MauledAgain

My support for a user fee or tax on the companies drilling for, and extracting, Marcellus shale natural gas in Pennsylvania has been the subject of more than a few posts. For example, I discussed the reasons such a fee or tax makes sense in commentaries such as Tax? User Fee? Does the Name Make a Difference?, Polls, Education, Taxes, and User Fees, and Life for My Proposed Marcellus Shale User Fee?. Similarly, I have shared a my reactions to the failure of the state legislature to enact, and the refusal of the current governor to consider, such a tax or user fee. My analysis appears in posts such as A Classic Tax Increase Battle, Giving Up on Taxes = Surrendering Taxpayer Rights?, The Logic and Illogic of Tax, Texas Taxation as a Role Model for Pennsylvania?, and Voter Polls on Taxes and Electoral Polls on Taxes.

Now comes news that Pennsylvania’s governor admits he “would consider allowing municipalities to impose [impact] fees on drillers as long as the money generated stayed in those communities.” Is this the crack in the dam that eventually will open up the state to a more sensible tax policy? Perhaps. Perhaps not.

Some view the governor’s statement as no big deal, claiming that the governor previously made similar statement, including comments during the gubernatorial campaign. Others see it as an interesting backing-off by a politician strongly opposed to “any levy” on the drilling and extraction industry. Considering that the governor had been arguing, since taking office, that any sort of tax or fee imposed on these companies would obstruct the job creation that they foster, this is a significant retreat. Only a few weeks ago the chair of the governor’s Marcellus Shale Advisory Commission reacted to the notion of a tax or impact fee on the companies with the statement, “I think the governor made it very clear . . . no means no.”

The governor admits what I and others have been saying for months. There is an impact to the local communities, and that impact needs to be addressed “in some way, shape, or form.” That’s a good start.

The governor continues to insist that any revenue from impact fees, or, I suppose, user fees, on the natural gas companies must not find its way to Harrisburg. In some respects, this makes sense. To the extent that the heavy vehicles of drilling and extraction companies damage roads and bridges – damage that sometimes is visible and damage that will show up in the future – it makes sense to let the localities in which those roads and bridges are located to funnel the revenue from impact and user fees into repair of that infrastructure. It’s more efficient than having the money flow to Harrisburg so that the legislature can fight over how it gets allocated to the localities. There are drawbacks, however, to the local approach. Will localities try to attract drillers to their area by enacting fees that are less than those imposed by other areas? Possibly, though, as I stated in earlier posts, the gas companies will go where the gas can be found. Differences in rates or fee amounts among localities might affect the timing, in terms of where the companies go next, but eventually, if there is natural gas, the companies will come. This problem also can be alleviated somewhat by having the fees imposed at a county level or through use of an cross-jurisdictional authority not unlike a sewer authority. Yet the biggest disadvantage to a local impact fee is that the impact often falls beyond the boundaries of the locality or county where the drilling occurs. A solution to this challenge might be enabling legislation that permits, for example, down-stream localities to impose impact fees on drillers and extraction companies that pollute the headwaters of the stream or river. That, however, is not an easy approach to administer.

Some legislators consider impact fees to be less effective and less efficient than extraction or severance taxes. As one legislator put it, “If you ask a suburban Republican legislator to tell their constituents, ‘Yes, we're going to let your kid's tuition at Penn State go sky-high, we're going to let your property taxes go sky-high, and yet we're not going to tax the drillers,’ I don't think those constituents are going to like that." No, they won’t. They’ll find out that they voted for something other than what they thought they were voting for. It’s pressure from people who begin to realize where the uncompromising “no tax” philosophy – which still has adherents in the legislature – sells the state’s residents short, that will widen the cracks in the anti-tax strategy that have appeared with the governor’s acknowledgement that there are problems, that the problems need to be given attention and resolved, and that at least a user or impact fee is in order.

In The Logic and Illogic of Tax, I explained how critics charged that the budget cuts proposed by Pennsylvania’s governor will require local governments to increase taxes to prevent cuts in services that would adversely affect Pennsylvanians. It didn’t take long for those predictions to come true. According to this report, Philadelphia plans to increase real property assessments in 2010 so that the revenue collected from the real property tax increases by 20 percent. This will prevent the governor’s proposed cuts from, to use a city official’s terminology, devastating the city, though even with the local tax increase, education and health care services in the city will be painful. Who is hurt? The proposed cuts answer that question. Reductions are planned for programs that assist the homeless, that seek to prevent the spread of HIV, that seek to abate lead, that provide services at city health centers, that fund after-school and summer youth programs, and that are used by the Department of Human Services. It’s a good insight into who really matters to the governor and his supporters. In the meantime, by shifting the problem to the local level, the governor has found a way to deflect citizen anger.

The impact of the proposed cuts is even worse that initially predicted. According to another report, economically distressed localities in Pennsylvania now face reductions in the ratings assigned to their bonds, which will increase their financing costs, in turn making their budget shortfalls larger. Some poor school districts will lose as much as one-fourth of their budgets because of the governor’s proposed cuts, and additional cuts will be required when funds otherwise spent directly on education are diverted to pay for those increased financing costs. Worse, in some instances financing will be unavailable, requiring even further cuts. On the other hand, school districts serving wealthy neighborhoods require less state aid, are barely affected by the proposed cuts, and continue to have easier access to financing at lower cost. The bond financing problems also affect local municipalities, which will be stuck with the cost of repairing damage done by heavy trucks to roads designed for automobiles and to bridges not engineered to handle the gas extractors’ traffic. Similarly, sewer and waste treatment facility authorities in rural areas will encounter similar financing woes, as they try to repair and replace plants overwhelmed with the waste water generated by untaxed drilling and extraction. It would be interesting to map the voting patterns in wealthy and poor neighborhoods with the outcome of the gubernatorial election. It might provide yet another insight into who really matters to the governor and his supporters.

Yet another story specifically illustrates the impact of the axe-wielding budget cutting frenzy fueled by the effects of the anti-tax movement. Among the items chopped by the House of Representatives in its mad dash to cut for the sake of cutting was a 93 percent reduction in federal funding for poison centers, a cut buried so deep it didn’t make the list in Spending Cuts, Full Disclosures, Hearts, and Voices. Pennsylvania’s governor, riding the same “cut, baby, cut” train, proposes to eliminate completely all state funding for poison centers. For all intents and purposes, poison control centers will need to close down. It’s not as though there are hundreds of poison centers and that closing some would generate some sort of efficiency. The entire nation is served by only 57 centers, that handle more than 4 million calls each year. The poison control center in Philadelphia serves one-third of Pennsylvania and the entire state of Delaware. One call to the center costs the center roughly $30 but often eliminates the need for a $500 emergency-room visit. Every dollar invested in the poison center saves consumers and government agencies between $7 and $14 in medical care costs avoided by the earlier intervention. This sort of legislative short-sightedness is no less silly than that which causes the Congress to cut funding for the IRS that in turn reduces revenues by huge multiples of the spending cuts. In fact, it’s worse. Cutting funding for the IRS is part of a strategic initiative to eliminate the income and other taxes, whereas cutting funding for the poison centers couldn’t possibly be intended to increase the 82 people who die every day from poisoning. But that’s the effect it will have. Worse, the lives that are saved when poison centers issue public service alerts, such as the one it published after figuring out that people were suffering carbon monoxide poisoning from sitting in cars with idling engines and tail pipes stuck in snow banks, will now be lost. It’s rather frightening to live in a country where some people would rather cause the closing of poison centers, despite the increase in poisoning deaths that would ensue, because they will resist to the last penny any attempt to revoke ill-advised and unjustified tax cuts and any effort to make businesses pay for the costs they impose on the public.

A bill introduced a few days ago by Representative John Lewis proposes a new tax break. According to the Library of Congress bill tracker, the actual text of the bill has not yet been provided. If that link doesn’t work, as often is the case with Library of Congress legislative links, try this one, though when last checked, it too did not have the text of the bill. The title of the bill, however, provides enough information to warrant serious questions about the wisdom of enacting yet another revenue-reducing tax break. The bill’s title is as follows: “To amend the Internal Revenue Code of 1986 to provide that a deduction equal to fair market value shall be allowed for charitable contributions of literary, musical, artistic, or scholarly compositions created by the donor.

