lest you think I'm simply ranting, do this: sit down and add up all the hours you spend doing something because someone else failed to do so or did something in the wrong way. Don't count hours expended taking care of children or ill family members. That's different. Think of the people to whom you've paid money only to get a product that requires you to invest more money or valuable time to fix it (want to hear the story about the peel and stick floor tiles that don't have enough glue and that turn out to be made by some company in Taiwan that is unreachable? Nah, I'll save that one for some other time). Surely, as things I've read recently indicate, it's a widespread problem. It is having and will continue to have, an erosive impact on the security, economic success, and well-being of our nation and our society.
The upshot is that we are paying people for the privilege of doing their work. We're paying extra to cover the misdeeds of others. We're paying extra to cover the costs imposed on society by the gamers. That's just flat out wrong. Most of us do not (and should not) object to paying to help the truly needy and unfortunate, especially those who suffer because society failed them in some way. It is difficult to believe that clamping down on the gamers without hurting the genuinely afflicted is a task that cannot be done. There are times I think that it's not a question of whether it can be done, but whether there is a desire to have it done. So long as the gamers win, they will keep gaming. Software virus writers, PGW gas bill avoiders, sloppy product manufacturers, intentionally incomplete software releases, no-show contractors, and the rest of gaming crowd need to be put in the penalty box.
Otherwise, we will continue to pay these hidden taxes. Thinking of them in this manner, it may change our approach to dealing with those who are benefitting at our expense and who don't deserve to do so. And if steps aren't taken to put an end to the hidden tax phenomenon, it will grow until it chokes the economy and corrupts our standard of living.
Oh, do go read Ferrick's column. He's a good writer, he tackles interesting topics, and today he resonated very well.
Monday, March 15, 2004
Elephants, Taxes, and Spin
This post ALMOST got the title of "Spinning Elephants" but the image it created in my mind was dreadful. It wasn't those circus elephants walking in tight circles. It was more the elephant doing break dancing.
Anyhow, remember the story about the three blind guys who are led to an elephant and asked to describe what they are touching? Or maybe in today's age of political correctness it's three visually challenged persons? Anyhow, each comes up with a different description. Everyone else knows it is an elephant.
What does this have to do with taxes?
A lot.
For those whose goal is lowering their taxes (which is almost every taxpayer, I suppose), the principal approach is to find tax benefits that apply to the taxpayer's situation. Most tax benefits require an outlay by the taxpayer or some activity by the taxpayer. Here's an example. A charitable contribution deduction is available to taxpayers who contribute cash to qualified charities. Wouldn't it be fun if a taxpayer could deduct a charitable contribution without contributing to charity? Hey, "That's fraud!" is a response that probably comes quickly to one's mind. Indeed.
It's easy to see the silliness (and illegality) of such a tactic because the law is relatively straight-forward (at least as I have described it) and because the facts are very obvious. Make the law complex or muddy up the facts and the door opens to some fancy tax footwork. Footwork quite unlike that of the spinning elephant.
Let me share two examples.
The first involves partnerships set up as investment devices designed to generate tax benefits in the form of depreciation and other deductions passed out to the partners. Over-simplifying things, many of these arrangements take advantage of the fact that the tax law allows deductions for depreciation on real estate even if the real estate is increasing in value. People who lack the resources to go it alone with this sort of investment find the investment partnership attractive because it lets them team up with others who also lack the resources to go it alone.
The arrangements require financing. If the financing is non-recourse (that is, the lender limits itself to recovering the loan by taking the real estate but not the partners' assets) then the investors get additional "basis" on account of the debt, which permits them to have the deductions passed through to them. Otherwise, basis (from the initial investment) will be insufficient to generate the desired tax benefits. The problem is that the lender wants more security than what is offered by a non-recourse debt, despite the higher interest rate on the debt. The lender either wants the debt to be recourse (can proceed against the general partner's other assets) or wants one or more of the partners to guarantee the loan (which makes it recourse). But if the debt is recourse, then the "basis" arising from the loan goes to the general partner or to the partners guaranteeing the loan. That's of no use to the investors who aren't guaranteeing the debt.
What to do?
What some want to do (and have tried) is to make the debt recourse so as to satisfy the lender and then to take the position that the debt is nonrecourse for tax purposes. The tax law prohibits this, but it doesn't stop people from setting up complex arrangments that are, in effect, smoke and mirrors to hide the reality. The hope is that the smoke will make the IRS blind, so that it thinks the elephant is an alligator or a tree trunk. Either it is or it isn't nonrecourse. (Sure, it can be partly recourse and partly non-recourse, but in that case the loan is treated as two separate loans). But a given dollar of loan is one thing or another, not both. The mindset of "I'll tell the bank one thing and I'll tell the IRS another" isn't unlike the mindset of "I'll tell the public investors one thing and I'll tell the insiders another" that gets people into trouble.
The second example involves small corporations that need a vehicle for the business. The corporation could make the purchase, but that process usually involves more paperwork, goes more slowly, and triggers higher insurance and vehicle registration costs than if acquired by an individual. So what some folks do is to have a shareholder acquire the vehicle in his or her name. However, they want the corporation to have the depreciation and other deductions associated with the vehicle. That requires that the corporation own the vehicle. But it doesn't.
A technique for dealing with this is to have the corporation and shareholder agree that the corporation is paying for the vehicle and is the owner, but that title will be in the shareholder's name. Does that work? It might, for tax purposes, because there are cases that attribute ownership not to who holds legal title but to who has the equitable (that is, the real) ownership. Fine. Except for one thing. If there is an accident, or the vehicle is stolen, and a claim is made to the insurance company, won't the insurance company figure out that the vehicle REALLY is owned by the corporation? Will the insurance company consider the placing of legal title in the shareholder's name to be a subterfuge designed to avoid higher insurance premiums? Will the insurance company deny coverage? Will it assert fraud? And what of the state or local government, which discovers that it has collected lower fees or taxes because the vehicle was treated as owned by the corporation for federal income tax purposes but as owned by the shareholder for state and local purposes?
A bit of having one's cake and eating it, too, though I never understood that phrase. If it's my cake, I get to eat it. (Supposedly after I eat the cake I no longer "have" it, but as cliches go, this one is weak.) In any event, in researching the cake phrase, it seems there are all sorts of situations where people try to get the advantages of mutually exclusive alternative situations while avoiding the disadvantages of both.
So the tax problem is simply a part of a bigger cultural phenomenon. Or is it even a deeper matter, such as basic human nature? Why not look at the choices, identify the advantages and disadvantages, weigh them, and pick? Recourse or non-recourse. Corporate ownership or individual ownership.
I suppose it's motivated by a sense of self-preservation, of maximizing benefits at any cost, of looking out for number one. I'm sure psychologists, social scientists, political analysts, and theologians have generated countless books, sermons, pamphlets, and speeches on the question.
Yet somehow, the cake disease continues to infect all sorts of things, including the tax law. Is it any wonder that tax simplication has no political support base? After all, who would vote to remove the mirrors, clear out the smoke, and put all the cards on the table? Not those who would lose (or perceive themselves losing) under those circumstances.
In the meantime, this average-height, slow, old guy is going to go play a few games in the NCAA March Madness Tournament. We'll just say I'm tall, quick, and young. It's madness, really.
Anyhow, remember the story about the three blind guys who are led to an elephant and asked to describe what they are touching? Or maybe in today's age of political correctness it's three visually challenged persons? Anyhow, each comes up with a different description. Everyone else knows it is an elephant.
What does this have to do with taxes?
A lot.
For those whose goal is lowering their taxes (which is almost every taxpayer, I suppose), the principal approach is to find tax benefits that apply to the taxpayer's situation. Most tax benefits require an outlay by the taxpayer or some activity by the taxpayer. Here's an example. A charitable contribution deduction is available to taxpayers who contribute cash to qualified charities. Wouldn't it be fun if a taxpayer could deduct a charitable contribution without contributing to charity? Hey, "That's fraud!" is a response that probably comes quickly to one's mind. Indeed.
It's easy to see the silliness (and illegality) of such a tactic because the law is relatively straight-forward (at least as I have described it) and because the facts are very obvious. Make the law complex or muddy up the facts and the door opens to some fancy tax footwork. Footwork quite unlike that of the spinning elephant.
Let me share two examples.
The first involves partnerships set up as investment devices designed to generate tax benefits in the form of depreciation and other deductions passed out to the partners. Over-simplifying things, many of these arrangements take advantage of the fact that the tax law allows deductions for depreciation on real estate even if the real estate is increasing in value. People who lack the resources to go it alone with this sort of investment find the investment partnership attractive because it lets them team up with others who also lack the resources to go it alone.
The arrangements require financing. If the financing is non-recourse (that is, the lender limits itself to recovering the loan by taking the real estate but not the partners' assets) then the investors get additional "basis" on account of the debt, which permits them to have the deductions passed through to them. Otherwise, basis (from the initial investment) will be insufficient to generate the desired tax benefits. The problem is that the lender wants more security than what is offered by a non-recourse debt, despite the higher interest rate on the debt. The lender either wants the debt to be recourse (can proceed against the general partner's other assets) or wants one or more of the partners to guarantee the loan (which makes it recourse). But if the debt is recourse, then the "basis" arising from the loan goes to the general partner or to the partners guaranteeing the loan. That's of no use to the investors who aren't guaranteeing the debt.
What to do?
What some want to do (and have tried) is to make the debt recourse so as to satisfy the lender and then to take the position that the debt is nonrecourse for tax purposes. The tax law prohibits this, but it doesn't stop people from setting up complex arrangments that are, in effect, smoke and mirrors to hide the reality. The hope is that the smoke will make the IRS blind, so that it thinks the elephant is an alligator or a tree trunk. Either it is or it isn't nonrecourse. (Sure, it can be partly recourse and partly non-recourse, but in that case the loan is treated as two separate loans). But a given dollar of loan is one thing or another, not both. The mindset of "I'll tell the bank one thing and I'll tell the IRS another" isn't unlike the mindset of "I'll tell the public investors one thing and I'll tell the insiders another" that gets people into trouble.
The second example involves small corporations that need a vehicle for the business. The corporation could make the purchase, but that process usually involves more paperwork, goes more slowly, and triggers higher insurance and vehicle registration costs than if acquired by an individual. So what some folks do is to have a shareholder acquire the vehicle in his or her name. However, they want the corporation to have the depreciation and other deductions associated with the vehicle. That requires that the corporation own the vehicle. But it doesn't.
A technique for dealing with this is to have the corporation and shareholder agree that the corporation is paying for the vehicle and is the owner, but that title will be in the shareholder's name. Does that work? It might, for tax purposes, because there are cases that attribute ownership not to who holds legal title but to who has the equitable (that is, the real) ownership. Fine. Except for one thing. If there is an accident, or the vehicle is stolen, and a claim is made to the insurance company, won't the insurance company figure out that the vehicle REALLY is owned by the corporation? Will the insurance company consider the placing of legal title in the shareholder's name to be a subterfuge designed to avoid higher insurance premiums? Will the insurance company deny coverage? Will it assert fraud? And what of the state or local government, which discovers that it has collected lower fees or taxes because the vehicle was treated as owned by the corporation for federal income tax purposes but as owned by the shareholder for state and local purposes?
A bit of having one's cake and eating it, too, though I never understood that phrase. If it's my cake, I get to eat it. (Supposedly after I eat the cake I no longer "have" it, but as cliches go, this one is weak.) In any event, in researching the cake phrase, it seems there are all sorts of situations where people try to get the advantages of mutually exclusive alternative situations while avoiding the disadvantages of both.
So the tax problem is simply a part of a bigger cultural phenomenon. Or is it even a deeper matter, such as basic human nature? Why not look at the choices, identify the advantages and disadvantages, weigh them, and pick? Recourse or non-recourse. Corporate ownership or individual ownership.
I suppose it's motivated by a sense of self-preservation, of maximizing benefits at any cost, of looking out for number one. I'm sure psychologists, social scientists, political analysts, and theologians have generated countless books, sermons, pamphlets, and speeches on the question.
Yet somehow, the cake disease continues to infect all sorts of things, including the tax law. Is it any wonder that tax simplication has no political support base? After all, who would vote to remove the mirrors, clear out the smoke, and put all the cards on the table? Not those who would lose (or perceive themselves losing) under those circumstances.
In the meantime, this average-height, slow, old guy is going to go play a few games in the NCAA March Madness Tournament. We'll just say I'm tall, quick, and young. It's madness, really.
Friday, March 12, 2004
The "Stealth Tax"
They call it the "stealth tax." It's the alternative minimum tax, or AMT for short. The federal Internal Revenue Code has one, and some states do, too, though many of the states that have one do so simply because they track the federal tax statutes generally.
The AMT was enacted in response to studies that showed many taxpayers in the highest income levels were paying income tax at rates lower than those inflicted on taxpayers in lower income levels. Some very high income taxpayers were paying no tax. It wasn't that they weren't paying what they owed. No, the tax law itself permitted them to reduce their tax liability.
Why?
Well, the tax law is full of exclusions and deductions that reduce taxable income from what it would be if there were no exclusions or deductions. There are all sorts of exclusions and deductions, some fitting in with an attempt to measure a person's net increase in wealth (business expense deductions, for example), others fitting in with the notion that the income tax should reflect ability to pay (medical expense deductions and casualty loss deductions, for example), and still others fitting in with the continued attempts by Congress to control or encourage specific behavior (charitable contribution deductions, scholarship exclusions, retirement savings deductions, and a long list of other examples).
High income taxpayers are in a better position to arrange their financial affairs so as to maximize the use of tax exclusions and deductions. After all, lower income taxpayers pretty much are limited to paying for housing, food, medical care, and other needs of themselves and their children and other dependents. There's not much left for investing in one or another of "arrangements" designed to take advantage of tax breaks (some of which were intended and some of which were not intended to be used as they are used by the high income taxpayers).
So Congress reacted in a typically obfuscatory way. Instead of dealing with the exclusions, deductions and tax rates, it created a second layer of income taxation. The approach was to require taxpayers to take taxable income and to add back certain "items of tax preference" and some other deductions and exclusions to generate "alternative minimum taxable income." It's called AMTI for short, and it could be called "taxable income as it would exist if Congress eliminated most of the deductions and exclusions that ought not exist in the first place."
Then, AMTI is reduced by an exemption amount. This creates what is called "taxable excess." (Isn't this fun?) The exemption amount is $33,750 for unmarried taxpayers, $45,000 for married taxpayers filing joint returns, and $22,500 for married individuals filing separate returns. These amounts are increased to $40,250, $58,000, and $29,000, respectively, for 2003 and 2004.... and then they are scheduled to go back down.