Why does this proposed new tax break make little sense? Aside from generating a reduction in tax revenue at a time when the federal budget deficit poses a significant threat to the nation’s economic welfare, the bill gives special treatment to a narrow class of taxpayers that is not available for other taxpayers who provide benefits to charities in the form of benefits originating in the taxpayer’s labor. Under current law, a person who performs services for a charity is not permitted to deduct the value of the person’s services. The principal justification for this treatment is that the person performing the services does not include the value of the services in gross income. This principle applies even if the person’s labor produces tangible property for the charity. Think, for example, of volunteers whose labor contributes to the construction of a building for a charity.

Under the proposed legislation, a person who creates a book, a song, a mural, a painting, a sculpture, or some other “literary, musical, artistic, or scholarly composition” and who donates it to a charity will be entitled to a deduction even though the person does not include anything in gross income. Perhaps the bill has language to distinguish between something created for the charity and something created for sale to the public that the person donates to the charity after deciding that public disinterest in the item requires removal of unsold products taking up space needed for newer creations.

Even if the proposed legislation is limited to “literary, musical, artistic, or scholarly” items created for a charity, and I don’t think that it is, the proposal is unwise. Consider a group of people who volunteer to build a structure for a charity. Some of the people work on the foundation, some lay bricks, some do carpentry, some wire the switches and light fixtures, some put down tile, and so on. One of the volunteers paints a mural on the side of the building. Why should that volunteer obtain a tax break when the other volunteers do not? Has the sense of fairness totally departed from the nation’s capital?

As seemingly written, taxpayers who paint the walls of the building being constructed for a charity are likely to claim that they are artists. And, in a sense, they are. Is not all of life art in the widest sense of the word? What about the volunteer who designs and carves a banister for the stairway? What about the person who lays tiles in an artistic style? Will the people who volunteer at a soup kitchens claim that they are sharing “artistry” in putting together a soup with a unique blend of ingredients? There is, of course, those skills wrapped into the phrase “culinary arts.” Is it sensible to create a situation in which government and private sector resources will be invested in the determination of who is and is not an artist and in the identification of things that constitute art and the things that do not? All of this discussion ignores the additional complexity of investing resources into the determination of the value of the items within the scope of the legislation.

And it can be even more alarming. Consider this tantalizing question. Is the person who volunteers to do a tax return for the clients of a charitable organization making a charitable contribution of a literary composition? A scholarly composition? An artistic composition? You decide.

Addendum: Joe Kristan already did decide. His post is an absolute must-read.

Legislative Follow-up: Thanks to an alert from Russell A. Willis, III, I learned that the text of the bill has now appeared, and can be found at Govtrack. Nothing in the text of the bill addresses any of the concerns that I raised.

Additional Note: The bill requires that the item in question be created no less than eighteen months before contribution. Careful planners will find ways to delay the actual contribution, perhaps through transferring use rather than title to the charity until eighteen months elapse, or by having the volunteer create but hold onto the item for eighteen months. The eighteen-month rule might foreclose the soup kitchen example, but when it comes to something like a shawl or chair restoration ministry, it's fairly easy to advise the volunteers to make the shawl or fix the chair and then wait eighteen months to transfer title to the charity. Other than creating jobs for tax practitioners for whom this bill would create work, at the expense of charities and volunteers paying for the advice unless the tax practitioner decides to create the advice and then contribute it eighteen months and a day later, the proposed legislation is yet another example of well-intentioned theoretical ideas failing when they arrive in the practice world.

Ten days ago, in The Logic and Illogic of Tax, I noted that although at least 60 percent of Pennsylvanians support a tax on Marcellus shale natural gas extraction and production companies, the governor continues to oppose any sort of user fee or tax to compel these companies to defray the economic burdens they impose on the state and its citizens. Somewhat rhetorically, I wondered “how a person whose anti-tax stance is contrary to the wishes of at least 60 percent of the population gets elected.” Last week, following up on that post, I noted in Texas Taxation as a Role Model for Pennsylvania? that the governor seems single-mindedly intent on turning Pennsylvania into another Texas, an outcome that does not bode well for most Pennsylvanians. Now comes a new poll from the Franklin and Marshall College Floyd Institute for Public Policy Center for Opinion Research that confirms widespread opposition not only to the governor’s anti-tax stance but to the budget cuts he proposes to defray the cost of opposing tax increases.

The latest poll shows that 62 percent of Pennsylvanians support a tax on the natural gas extraction and production companies. Even more – 72 percent – support new taxes on the sale of smokeless tobacco. Slightly more than half want the sales tax expanded to cover more items. On the other hand, only 37 percent support an increase in business taxes, only 36 percent support an increase in the sales tax rate, and only 27 percent support an increase in the state income tax. In terms of spending cuts, the only proposal to gather more than majority support – specifically, 60 percent – is a reduction in the number of state employees. When it comes to reducing pay and benefits for public employees, only 45 percent step up in support, while 43 percent support cuts in prison funding, a mere 28 percent support the governor’s 50-percent cuts in state funding for public universities, an mere 26 percent support his proposed cuts in Medicaid, and a paltry 19 percent favor his plan to reduce state funding for local school districts.

So again, I ask, how is it that the state has a governor so out of tune with a majority of its citizens? It’s not a matter of someone who has been in office for several years or more who has evolved or changed. The governor has been in office for barely two months. Something seems strange. The governor’s response is rather interesting. As reported in this story, Corbett quipped, “We didn't campaign based on polls, and we're not going to govern based on a poll." But somehow he was elected at the polls.

There are several possibilities for the disconnect between the governor and the populace. The evidence is insufficient to identify any one of them as the sole explanation.

One possibility is that the people responding to the Franklin and Marshall poll didn’t vote. In other words, the segment of the state’s population that voted in the gubernatorial election is not representational of the state’s population generally. In that instance, those who chose not to vote and who dislike what the governor plans to do have only themselves to blame for sitting out the election. Eligible voters who think that by not voting they are sending some sort of signal that they are abstaining nonetheless are casting votes in favor of the person for whom they would not have voted had they shown up at the election booth last November.

A second possibility is that voters did not understand what Corbett was saying during the campaign, or misunderstood what he was saying. Although this seems unlikely because Corbett was very up-front with his opposition to taxes and his desire to chop state spending, it is not implausible that some people figured this was campaign rhetoric and that he didn’t mean what he said. To his credit, Corbett meant what he said. It’s just unfortunate that what he means and says is not the prescription for the state’s ills.

A third possibility is that too many voters subscribe to the “don’t raise taxes and don’t cut spending” approach that has created the fiscal mess afflicting the federal government and all but one or two state governments. I previously addressed this oxymoronic perspective more than a year ago in Poll on Tax and Spending Illustrates Voter Inconsistency and six months ago in A Grander Delusion: Cut Taxes, Don’t Cut Spending, Cut the Deficit . More specifically, too many voters favor tax reductions for themselves, spending cuts for programs from which they don’t benefit, and spending increases for programs from which they benefit. Matched against the array of taxes and spending programs, consensus becomes impossible. It can manifest itself in the sort of outcome evident in Pennsylvania, a governor whose policies, when reduced to details, conflicts with the wishes of the state’s population. Here’s an example. The poll also revealed that only 35 percent of respondents want to put tolls on the state’s major highways. Would a fair guess be that most of those 35 percent do not drive, drive infrequently, or do not use the major highways? One of the many advantages of user fees is that it connects what the citizen is paying with what the citizen is getting, a concept consistent with a recent study showing that letting taxpayers designate the use of what they pay causes them to “look more favorably on paying taxes.”