The taxable excess is then taxed at 26% on the first $175,000 and 28% on anything over $175,000. The resulting tax is a "tentative tax" and the AMT equals the excess of the tentative tax over the regular tax. The taxpayer pays both, so that the total tax liability is essentially the same as the tentative tax. (I say "essentially" because there are some wrinkles involving tax credits that change this, but let's keep this on the simpler side.)
So why is this a "stealth" tax?
Because those not in the know think that it applies to the very rich. After all, they were the target of the AMT when it was enacted. But because of the nature of the items of tax preference and other adjustments added back, and because the exemption amounts DO NOT CHANGE WITH INFLATION, taxpayers who are not very rich, or rich at all, are finding themselves subject to this tax. And as we move into the later part of this decade, the spreadsheet operators tell us that tens of millions, I'll repeat, TENS OF MILLIONS, of taxpayers will be subject to this tax.
What's the big deal? The big deal is that these taxpayers end up NOT GETTING THE BENEFIT of the tax cuts that the Congress has enacted. Worse, the AMT really hasn't done much to prevent the abuses it was designed to eliminate. After all, if it worked well, why would the tax shelter industry continue to prosper?
Here's an example. Stay with me. There's numbers here, but if we don't let ourselves understand the numbers, we're at the mercy of others. Others who perhaps don't have our best interests at heart.
Suppose Wanda and Harry are married and have four minor children. Harry earns $90,000 in salary, and Wanda stays at home. They pay $15,000 in state and local income taxes and real estate taxes, and $23,400 in housing interest, of which $8,000 is on the first mortgage and $15,400 is on a second mortgage. Because they have four dependent children, their 6 personal and dependency exemptions amount to $18,600.
Wanda and Harry file a joint return. They have gross income of $90,000. They deduct $57,000 of interest, taxes, and exemption amount. So they have taxable income of $33,000. The regular income tax is $3,235.
Harry and Wanda have an AMTI of $82,000. Why? Because AMTI equals their taxable income of $39,000, increased by the taxes, the interest on the second mortgage, and exemption amount not allowed for AMT purposes. $33,000 plus $49,000 equals $82,000. For 2003 and 2004 the exemption amount of $58,000 gives them a "taxable excess" of $24,000. The tentative tax, at 26%, is $6,240. That makes the AMT $3,005 ($6,240 minus $3,235). So instead of paying a regular income tax of $3,235, they must pay a total of $6,240. Their tax almost DOUBLES.
No one would call Wanda and Harry super-rich. Even folks earning $30,000, and surely folks earning $30,000 can picture life when earning $90,000 as higher scale living, would not call a married couple trying to raise four children on $90,000 a year "super rich." Comfortable? Maybe (I've omitted medical expenses and charitable contributions simply to keep the example easier to understand.)
It gets worse. In 2005, unless Congress does something, the exemption amount returns to $45,000. Ignoring changes in the amount of the personal and dependency exemption, or the regular rates, and assuming Harry continues to earn $90,000 and the amount of interest and taxes does not change, their taxable excess would be $37,000 ($82,000 minus $45,000). The tentative tax would be $9,620. The AMT would be $6,385. So instead of paying a regular income tax of $3,235, they would be required to pay a total of $9,620. Their tax almost TRIPLES.
I'll spare you the numbers if Wanda decides to get a job making, say, $20,000 a year in order to make ends meet. The tax on that $20,000 would be $5,200 (26%), not $3,000 (which is what she and Harry would expect with all the talk from Congress that "we reduced your tax rate to 15%)).
Interestingly, if Harry and Wanda earned their way with dividends from a trust fund, or capital gains, they'd be much better off, tax-wise. That, of course, is a topic I've promised to discuss in a future posting, and I will.
But for now, the question is the impact of the AMT. As mentioned, if Congress does nothing, it will affect more and more taxpayers, to the point of tens of millions. Already the attention being given to the AMT in the popular press is beginning to generate a reaction. If the Congress "fixes" the AMT so that it doesn't affect taxpayers earning less than, say, $150,000 (though I don't think that's the cut-off for "super rich"), it will cost a lot. How much? Over a ten-year period, somewhere between $328 BILLION and $647 BILLION. If you're really into the numbers, and some good discussion and charts on the AMT issue, take a look at The AMT: Out of Control, a paper presented the IRS June 2003 Research Conference by several persons affiliated with the Urban Institute.
In an era of growing deficits and increasing domestic and defense spending, how can this happen? Well, sure, some would advocate letting the deficit increase, and others will advocate that tax cuts will lower the deficit by sparking economic activity that, by being taxed, will generate revenue increases. Many others disagree. The point is, it's an expensive proposition to fix this (without some offsetting revenue increases) and it's a politically charged issue. Yet it hasn't gotten much attention from any of the presidential hopefuls. Maybe they don't know how to "soundbite" it.
So, this year, look at your tax return. Are YOU paying AMT? (Technically, a taxpayer pays AMT if the AMT tax is more than the regular tax).
So when you are wondering why all those tax cuts aren't cutting your taxes, could it be that the AMT is offsetting the cuts supposedly benefitting you? Could it be that because you make your living through a job that pays salary, rather than living on dividends and capital gains, that you don't benefit from the juicy part of the tax cut packages?
I still think tax should be taught in the 11th grade. I think high school juniors, who are of the age when some (too few) of our children begin to enter the job market, would be far more interested in numbers that affect what's in their wallets than in that abstract mathematical stuff. Oh, that would still be taught, but it's more fun using tax as an example than apples, oranges, or some other commodity.
But I doubt Congress (and the state legislatures) would be all that happy. Especially if I wrote the curriculum.
The AMT was enacted in response to studies that showed many taxpayers in the highest income levels were paying income tax at rates lower than those inflicted on taxpayers in lower income levels. Some very high income taxpayers were paying no tax. It wasn't that they weren't paying what they owed. No, the tax law itself permitted them to reduce their tax liability.
Why?
Well, the tax law is full of exclusions and deductions that reduce taxable income from what it would be if there were no exclusions or deductions. There are all sorts of exclusions and deductions, some fitting in with an attempt to measure a person's net increase in wealth (business expense deductions, for example), others fitting in with the notion that the income tax should reflect ability to pay (medical expense deductions and casualty loss deductions, for example), and still others fitting in with the continued attempts by Congress to control or encourage specific behavior (charitable contribution deductions, scholarship exclusions, retirement savings deductions, and a long list of other examples).
High income taxpayers are in a better position to arrange their financial affairs so as to maximize the use of tax exclusions and deductions. After all, lower income taxpayers pretty much are limited to paying for housing, food, medical care, and other needs of themselves and their children and other dependents. There's not much left for investing in one or another of "arrangements" designed to take advantage of tax breaks (some of which were intended and some of which were not intended to be used as they are used by the high income taxpayers).
So Congress reacted in a typically obfuscatory way. Instead of dealing with the exclusions, deductions and tax rates, it created a second layer of income taxation. The approach was to require taxpayers to take taxable income and to add back certain "items of tax preference" and some other deductions and exclusions to generate "alternative minimum taxable income." It's called AMTI for short, and it could be called "taxable income as it would exist if Congress eliminated most of the deductions and exclusions that ought not exist in the first place."
Then, AMTI is reduced by an exemption amount. This creates what is called "taxable excess." (Isn't this fun?) The exemption amount is $33,750 for unmarried taxpayers, $45,000 for married taxpayers filing joint returns, and $22,500 for married individuals filing separate returns. These amounts are increased to $40,250, $58,000, and $29,000, respectively, for 2003 and 2004.... and then they are scheduled to go back down.
The taxable excess is then taxed at 26% on the first $175,000 and 28% on anything over $175,000. The resulting tax is a "tentative tax" and the AMT equals the excess of the tentative tax over the regular tax. The taxpayer pays both, so that the total tax liability is essentially the same as the tentative tax. (I say "essentially" because there are some wrinkles involving tax credits that change this, but let's keep this on the simpler side.)
So why is this a "stealth" tax?
Because those not in the know think that it applies to the very rich. After all, they were the target of the AMT when it was enacted. But because of the nature of the items of tax preference and other adjustments added back, and because the exemption amounts DO NOT CHANGE WITH INFLATION, taxpayers who are not very rich, or rich at all, are finding themselves subject to this tax. And as we move into the later part of this decade, the spreadsheet operators tell us that tens of millions, I'll repeat, TENS OF MILLIONS, of taxpayers will be subject to this tax.
What's the big deal? The big deal is that these taxpayers end up NOT GETTING THE BENEFIT of the tax cuts that the Congress has enacted. Worse, the AMT really hasn't done much to prevent the abuses it was designed to eliminate. After all, if it worked well, why would the tax shelter industry continue to prosper?
Here's an example. Stay with me. There's numbers here, but if we don't let ourselves understand the numbers, we're at the mercy of others. Others who perhaps don't have our best interests at heart.
Suppose Wanda and Harry are married and have four minor children. Harry earns $90,000 in salary, and Wanda stays at home. They pay $15,000 in state and local income taxes and real estate taxes, and $23,400 in housing interest, of which $8,000 is on the first mortgage and $15,400 is on a second mortgage. Because they have four dependent children, their 6 personal and dependency exemptions amount to $18,600.
Wanda and Harry file a joint return. They have gross income of $90,000. They deduct $57,000 of interest, taxes, and exemption amount. So they have taxable income of $33,000. The regular income tax is $3,235.
Harry and Wanda have an AMTI of $82,000. Why? Because AMTI equals their taxable income of $39,000, increased by the taxes, the interest on the second mortgage, and exemption amount not allowed for AMT purposes. $33,000 plus $49,000 equals $82,000. For 2003 and 2004 the exemption amount of $58,000 gives them a "taxable excess" of $24,000. The tentative tax, at 26%, is $6,240. That makes the AMT $3,005 ($6,240 minus $3,235). So instead of paying a regular income tax of $3,235, they must pay a total of $6,240. Their tax almost DOUBLES.
No one would call Wanda and Harry super-rich. Even folks earning $30,000, and surely folks earning $30,000 can picture life when earning $90,000 as higher scale living, would not call a married couple trying to raise four children on $90,000 a year "super rich." Comfortable? Maybe (I've omitted medical expenses and charitable contributions simply to keep the example easier to understand.)
It gets worse. In 2005, unless Congress does something, the exemption amount returns to $45,000. Ignoring changes in the amount of the personal and dependency exemption, or the regular rates, and assuming Harry continues to earn $90,000 and the amount of interest and taxes does not change, their taxable excess would be $37,000 ($82,000 minus $45,000). The tentative tax would be $9,620. The AMT would be $6,385. So instead of paying a regular income tax of $3,235, they would be required to pay a total of $9,620. Their tax almost TRIPLES.
I'll spare you the numbers if Wanda decides to get a job making, say, $20,000 a year in order to make ends meet. The tax on that $20,000 would be $5,200 (26%), not $3,000 (which is what she and Harry would expect with all the talk from Congress that "we reduced your tax rate to 15%)).
Interestingly, if Harry and Wanda earned their way with dividends from a trust fund, or capital gains, they'd be much better off, tax-wise. That, of course, is a topic I've promised to discuss in a future posting, and I will.
But for now, the question is the impact of the AMT. As mentioned, if Congress does nothing, it will affect more and more taxpayers, to the point of tens of millions. Already the attention being given to the AMT in the popular press is beginning to generate a reaction. If the Congress "fixes" the AMT so that it doesn't affect taxpayers earning less than, say, $150,000 (though I don't think that's the cut-off for "super rich"), it will cost a lot. How much? Over a ten-year period, somewhere between $328 BILLION and $647 BILLION. If you're really into the numbers, and some good discussion and charts on the AMT issue, take a look at The AMT: Out of Control, a paper presented the IRS June 2003 Research Conference by several persons affiliated with the Urban Institute.
In an era of growing deficits and increasing domestic and defense spending, how can this happen? Well, sure, some would advocate letting the deficit increase, and others will advocate that tax cuts will lower the deficit by sparking economic activity that, by being taxed, will generate revenue increases. Many others disagree. The point is, it's an expensive proposition to fix this (without some offsetting revenue increases) and it's a politically charged issue. Yet it hasn't gotten much attention from any of the presidential hopefuls. Maybe they don't know how to "soundbite" it.
So, this year, look at your tax return. Are YOU paying AMT? (Technically, a taxpayer pays AMT if the AMT tax is more than the regular tax).
So when you are wondering why all those tax cuts aren't cutting your taxes, could it be that the AMT is offsetting the cuts supposedly benefitting you? Could it be that because you make your living through a job that pays salary, rather than living on dividends and capital gains, that you don't benefit from the juicy part of the tax cut packages?
I still think tax should be taught in the 11th grade. I think high school juniors, who are of the age when some (too few) of our children begin to enter the job market, would be far more interested in numbers that affect what's in their wallets than in that abstract mathematical stuff. Oh, that would still be taught, but it's more fun using tax as an example than apples, oranges, or some other commodity.
But I doubt Congress (and the state legislatures) would be all that happy. Especially if I wrote the curriculum.
Wednesday, March 10, 2004
Jobs, Jobs, Where are the Jobs?
Some more thoughts about jobs, or the lack of them, are in order. It looks as though the jobs issue is going to be a significant factor in the November elections.
In the political arena, the jobs issue unfortunately becomes one of partisan bickering. For a person who has lost a job, or who cannot find a job, to pin the blame on the President or the Congress presupposes too much. Likewise, to encourage that sort of thinking oversimplifies matters to the level of a mindless soundbite.
After all, some folks don't have jobs because they cannot be trusted. Who wants to hire an embezzler, inventory thief, or substance abuser? Some folks don't have jobs because they do incompetent work. Who wants to expose their business to liability because a worker was grossly negligent? And some folks don't have jobs because they don't have the requisite training.
Surely there is a place for the government to encourage, and even fund, education of adult workers whose skill sets haven't evolved to keep pace with changes in workplace technology and techniques. Whether done by grant (which is preferable) or through the tax code (not so preferable because there are those who would turn the tax provision into a tax shelter benefitting those not in need of jobs), it's at least an investment that should generate a positive return (in the form of tax revenues on increased wages).
Consider, though, that some people with inadequate skill sets are in that position because they never acquired a skill set. It's one thing to be well trained for an industry that goes extinct (buggy whip manufacturers, rotary phone repairers, and typewriter factory workers), but it's another to be lacking in skill sets because of failure to attend school, to listen to teachers, to do homework, and to work diligently. Decades of attempts to deal with the schooling problems have produced nothing but further decline among those who leave school lacking skill sets. All the money in the world isn't going to change anything unless values are changed, and if changing values means attacking the lifestyles that inculcate anti-education values, then that needs to be done. That sort of talk, though, doesn't sell in election ads.
And that brings me to a suggestion made yesterday in a discussion about the role of government, and taxes, in creating jobs. There are two ways for a government to create jobs. One is for a government to hire people. That shifts activity to the public sector, which generally is inefficient, and in the long run, bad for the economy. The inefficiencies of government bureaucracies is not a secret. The other is for the government to fund jobs in the private sector, through direct funding or tax incentives. Direct funding usually amounts to substitute government hiring, because it often brings government supervision, imposition of government work rules that are a contributor to the inefficiencies of government bureaucracy, and government controls inconsistent with a free market place. Funding through tax incentives or disincentives can work, but its design requires knowledge and understanding of how tax incentives affect the economy. Well-designed tax incentives are a rarity, even when the advocates are attempting to design an efficient tax incentive (and despite the political chest thumping, many tax incentives aren't subjected to good design attempts).
Here is an example. The most recent major tax legislation contained provisions that, in theory, encourage businesses to invest in depreciable property other than real estate. The incentives come in two major forms. One is an increase in the absolute dollar amount that the business can deduct in the year the equipment or vehicles or other property is purchased and put to use. The other is an increase in the portion of the depreciation that can be deducted in that year. Combined, the impact is substantial.
Has it worked? Presumably, yes. Businesses are investing in equipment, vehicles, and other property. Businesses are taking advantage of these provisions to purchase expensive SUVs and other vehicles, a phenomenon that has already made the popular press in terms of public outrage. But businesses also are purchasing file cabinets, desks, computers, and all other sorts of business property.
How does this increased business spending for property affect the number of jobs? The debate is underway, and it will be a few years before the facts are gathered and analyzed. One effect of increased business spending for property is that the factories making the equipment need to hire more people to staff the additional assembly lines or other manufacturing processes. If those factories are overseas, the jobs being created don't favorably shift the U.S. unemployment rate. Another effect is that much of the equipment is robotic in nature, permitting and encouraging businesses to let workers go, or to refrain from replacing a retired or deceased worker. Those annoying "press 843,403 numbers to get to a human voice" automated telephone systems put some telephone receptionists, operators, and secretaries out of work. Robots are used in the factories that make vehicles. Better technology makes equipment more reliable, and those Maytag service staff folks are not only bored but pounding the pavement. Advertisements for the robot lawn mower and the robot swimming pool cleaner are additional examples of the replacement of people with machines.
But, and this is the big but, somehow the transformation to robots and the shifting of jobs overseas has NOT improved the American economic life style. Millions of hours are wasted trying to find a human who can fix what the automatic telephone answering system cannot. There is a shortage of nurses. California continues to recruit teachers from other states to fill an expanding gap. Surely more child psychologists are needed in the school systems to head off the increases in school violence and in sociopathic behavior of adults who weren't vetted out during their school years. Is the tax law encouraging this sort of job growth?
NO.
When it comes to jobs (in contrast to investment in equipment), the tax law encourages the hiring of the downtrodden. There are tax credits for hiring ex-felons, people from economically distressed neighborhoods, and others who might otherwise not be hired. But for what sorts of jobs are these people qualified? Without a tax incentive for training, these folks are hired to do the jobs that most other Americans don't want: mowing lawns, cleaning motel rooms, and similar low-paying, low-skill positions. The theory is, I suppose, that the positions that need filling (nurses, teachers, school psychologists, humans on the other end of the phone) will be filled through the incentives of the free market, that is, through higher salaries. But that isn't happening. Why?
Why?
Think about it. Share your thoughts. And wonder, is this question being addressed where it should be? As it should be?
As I sometimes do in my classes, I'll leave this to you to consider.
In the political arena, the jobs issue unfortunately becomes one of partisan bickering. For a person who has lost a job, or who cannot find a job, to pin the blame on the President or the Congress presupposes too much. Likewise, to encourage that sort of thinking oversimplifies matters to the level of a mindless soundbite.
After all, some folks don't have jobs because they cannot be trusted. Who wants to hire an embezzler, inventory thief, or substance abuser? Some folks don't have jobs because they do incompetent work. Who wants to expose their business to liability because a worker was grossly negligent? And some folks don't have jobs because they don't have the requisite training.
Surely there is a place for the government to encourage, and even fund, education of adult workers whose skill sets haven't evolved to keep pace with changes in workplace technology and techniques. Whether done by grant (which is preferable) or through the tax code (not so preferable because there are those who would turn the tax provision into a tax shelter benefitting those not in need of jobs), it's at least an investment that should generate a positive return (in the form of tax revenues on increased wages).
Consider, though, that some people with inadequate skill sets are in that position because they never acquired a skill set. It's one thing to be well trained for an industry that goes extinct (buggy whip manufacturers, rotary phone repairers, and typewriter factory workers), but it's another to be lacking in skill sets because of failure to attend school, to listen to teachers, to do homework, and to work diligently. Decades of attempts to deal with the schooling problems have produced nothing but further decline among those who leave school lacking skill sets. All the money in the world isn't going to change anything unless values are changed, and if changing values means attacking the lifestyles that inculcate anti-education values, then that needs to be done. That sort of talk, though, doesn't sell in election ads.
And that brings me to a suggestion made yesterday in a discussion about the role of government, and taxes, in creating jobs. There are two ways for a government to create jobs. One is for a government to hire people. That shifts activity to the public sector, which generally is inefficient, and in the long run, bad for the economy. The inefficiencies of government bureaucracies is not a secret. The other is for the government to fund jobs in the private sector, through direct funding or tax incentives. Direct funding usually amounts to substitute government hiring, because it often brings government supervision, imposition of government work rules that are a contributor to the inefficiencies of government bureaucracy, and government controls inconsistent with a free market place. Funding through tax incentives or disincentives can work, but its design requires knowledge and understanding of how tax incentives affect the economy. Well-designed tax incentives are a rarity, even when the advocates are attempting to design an efficient tax incentive (and despite the political chest thumping, many tax incentives aren't subjected to good design attempts).
Here is an example. The most recent major tax legislation contained provisions that, in theory, encourage businesses to invest in depreciable property other than real estate. The incentives come in two major forms. One is an increase in the absolute dollar amount that the business can deduct in the year the equipment or vehicles or other property is purchased and put to use. The other is an increase in the portion of the depreciation that can be deducted in that year. Combined, the impact is substantial.
Has it worked? Presumably, yes. Businesses are investing in equipment, vehicles, and other property. Businesses are taking advantage of these provisions to purchase expensive SUVs and other vehicles, a phenomenon that has already made the popular press in terms of public outrage. But businesses also are purchasing file cabinets, desks, computers, and all other sorts of business property.
How does this increased business spending for property affect the number of jobs? The debate is underway, and it will be a few years before the facts are gathered and analyzed. One effect of increased business spending for property is that the factories making the equipment need to hire more people to staff the additional assembly lines or other manufacturing processes. If those factories are overseas, the jobs being created don't favorably shift the U.S. unemployment rate. Another effect is that much of the equipment is robotic in nature, permitting and encouraging businesses to let workers go, or to refrain from replacing a retired or deceased worker. Those annoying "press 843,403 numbers to get to a human voice" automated telephone systems put some telephone receptionists, operators, and secretaries out of work. Robots are used in the factories that make vehicles. Better technology makes equipment more reliable, and those Maytag service staff folks are not only bored but pounding the pavement. Advertisements for the robot lawn mower and the robot swimming pool cleaner are additional examples of the replacement of people with machines.
But, and this is the big but, somehow the transformation to robots and the shifting of jobs overseas has NOT improved the American economic life style. Millions of hours are wasted trying to find a human who can fix what the automatic telephone answering system cannot. There is a shortage of nurses. California continues to recruit teachers from other states to fill an expanding gap. Surely more child psychologists are needed in the school systems to head off the increases in school violence and in sociopathic behavior of adults who weren't vetted out during their school years. Is the tax law encouraging this sort of job growth?
NO.
When it comes to jobs (in contrast to investment in equipment), the tax law encourages the hiring of the downtrodden. There are tax credits for hiring ex-felons, people from economically distressed neighborhoods, and others who might otherwise not be hired. But for what sorts of jobs are these people qualified? Without a tax incentive for training, these folks are hired to do the jobs that most other Americans don't want: mowing lawns, cleaning motel rooms, and similar low-paying, low-skill positions. The theory is, I suppose, that the positions that need filling (nurses, teachers, school psychologists, humans on the other end of the phone) will be filled through the incentives of the free market, that is, through higher salaries. But that isn't happening. Why?
Why?
Think about it. Share your thoughts. And wonder, is this question being addressed where it should be? As it should be?
As I sometimes do in my classes, I'll leave this to you to consider.
Monday, March 08, 2004
Outsourcing and Taxes: Part 2
Having shared my thoughts about the relationships among employment, outsourcing and tax policy, it's time to explain what's going on with outsourcing in the world of tax return preparation.
The facts are fairly simple. U.S. tax return preparation businesses are sending tax returns overseas for preparation. The numbers are in the tens of thousands and by next year are expected to reach into the hundreds of thousands.
The matter is starting to get attention. This is good because there are some serious issues involved. But first, some more background.
1. Why is this happening? Simple. It's cheaper. The hourly rates paid to tax return preparers in India (which is where most, if not all, of the returns are going) are far less than those paid to tax return preparers in the U.S.
2. How would preparers in India know how to do a U.S. or a state income tax return? They take a 12-week crash course. Most presumably already read and write English, although the tax stuff is its own language so there's still a hurdle.
So what's the big deal?
Big Issue Number One: The U.S. professional hired to do the return is shipping the taxpayer-client's financial information over the Internet to people in another country. The U.S. professionals THINK they have control over the data, but we all know what hackers can do. We all know about the password on a post-it stuck onto the monitor. We all know about unscrupulous people leaking information. We all know that privacy isn't valued in the same way in all places. Do you want YOUR financial data AND YOUR SOCIAL SECURITY NUMBER and a whole bunch of other stuff making theft of your identify easy going to some place you've not been? What ever happened to dealing with the trusted, known, in-town professional? We can thank the new-world-order-corporate culture for this one. The dollar rules, and no slowing down for whomever is hurt in the stampede to the almighty dollar.
Big Issue Number Two: It's bad enough "they" do this. It's worse that they don't tell their clients. Should not clients have the right to say "if you are sending this overseas I will take my business elsewhere?" Of course. But the professionals who are doing this know that they'd lose their clientele if they disclosed what they were doing, so they don't let on. Don't they realize the mess they will be in the first time someone suffers identity theft or bank account clean-out because of this tax return preparation outsourcing? When the lawyers line up to take these cases, I'm sure the "we hate lawyers" crowd will start jeering. The lawyers wouldn't be needed if some decent ethics were being practiced.
Big Issue Number Three: Before the net is cast wide over all tax return preparers, be aware that many of them do NOT like the outsourcing idea and do not outsource. Good for them. They are motivated by a longer-term perspective that gives credit to the idea that one needs to look past the end of the short-term dollar. What's being outsourced are the "easy" or "easier" returns. The tough, complicated ones aren't being outsourced, in part because what's needed to do those returns can't be taught in the crash course. Eventually, the tax return preparers here in the U.S. doing the complex returns will move on, to retirement, to other professions, or to the next life. Traditionally, their replacements "moved up the ladder" from the ranks of those who were doing the easy and not so complicated returns. But if the outsourcing trend continues, there won't be anyone in the ranks. Then what? The ones who made the quick buck from outsourcing will also be retired, and our children and grandchildren will have not only the federal budget deficit mess to clean up but this mess, too.
These aren't the only issues. There is an issue of whether it is good national security policy to outsource, particularly tax returns. (The outsourcing of military parts manufacture and the non-existence of the tool and die industry in this country, and the effect on the nation's ability to defend itself in war, is yet another topic, one that I will leave to others.) There is an issue of whether business decisions should be made solely in reference to the bottom-line. There is an issue of whether the bottom-line is today's bottom-line or the long-term bottom-line. There is an issue of whether abuse of freedom (from government regulation) --- which some say sparked some of these problems --- will bring the usual counter-reactive suppression of such freedom, that is, a surge in government regulation. From the fire to the frying pan.
All of these issues, big and not so big, are issues that need to be discussed. This is particularly so in an election year. Sound bites don't work. The citizenry needs to be educated. A good start is disclosure.
SO: WHEN YOU TAKE YOUR TAX RETURN TO SOMEONE FOR PREPARATION, ASK THEM FOR A GUARANTEE IN WRITING, SIGNED, THAT THEY ARE NOT SHIPPING YOUR FINANCIAL AND OTHER INFORMATION TO AN OUTSOURCED SERVICE. Unless, of course, you don't care. I hope that you do.
The facts are fairly simple. U.S. tax return preparation businesses are sending tax returns overseas for preparation. The numbers are in the tens of thousands and by next year are expected to reach into the hundreds of thousands.
The matter is starting to get attention. This is good because there are some serious issues involved. But first, some more background.
1. Why is this happening? Simple. It's cheaper. The hourly rates paid to tax return preparers in India (which is where most, if not all, of the returns are going) are far less than those paid to tax return preparers in the U.S.
2. How would preparers in India know how to do a U.S. or a state income tax return? They take a 12-week crash course. Most presumably already read and write English, although the tax stuff is its own language so there's still a hurdle.
So what's the big deal?
Big Issue Number One: The U.S. professional hired to do the return is shipping the taxpayer-client's financial information over the Internet to people in another country. The U.S. professionals THINK they have control over the data, but we all know what hackers can do. We all know about the password on a post-it stuck onto the monitor. We all know about unscrupulous people leaking information. We all know that privacy isn't valued in the same way in all places. Do you want YOUR financial data AND YOUR SOCIAL SECURITY NUMBER and a whole bunch of other stuff making theft of your identify easy going to some place you've not been? What ever happened to dealing with the trusted, known, in-town professional? We can thank the new-world-order-corporate culture for this one. The dollar rules, and no slowing down for whomever is hurt in the stampede to the almighty dollar.
Big Issue Number Two: It's bad enough "they" do this. It's worse that they don't tell their clients. Should not clients have the right to say "if you are sending this overseas I will take my business elsewhere?" Of course. But the professionals who are doing this know that they'd lose their clientele if they disclosed what they were doing, so they don't let on. Don't they realize the mess they will be in the first time someone suffers identity theft or bank account clean-out because of this tax return preparation outsourcing? When the lawyers line up to take these cases, I'm sure the "we hate lawyers" crowd will start jeering. The lawyers wouldn't be needed if some decent ethics were being practiced.
Big Issue Number Three: Before the net is cast wide over all tax return preparers, be aware that many of them do NOT like the outsourcing idea and do not outsource. Good for them. They are motivated by a longer-term perspective that gives credit to the idea that one needs to look past the end of the short-term dollar. What's being outsourced are the "easy" or "easier" returns. The tough, complicated ones aren't being outsourced, in part because what's needed to do those returns can't be taught in the crash course. Eventually, the tax return preparers here in the U.S. doing the complex returns will move on, to retirement, to other professions, or to the next life. Traditionally, their replacements "moved up the ladder" from the ranks of those who were doing the easy and not so complicated returns. But if the outsourcing trend continues, there won't be anyone in the ranks. Then what? The ones who made the quick buck from outsourcing will also be retired, and our children and grandchildren will have not only the federal budget deficit mess to clean up but this mess, too.