A fourth possibility is one that I raised in The Logic and Illogic of Tax, reflecting information provided in, among others, this story and this report. The latter goes so far as to suggest, “The governor isn't ignoring the polls because he's a man of principle, but he's ignoring the polls because the people of Pennsylvania don't want what's good for his billionaire campaign donors from Boca Raton and from Oklahoma.”

A fifth possibility is one that can be discovered by reading the comments to the previously cited report, or the comments to the many other stories dealing with government budget crises. It is manifestly apparent that many people do not understand macroeconomics, microeconomics, tax policy, or public finance. Of course an extraction tax would be passed by the taxed companies onto their customers, but those customers are principally in other states. Pennsylvanians, in the meantime, are paying for the taxes imposed by other states on the companies that sell gasoline, oil, and all sorts of other products to Pennsylvanians. In other words, failure to tax out-of-state companies, while other states are taxing Pennsylvania companies and, by taxing out-of-state companies doing business in Pennsylvania indirectly taxing Pennsylvanians, causes public revenue to flow out of Pennsylvania into other states. Who really pays those extraction taxes imposed by Texas? Come to think of it, it appears the governor also doesn’t understand public finance and tax policy, else in his fervent attempt to emulate Texas – see Texas Taxation as a Role Model for Pennsylvania? – he would follow its blueprint and tax the extraction companies. This reasoning brings the spotlight back to the fourth possibility.

The current disconnect in Pennsylvania probably is attributable to some combination of the preceding five factors, though the second possibility deserves little weight and the fourth carries much more impact than people realize or prefer. None of these factors is unchangeable, though decades of trying to get more Americans to the voting booth and efforts to curtail external interference in the electoral process have repeatedly come up short. Increasing voter education with respect to public finance, economics, and tax policy has always been difficult, and will become increasingly so as politicians continue to axe funding for education, perhaps because an educated electorate is perceived to be a danger, and a badly educated electorate – getting its learning from anyone who shows up on cable television or the internet, credentialed or not – seems to be more conducive to the sort of politics now afflicting this nation.

Perhaps in the long run, the short term exacerbation of the public finance crisis will be a good thing. Perhaps, after voters figure out that by voting for a “no taxes” gubernatorial candidate they ended up voting for increased local taxes, they will re-evaluate the “we can have guns and butter without anyone paying much of anything in taxes” promises of the siren-song politicians. The tough talk is more than “no taxes, cut spending.” The tough talk is, “You can avoid more state and local taxes by gutting public education, health care, police and fire protection, highway maintenance, and just about every other benefit you take for granted and will need to purchase on the private market at a higher price, or you can maintain quality education, acceptable roads, public safety, and the other benefits of well-run government by getting out of your head the idea that life as an adult brings the same ‘something for nothing’ that blessed a few too many children.” The problem is that people willing to provide that tough talk aren’t going to get elected, because the people financing campaigns want nothing of it, even if a majority of the voters believe it, want to hear it, and want to see it put into action.

Last week, in The Logic and Illogic of Tax, I questioned the claim by the governor of Pennsylvania, Tom Corbett, that if he succeeds in preventing the imposition of taxes or user fees on Marcellus shale gas drillers and producers, those businesses will decide to “move here and use the state as a base to drill deeper, to the gassy Utica Shale.” Corbett claims that this can happen “as long as ‘we don't scare off these industries with new taxes.’” I pointed out that taxes or no taxes, there’s money to be made, lots of money, and that gas drillers won’t stay home if Pennsylvania imposes on them the burden of paying for the costs they impose on the state and its citizens. I noted that every other state with natural gas resources imposes taxes and user fees, and the gas companies have not abandoned those states.

In his Wednesday Philadelphia Inquirer column, Joe DiStefano shared the outcome of his attempt to prove or disprove the governor’s claim. DiStefano spoke with Sid Smith, a Texan who lives in the Philadelphia suburbs and works in center city. DiStefano asked Smith if the oil companies that left Pennsylvania some years ago, such as Atlantic Richfield, would likely seek to move their corporate headquarters back to Pennsylvania. Smith’s response, “[T]hey’re not dying to come back.” Apparently, it is easier to do business in Houston because one government agency is responsible for “real estate, leasing, licensing, and tax questions.” Pennsylvania’s tax and regulatory regime is, in contrast, too complicated.

The prospect of a tax or user fee isn’t the issue. Echoing my comments in The Logic and Illogic of Tax, that the gas companies will show up, tax or no tax, Smith explained, “Companies want the gas, and they’ll pay the tax.” He added that “Pennsylvania may be passing up a good thing that could benefit all industries.” Texas, for example, raises so much revenue from its energy taxes that it doesn’t have an income tax. Its energy taxes did not discourage gas companies from doing business there. But rest assured, the governor will not permit logic and common sense to get in the way of his inflexible opposition to making gas companies defray the costs otherwise imposed on the state and its citizens. Those costs, according to Smith, include the “drilling byproducts and wastewater accumulating” in rural Pennsylvania. Says Smith, “Ponds like that are never a good story on any property.” The governor must think that when it comes time to deal with the short-term and long-term consequences, the taxpaying public should foot the bill.

Pennsylvania’s new governor also expressed hope that “Big Gas will make Pennsylvania the Texas of the natural gas boom.” In his Philadelphia Inquirer column, John Baer considers what that would mean. He also wonders what it is about Texas that has such appeal for Tom Corbett. Is it because Corbett, “a law-and-order former prosecutor” likes the fact “Texas executes more people than any state in the nation”? Is it because Corbett likes the fact that public employees in Texas have no bargaining rights? Is it any wonder that Texas state employees “rank last nationally in benefits and haven't gotten a cost-of-living raise in a decade”? Or perhaps it is the wonderful public education system in Texas, ranked 30th in a 2010 CNBC report that puts Pennsylvania in fourth place. Baer points out that this year’s U.S. News & World Report rankings of top-50 universities lists four in Pennsylvania and two in Texas, while its top-50 college rankings put eight in Pennsylvania and zero in Texas. In the meantime, the governor of Texas proposes to cut $9 billion from education funding. What a role model for Pennsylvania’s new governor. Baer then provides several “appealing” things about Texas, including its rank as 45th in tax burden, compared to Pennsylvania’s 10th-place position.

Is it any wonder that Texas scores so badly in education? “You get what you pay for” has more than a ring of truth to it. It’s also true that Texas came in first place in that 2010 CNBC poll in technology, transportation, business friendliness, cost of doing business, quality of life, and state economy. How did that happen? Obviously, businesses prefer low taxes, move to Texas, causing in-migration of population from other states with those people bringing with them the education acquired elsewhere, and then oppose and market opposition to tax revenues to fund public education. So will the children of those who emigrated to Texas be as well educated as their parents? What’s next? Yet another $9 billion funding reduction? At what point comes the proposal to close all the schools because doing so will save money and permit reducing taxes to even lower levels? Perhaps if someone demonstrates that the stream of budget cuts pushed the children of Texas higher and higher in educational achievement, I would buy the argument that it’s all about efficiency. It’s not. Let’s see where Texas stands in quality of life 10, 20, 30 years from now, when the fruits of underfunding education are ready for harvest.

Texas, at least, knows that it can tax its energy sector, even to the point of amounts exceeding the costs those businesses impose on the state, without chasing out those companies. I could say that I wonder why it is so difficult for Pennsylvania’s governor to understand that Pennsylvania can and will become the “Texas of Natural Gas” even with a modest tax, but I don’t so wonder, because I’m confident the governor understands that point. It’s simply that he rejects the idea of gas companies paying their own way. I explained why in The Logic and Illogic of Tax.

Consider a no-energy-tax Texas as the role model for Pennsylvania. I wonder how Pennsylvanians would vote if they knew that’s what they would be getting. Sadly, that’s a question that can be asked about too many electoral outcomes.