These aren't the only issues. There is an issue of whether it is good national security policy to outsource, particularly tax returns. (The outsourcing of military parts manufacture and the non-existence of the tool and die industry in this country, and the effect on the nation's ability to defend itself in war, is yet another topic, one that I will leave to others.) There is an issue of whether business decisions should be made solely in reference to the bottom-line. There is an issue of whether the bottom-line is today's bottom-line or the long-term bottom-line. There is an issue of whether abuse of freedom (from government regulation) --- which some say sparked some of these problems --- will bring the usual counter-reactive suppression of such freedom, that is, a surge in government regulation. From the fire to the frying pan.
All of these issues, big and not so big, are issues that need to be discussed. This is particularly so in an election year. Sound bites don't work. The citizenry needs to be educated. A good start is disclosure.
SO: WHEN YOU TAKE YOUR TAX RETURN TO SOMEONE FOR PREPARATION, ASK THEM FOR A GUARANTEE IN WRITING, SIGNED, THAT THEY ARE NOT SHIPPING YOUR FINANCIAL AND OTHER INFORMATION TO AN OUTSOURCED SERVICE. Unless, of course, you don't care. I hope that you do.
Friday, March 05, 2004
Outsourcing and Taxes
It's one of those aha moments. Listening to a report on the local news radio that job increases in February were a fraction of what was expected but that the economy is booming, an inconsistency that some attribute to outsourcing, "it" suddenly made sense. Of course if the economy is booming and the jobs fueling the boom and being fueled by the boom are overseas, then domestic job growth will be very small.
The solution? Well, people can run around and blame the current President, but he's not the one firing people and moving jobs abroad. Is it the Congress? Maybe. The trend began in the 90s but no one seems to want to say anything about the past president (not that he fired anyone, either).
Enough of the blame searching. It accomplishes nothing. How about a solution?
Tax cuts have been advertised as good for the economy. Well, they have been. But the tax cuts have NOT been good for job creation (even though the current president so claims). So, the answer is to tailor the tax cuts to job creation. I'm not talking about those nickel and dime employment credits. I'm talking about job location.
So, let's simply deny deductions for compensation paid to outsource workers and independent contractors who aren't domestic enterprises. No deduction for creating jobs elsewhere. Unless the unemployment rate falls to the natural 1% baseline (there always will be unemployment at that level because of people quitting jobs, small employers dying, etc.) If the jobs are funded through foreign subsidiaries, require the American taxpayer owner of the foreign subsidiary to pay tax on the subsidiary's income, whether or not distributed to the American owner, and computed without deductions for compensation and related expenses.
Maybe THAT will send a message to the overpaid corporate executives, namely, you were given tax cuts not to pad your bottom line and increase your own pay but to give our citizens an opportunity to work.
To the argument that the jobs must be outsourced overseas because there are insufficient numbers of skilled workers in this country, employers can be allowed a deduction for the expense of training and re-training employees, whether on-site or through payments to educational institutions.
To the argument that the proposal ignores the globalization of the economy, the response is that the tax law ought not encourage the payment of poverty wages to folks in underdeveloped countries. To mollify the advocates of the global economy argument, perhaps a deduction can be allowed for outsourcing costs that include American level wages paid to workers in other countries. Guaranteed no employer is going to find that an attractive option. And that will demonstrate what this outsourcing is all about. Greed.
And to the Presidential candidates (all 4 or 5 of you): let's see if you pick up on this idea and do something positive with it rather than sniping at each other. The nation deserves better than mere blame casting.
The solution? Well, people can run around and blame the current President, but he's not the one firing people and moving jobs abroad. Is it the Congress? Maybe. The trend began in the 90s but no one seems to want to say anything about the past president (not that he fired anyone, either).
Enough of the blame searching. It accomplishes nothing. How about a solution?
Tax cuts have been advertised as good for the economy. Well, they have been. But the tax cuts have NOT been good for job creation (even though the current president so claims). So, the answer is to tailor the tax cuts to job creation. I'm not talking about those nickel and dime employment credits. I'm talking about job location.
So, let's simply deny deductions for compensation paid to outsource workers and independent contractors who aren't domestic enterprises. No deduction for creating jobs elsewhere. Unless the unemployment rate falls to the natural 1% baseline (there always will be unemployment at that level because of people quitting jobs, small employers dying, etc.) If the jobs are funded through foreign subsidiaries, require the American taxpayer owner of the foreign subsidiary to pay tax on the subsidiary's income, whether or not distributed to the American owner, and computed without deductions for compensation and related expenses.
Maybe THAT will send a message to the overpaid corporate executives, namely, you were given tax cuts not to pad your bottom line and increase your own pay but to give our citizens an opportunity to work.
To the argument that the jobs must be outsourced overseas because there are insufficient numbers of skilled workers in this country, employers can be allowed a deduction for the expense of training and re-training employees, whether on-site or through payments to educational institutions.
To the argument that the proposal ignores the globalization of the economy, the response is that the tax law ought not encourage the payment of poverty wages to folks in underdeveloped countries. To mollify the advocates of the global economy argument, perhaps a deduction can be allowed for outsourcing costs that include American level wages paid to workers in other countries. Guaranteed no employer is going to find that an attractive option. And that will demonstrate what this outsourcing is all about. Greed.
And to the Presidential candidates (all 4 or 5 of you): let's see if you pick up on this idea and do something positive with it rather than sniping at each other. The nation deserves better than mere blame casting.
Wednesday, March 03, 2004
March: In Like a Tax Lion
They say March comes in like a lion and leaves like a lamb. Weatherwise, that is. Didn't happen this year. The past few days have been several months "ahead of time" (making up for a miserably cold global warming winter).
But the entrance of March has brought a flood of tax stories. The newpapers continue to grind out infomation. And April 15 is still more than 40 days away.
Story Number One
A federal court issued an injunction against Daniel Gleason, a fellow who was selling a "Tax Toolbox"... one of those "yes, if it's too good to be true it isn't" tax evasion blueprints that claim numerous gullible victims each year. The court also permanently barred Gleason from falsely claiming he is a lawyer. Gee, the law already prohibits people from doing that but apparently Gleason needed to have it put to him personally. Gleason also falsely represented he was an adjunct professor of business law and federal taxation, and an author, editor and reviewer of articles for Newsweek magazine. Yep, the Court told him to stop making those statements. I wonder if he will comply.
He also guaranteed his tax return preparation customers that they would receive tax refunds. But Federal law specifically prohibits tax return preparers from making such guarantees. That law didn't stop Gleason. So the court required Gleason and his sales associates to post a copy of the injunction on their websites for a year. Why a year? Why not forever? A year from now it will still be illegal for him to make these false representations. The court also required Gleason to notify his customers about the injunction and to give the Justice Department, within 14 days, records identifying those customers. I'd like to see the letter he sends to his customers.
More info: The Gleason case
Story Number Two
The Philadelphia Inquirer did a write-up on the "stealth tax" which is what people are calling the Alternative Minimum Tax (AMT). The AMT was designed to make certain wealthy taxpayers did not avoid income taxation by using tax benefits available generally only to the wealthy. But because the dollar amount used to identify "wealthy taxpayers" isn't adjusted for inflation, more and more taxpayers are becoming subject to this tax. Not wealthy taxpayers. Middle-class taxpayers. Taxpayers who are surprised to find out that there is this parallel income tax system. That sneaks up on them. Hence the use of the term "stealth."
Much has been written about the AMT. Much more will be written, because by the end of the decade tens of millions of taxpayers will be caught in the AMT trap. Pressure is mounting to fix the problem but the revenue cost is very high. It's about 60 billion dollars, the amount of tax revenue reportedly lost on account of the reduction of dividend taxation to 15 percent.
Anyhow, the real problem is that the AMT is a symptom. Good physicians remediate symptoms so that they can CURE the disease. If the disease is curable. This particular tax disease IS curable. Fix the income tax system the way it ought to be fixed and there is no need for an AMT.
Right now it's all smoke and mirrors. Some people apparently prefer that it remain that way. I don't.
Story Number Three
This isn't from the newspapers. It's from a discussion on the ABA Tax Section list serve.
Someone posted a question asking how people in practice were complying with the requirements of section 751(a), a complicated provision that applies to sales of partnership interests and that is designed to separate capital gains from ordinary income. Capital gains are generally taxed at lower rates than is ordinary income. The person asking the question pointed out that in order to comply, one needs a valuation of each of the partnership's assets and not just the partnership interest generally, and that the information wasn't readily available. So I replied:
One subscriber replied that the biggest problem in tax law isn't "the interpretation or understanding of the law but establishing to factual information to apply the law."
I replied:
And that's part of the mess that the federal (and state) income tax law creates. It reflects a huge amount of micro-managed social engineering, so it requires taxpayers to keep track of all sorts of things that ordinarily would not be tracked. The non-tax business world has a market that lets someone sell a partnership interest, but the tax law then imposes an additional time and money burden by requiring the taxpayer to get valuations of each asset of the partnership. If we go back to my toll bridge comparison, imagine if the toll required the driver and passengers to keep track of the number of times each person in the car had yawned during the preceding 10 miles or 20 minutes of driving, whichever was less, but reduced by 28.5 percent if the driver and passengers had not had coffee at any time during the past 45 minutes other than coffee purchased at places more than 8 miles or 12 minutes driving time, whichever less, from the road with most direct access to the brider. If my example seems bizarre, it is, but it's the way "they" write tax laws.
Another subscriber pointed out that the obscure provisions in the tax law have the strange effect of penalizing the taxpayer who pays professional fees to locate those provisions and to determine whether they apply to the taxpayer (they often don't) whereas the taxpayer who doesn't know about the obscure provision and whose tax advisor doesn't check for them has a lower cost of complying with the law, except in the not-so-common situation in which the obscure provision applies to that taxpayer. Does anyone in Congress do his or her own tax return? If any member of Congress or staff aide is reading this, and you know that the member of Congress does, let me know. I'll do a nice write-up, bi-partisan approach. Imagine "I do my own tax return" as a campaign slogan. [need those hahaha graphic emoticons and haven't figured out yet how to put them in here.]
Story Number Four
Again, not a recent newspaper story but a tangent spinning from the previous discussion. I pointed out that one solution is to divide partnerships into tax shelters and not tax shelters, and to subject the tax shelters to the complex provisions designed to prevent abuse and to let the not tax shelters file taxes in compliance with simpler tax laws. That approach could be used with taxpayers generally, and though Congress and the IRS claim that it is (pointing out, for example, that people can use 1040-EZ (isn't that a great name for a tax form? haha)), the truth is that the previously mentioned AMT attacks taxpayers from one side, and the earned income tax credit, designed to assist low income taxpayers, creates a complex tax return preparation mess for low-income taxpayers. Nothing is EZ, really.
I also pointed out that eliminating the lower tax rates for capital gains would cut the tax law size down significantly and simplify things. To the advocates of low tax rates for capital gains who argue that part of the gain is inflation and ought not be taxed, I suggested indexing basis in the asset for inflation, as is done with many other provisions in the tax code. That suggestion brought a response that unless debt and other things also were indexed there would be possibilities for abuse.
Of course. I'd rather have indexing, where computers can multiply numbers by an index such as 1.015 than to chew up time and money deciding if a taxpayer's intent and behavior were such as to make a piece of real property inventory (ordinary income) or an investment (capital gain). Computers can't resolve the subjective stuff, yet. Back we are at the "it's the determination of the facts that makes some things in tax law so complex" argument that makes so much sense. If we don't need to know where the coffee was purchased and how many times we yawned, we're across that toll bridge in a jiffy. So we can get to the business of living.
Later I'll explore the capital gains preference and the indexing question. For now, I just wanted to include it in the roar of the March tax lion. Or is that tax lying? Or tax march? Or tax parade? (Years ago, Commerce Clearing House issued its weekly tax news updates in something called "Taxes on Parade." Try arranging one of THOSE in your hometown!)
Story Number Five
Last, but not least, is a report about the impact of the reduced tax rate on dividends. Several researchers decided to examine the facts concerning dividend payouts, and to determine if taxing dividends at the same rates as interest, wages, and lottery winnings unfavorably restricted dividend payouts. So Jennifer L. Blouin, Jana Smith Raedy, and Douglas A. Shackelford issued "Did Dividends Increase Immediately After the 2003 Reduction in Tax Rates?" This is an NBER Working Paper 10301, Feb. 2004, which you can read here.
The authors learned that dividend payouts by public companies increased a bit in the first quarter after the tax rate on dividends was reduced, but that this happened mostly in companies owned primarily by individuals. And most of the increases were special dividends rather than increases in the routine quarterly dividend. Only 17 companies (SEVENTEEN!) meaningfully increased dividend payouts.
Another story, in the National Journal's February 28, 2004 issue ("Dividend Tax Cut Benefits Only a Few") explained that among the 17 companies was Iomega, which although earning $5 million during the first 9 months of 2003, paid out $257 million in special dividends. How? Well, Iomega had done well before the dot.com technology nose-dive in 2000, and it had stashed about $500 million in offshore accounts to avoid taxes. Once the rate on dividends was reduced, Iomega pulled half of its cash reserves out and moved them to the shareholders at the low rates.
My question is whether having the shareholders spend or invest the $257 million is better for the economy than having Iomega spend or invest it. And that's the question to which there is no clear answer, as discussed in some earlier posts. Considering that the shareholders of Iomega are the ones who would be deciding what Iomega would do with the money, it's not a case simply of moving the decision making from an corporation to individuals (even if one accepts that corporations are "impersonal" whatever that means).
Another question is simply, if it's good to reduce the taxes on the $257 million, then isn't it just as good to reduce taxes on wages and interest income? Of course, if that happens and government spending doesn't get reduced, there are huge deficits, which are, of course, tax increases in their own strange way. Shouldn't the process be (1) how much must we or are we willing to spend? (2) how much tax revenue is needed to do that? (3) how is the tax burden allocated among the taxpayers? Perhaps (2a) can be added: how much tax are taxpayers willing to pay? If the answer is "not as much as is being spent" then cut the budget. Here comes a theology connection: Many churches (mine included) set preliminary budgets (through elected boards, committees or the like) and then go to the membership seeking pledges. Once pledges are tallied (and estimates made for pledges not yet returned), then the budget is re-examined. The idea that "we should spend $5x while pledging $2x" is tough to sell. But that's what politicians try to sell to the voters. Many voters are taxpayers, and (too) many taxpayers do not vote. That's another disconnect that doesn't work well in post-modern corporate America. Another topic for another day.
How will all of this play out in November? Not well. It can't be reduced to a soundbite (oh, they'll try, but they'll give us nice-sounding but substantively misleading and erroneous quips). It requires study. It forces us to look seriously at the "I want the government to provide the following [fill in your favorites from the incomplete list of jobs, health, safety, highways, education, etc.] but I want taxes to be decreased." Spin all we want, and apply post-modern thought, yet 2 plus 3 equals 5. At least it does in the world of dollars. Disagree? Hand three one-dollar bills to a sales clerk for a $5 purchase. See what happens. :-)
My thanks to Prof. Evelyn Brody for bringing these two reports to my attention.
Well, don't let the tax lion get you before it gets chased out by the tax lamb. More, later.
But the entrance of March has brought a flood of tax stories. The newpapers continue to grind out infomation. And April 15 is still more than 40 days away.
Story Number One
A federal court issued an injunction against Daniel Gleason, a fellow who was selling a "Tax Toolbox"... one of those "yes, if it's too good to be true it isn't" tax evasion blueprints that claim numerous gullible victims each year. The court also permanently barred Gleason from falsely claiming he is a lawyer. Gee, the law already prohibits people from doing that but apparently Gleason needed to have it put to him personally. Gleason also falsely represented he was an adjunct professor of business law and federal taxation, and an author, editor and reviewer of articles for Newsweek magazine. Yep, the Court told him to stop making those statements. I wonder if he will comply.
He also guaranteed his tax return preparation customers that they would receive tax refunds. But Federal law specifically prohibits tax return preparers from making such guarantees. That law didn't stop Gleason. So the court required Gleason and his sales associates to post a copy of the injunction on their websites for a year. Why a year? Why not forever? A year from now it will still be illegal for him to make these false representations. The court also required Gleason to notify his customers about the injunction and to give the Justice Department, within 14 days, records identifying those customers. I'd like to see the letter he sends to his customers.
More info: The Gleason case
Story Number Two
The Philadelphia Inquirer did a write-up on the "stealth tax" which is what people are calling the Alternative Minimum Tax (AMT). The AMT was designed to make certain wealthy taxpayers did not avoid income taxation by using tax benefits available generally only to the wealthy. But because the dollar amount used to identify "wealthy taxpayers" isn't adjusted for inflation, more and more taxpayers are becoming subject to this tax. Not wealthy taxpayers. Middle-class taxpayers. Taxpayers who are surprised to find out that there is this parallel income tax system. That sneaks up on them. Hence the use of the term "stealth."
Much has been written about the AMT. Much more will be written, because by the end of the decade tens of millions of taxpayers will be caught in the AMT trap. Pressure is mounting to fix the problem but the revenue cost is very high. It's about 60 billion dollars, the amount of tax revenue reportedly lost on account of the reduction of dividend taxation to 15 percent.
Anyhow, the real problem is that the AMT is a symptom. Good physicians remediate symptoms so that they can CURE the disease. If the disease is curable. This particular tax disease IS curable. Fix the income tax system the way it ought to be fixed and there is no need for an AMT.
Right now it's all smoke and mirrors. Some people apparently prefer that it remain that way. I don't.
Story Number Three
This isn't from the newspapers. It's from a discussion on the ABA Tax Section list serve.
Someone posted a question asking how people in practice were complying with the requirements of section 751(a), a complicated provision that applies to sales of partnership interests and that is designed to separate capital gains from ordinary income. Capital gains are generally taxed at lower rates than is ordinary income. The person asking the question pointed out that in order to comply, one needs a valuation of each of the partnership's assets and not just the partnership interest generally, and that the information wasn't readily available. So I replied:
The tax law requires that there be a valuation of the partnership assets when there is a transfer that is a sale for tax purposes. Identifying the person who bears the cost of the effort to value the assets is a matter for the parties. Ideally, the question was addressed in the partnership or LLC agreement. Ideally. Additionally, the agreement would have a provision giving the partner the right to have the requisite information provided (rather than relying on an implicit reading of the state law right to access the partnership books).
So I'd check the agreement to see what's in it on this matter. Alternatively, if that doesn't resolve the problem, then I'd approach the managing partner and explain that it's better to get this done than to have the transferor partner attach a statement to her return that says "section 751(a) possibly applicable but partnership has not (or will not) provide the information." Guaranteed, any sensible managing partner will get the valuation breakdown that is needed. It's cheaper than having the IRS do it.
I remain curious as to what is, in fact, going on in practice outside of the world in which my students and grads circulate.
One subscriber replied that the biggest problem in tax law isn't "the interpretation or understanding of the law but establishing to factual information to apply the law."
I replied:
Indeed. I keep stressing to my students that getting the facts (accurately, fully, and without surprises) is the tough part. Once the facts are known, ascertaining the law is usually easy (aside from a few splits of authority and a few "no answer" situations). Just got off the phone with a friend who had a question but within three sentences we realized that we didn't know the facts. I'm sure the phone will be ringing again. :-)
And that's part of the mess that the federal (and state) income tax law creates. It reflects a huge amount of micro-managed social engineering, so it requires taxpayers to keep track of all sorts of things that ordinarily would not be tracked. The non-tax business world has a market that lets someone sell a partnership interest, but the tax law then imposes an additional time and money burden by requiring the taxpayer to get valuations of each asset of the partnership. If we go back to my toll bridge comparison, imagine if the toll required the driver and passengers to keep track of the number of times each person in the car had yawned during the preceding 10 miles or 20 minutes of driving, whichever was less, but reduced by 28.5 percent if the driver and passengers had not had coffee at any time during the past 45 minutes other than coffee purchased at places more than 8 miles or 12 minutes driving time, whichever less, from the road with most direct access to the brider. If my example seems bizarre, it is, but it's the way "they" write tax laws.
Another subscriber pointed out that the obscure provisions in the tax law have the strange effect of penalizing the taxpayer who pays professional fees to locate those provisions and to determine whether they apply to the taxpayer (they often don't) whereas the taxpayer who doesn't know about the obscure provision and whose tax advisor doesn't check for them has a lower cost of complying with the law, except in the not-so-common situation in which the obscure provision applies to that taxpayer. Does anyone in Congress do his or her own tax return? If any member of Congress or staff aide is reading this, and you know that the member of Congress does, let me know. I'll do a nice write-up, bi-partisan approach. Imagine "I do my own tax return" as a campaign slogan. [need those hahaha graphic emoticons and haven't figured out yet how to put them in here.]
Story Number Four
Again, not a recent newspaper story but a tangent spinning from the previous discussion. I pointed out that one solution is to divide partnerships into tax shelters and not tax shelters, and to subject the tax shelters to the complex provisions designed to prevent abuse and to let the not tax shelters file taxes in compliance with simpler tax laws. That approach could be used with taxpayers generally, and though Congress and the IRS claim that it is (pointing out, for example, that people can use 1040-EZ (isn't that a great name for a tax form? haha)), the truth is that the previously mentioned AMT attacks taxpayers from one side, and the earned income tax credit, designed to assist low income taxpayers, creates a complex tax return preparation mess for low-income taxpayers. Nothing is EZ, really.
I also pointed out that eliminating the lower tax rates for capital gains would cut the tax law size down significantly and simplify things. To the advocates of low tax rates for capital gains who argue that part of the gain is inflation and ought not be taxed, I suggested indexing basis in the asset for inflation, as is done with many other provisions in the tax code. That suggestion brought a response that unless debt and other things also were indexed there would be possibilities for abuse.
Of course. I'd rather have indexing, where computers can multiply numbers by an index such as 1.015 than to chew up time and money deciding if a taxpayer's intent and behavior were such as to make a piece of real property inventory (ordinary income) or an investment (capital gain). Computers can't resolve the subjective stuff, yet. Back we are at the "it's the determination of the facts that makes some things in tax law so complex" argument that makes so much sense. If we don't need to know where the coffee was purchased and how many times we yawned, we're across that toll bridge in a jiffy. So we can get to the business of living.
Later I'll explore the capital gains preference and the indexing question. For now, I just wanted to include it in the roar of the March tax lion. Or is that tax lying? Or tax march? Or tax parade? (Years ago, Commerce Clearing House issued its weekly tax news updates in something called "Taxes on Parade." Try arranging one of THOSE in your hometown!)
Story Number Five
Last, but not least, is a report about the impact of the reduced tax rate on dividends. Several researchers decided to examine the facts concerning dividend payouts, and to determine if taxing dividends at the same rates as interest, wages, and lottery winnings unfavorably restricted dividend payouts. So Jennifer L. Blouin, Jana Smith Raedy, and Douglas A. Shackelford issued "Did Dividends Increase Immediately After the 2003 Reduction in Tax Rates?" This is an NBER Working Paper 10301, Feb. 2004, which you can read here.
The authors learned that dividend payouts by public companies increased a bit in the first quarter after the tax rate on dividends was reduced, but that this happened mostly in companies owned primarily by individuals. And most of the increases were special dividends rather than increases in the routine quarterly dividend. Only 17 companies (SEVENTEEN!) meaningfully increased dividend payouts.
Another story, in the National Journal's February 28, 2004 issue ("Dividend Tax Cut Benefits Only a Few") explained that among the 17 companies was Iomega, which although earning $5 million during the first 9 months of 2003, paid out $257 million in special dividends. How? Well, Iomega had done well before the dot.com technology nose-dive in 2000, and it had stashed about $500 million in offshore accounts to avoid taxes. Once the rate on dividends was reduced, Iomega pulled half of its cash reserves out and moved them to the shareholders at the low rates.
My question is whether having the shareholders spend or invest the $257 million is better for the economy than having Iomega spend or invest it. And that's the question to which there is no clear answer, as discussed in some earlier posts. Considering that the shareholders of Iomega are the ones who would be deciding what Iomega would do with the money, it's not a case simply of moving the decision making from an corporation to individuals (even if one accepts that corporations are "impersonal" whatever that means).
Another question is simply, if it's good to reduce the taxes on the $257 million, then isn't it just as good to reduce taxes on wages and interest income? Of course, if that happens and government spending doesn't get reduced, there are huge deficits, which are, of course, tax increases in their own strange way. Shouldn't the process be (1) how much must we or are we willing to spend? (2) how much tax revenue is needed to do that? (3) how is the tax burden allocated among the taxpayers? Perhaps (2a) can be added: how much tax are taxpayers willing to pay? If the answer is "not as much as is being spent" then cut the budget. Here comes a theology connection: Many churches (mine included) set preliminary budgets (through elected boards, committees or the like) and then go to the membership seeking pledges. Once pledges are tallied (and estimates made for pledges not yet returned), then the budget is re-examined. The idea that "we should spend $5x while pledging $2x" is tough to sell. But that's what politicians try to sell to the voters. Many voters are taxpayers, and (too) many taxpayers do not vote. That's another disconnect that doesn't work well in post-modern corporate America. Another topic for another day.
How will all of this play out in November? Not well. It can't be reduced to a soundbite (oh, they'll try, but they'll give us nice-sounding but substantively misleading and erroneous quips). It requires study. It forces us to look seriously at the "I want the government to provide the following [fill in your favorites from the incomplete list of jobs, health, safety, highways, education, etc.] but I want taxes to be decreased." Spin all we want, and apply post-modern thought, yet 2 plus 3 equals 5. At least it does in the world of dollars. Disagree? Hand three one-dollar bills to a sales clerk for a $5 purchase. See what happens. :-)
My thanks to Prof. Evelyn Brody for bringing these two reports to my attention.
Well, don't let the tax lion get you before it gets chased out by the tax lamb. More, later.
Sunday, February 29, 2004
Comments Roll In
One of the intended consequences of this blog is to plant ideas and energize discussion. To that extent, this blog is beginning to succeed. Word is getting out. One person wrote "A friend sent me your web site address." Now there's the start of five minutes of fame!! [Eventually I'll figure out how to put a pictorial emoticon in here, showing a laugh]. I've had comments from several folks, which I will share.
Note: I play it safe and identify people if they so request. Please do let me know whether you want the publicity or prefer the anonymity. Far better to go back and add a name than to try the impossible task of removing one!!
Ron Feinman shared this:
"I liked your analysis of the "spin" on the respending of the taxes by the taxpayer for dividends.
"I wonder what would happen if you included in your analysis a comparison with what happens to those tax dollars if the tax cut isn't implemented -- i.e they stay with the government and 100% are spent immediately.
"No matter what the velocity of money, the government spending produces more stimulus and (according to your spiral) more tax dollars.
"Of course you might note the savings rate (I suggest it's higher for the wealthy) provides a drain on the money to be spent from the tax savings. That is the government spends 100% of its tax dollars and the rich save a portion creating less flow."
Good questions. Ultimately it comes down to this: is it better for a given amount of money to be paid in taxes and spent by the government or to be left with citizens and spent by them? The answer is one of those "it depends" musings. The existence and size of the deficit is a factor. The nature of the spending matters; for example, in time of war the government can and must spend for the sort of goods and services that citizens generally cannot purchase. (Well, in recent years a lot of military hardware is out there for purchase, but it's illegal, and anyhow, last I looked, there weren't any aircraft carriers on e-bay. Yet. Groan.) Lastly, there is an issue of efficiency, that is, does the private sector get more for its dollar when it spends a dollar than does the federal government? New reports and anecdotes suggest, yes, that the dollar spent in the private sector is more efficient and has a greater impact on gross domestic product. But that doesn't answer the question.
The original question arose when I pondered how tax cuts could increase federal revenue. Clearly tax increases increase federal revenue. If tax cuts also increase federal revenue, then increases in federal revenue are unavoidable. Hmmm. Of course, the federal government, as the writer points out, doesn't appear to save or invest so it pumps more back into the economy than would the citizen retaining and spending what otherwise would be a tax payment. I'm unsure about this proposition. For one thing, the government does invest. It purchases and builds assets, such as buildings, military bases, equipment, and other long-term assets. For another, when a citizen invests (saves), it generates interest income, which is taxed (whereas interest payments aren't always deductible), which has a net increase effect on federal revenue. The investment, in turn, provides resources for others, for example, a business that borrows (uses the citizen's investment with the bank) in turn pays a salary that is taxed, or pays for supplies that enter into the taxable income computation of the vendor.
With all these variables, is it any wonder that different "parts" of the government reached such contrasting conclusions about the impact of cutting taxes?
Another writer pointed out that the deficit itself is a "hidden tax" that causes the value of the dollar to drop against foreign currency. This writer wondered if he was the only one considering this aspect of the economy. He's right, I surely didn't factor it into the equation. Living abroad, this writer is very aware of how the drop in dollar value diminishes the value of his income but yet causes an increase in the value (in dollars) of his assets. There's a long-term consequence sitting here, as he points out, and I join him in wondering if anyone in the Congress or Administration is studying the matter.