My post on Monday, Getting Specific with Tax-Related Deficit Reduction Ideas: Making Section 85 Fairer and Simpler, brought a helpful response from Mary O’Keeffe of Bed Buffaloes in Your Tax Code. Mary focused on my observations that the change in social security taxation set forth by the Congressional Budget Office, which I endorse, would, in my words, require “some retirees not currently filing tax returns [to] file them” and that “I would not be surprised to discover that most retirees file tax returns in any event, for a variety of reasons.” Mary pointed out that under current law, many retirees do not file tax returns, and that in 2008, when retirees were required to file returns in order to obtain the $300 rebate, “complete and utter chaos” prevailed because there were so many retirees who had not been filing federal income tax returns for many years.

So I stand corrected. Many retirees apparently are not filing federal income tax returns. Almost all of the retirees who talk taxes with me file tax returns, but perhaps that is why they talk taxes with me! Unfortunately, most retirees who are not required to file a return are living on the edge, because they have so little income, aside from social security, which is the reason they aren’t required to file. The few who aren’t required to file because their income is significant but attributable almost entirely to tax-exempt interest are the exception. Mary pointed out that according to a Social Security Administration fact sheet, for roughly one-fifth of married couples receiving social security and two-fifths of unmarried persons receiving social security, their social security benefits account for 90 percent or more of their income.

However, it seems that switching to a system that requires retirees to include in gross income the portion of social security benefits representing gain, that is, the excess of benefits over what the retiree paid into the system, will shift, at most, few retirees from the “does not need to file” to the “must file” category. The reason is that, for retirees who have little or no other income, the standard deduction and personal exemption will “shelter” the social security gross income. In 2011, a married couple, both over 65, has a combined standard deduction and personal exemption of $21,300 (standard deduction of $13,900 ($11,600 plus (2 x $1,150)) plus personal exemption of $7,400 (2 x $3,700)). An unmarried individual has a combined standard deduction and personal exemption of $10,950 (standard deduction of $7,250 ($5,800 plus $1,450) plus personal exemption of $3,700). According to this information, the typical annual social security benefit payment for a married couple, both of whom are entitled to benefits, is roughly $22,500. Considering that under the CBO proposal approximately 80 percent, or $18,000, would be taxed, a married retiree couple could have as much as $3,300 of other income without needing to file a return. For unmarried retirees, according to the same source, the typical annual benefit is roughly $13,500. With 80 percent, or $10,800, being includable in gross income under the CBO approach, the unmarried retiree would have little room for additional income (demonstrating either that the social security system tilts in favor of unmarried retirees or the tax law tilts in favor of married couples, or a little of both).

Thus, individuals and married couples relying solely on social security generally would continue to be free of return filing obligations. The same can be said of those relying on social security plus a small amount of other income. Those with more than de minimis amounts of other income already are required, for the most part, to file returns under current law. Thus, retirees with other income exceeding $25,000 reduced by one-half of social security benefits pretty much are required to file under current law and would continue being required to file. The few retirees who would move from the “does not need to file” to the “must file” category are those who, under the proposal, would have additional other gross income to push their combined other income and currently taxable social security benefits over the standard deduction/personal exemption cut-off.

Mary also pointed out that for people whose earnings over a long period were at the maximum, social security benefits could reach $28,000 a year. It is rare for retirees of this sort to have no other income, at least until they get to the point where they require long-term medical care, in which case their medical expense deductions will bring their taxable incomes and tax liabilities down to zero. In instances where that does not happen, is it any less inappropriate to tax someone with social security gross income of $28,000 than it is to tax someone with interest income of $28,000?

If, as a matter of policy, the nation’s citizens determine that people living solely on social security ought not pay federal income tax, the solution is, as I pointed out in Getting Specific with Tax-Related Deficit Reduction Ideas: Making Section 85 Fairer and Simpler, to increase the standard deduction and personal exemption amount. Though this would also protect from taxation individuals who are not receiving social security benefits but whose income is less than the combined amount, does it not make sense to conclude that if a person living solely on $15,000 or $20,000 of social security benefits ought not be taxed, then a non-retired person trying to live, and perhaps trying to raise a family on, as little as $15,000 or $20,000 of other types of income also ought not be taxed? In other words, what’s so special about social security gross income in contrast to dividends, capital gains, salary, or interest?

The Congressional Budget Office has released its Reducing the Deficit: Spending and Revenue Options, in which it sets forth dozens of ideas for reducing the federal budget deficit. Some of the ideas relate to spending cuts, and others relate to tax increases. Almost every tax increase proposal has its opponents, some well organized and some probably being galvanized into organizing if their particular special tax favor comes under increasing scrutiny. Of the 35 tax-raising ideas, most have been around the block more than a few times. Suggestions to raise individual rates, to reduce or eliminate the tax break for capital gains, to phase out the mortgage interest deduction, to eliminate the state and local tax deduction, to impose additional limitations on the charitable contribution deduction, to tax carried interests as ordinary income, to replace the exemption for interest on tax-exempt bonds with a direct subsidy to state and local governments, to name but a few, have been around for years, if not decades. Each time one of these proposals moves into the spotlight, those who benefit from the tax break jump in to preserve the advantage that it gives them.

One option that caught my eye did so because it is something that I’ve advocated for a long time. One of the ideas floated by the CBO is to tax social security and railroad retirement benefits in the same way that distributions from qualified retirement plans are taxed. When Congress first decided to include a portion of social security benefits in gross income, its legislation contained a complicated algorithm that put into gross income the lesser of half of the taxpayer’s social security benefits into gross income or half of the excess of the taxpayer’s modified adjusted gross income over a threshold tied to the taxpayer’s filing status. I questioned this approach, and argued that the easiest and fairest way to hand the matter was to permit taxpayers to receive tax-free social security benefits until they had received back the contributions they had put into the system, which come out of after-tax dollars. Thereafter, everything that the person receives is “profit,” because it exceeds the investment the person has made. One objection to my approach was that it would cause low-income retirees to be taxed when they ought not to be taxed. My response was simple. If the standard deduction and personal exemption deduction, when combined, are sufficient to prevent taxation of truly low-income individuals, then there would be no taxation of low-income retirees. Another objection to my approach was that people don’t know how much they have paid into social security. My response, that the Social Security Administration has that information and provides it annually even to those who have not yet retired, fell on deaf ears. Instead, those who value the theoretical over the practical prevailed, and the Congress enacted its convoluted approach, meaning that a retiree not entitled to social security benefits whose income consisted of interest would be taxed whereas their neighbor receiving social security benefits would not be taxed. To make matters worse, some years later Congress, in need of revenue to fund some other tax breaks, increased the one-half element of the computation to 85 percent, but in an even more byzantine manner that necessitated creating another set of thresholds and arithmetic gyrations that required more time and expense for retirees and challenged everyone’s patience with the tax law. These computations generate a “bubble” that, in effect, imposes a higher marginal tax rate on lower-income taxpayers than is faced by upper-income and wealthy taxpayers, as described in The Joys of IRC Section 86, and in More Joys of IRC Section 86.

Thus, the option put forth by the CBO is one that taxpayers should welcome. The CBO goes so far as to propose that the SSA could provide social security recipients with the amount of the benefits that are taxable. The computation would be patterned after the one used for private pensions. Using actuarial factors, the retiree’s expected return from the social security system would be calculated. The total that was paid in by the retiree using after-tax dollars would be divided by the expected return to provide a percentage reflecting the portion of each payment that would be excluded from gross income, leaving the rest of the benefit taxable. This approach works for private pensions, so there is no reason it cannot work for social security, which is, in effect, a public pension.

The CBO points out three disadvantages with the option. First, there would be some retirees not currently filing tax returns who would be required to file them. Though no statistics are provided, I would not be surprised to discover that most retirees file tax returns in any event, for a variety of reasons, including claiming credits to which they are entitled. Second, some low-income retirees would end up paying taxes, but to me, that is no reason to exclude social security from taxation while taxing retirees’ pensions and interest income. Instead, if low-income individuals are paying federal income taxes, it’s because the standard deduction and personal exemption deduction aren’t sufficient to shield them. Third, some retirees would view taxation of social security as a reduction in benefits, but that concern existed when social security benefits were first brought into the tax base, and has not proven to be a serious issue. Fourth, the SSA would have more work to do, but I’m confident that its computer systems could generate the necessary information with a minimum of programming adjustments.

On balance, the CBO option is fair, simple, and efficient. It eliminates one of the absurd bubbles in the tax law. It makes sense. Even if I had not been advocating this approach for the past several decades, I still would support the CBO option. The simplification will be welcomed by the millions of retirees who either slog through the long worksheet or pay a tax professional to make the computations for them. The simplification also will be welcomed by tax law students, and many tax practitioners. It will bring into gross income the social security benefits that represent “profit,” including the social security benefits of upper-income taxpayers, who end up excluding 15 percent of their benefits even if some portion of that 15 percent represents a return exceeding what was paid in using after-tax dollars. In short, there is no reason to treat the computation of taxable social security benefits any differently from the computation of taxable private qualified retirement plan benefits.

On Tuesday, the new governor of Pennsylvania, Tom Corbett, revealed his budget plans. As reported in multiple sources, including this article, Corbett took a three-fold approach. He omitted any tax increases. He restored suspended tax reductions, and resumed the film tax credit, which I lambasted most recently in When Spending Exceeds Revenue, Hand Out Tax Credits? Really?. He chopped enormous sums from state spending on assisting the mentally ill and educating future generations, and plans to seek pay reductions for the public workers after he cuts 1,500 state jobs.

Critics predict that the proposed cuts, if enacted, will require local governments to increase taxes. Otherwise, thousands of mentally disturbed individuals will go without treatment and supervision and students will be packed into classrooms because of reductions in teaching staffs, to mention just two of the impending crises looming for Pennsylvanians. Though Corbett tried to make his budget cuts look like a gift to the middle class, and supporters tried to liken his plans to a middle class family trying to cut spending in difficult times, the cost of his plans will fall on the middle class, either through increased local taxes, decreased services such as lower quality education for their children, or a combination of both.

Corbett was compelled to cut spending drastically because of his refusal to increase taxes. Thus, although, as reported in this article, surveys show at least 60 percent of Pennsylvanians support a tax on Marcellus Shale natural gas extraction and production companies, Corbett continues to dismiss the idea of requiring corporations to pay for the social, environmental, health, and other costs of their activities in the state. The logical case for taxing Marcellus Shale producers has been made by many, including myself. In Tax? User Fee? Does the Name Make a Difference?, and again in Giving Up on Taxes = Surrendering Taxpayer Rights?, I suggested that a key to breaking the stalemate with respect to the Marcellus shale issue could be reliance on user fees rather than a tax. Later, in Life for My Proposed Marcellus Shale User Fee?, I described how even some Republican legislators had owned up to the need to compel Marcellus shale producers to bear the burden of the costs they have been imposing on Pennsylvanians, including the yet-to-be-determined and possibly catastrophic costs of dumping into the state’s waterways, according to this report, mystery fluids that have not yet been tested. Even the reality that every other state in which natural gas is produced taxes the producers doesn’t overcome the total resistance of the governor to taxing natural gas extraction.

Corbett’s reasoning for his refusal to support a tax, or user fee, on Marcellus shale producers defies logic. According to this article by Joe DiStefano, Corbett wants gas companies to “move here and use the state as a base to drill deeper, to the gassy Utica Shale.” He hopes that “Big Gas will ‘make Pennsylvania the Texas of the natural gas boom,’ as long as ‘we don't scare off these industries with new taxes.’” Why does this analysis defy logic? Consider the two choices now facing gas producers. Choice one: Don’t go to Pennsylvania and thus don’t make the money that could be made by conducting operations there. Choice two: Go to Pennsylvania, make money, don’t pay any taxes. This is an easy decision. Choice two wins. Now consider the two choices facing gas producers if they were subject to a tax or user fee to compensate the state’s citizens for the environmental, health, road system, and other damage caused by gas production. Choice one: Don’t go to Pennsylvania and thus don’t make the money that could be made by conducting operations there. Choice two: Go to Pennsylvania, make money, pay some taxes representing the true cost of doing business, and still make lots of money. This still is an easy decision. Choice two wins. Corbett seems to think that gas producers would select choice one. But does he really think that? Of course not. Then what is he thinking?

What Corbett apparently is thinking are memories of the past few months. According to this report, oil and gas producers pumped $835,720 into Corbett’s campaign to become governor. One driller alone gave $305,000 to Corbett. That driller will never be subject to tax because he sold his company to Royal Dutch Shell for $3 billion. It’s difficult to imagine that if the driller in question, or more precisely, his corporation, had been compelled to pay user fees for the damage that it has caused to, and the usage it has imposed on, Pennsylvania, that the prospect of walking away with “only” $2.9 billion would have deterred him and his corporation from digging for money in Pennsylvania. According to the same report, seven years ago, when Corbett first entered politics, he was the beneficiary of a $480,000 donation from an Oklahoma gas driller. How happy should Pennsylvanians be that an Oklahoman’s money can dictate the outcome of Pennsylvania elections? There is no question that these “campaign donations” are not gifts. The “contributors” want something in return, and it’s very clear what that is. They want to make money without bearing the burden of the true cost of making that money. Sound familiar?

Something is very wrong with the governor’s budget. It is infected by the same disease that afflicts similar proposals throughout the country. The formula is simple. Cut taxes for the wealthy, and refuse to impose taxes on multibillion corporations and multimillionaire individuals. Justify this position by claiming – without proving – that this generates jobs. As jobs decline, or barely hold steady, cut government spending, and seek pay cuts for middle class workers. Pay no heed to the accompanying consequences, as middle and lower classes then face higher costs, receive fewer services, and find the income from the jobs they do manage to find inadequate to support any sort of decent living. Make the cost of college education for the children of the middle and lower classes more expensive, if not altogether unavailable. Cut the quality of public education, hoping that fewer youngsters learn what they need to learn to become educated citizens who can see through the nonsense spewed out by those caught up in the “pay me and I’ll deliver to you” game that only the wealthy can afford to finance.

When Corbett proclaims that “Limited government means not mistaking someone else’s property for your own” as a defense of his anti-tax stance, he seems to forget that a user fee or tax on a multibillion-dollar corporation is nothing more than compelling the corporation not to treat Pennsylvania’s roads, streams, forests, wildlife, or the health or safety of its residents, as its own. The two-facedness of this approach is so blatantly obvious, one might wonder how a person whose anti-tax stance is contrary to the wishes of at least 60 percent of the population gets elected. But one need not wonder. That answer is just as blatantly obvious.

Bad tax ideas can find their way into the tax law. It can happen for all sorts of reasons. What’s unusual is a successful effort to remove bad tax ideas from the Internal Revenue Code. Yet, that did happen. Unfortunately, that success is going to turn out to be a short-lived accomplishment if the Obama Administration has its way.

The bad tax idea in question is the nefarious phase-out of itemized deductions and personal and dependency exemption deductions. The two phase-outs in question entered the tax law in 1990, when Congress enacted the Omnibus Reconciliation Act of 1990. The phase-outs were implemented for one reason, and one reason only. They permitted Congress to enact a hidden tax increase, that is, to raise taxes without touching the tax rates in section 1 of the Code. This allowed members of Congress to tell Americans that Congress had not raised taxes, when, in fact, it had.

These sorts of phase-outs are bad ideas for several reasons. They are absurdly complicated, adding almost a dozen lines to worksheets accompanying individual tax returns. Taxpayers generally don’t understand the phase-outs, and even most tax economists from time to time erroneously describe them. The phase-outs create a “bubble,” which has the effect of creating a higher marginal tax rate on the upper middle class than exists for the taxpayers at the top of the income pyramid. By creating marginal rates in the “middle” of the income array, phase-outs create economic distortions that can produce deadweight losses.