A third writer wrote "An interesting topic might be to review the subject of existing generation skipping trusts. I believe in the late 60's new trusts were banned but existing trusts were allowed to remain. Some will be in existence for perhaps another 100 or more years. In the debate about estate taxes it seems only fair to propose to eliminate immediately this shelter and perhaps tax the assets at the tax rate now in existence. Senators such as Ted Kennedy seem quite willing to tax others as long as they can retain their own exemption for taxes they believe are fair for others. "
Indeed, it is an interesting topic. Onto the "to write about" list it goes. Funny, I had some concern I'd not have enough ideas to keep this blog going, but I need not have worried. My brain, the growing number of tax stories in the newspapers (an AMT article today), and now ideas from visitors will keep the selection large and rich. Well, not THAT kind of rich, ha ha. Seriously, there is something unsettling about the "grandfathered" trusts, especially because a few years ago Congress did not hesitate to make some tax increases retroactive even though taxpayers who had died were denied any chance to restructure their tax planning to take the tax increases into account. Let me ponder this for a while. As they say, I'll get back to you.
Finally, yet another writer simply said, "Excellent blog -- taxation with a little humor." Thanks. I try. I teach this stuff. If it weren't for the humor, the course would be intolerable. OK, sometimes the humor gets a bit crazy, but it works for most students. Here's an example: Students have "spring" break this week, and I reminded them it's a good time to review, assimilate, and get a handle on things so that they can dig in during the second half of the semester. Knowing that many are heading out for a week of vacation, I urged them to take their tax books. "You just don't know who will sit next to you on the plane, or on the beach, look over at what you are reading, and decide to strike up a conversation. Surely you won't be at a loss for words and it will be easy to chat. After all, tax is tough to resist." Coming next: "How to Meet People By Reading and Doing Taxes" soon at amazon.books.com. Here I REALLY do need an emoticon with a look of "you're kidding, right?" Yes. Rest easy. No pick up books from me.
Thanks to all who wrote.
Note: I play it safe and identify people if they so request. Please do let me know whether you want the publicity or prefer the anonymity. Far better to go back and add a name than to try the impossible task of removing one!!
Ron Feinman shared this:
"I liked your analysis of the "spin" on the respending of the taxes by the taxpayer for dividends.
"I wonder what would happen if you included in your analysis a comparison with what happens to those tax dollars if the tax cut isn't implemented -- i.e they stay with the government and 100% are spent immediately.
"No matter what the velocity of money, the government spending produces more stimulus and (according to your spiral) more tax dollars.
"Of course you might note the savings rate (I suggest it's higher for the wealthy) provides a drain on the money to be spent from the tax savings. That is the government spends 100% of its tax dollars and the rich save a portion creating less flow."
Good questions. Ultimately it comes down to this: is it better for a given amount of money to be paid in taxes and spent by the government or to be left with citizens and spent by them? The answer is one of those "it depends" musings. The existence and size of the deficit is a factor. The nature of the spending matters; for example, in time of war the government can and must spend for the sort of goods and services that citizens generally cannot purchase. (Well, in recent years a lot of military hardware is out there for purchase, but it's illegal, and anyhow, last I looked, there weren't any aircraft carriers on e-bay. Yet. Groan.) Lastly, there is an issue of efficiency, that is, does the private sector get more for its dollar when it spends a dollar than does the federal government? New reports and anecdotes suggest, yes, that the dollar spent in the private sector is more efficient and has a greater impact on gross domestic product. But that doesn't answer the question.
The original question arose when I pondered how tax cuts could increase federal revenue. Clearly tax increases increase federal revenue. If tax cuts also increase federal revenue, then increases in federal revenue are unavoidable. Hmmm. Of course, the federal government, as the writer points out, doesn't appear to save or invest so it pumps more back into the economy than would the citizen retaining and spending what otherwise would be a tax payment. I'm unsure about this proposition. For one thing, the government does invest. It purchases and builds assets, such as buildings, military bases, equipment, and other long-term assets. For another, when a citizen invests (saves), it generates interest income, which is taxed (whereas interest payments aren't always deductible), which has a net increase effect on federal revenue. The investment, in turn, provides resources for others, for example, a business that borrows (uses the citizen's investment with the bank) in turn pays a salary that is taxed, or pays for supplies that enter into the taxable income computation of the vendor.
With all these variables, is it any wonder that different "parts" of the government reached such contrasting conclusions about the impact of cutting taxes?
Another writer pointed out that the deficit itself is a "hidden tax" that causes the value of the dollar to drop against foreign currency. This writer wondered if he was the only one considering this aspect of the economy. He's right, I surely didn't factor it into the equation. Living abroad, this writer is very aware of how the drop in dollar value diminishes the value of his income but yet causes an increase in the value (in dollars) of his assets. There's a long-term consequence sitting here, as he points out, and I join him in wondering if anyone in the Congress or Administration is studying the matter.
A third writer wrote "An interesting topic might be to review the subject of existing generation skipping trusts. I believe in the late 60's new trusts were banned but existing trusts were allowed to remain. Some will be in existence for perhaps another 100 or more years. In the debate about estate taxes it seems only fair to propose to eliminate immediately this shelter and perhaps tax the assets at the tax rate now in existence. Senators such as Ted Kennedy seem quite willing to tax others as long as they can retain their own exemption for taxes they believe are fair for others. "
Indeed, it is an interesting topic. Onto the "to write about" list it goes. Funny, I had some concern I'd not have enough ideas to keep this blog going, but I need not have worried. My brain, the growing number of tax stories in the newspapers (an AMT article today), and now ideas from visitors will keep the selection large and rich. Well, not THAT kind of rich, ha ha. Seriously, there is something unsettling about the "grandfathered" trusts, especially because a few years ago Congress did not hesitate to make some tax increases retroactive even though taxpayers who had died were denied any chance to restructure their tax planning to take the tax increases into account. Let me ponder this for a while. As they say, I'll get back to you.
Finally, yet another writer simply said, "Excellent blog -- taxation with a little humor." Thanks. I try. I teach this stuff. If it weren't for the humor, the course would be intolerable. OK, sometimes the humor gets a bit crazy, but it works for most students. Here's an example: Students have "spring" break this week, and I reminded them it's a good time to review, assimilate, and get a handle on things so that they can dig in during the second half of the semester. Knowing that many are heading out for a week of vacation, I urged them to take their tax books. "You just don't know who will sit next to you on the plane, or on the beach, look over at what you are reading, and decide to strike up a conversation. Surely you won't be at a loss for words and it will be easy to chat. After all, tax is tough to resist." Coming next: "How to Meet People By Reading and Doing Taxes" soon at amazon.books.com. Here I REALLY do need an emoticon with a look of "you're kidding, right?" Yes. Rest easy. No pick up books from me.
Thanks to all who wrote.
Friday, February 27, 2004
A Response to the Social Security Suggestions
From James Howard, a tax professional who is a ABA-TAX list colleague:
"I scanned today's blog and believe there's another alternative for social security. It's not an obvious one, and it's probably not even reasonable, but one I thought of in a discussion of tax lawyers yesterday. Everyone hates the estate tax, right? [So let's] repeal the estate tax when social security is fully funded. In the interim, remove estate tax revenue from the general revenue and apply all receipts to funding social security benefits. Isn't the whole concept of the estate tax a redistribution of wealth? If the estate tax goes into general revenue to pay government expenses, such as contract obligations, is there really a redistribution? Put that money in social security and you have an immediate and direct redistribution."
"Probably will never get any traction, because the Rep's won't defer on the tax repeal for that long and the Dem's won't tolerate the loss of receipts. But as a policy matter, it accomplishes 2 goals, elimination
of the estate tax and shoring up social security. With 3-4% of the gross revenue being added to social security, I think you could get to a level of full funding pretty quick."
This is an interesting idea. It can be categorized as a "challenge": Look, Congress, if you're serious about not letting Social Security wither and shrink, it has to be funded. It's primarily an income/wealth redistribution arrangement, so where's a good place to get the funds? The estate tax. If you're willing to make the repeal of the estate tax permanent, then make that repeal conditioned on funding social security the way you require private employers to fund pensions. No more pay as you go. Can you do that, Congress? Can you show the citizens that you're serious about this?"
Sadly, I agree that the chances of this happening aren't high. That's too bad. Goodness, at the moment I'd go for a high chance of it being discussed and made visible. That's what blogs are for (at least if anyone from Capital Hill is reading this). Thanks, James Howard, for an idea that wasn't in my head but that has found a nice place there not too far from the fire.
Now if I can figure out how to set up a poll like they have on the cable news websites.... :-)
"I scanned today's blog and believe there's another alternative for social security. It's not an obvious one, and it's probably not even reasonable, but one I thought of in a discussion of tax lawyers yesterday. Everyone hates the estate tax, right? [So let's] repeal the estate tax when social security is fully funded. In the interim, remove estate tax revenue from the general revenue and apply all receipts to funding social security benefits. Isn't the whole concept of the estate tax a redistribution of wealth? If the estate tax goes into general revenue to pay government expenses, such as contract obligations, is there really a redistribution? Put that money in social security and you have an immediate and direct redistribution."
"Probably will never get any traction, because the Rep's won't defer on the tax repeal for that long and the Dem's won't tolerate the loss of receipts. But as a policy matter, it accomplishes 2 goals, elimination
of the estate tax and shoring up social security. With 3-4% of the gross revenue being added to social security, I think you could get to a level of full funding pretty quick."
This is an interesting idea. It can be categorized as a "challenge": Look, Congress, if you're serious about not letting Social Security wither and shrink, it has to be funded. It's primarily an income/wealth redistribution arrangement, so where's a good place to get the funds? The estate tax. If you're willing to make the repeal of the estate tax permanent, then make that repeal conditioned on funding social security the way you require private employers to fund pensions. No more pay as you go. Can you do that, Congress? Can you show the citizens that you're serious about this?"
Sadly, I agree that the chances of this happening aren't high. That's too bad. Goodness, at the moment I'd go for a high chance of it being discussed and made visible. That's what blogs are for (at least if anyone from Capital Hill is reading this). Thanks, James Howard, for an idea that wasn't in my head but that has found a nice place there not too far from the fire.
Now if I can figure out how to set up a poll like they have on the cable news websites.... :-)
Triple Tax / Tax Times Three
Six stories on the front page of the Philadelphia business section and THREE are about taxes.
One of the stories is a followup on the Pennsylvania tax breaks for profitable companies and their owners who apparently cannot build or rent office space in Philadelphia without taxpayer assistance. I've already written about this, but some new news: (1) we can see a few more names of persons who would benefit or who already are getting the tax break, (2) proposals are being made to limit the tax breaks to persons who actually generate new jobs, and (3) the chairman of one company getting benefits said it was "offensive" to call the tax breaks a result of cronyism. OK, well, you didn't see that charge here. Cronies or not, a bad thing is a bad thing.
The second story describes IRS intentions of getting tough on "high risk tax evaders." Who's the target? This group: wealthy people hiding income. (They wouldn't do that now, would they? haha)
tax professionals inventing questionable tax shelters (a profession in and of itself these days)
people mis-using charitable tax-exempt status (is nothing sacred?)
people hiding income off-shore (wouldn't it be annoying if they asked for military assistance to retrieve their hidden funds?)
Let's have some fun. Here's a list of the sort of stuff the tax evaders get into (and note that no one would do any of this but for the saving of taxes with schemes that aren't economically feasible other than the tax evasion and avoidance effect): In the area of reducing taxable gain, they use arrangements with names like Tempest, InsureCo, Basis Importation, 79-21, BLAST, B-FLIP, Asset Monetization/Asset Protection (Triple By-Pass), 501(c)(15) Co., LADD, Leveraged Disposition, Othello, Prepaid Lease, Mixing Bowl, Enhanced Mixing Bowl, CPLS II, Basis Leap, Busted 351, Venture Capital Planning, Leveraged 704(c), PIF, SC2 Gain Mitigator, and PERX. To avoid or evade taxes in the international arena, they resort to things with names like U.S. Withholding Tax Eliminator, A&M Base Shifting, Alhambra, Pathfinder, and Short Option. To jack up losses and deductions, there's CCB, 172(f), Mitigation, 382, FEIGHT, CLC, Dot-Bomb-Monetization, and PALS (partnership allocating loss strategy) -- Income Absorption. Or how about Insureco, 501(c)(15) Captive, PINSCO (Personal Insurance Company), Captive Tune-Up, 21% Solution, WITS, E Replacement (WITS for Homebuilders), and Employee Benefits Captive? They take S corporations and use them for what they weren't intended to do, with things like SC2, SC2 Variation #1, SC2 Gain Mitigation, SC2 CLAS, S-corp Basis Enhancer, and SC2 Redemption Strategy. And then there's the finance and leasing stuff: AF-EXO (Alternative Financing for Exempt Organizations), Dot-Bomb-Monetization, Enhanced Venture Leasing, Inbound Cross Border Leasing, LIFT, PERX, PIF (Partnership Investment and Financing Structure), SLOTS (Sale Leaseback of Tenant Improvements), TAT. Or they go the accounting strategy route, with Bad Debt Reserve Acceleration Strategies, Inventory Methods Review, Contested Liability Acceleration Strategy, California Franchise Tax Acceleration, MEALS, Acceleration of Prepaid Expenses, Service Company Strategy, and IBNR: Incurred But Not Reported. These things sound like Pentagon weaponry, cleaning products, and video games. But it's no game. The last one says it all: "incurred but not reported." The last time I jumped on tax avoiders (namely, the tax protest crowd), I got all sorts of email from people who had fancy ways of telling me I was wrong to criticize them for wanting a free ride from the rest of us.
Who creates this stuff? To paraphrase Cal Johnson, who teaches tax law at Texas, it's a bunch of very bright people paid big bucks to outsmart IRS employees. The IRS, not permitted nor funded to pay big bucks, can't compete. The IRS is being out-brained. And it's being out-numbered.
So, the IRS wants more money to do this enforcement. They're asking a Congress that annually REDUCES the IRS budget. What fools. There has been a cadre of politicians who earn votes by running for election and re-election on an anti-IRS platform. It plays well to the crowds who don't realize that they're being persuaded to vote for someone whose chopping of the IRS ultimately will shift the tax burden from the tax cheats to these voters. Except that polls show a majority of Americans are willing to cheat on their taxes. Big surprise. Honesty isn't exactly king (or queen) in this nation anymore (and no political party is free of responsibility).