In Getting Hamr'd: Highest Applicable Marginal Rates That Nail Unsuspecting Taxpayers 53 Tax Notes 1423 (1991), I denounced the phase-outs for the reasons described in the preceding paragraph, providing examples of how the phase-outs had the most disadvantageous effect on taxpayers other than those at the top of the income pyramid. A few years later, I responded to a call to reduce the phase-outs with a plea for a better solution, in Don't Phase Out the Phaseouts, Kill Them, 70 Tax Notes 911 (1996). As a consequence of my unbridled opposition to phase-outs, I was invited to work with the American Bar Association Section of Taxation Tax Structure and Simplification Committee’s Phaseout Tax Elimination Project, whose report recommending repeal of these phase-outs was published in July 1997. Working alongside me on the project, and in many respects making effectively us a team of two or three, was Calvin Johnson, who teaches tax law at the University of Texas. While the Project’s proposal was working its way to Capitol Hill, Calvin summarized our report in a two-part article, Simplification: Replace the Personal Exemptions Phaseout Bubble, 77 Tax Notes 1403 (1997), available on his web site, and Simplification: Replacement of the Section 68 Limitation on Itemized Deductions, 78 Tax Notes 89 (1998), also available on his web site. Our efforts to rid the nation of this unnecessary complication and inequitable consequence of attempts to deceive the public eventually succeeded. In June of 1998, the proposal was introduced as H.R. 4053, though it was not until 2001 that it was adopted. In that year, Congress enacted section 68(f) and section 151(d)(3)(E) to provide for, yes, a phasing out of the phase-outs, and also enacted section 68(g) and section 151(d)(3)(F) to provide for complete elimination of these two phase-outs for taxable years beginning after December 31, 2009.

After too many years dealing with these, to use the words of Rep. Downey as reported in Taxes Raised “Marginally” on Well-to-Do Filers, 49 Tax Notes 599 (1990), “blisters” or “pustules” infecting the tax law, and having succeeded in getting rid of them, it was disheartening and disappointing to learn that the President yet again wants to put one of them back into the tax law, although in modified form. In his Fiscal Year 2012 Budget Proposal, the President suggests a 30-percent phase-out of itemized deductions. By limiting the cutback on itemized deductions to taxpayers with adjusted gross incomes over specified amounts, the proposal re-introduces the same sort of bubble that subjects the wealthy to a lower marginal rate than the rate affecting the upper middle-class. It also puts more complexity into the Code, a strange outcome considering the President’s criticism of the tax law elsewhere in the budget proposal as too complicated. I agree with the President when he calls the tax law a “complex, inefficient, and loophole-riddled mess” but I disagree with his proposal to make it more complicated.

This isn't the first attempt to resurrect these phaseouts. Six years ago, in Objections Raised to Elimination of Legislative Tax Deceit, I criticized efforts by the Center on Budget and Policy Priorities to repeal or delay the scheduled elimination of these phaseouts. Fortunately, its efforts failed. Nor is it the President's first attempt. Two years ago, in Tax Change Ought Not Be Tax Redux, a post that disappeared from the MauledAgain archive at blogger.com but that is republished here, I opened my criticism of his proposal with a similar reaction: "Just as a foolish idea is about to fade away from the tax law, the new Administration seeks to bring it back in an even more perverse form. I'm talking about tax increases masquerading as phaseouts." The attempt didn't work then. Will it work now?

Perhaps the President thinks that a phase-out is a clever way to raise taxes without admitting that taxes are being raised. After all, it worked several decades ago. Why would it not work now? It won’t work now because a critical mass of informed tax experts, tax practitioners, taxpayers, and even politicians understand this particular game, and won’t be so easily persuaded that all one needs to do to stake a claim to “not a tax raiser” status is to leave the section 1 rates alone. The debate over tax increases should be an up-front, transparent, on and not below the table, examination of the advantages and disadvantages of enacting or repealing gross income inclusions, gross income exclusions, deductions, tax rates, and credits. The rest of the “gimmickry,” as Congressional tax staff once described the phase-outs, should be ditched as unwanted, unworthy, and unnecessary obfuscation.

What the President seeks to do can be done much more easily, simply, efficiently, and sensibly by transforming itemized deductions into credits. This removes the higher tax subsidy that deductions provide to higher income taxpayers, and gives all taxpayers the same tax subsidy. Much has been written about this approach, and I simply encourage those interested in the issue to examine those analyses. In fact, as pointed out in the Citizens for Tax Justice analysis of the budget proposal, the President’s plan to restore the phase-outs would reduce but not eliminate the discrepancy in tax subsidy. So there’s no point in bringing back the absurdity of phase-outs when a much simpler, more equitable approach is available.

Let the phase-outs rest in Pease. Yes, that’s an inside joke for the benefit of those who remember the complete story of how these two phase-outs originally came into being.

The problem is simple. As related in this Philadelphia Inquirer article, the prices of various commodities and other items are soaring. Most people are keenly aware of rising gas prices, which are moving almost in lockstep with rising crude oil prices. The price of cotton has skyrocketed. The price of sugar has risen roughly 33 percent since last year at this time. The price of Cheese Whiz, used in those famous Philadelphia cheese steaks, is up almost 25 percent in one year. Soybeans are up 48 percent, wheat is up 62 percent, and corn, 78 percent. There’s also the implicit price increase taking place as manufacturers reduce the size of their products without lowering the price. These wholesale price increases have not yet fully hit the consumer, but they will, and soon. Also waiting in the wings are increased prices for products manufactured by Procter & Gamble, for clothing, and for maternity items.

My concern is that politicians, reacting to the already noticeable stream of price complaints that surely will grow into a resounding chorus of demands that something be done, will turn to the tax law and add a pile of credits and deductions in a fruitless (sorry) effort to hold back the tide. The naïve belief that every problem can be solved with tax law amendments is destined to make the situation worse.

The causes of the problem are simple. Demand is increasing. Supply is decreasing. Though the global economic malaise postponed the day when demand outracing supply would become overwhelming, it did not eliminate the inevitable. Demand is increasing because people in China, India, and other rapidly developing nations need and want food, clothing, concrete, electronics, vehicles, and hardware. The rate of demand is accelerating because global population is growing at an unrelenting pace. In the meantime, supply is decreasing for two reasons. Some items, such as crude oil, exist in finite quantities and are rapidly being depleted. Other items have been the victims of political unrest and devastating weather. Until I read the article, I had not known that the wheat crop in Russia, usually an exporter of a crucial global foodstuff, had been significantly reduced by heat and wildfires, or that dry weather had shrunk Argentina’s soybean crop. I knew about the price of oil going through the roof, and I had heard about the cotton shortage. But what else will soon join the list of items in short supply?

This is not the first time I have questioned the wisdom of using tax law to deal with a problem that needs another solution. Three years ago, in Can a Tax Rebate Band-Aid Stop the Economic Bleeding? I criticized use of tax rebates because they do not address the underlying economic problems. My concluding paragraph touched some nerves. I wrote:

The impending shortages of critical goods and materials, including oil, clean water concrete, steel, natural gas, health care, copper, agricultural products, and similar life-essential ingredients, will only worsen the problem. An ever-increasing world population, seeking more and more quantities of these and other items, coupled with the emergence of a small creditor group and massive hordes of debtors, is a recipe for disaster. Somewhere along the way, these conditions will trigger armed conflict, pestilence and pandemics, civil disorder, and breakdowns in societal structures. No one ever promised that the Dark Ages were a one-time event.

Joe Kristan, in a post headlined by one of my favorite captions, Good Morning, We’re All Doomed, explained that ever the optimist, he was confident of human ingenuity coming to the rescue, and not very concerned because similar warnings had been issued for decades, going back at least to Thomas Malthus in the 1830s. In Can Tax Rebates Help Prove Malthus Wrong?, I responded that there are shortcomings in the supply-demand curve theory of economics, argued that government borrowing to finance rebates worsened the situation in the long-term, and suggested that "people and governments [and not just government] mobilize to deal with these issues while there still is time." I then questioned the confidence in market-based solutions because I do not think that the market is a truly FREE market.

Several months later, in If Only It Were Prices Getting Depressed, I revisited the question of supply and demand, motivated by reports of increases in the price of oil, gasoline, and food, and by news of shortages of steel, lumber, timber, polyvinyl chloride pipe, and even, good grief, chocolate, hops, and barley. Joe replied, in Good on Taxes, Not so Good on Economics, taking issue with my supposed advocacy of government direction of markets. In Keeping Free Markets Free, I noted that “I am not advocating government management of the markets,” but seeking government regulation to prevent markets from being “hijacked by speculators, cheaters, shoddy artisans, defective manufacturers, cronyism-afflicted traders, and others whose greed surpasses their respect for the market's consumers.”

Although it is possible that some of the current supply and demand disequilibrium is caused by speculators, it seems to me that it is caused by the confluence of three major trends: political unrest, weather and climate disruption, and excessive population growth. Government intervention with respect to any of these issues sparks deep controversy, aside from the question of whether government of the United States can do much of anything about them on its own. These are global problems. If they are to be solved, they need to be addressed globally. The weather in Russia affects food prices in this nation. Political upheavals in African and middle Eastern nations affects energy and mineral prices here. Rapid population growth in developing countries puts demand-side pressure on the demand-supply balance. Enacting federal income tax law credits or deductions would be much like putting a band-aid on a hemorrhage. Yet I would not be surprised to see a Congress engage in such futility for the sake of obtaining campaign-time sound bites. By the time people figure out that tax law will not fix the wheat crop in Australia, the soybean shortage in Argentina, the demand for steel and concrete in China, the increasing use of oil in India, or the “revolt of the oppressed” in nation after nation, yet another “election cycle” will have passed. And the tax practitioners, though seemingly facing the prospect of even more fees to charge to help clients deal with an over-supply of legislative tinkering, will cringe at the thought of having to muddle through yet more bad legislation. I don’t think I have been wrong about the tension in the supply-demand situation, and yet I hope I’m wrong about the prediction of Congress using tax law to deal with issues it cannot or will not face head-on.

Last week came news, in What Harvey Dorfman did for the Phillies, of the death of Harvey Dorfman. Few people, even most baseball fans, knew who Harvey Dorfman was and what he did. Now many more people do know, thanks to the tributes pouring in from around the baseball world.

Harvey Dorfman was a sports psychologist, and, according to dozens of baseball players, an extremely good one. I understood, as soon as I read this quote from Roy Halladay, one of the Philadelphia Phillies aces, about why Dorfman succeeded. Halladay said, "He made you be accountable to yourself and accountable to him. I don't think you ever got the feeling that he was a psychologist. It wasn't warm and fuzzy, you know, it was 'Let's figure this out.' You didn't feel like you went in and told him all your problems and he gave you a solution. He teaches you to do it yourself."

The sentence, "He teaches you to do it yourself." grabbed my eye, as did the quip, "It wasn't warm and fuzzy." I thought of the many students who complain that they end up teaching themselves, somehow so blissfully unaware that it's precisely learning to teach one's self, to depend on one's self, to be accountable to one's self, is what it's all about. When I wrote about this a few years ago in Learning to Teach and Teaching to Learn, an article for the Gavel Gazette (the now-extinct newsletter of the Villanova University School of Law), I didn't address the "warm and fuzzy" issue, but "warm and fuzzy" sometimes gets in the way of learning, especially learning to teach one's self.

Dorfman drove home the point in an interview, reported in this story: "It's not like in school, where you get high grades for what you know." For all those students whose focus is on the acquisition of knowledge, here's yet another reason that properly taught law school courses – and those in other disciplines – focus on much more than knowedge. It's not what you know. It's what you do with it. It is, as Dorfman said, "what you do."

I never met Harvey Dorfman. I'm pretty sure I would have liked him. Our conversations would have been fun. Those will need to wait until the life beyond.

This morning came news of the death of Cynthia Holcomb Hall, who served on the Ninth Circuit Court of Appeals since 1984, and had served as a Tax Court judge from 1972 through 1981. I knew Judge Hall, whose chambers were directly below those of Judge Herbert L. Chabot, for whom I served as attorney-advisor from 1978 through the end of 1980.

During the 1980s I learned that one of my ancestral lines included the Holcomb family (with the details in this chart). Curious, I invested a few minutes this morning trying to determine if Judge Hall also belonged to “my” Holcomb family. My copy of Elizabeth Weir McPherson’s The Holcombe Family: Nation Builders, a hefty tome not only in terms of weight, did not include any information on Cynthia Holcomb. Next stop, google, which led me to a Wikipedia page that provided her birth date but not the names of her parents. Next, it was time to search the 1930 census, and I found her, with her mother, aunt, grandmother, and brother, in Hawaii, where, apparently, her father, a Navy Admiral, was stationed. From the census entry I determined that her mother’s name was Mildred Gould Kuck, so back to google! That led me to a genealogy page for the descendants of Thomas Holcombe of Connecticut. Following the links, I traced Judge Hall’s ancestry back to Gilbert Holcombe, who is known to be the brother of Christopher Holcombe, from whom I descend. Although it has not been definitively proven, many Holcomb researchers have concluded, by piecing together the evidence, that Gilbert, Christopher, and their siblings were the children of Thomas Holcombe and his wife Margaret Tretford (or Threthford). Even if that conclusion is erroneous, it does not undo the relationship between Gilbert and Christopher.

It then took only several minutes for me to set up my descent and Judge Hall’s descent from Thomas Holcombe (or whoever might be the father of Gilbert and Christopher if it turns out not to be Thomas, which is unlikely). I am her eleventh cousin once removed (she being an eleventh cousin to my father, who was roughly 6 years older than she).

My collection of “people to whom I am related” continues to grow, though I’ve yet to arrange and publish the information, aside from my My Cousins the Presidents venture. I shared a few in Relatively Speaking, Is It That Big A Deal? (fifth cousin four times removed to James Longstreet, the Confederate General, eighth cousin once removed to Georgia O'Keeffe, ninth cousin to Loudon Wainwright III, ninth cousin to Buster Crabbe, ninth cousin to Birch Bayh, Jr., and fifth cousin three times removed to Theodore Vail, founder of AT&T, ninth cousin once removed to Birch Bayh III, and ninth cousin twice removed to JonBenet Ramsey). There’s also Maxfield Parrish, Thomas Edison, Robert E. Lee, and William Butler Ogden, the first mayor of, and in many respects founder of, the city of Chicago (much to the delight of my son who presently lives there), to name but a few.

Judge Cynthia Holcomb Hall was an accomplished lawyer and judge, and also a superb ornamental garden designer. She will be missed.

Edit: Mary O'Keeffe, a public policy economist teaching -- among other things -- tax courses and blogging on tax and related issues (as well as from time to time providing comments and feedback to MauledAgain posts), noted that I had spelled Georgia O'Keeffe's name with one f. Oops. A quick google check explains how I went wrong: almost 500,000 hits using "O'Keefe" and 1.1 million hits using "O'Keeffe." Mary, who thinks she is not related to Georgia -- but I think with enough digging she may discover she is -- has several most interesting anecdotes that I hope she gets a chance to share. And, yes, I fixed the spelling in this post, but not the one from several years ago.

On the heels of the spending cuts, affecting chiefly the impoverished and the lower ranks of the middle class, paraded out last week by the spending cut advocates, as I inventories in Spending Cuts, Full Disclosures, Hearts, and Voices, comes yet another, in some respects the most absurd of them all. The wizards who surely must be trying to dismantle government, and reintroduce the culture of the wild, wild West, now seek to cut the IRS budget. According to this Philadelphia Inquirer story, even though the IRS brings in $10 of tax revenue from noncompliant taxpayers for every $1 that is spent, House Republicans want to cut the IRS budget by $600 million in 2011 and by even more next year. Translated, according to the IRS Commissioner, this amounts to a reduction of at least $4 billion in annual tax revenues, giving the spending cut advocates yet more excuses to cut even more federal spending, other than, of course, spending that benefits their own districts and their campaign fund contributors.