During the past 8 years, the number of IRS revenue officers is down 27%, the number of special agents (who investigate criminal tax fraud), down 13%, and the "tax gap" is officially $311 billion. Unofficially it's surely twice that or more. Budget deficits? Why blame enacted tax cuts when most of the deficit arises from "self-appointed tax cuts." How do you react to the idea of paying a higher bridge toll to offset bridge toll losses from people driving through the EZPass lane without paying, while the bridge revenue authority fires all its toll takers and police officers? Well, that's where things have been headed. What's really outrageous is that the IRS bashing that led to the funding cuts were orchestrated by hearings at which witnesses presented what is now admitted to be fraudulent testimony about alleged IRS abusive treatment of taxpayers. Not only did most of the stuff not happen, but there are clowns in Congress who think it is abusive for the IRS to send a letter to someone who owes taxes and to ask for payment. How DARE they ask someone to pay a bridge toll? Amazing.
And that brings us to the third story. Alan Greenspan once again is predicting (correctly) that the Social Security and Medicare/Medicaid system funds are going to go broke. Well, they can't go broke they way you and I can, because the government can print more dollars or borrow money to meet the obligations, but the problem is that the amounts going OUT of these funds is going to exceed the amounts coming IN by a lot. A WHOLE LOT. Right now the value of the amount due to recipients under current law is FOURTEEN TRILLION DOLLARS. And the value of what is available now plus what is scheduled to come in is a mere THREE AND A HALF TRILLION DOLLARS. The shortfall? TEN AND ONE HALF TRILLION DOLLARS. Put that in perspective. People are (rightly) worried about a quarter to half trillion dollar federal deficit.
So what happens?
1. If the government prints money, it will generate inflation. Retirees and other recipients of these programs will demand cost of living adjustments. Inflation also stagnates the economy (were you there in the late 70s? Do you remember 18% home mortgage interest rates? I do.) Long-term, very bad move.
2. If the government borrows money, it increases the federal deficit. It put pressure on the capital markets. Interest rates increase. It becomes more expensive, if not impossible, to start businesses and buy homes. Long-term, bad move.
Most economists believe that absent a better solution, the standard of living in America WILL DECLINE if either or both of the preceding paths are taken. Hey, Congress, are you listening? Hey, voters (with or without great grandchildren), are you listening?
Are there other options?
Indeed there are.
1. Raise the payroll taxes. This won't sell, will it? Well, one bit will. At present there is a cap on the amount of wages that can be taxed for Social Security. Eliminate it. Why should someone making $1,000,000 a year pay the same social security tax as someone making $100,000? The answer traditionally has been that they both would get the same benefit. That argument, though, didn't stop the Congress from eliminating the cap for the OASDI portion (the 1.45% part of the tax). Eliminating the cap will affect relatively few (though politically powerful) wage earners, so it would sell at the grass roots level. But of course it won't raise all that much money. It's not enough.
2. Cut back benefits. OUCH OUCH OUCH. I debate this with other tax law professors and I'm in the minority. See, I look at the official name of Social Security and one word pops out. You see "FICA" on your paystub and on your W-2. What does it mean? Federal INSURANCE Contributions Act. Yes, insurance. Insurance is something we purchase with no guarantee of return (other than whole life insurance, and for that the price is very high). The rest is a gamble that we want to LOSE! If I can get through life never collecting on my fire insurance policy, or my disability insurance policy, hey, I'd be much happier than if I had to file a claim. Ditto for auto theft insurance, auto collision insurance, and the rest of them. Gee, if you can tell me how to avoid my beneficiaries collecting on life insurance, you're onto something. Somehow people have come to view social security as an ENTITLEMENT. Why? Do we get paid fire insurance if there is no fire? Car theft insurance if there is no theft? NO. Some folks, of course, TRY to collect when there is no car theft, and well, not a good idea. So let's stop paying social security to people who aren't poor or who are covered by pension plans, IRAs, Roth IRAs, and all the other tax-favored retirement savings plans.
3. Let's tax social security receipts that exceed what the employee paid in. That sounds bad, but it isn't. The tax law already taxes some social security receipts, but it uses a convoluted formula that drives everyone nuts when they see it and try to apply it. Ask the students in the Basic Federal Income tax class. Ask your grandparents. Or anyone you know who gets social security. The complexity arises from a desire not to tax people who are scraping by on social security. Well, if the standard deduction and personal exemption are set at the right level (that is, don't tax poor people) then there's no harm in treating social security as gross income because it won't be taxed if the person has no other income or very little other income. Another reason for the complexity is the notion that a person should not be taxed on a recovery of their own savings. True. The Social Security Administration has a record of a person's contributions, so if the person contributed $10,000, the first $10,000 of social security ought not be taxed. Then the rest of it is included in gross income and taxed if the person's other income is enough to trigger tax liability (that is, not poor).
4. Increase the retirement age. This has been happening and I predict it will continue. After all, 70 years ago, when social security was first put into the law, not that many people lived to retirement age and most died within a few years of retirement. Now, many people in their sixties are active and healthy, and most will live for another 20 or more years. Oh, say the critics, increasing retirement age will compel people in poor health to keep working. No, it won't. They'd be eligible to retire if the statute is properly drafted. Oh, say the critics, you're forcing people to work. Or at least discouraging retirement at 65. Good, I reply. It's good to do things. It's good to work. Why not permit a scaling back of hours rather then the "all or nothing" retirement arrangement? After all, some companies already permit this. Oh, say the critics, you're taking jobs from the younger people? What younger people? When social security was enacted there were 20 workers for every retiree. In 1950, 16 workers for every retiree. Now, there's about 5, and by 2025, only 2 and a quarter workers for every retiree. It's not a matter of too many workers and not enough jobs. It's a matter of job - worker matching. And we'll get into overseas outsourcing later.
5. Let's cut out the fraud. What fraud? Well, those folks that are trying to avoid income taxes with all those tax shelters? They not only are trying (and often succeed) in avoiding the INCOME tax, they also avoid the social security and other payroll taxes. It's not that the amount in question is enough to offset a ten and a half TRILLION dollar deficit, but it is wrong to put the burden of that shortfall on honest, hard-working Americans when there are a growing few who are trying to stick their good life on everyone else's tax back. A crackdown here sends a message: this sort of behavior is no less a threat to the well being of America than is any other assault.
One of the stories is a followup on the Pennsylvania tax breaks for profitable companies and their owners who apparently cannot build or rent office space in Philadelphia without taxpayer assistance. I've already written about this, but some new news: (1) we can see a few more names of persons who would benefit or who already are getting the tax break, (2) proposals are being made to limit the tax breaks to persons who actually generate new jobs, and (3) the chairman of one company getting benefits said it was "offensive" to call the tax breaks a result of cronyism. OK, well, you didn't see that charge here. Cronies or not, a bad thing is a bad thing.
The second story describes IRS intentions of getting tough on "high risk tax evaders." Who's the target? This group:
Let's have some fun. Here's a list of the sort of stuff the tax evaders get into (and note that no one would do any of this but for the saving of taxes with schemes that aren't economically feasible other than the tax evasion and avoidance effect): In the area of reducing taxable gain, they use arrangements with names like Tempest, InsureCo, Basis Importation, 79-21, BLAST, B-FLIP, Asset Monetization/Asset Protection (Triple By-Pass), 501(c)(15) Co., LADD, Leveraged Disposition, Othello, Prepaid Lease, Mixing Bowl, Enhanced Mixing Bowl, CPLS II, Basis Leap, Busted 351, Venture Capital Planning, Leveraged 704(c), PIF, SC2 Gain Mitigator, and PERX. To avoid or evade taxes in the international arena, they resort to things with names like U.S. Withholding Tax Eliminator, A&M Base Shifting, Alhambra, Pathfinder, and Short Option. To jack up losses and deductions, there's CCB, 172(f), Mitigation, 382, FEIGHT, CLC, Dot-Bomb-Monetization, and PALS (partnership allocating loss strategy) -- Income Absorption. Or how about Insureco, 501(c)(15) Captive, PINSCO (Personal Insurance Company), Captive Tune-Up, 21% Solution, WITS, E Replacement (WITS for Homebuilders), and Employee Benefits Captive? They take S corporations and use them for what they weren't intended to do, with things like SC2, SC2 Variation #1, SC2 Gain Mitigation, SC2 CLAS, S-corp Basis Enhancer, and SC2 Redemption Strategy. And then there's the finance and leasing stuff: AF-EXO (Alternative Financing for Exempt Organizations), Dot-Bomb-Monetization, Enhanced Venture Leasing, Inbound Cross Border Leasing, LIFT, PERX, PIF (Partnership Investment and Financing Structure), SLOTS (Sale Leaseback of Tenant Improvements), TAT. Or they go the accounting strategy route, with Bad Debt Reserve Acceleration Strategies, Inventory Methods Review, Contested Liability Acceleration Strategy, California Franchise Tax Acceleration, MEALS, Acceleration of Prepaid Expenses, Service Company Strategy, and IBNR: Incurred But Not Reported. These things sound like Pentagon weaponry, cleaning products, and video games. But it's no game. The last one says it all: "incurred but not reported." The last time I jumped on tax avoiders (namely, the tax protest crowd), I got all sorts of email from people who had fancy ways of telling me I was wrong to criticize them for wanting a free ride from the rest of us.
Who creates this stuff? To paraphrase Cal Johnson, who teaches tax law at Texas, it's a bunch of very bright people paid big bucks to outsmart IRS employees. The IRS, not permitted nor funded to pay big bucks, can't compete. The IRS is being out-brained. And it's being out-numbered.
So, the IRS wants more money to do this enforcement. They're asking a Congress that annually REDUCES the IRS budget. What fools. There has been a cadre of politicians who earn votes by running for election and re-election on an anti-IRS platform. It plays well to the crowds who don't realize that they're being persuaded to vote for someone whose chopping of the IRS ultimately will shift the tax burden from the tax cheats to these voters. Except that polls show a majority of Americans are willing to cheat on their taxes. Big surprise. Honesty isn't exactly king (or queen) in this nation anymore (and no political party is free of responsibility).
During the past 8 years, the number of IRS revenue officers is down 27%, the number of special agents (who investigate criminal tax fraud), down 13%, and the "tax gap" is officially $311 billion. Unofficially it's surely twice that or more. Budget deficits? Why blame enacted tax cuts when most of the deficit arises from "self-appointed tax cuts." How do you react to the idea of paying a higher bridge toll to offset bridge toll losses from people driving through the EZPass lane without paying, while the bridge revenue authority fires all its toll takers and police officers? Well, that's where things have been headed. What's really outrageous is that the IRS bashing that led to the funding cuts were orchestrated by hearings at which witnesses presented what is now admitted to be fraudulent testimony about alleged IRS abusive treatment of taxpayers. Not only did most of the stuff not happen, but there are clowns in Congress who think it is abusive for the IRS to send a letter to someone who owes taxes and to ask for payment. How DARE they ask someone to pay a bridge toll? Amazing.
And that brings us to the third story. Alan Greenspan once again is predicting (correctly) that the Social Security and Medicare/Medicaid system funds are going to go broke. Well, they can't go broke they way you and I can, because the government can print more dollars or borrow money to meet the obligations, but the problem is that the amounts going OUT of these funds is going to exceed the amounts coming IN by a lot. A WHOLE LOT. Right now the value of the amount due to recipients under current law is FOURTEEN TRILLION DOLLARS. And the value of what is available now plus what is scheduled to come in is a mere THREE AND A HALF TRILLION DOLLARS. The shortfall? TEN AND ONE HALF TRILLION DOLLARS. Put that in perspective. People are (rightly) worried about a quarter to half trillion dollar federal deficit.
So what happens?
1. If the government prints money, it will generate inflation. Retirees and other recipients of these programs will demand cost of living adjustments. Inflation also stagnates the economy (were you there in the late 70s? Do you remember 18% home mortgage interest rates? I do.) Long-term, very bad move.
2. If the government borrows money, it increases the federal deficit. It put pressure on the capital markets. Interest rates increase. It becomes more expensive, if not impossible, to start businesses and buy homes. Long-term, bad move.
Most economists believe that absent a better solution, the standard of living in America WILL DECLINE if either or both of the preceding paths are taken. Hey, Congress, are you listening? Hey, voters (with or without great grandchildren), are you listening?
Are there other options?
Indeed there are.
1. Raise the payroll taxes. This won't sell, will it? Well, one bit will. At present there is a cap on the amount of wages that can be taxed for Social Security. Eliminate it. Why should someone making $1,000,000 a year pay the same social security tax as someone making $100,000? The answer traditionally has been that they both would get the same benefit. That argument, though, didn't stop the Congress from eliminating the cap for the OASDI portion (the 1.45% part of the tax). Eliminating the cap will affect relatively few (though politically powerful) wage earners, so it would sell at the grass roots level. But of course it won't raise all that much money. It's not enough.
2. Cut back benefits. OUCH OUCH OUCH. I debate this with other tax law professors and I'm in the minority. See, I look at the official name of Social Security and one word pops out. You see "FICA" on your paystub and on your W-2. What does it mean? Federal INSURANCE Contributions Act. Yes, insurance. Insurance is something we purchase with no guarantee of return (other than whole life insurance, and for that the price is very high). The rest is a gamble that we want to LOSE! If I can get through life never collecting on my fire insurance policy, or my disability insurance policy, hey, I'd be much happier than if I had to file a claim. Ditto for auto theft insurance, auto collision insurance, and the rest of them. Gee, if you can tell me how to avoid my beneficiaries collecting on life insurance, you're onto something. Somehow people have come to view social security as an ENTITLEMENT. Why? Do we get paid fire insurance if there is no fire? Car theft insurance if there is no theft? NO. Some folks, of course, TRY to collect when there is no car theft, and well, not a good idea. So let's stop paying social security to people who aren't poor or who are covered by pension plans, IRAs, Roth IRAs, and all the other tax-favored retirement savings plans.
3. Let's tax social security receipts that exceed what the employee paid in. That sounds bad, but it isn't. The tax law already taxes some social security receipts, but it uses a convoluted formula that drives everyone nuts when they see it and try to apply it. Ask the students in the Basic Federal Income tax class. Ask your grandparents. Or anyone you know who gets social security. The complexity arises from a desire not to tax people who are scraping by on social security. Well, if the standard deduction and personal exemption are set at the right level (that is, don't tax poor people) then there's no harm in treating social security as gross income because it won't be taxed if the person has no other income or very little other income. Another reason for the complexity is the notion that a person should not be taxed on a recovery of their own savings. True. The Social Security Administration has a record of a person's contributions, so if the person contributed $10,000, the first $10,000 of social security ought not be taxed. Then the rest of it is included in gross income and taxed if the person's other income is enough to trigger tax liability (that is, not poor).
4. Increase the retirement age. This has been happening and I predict it will continue. After all, 70 years ago, when social security was first put into the law, not that many people lived to retirement age and most died within a few years of retirement. Now, many people in their sixties are active and healthy, and most will live for another 20 or more years. Oh, say the critics, increasing retirement age will compel people in poor health to keep working. No, it won't. They'd be eligible to retire if the statute is properly drafted. Oh, say the critics, you're forcing people to work. Or at least discouraging retirement at 65. Good, I reply. It's good to do things. It's good to work. Why not permit a scaling back of hours rather then the "all or nothing" retirement arrangement? After all, some companies already permit this. Oh, say the critics, you're taking jobs from the younger people? What younger people? When social security was enacted there were 20 workers for every retiree. In 1950, 16 workers for every retiree. Now, there's about 5, and by 2025, only 2 and a quarter workers for every retiree. It's not a matter of too many workers and not enough jobs. It's a matter of job - worker matching. And we'll get into overseas outsourcing later.
5. Let's cut out the fraud. What fraud? Well, those folks that are trying to avoid income taxes with all those tax shelters? They not only are trying (and often succeed) in avoiding the INCOME tax, they also avoid the social security and other payroll taxes. It's not that the amount in question is enough to offset a ten and a half TRILLION dollar deficit, but it is wrong to put the burden of that shortfall on honest, hard-working Americans when there are a growing few who are trying to stick their good life on everyone else's tax back. A crackdown here sends a message: this sort of behavior is no less a threat to the well being of America than is any other assault.
Wednesday, February 25, 2004
Philadelphia Admits its Tax System is a Mess
Full story from the Philadelphia Inquirer
Favorite quotes and reports:
1. By Paul Levy, head of the Center City District: "The city's array of local taxes, designed for the industrial age, are hampering growth of knowledge industries that are the key to the region's future."
Why I like it: It's easy to explain by that bridge-toll comparison I use so much. Suppose that when bridges replaced ferries and automobiles replaced wagons, the toll continued to be computed on the basis of the number of mules that you were taking across the river. Because it is easy to see the silliness, it's easy to understand how the public would bring pressure on whoever set the bridge tolls to get out of the past and into the present. Other types of revenue (such as taxes) aren't so easy to understand, so the public doesn't understand why or how the system is so bad, and even after it realizes how inefficient the system is it doesn't know what to advocate. This opens the door to the politicians whose desire to be and remain elected surpasses their sense of service-leadership. The few politicians who aren't that way (yes, there are some) just don't have the clout.
2. Levy "proposed business tax breaks, akin to those in the commonwealth's Keystone Opportunity Zones, for all companies that create jobs, not just those moving to new buildings."
Why I like it: It puts the spotlight on the disservice that governments do to their citizens when they fashion tax provisions designed to benefit a few, when there are far more who do just as much, if not more, for the common good of the society. I've already shared my views on the silliness of extending the tax break to companies that don't need it, in Tax Breaks, Politician Takes. It's nice to see that there are others who understand the double whammy of a tax break that favors some but not all, and a tax break that favors those who are least in need.
Feel free to send the URL for these comments to your favorite legislator or executive branch administrator. Or your least favorite.
Favorite quotes and reports:
1. By Paul Levy, head of the Center City District: "The city's array of local taxes, designed for the industrial age, are hampering growth of knowledge industries that are the key to the region's future."
Why I like it: It's easy to explain by that bridge-toll comparison I use so much. Suppose that when bridges replaced ferries and automobiles replaced wagons, the toll continued to be computed on the basis of the number of mules that you were taking across the river. Because it is easy to see the silliness, it's easy to understand how the public would bring pressure on whoever set the bridge tolls to get out of the past and into the present. Other types of revenue (such as taxes) aren't so easy to understand, so the public doesn't understand why or how the system is so bad, and even after it realizes how inefficient the system is it doesn't know what to advocate. This opens the door to the politicians whose desire to be and remain elected surpasses their sense of service-leadership. The few politicians who aren't that way (yes, there are some) just don't have the clout.
2. Levy "proposed business tax breaks, akin to those in the commonwealth's Keystone Opportunity Zones, for all companies that create jobs, not just those moving to new buildings."
Why I like it: It puts the spotlight on the disservice that governments do to their citizens when they fashion tax provisions designed to benefit a few, when there are far more who do just as much, if not more, for the common good of the society. I've already shared my views on the silliness of extending the tax break to companies that don't need it, in Tax Breaks, Politician Takes. It's nice to see that there are others who understand the double whammy of a tax break that favors some but not all, and a tax break that favors those who are least in need.
Feel free to send the URL for these comments to your favorite legislator or executive branch administrator. Or your least favorite.
Sunday, February 22, 2004
Tax Spin: Rotating the Numbers in Circles
Well, it's fun enough, isn't it, to work through a tax return line by line, pausing every now and then to jump to another form or a worksheet, travel through that morass, and then bring a number back to the place where one left off. It's even more fun to explore the numbers that ultimately generate the forms, the lines on the forms, the instructions, and the joys of tax return preparation.
Most people don't go near this topic. It rarely makes the front pages or the soundbite news shows, but it's a topic at the very heart of the tax policy debate. And there will be a LOT of that during the summer and early fall. Election campaigns, especially presidential ones, tend to bring taxation discussions to the surface, but much of the chatter is just that, peppered with spin.
Last year Congress decided to lower the rate of tax on some corporate dividends. Of course, the major policy issue is why? If it is to reduce the tax burden on retirees depending on investment income, then the rate on interest income should have been reduced. It wasn't. If it is to encourage investment, doesn't the reduction of tax on pay-outs from the corporation encourage withdrawal of monies from the corporation supposedly being encouraged to invest and produce? And what tax reduction awaits those who invest or operate business through partnerships and LLCs? Oh, say the supporters of the lower dividend rate, it's to eliminate the double taxation of corporate profits. Corporate profits are taxed to the corporation, and when the after-tax profit is paid out as dividends, it is taxed again. But advocates of "corporate shareholder tax integration" (the notion that corporate income should be taxed once) don't offer reduced dividend taxation as the most efficient or most sensible approach. No matter, the folks who advocate the reduced dividend tax rate are the folks who brought us the reduced capital gains tax rate. And that is a topic that deserves its own post, which it will get, later. The short of it is that when two people go into the coffee shop for a latte, the person behind the counter doesn't ask if the dollar bills being offered in payment are "wages dollars," "capital gain dollars," or "dividend dollars." Note that the folks with the capital gain and dividend dollars will have more of them, proportionately, than does the person with the wages dollars.
All of that is bad enough. Now comes the spin. The Congress, through its Joint Committee on Taxation, estimates that the reduction of tax rates on dividends from 25%, 28%, 33% and 35% to 15% will cost 66.1 BILLION dollars for 2004 alone. Well, that makes sense. If the goal is to reduce taxes, one would expect that a tax cut would reduce tax revenue.
It isn't difficult to imagine that someone might challenge the computation and decide that the cost is 60 billion or 68 billion or some other amount. That's fairly common with just about every change made to the Internal Revenue Code other than the ones affecting procedure and paperwork. But the White House budget describes the dividend tax cut as a "negative tax expenditure", that is, something that INCREASES tax revenue by 26.7 billion dollars. How's that? Well, the argument is that the taxes not paid by the recipients of dividends are in turn used by them to purchase goods and services, and the providers of the goods and services then pay taxes on the income from selling those goods and services.
So, let's see. Dividend recipients save $66 billion, and spend the $66 billion. The people receiving the $66 billion pay taxes of, say, $22 billion on the $66 billion of income from the sale of goods and services (and that's not quite right, because someone selling goods isn't taxed on the sale price, but on the sale price minus the cost of the goods sold). That means the net cost of the dividend tax cut is $44 billion. But it's still a revenue loss.
Ah, wait. The people who received $66 billion in revenue from the purchase of goods and services by the dividend recipients will in turn spend the $44 billion they have left over after paying the $22 billion in taxes. So that the people selling goods and services to THEM will have $44 billion of income, generating taxes of, say, $14 billion. So the net cost of the dividend tax cut would be $30 billion.
One can play this loop over and over. Economists call it the economic multiplier. Where does it get us? Theoretically, the cost of the dividend tax cut can be reduced to zero. Maybe. But how does it then go in the other direction and generate additional tax revenue?
Now we get to another piece of tax policy argumentation. Theoretically, people who are invested in things that generate interest income will pull their investments out of those things and put it into dividend-paying stock. Well, won't that REDUCE tax revenue? Well, it would unless the dividends are paid at a higher rate than the interest rate. For example, if $100 generates $2 of interest income taxed at 25% (50 cents of tax), then the $100 needs to generate a dividend of $3.33 so that the 15% rate generates the same 50 cents in income. Does the market do that? Perhaps. If everyone is moving money INTO stocks, then stock prices will react to the demand for stocks and increase. Presumably, the increased trading in stocks will generate capital gains which, though taxed only at 15%, will generate tax revenue.
There's a lot of "ifs" going on this analysis. There's a lot of guessing. There's a lot of financial pyschological prediction. Maybe. Maybe not. Perhaps. Could be.
The point is, no one really knows until after the fact what will happen. Some tax cuts do in fact stimulate the economy and in turn generate even more revenue. Other tax cuts don't. Can one distinguish between the two types based on the nature of the tax cut? No. The outcome isn't so much whether the tax rate is cut on dividends instead of interest, or dividends instead of wages, or capital gains instead of wages. It appears that it is more a matter of the national mood, international trade and politics, and a variety of other measurable economic data and immeasurable psychological data.
What's sad is that these numbers get trotted out by their respective adherents as though they were handed down from on High. No one, at least not on the soundbite news, bothers to explain that they are nothing more than conjecture. People make voting decisions based on information of this sort, and yet it isn't information. People also reserved rooms in Houston, Texas, thinking the Philadelphia Eagles were a shoo-in. But in economics, taxation, and elections, nothing is certain except that we will continue to be spun, as the numbers are tossed in circles and circles.
It's dizzying, isn't it?
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Most people don't go near this topic. It rarely makes the front pages or the soundbite news shows, but it's a topic at the very heart of the tax policy debate. And there will be a LOT of that during the summer and early fall. Election campaigns, especially presidential ones, tend to bring taxation discussions to the surface, but much of the chatter is just that, peppered with spin.
Last year Congress decided to lower the rate of tax on some corporate dividends. Of course, the major policy issue is why? If it is to reduce the tax burden on retirees depending on investment income, then the rate on interest income should have been reduced. It wasn't. If it is to encourage investment, doesn't the reduction of tax on pay-outs from the corporation encourage withdrawal of monies from the corporation supposedly being encouraged to invest and produce? And what tax reduction awaits those who invest or operate business through partnerships and LLCs? Oh, say the supporters of the lower dividend rate, it's to eliminate the double taxation of corporate profits. Corporate profits are taxed to the corporation, and when the after-tax profit is paid out as dividends, it is taxed again. But advocates of "corporate shareholder tax integration" (the notion that corporate income should be taxed once) don't offer reduced dividend taxation as the most efficient or most sensible approach. No matter, the folks who advocate the reduced dividend tax rate are the folks who brought us the reduced capital gains tax rate. And that is a topic that deserves its own post, which it will get, later. The short of it is that when two people go into the coffee shop for a latte, the person behind the counter doesn't ask if the dollar bills being offered in payment are "wages dollars," "capital gain dollars," or "dividend dollars." Note that the folks with the capital gain and dividend dollars will have more of them, proportionately, than does the person with the wages dollars.
All of that is bad enough. Now comes the spin. The Congress, through its Joint Committee on Taxation, estimates that the reduction of tax rates on dividends from 25%, 28%, 33% and 35% to 15% will cost 66.1 BILLION dollars for 2004 alone. Well, that makes sense. If the goal is to reduce taxes, one would expect that a tax cut would reduce tax revenue.
It isn't difficult to imagine that someone might challenge the computation and decide that the cost is 60 billion or 68 billion or some other amount. That's fairly common with just about every change made to the Internal Revenue Code other than the ones affecting procedure and paperwork. But the White House budget describes the dividend tax cut as a "negative tax expenditure", that is, something that INCREASES tax revenue by 26.7 billion dollars. How's that? Well, the argument is that the taxes not paid by the recipients of dividends are in turn used by them to purchase goods and services, and the providers of the goods and services then pay taxes on the income from selling those goods and services.
So, let's see. Dividend recipients save $66 billion, and spend the $66 billion. The people receiving the $66 billion pay taxes of, say, $22 billion on the $66 billion of income from the sale of goods and services (and that's not quite right, because someone selling goods isn't taxed on the sale price, but on the sale price minus the cost of the goods sold). That means the net cost of the dividend tax cut is $44 billion. But it's still a revenue loss.
Ah, wait. The people who received $66 billion in revenue from the purchase of goods and services by the dividend recipients will in turn spend the $44 billion they have left over after paying the $22 billion in taxes. So that the people selling goods and services to THEM will have $44 billion of income, generating taxes of, say, $14 billion. So the net cost of the dividend tax cut would be $30 billion.
One can play this loop over and over. Economists call it the economic multiplier. Where does it get us? Theoretically, the cost of the dividend tax cut can be reduced to zero. Maybe. But how does it then go in the other direction and generate additional tax revenue?
Now we get to another piece of tax policy argumentation. Theoretically, people who are invested in things that generate interest income will pull their investments out of those things and put it into dividend-paying stock. Well, won't that REDUCE tax revenue? Well, it would unless the dividends are paid at a higher rate than the interest rate. For example, if $100 generates $2 of interest income taxed at 25% (50 cents of tax), then the $100 needs to generate a dividend of $3.33 so that the 15% rate generates the same 50 cents in income. Does the market do that? Perhaps. If everyone is moving money INTO stocks, then stock prices will react to the demand for stocks and increase. Presumably, the increased trading in stocks will generate capital gains which, though taxed only at 15%, will generate tax revenue.
There's a lot of "ifs" going on this analysis. There's a lot of guessing. There's a lot of financial pyschological prediction. Maybe. Maybe not. Perhaps. Could be.
The point is, no one really knows until after the fact what will happen. Some tax cuts do in fact stimulate the economy and in turn generate even more revenue. Other tax cuts don't. Can one distinguish between the two types based on the nature of the tax cut? No. The outcome isn't so much whether the tax rate is cut on dividends instead of interest, or dividends instead of wages, or capital gains instead of wages. It appears that it is more a matter of the national mood, international trade and politics, and a variety of other measurable economic data and immeasurable psychological data.
What's sad is that these numbers get trotted out by their respective adherents as though they were handed down from on High. No one, at least not on the soundbite news, bothers to explain that they are nothing more than conjecture. People make voting decisions based on information of this sort, and yet it isn't information. People also reserved rooms in Houston, Texas, thinking the Philadelphia Eagles were a shoo-in. But in economics, taxation, and elections, nothing is certain except that we will continue to be spun, as the numbers are tossed in circles and circles.
It's dizzying, isn't it?