Inadequate funding of the IRS has plagued this nation for decades. A significant portion of the accumulated federal budget deficit, also known as the national debt, consists of taxes that should have been paid under existing law but that have not been paid by tax scofflaws, some openly defying their obligations to function as responsible citizens and some, with the assistance of the tax shelter and tax evasion industry, wiggling through loopholes and sometimes flouting the law in order to shift their public duty onto the rest of the nation’s taxpayers.

For years, I have lamented the short-sightedness of the Congress. Seven years ago, in Getting It Right, I asked, in connection with complaints about the high rate of erroneous answers provided by IRS employees, “Does the IRS have enough funding to handle the millions of calls that it receives?” Just last month, in The Problem with Income Tax Vehicle Credits, I criticized the failure of Congress to provide the IRS with sufficient funding to administer the dozens of tax credits enacted by the Congress to deal with matters under the jurisdiction of other executive departments and agencies.

Several years ago, in Taxing High-Income Individuals, I advocated, among other things, a way to reduce the federal deficit without raising tax rates. I explained what Congress needed, and still needs, to do: “Increase funding for the IRS so that it can track down and deal with tax shelter promoters, offshore schemes, fraudulent returns, and other gimmicks used to make a person with high income pay taxes at rates lower than those imposed on the middle and lower income echelons.”

How serious is this problem? How much more serious would it be if those lacking a wide perspective on public finance have their way? Tax evasion arrangements will grow, and eventually only the foolishly honest will be paying the taxes that they should be paying, as success or even perceived success at tax avoidance and evasion by others tempts those not yet playing the tax cheat game to jump in. In Triple Tax / Tax Times Three, I analyzed the growing success of tax evasion schemes:

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.

If the House Republicans succeed in cutting IRS tax law enforcement, what will flourish in its place? I answered this in Triple Tax / Tax Times Three:

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.

And that, I contend, is what all of this is about. Some people think that they deserve to pay less and get more, even if it comes at the expense of those lacking the political power, the economic clout, the cerebral understanding, or the firm conviction to learn about, expose, and oppose this arrogance.

The Administration wants to increase IRS funding. Why? Aside from the creation of jobs, it would cut the deficit and restore moral balance to the revenue system. Think of it. Every dollar brings back ten. What advocate of the free market would walk away from such a deal? One dollar brings back ten. The private sector wouldn’t toss that opportunity aside, and neither should the fiduciaries of the public trust. America deserves no less.

So what’s a state to do when it faces a budget deficit, with revenues trailing expenditures? One choice is to raise taxes, but that approach brings howls of protest from those who oppose taxes and the common weal to which they are directed. Another choice is to cut spending, but that approach brings howls of protest from those who understand both the short-term and long-term adverse consequences to individuals and to the state of putting an economy into reverse. The worse thing to do would be to increase spending or to cut taxes, especially when the tax cut is not an across-the-board rate decrease but a credit targeted to a special interest group in what amounts to the equivalent of increased state government spending. That is why it boggles the mind of anyone who understands public finance to learn, as reported in this Philadelphia Inquirer story, that tax credit applications approved by the state’s previous administration and put on hold by the new governor would be processed and approved. Did not Wisconsin get itself into a fiscal mess – converting surplus into deficit in a non-miracle reminiscent of a similar switch-a-roo at the federal level ten years ago – by enacting tax credits and other tax breaks targeted toward a certain preferred group, as described in this article? Is this the path the governor of Pennsylvania intends to follow? Is it a path that Pennsylvania may end up following unintentionally?

I have previously explained why tax credits for the film industry are contrary to best public finance practices. In You’ve Gotta Give 'Em (a Tax) Credit?, I questioned the assumption that without the credit, film companies would go elsewhere, considering that Pennsylvania has nothing to offer companies wanting Rocky Mountain backdrops but has all sorts of features that should attract film companies in any event. I questioned the role of tax credits as incentives. Most important, I questioned why film companies were getting tax breaks not available to other businesses that do as much, if not more, for the state’s economy. An disheartening example of this special treatment occurred in 2007, when the then-governor of New Jersey vetoed legislation that would have extended to producers of digital content the benefits of a tax credit in place for the film industry, highlighting the inequities I criticized in Do Profitable Companies Need Tax Breaks?. Unfortunately, the legislative process did not and does not give that governor the opportunity not only to block expansion of the tax credit, but also to revoke its availability to the film industry.

Four years earlier, in Using Taxes to Rescue a Non-Drowning Film Industry?, I had lambasted the California legislature for handing out tax breaks to the film industry, something it felt compelled to do because other states had started dishing out tax credits to the film industry. I noted that “Economic growth isn't nurtured by states fighting with each other for a piece of the existing pie.” Perhaps there’s a clue in this analysis to yet another factor in the economic malaise gripping the country. I argued that to have “growth in the film industry.” There need to be “more people [who] want to see films,” and better films. I also noted that, “Tax incentives have nothing to do with [the] growth [in movie attendance] because no state has “enacted a tax credit for going to the theater or for watching a movie on cable.” Finally, I pointed out that, “The film industry is rolling in money[, and] can afford to pay outrageous salaries to its ‘stars’ and if times get tight, those ‘stars’ ought to take pay cuts.” Surely they are in a better position to absorb those cuts and are of less importance to the future of this nation than are school teachers and skilled workers.

It is possible to argue that the tax credits had been enacted, and that the governor should simply have accepted the decisions that had been made by the previous administration. However, the spending process permits the governor to examine those expenditures. Unlike the former governor of New Jersey, who could veto expansion of tax credits but not revoke those available to the film industry, Pennsylvania’s governor had an opportunity to show by action what he has been preaching in terms of cutting state expenditures. Tax credits for a narrow group of taxpayers are simply disguised spending increases, and it’s well known that Pennsylvania’s governor wants to decrease, not increase, state spending. So why did he permit these credits to go forward? One plausible explanation is that that they were already authorized, and he had no choice. I don’t think that is the case. I don’t think that is the case because, during the campaign, the advocate of shrinking state government had supported the tax credit for the film industry. Why? What is so special about the film industry? Fortunately, representatives of the governor have declined to confirm that the credit will survive the next budget proposal, and though some members of the governor’s party, who had opposed the credit, now support it, others continue to question the wisdom of having taxpayers finance a private enterprise. Other states, including New Jersey under the leadership of a new governor, have suspended credits or are tackling legislation designed to suspend or terminate film credits, in the face of large state budget deficits.

In Using Taxes to Rescue a Non-Drowning Film Industry?, I explained:

In order for the tax burden of the film industry, for example, to be reduced, the tax burden of other taxpayers must be increased. Or, state tax expenditures on health, safety, education, and other essential and legitimate government services need to be cut, shifting the cost to the population generally, particularly through increases in local taxes. This puts upward pressure on the wage demands of workers in the state, it puts upward pressure on prices charged by other entrepreneurs in the state, and it puts upward pressure on interest rates as localities increase borrowing to cope with the impact of the state income tax incentive. Though the arrival of a production in the state brings a temporary boost to that state's economy, particularly that of the area in which the production exists, it isn't necessarily sufficient to offset the negative impact of the true cost of the specialized tax incentive. After all, the decision to bless one industry, thus shifting costs to another industry, may encourage those other industries to leave the state.

Advocates of the credit claim that the credit creates jobs, and that terminating the credit will cause jobs to disappear. Is not the deduction for compensation paid sufficient to reduce tax liabilities for film producers? Apparently not. Is the film industry incapable of surviving without the credits? Perhaps we will find out, and soon. One advocate for the handout to the film industry claims that ending the tax credits would “wreak havoc on the industry.” So the better choice is to wreak havoc on the taxpayers who foot the bill, or on the school teachers and other public sector employees who will lose their jobs so that the credit can continue to be financed with public dollars, or on the school children whose programs will be cut because the money is needed to fund the credit, or on the impoverished who will go without food and health care so that state money can finance an industry that pays salaries to “stars” that dwarf the allegedly “excessive pay” that permits a skilled worker or school teacher to barely make ends meet?

Anyone who has explored the world of sales tax exemptions knows that the distinction between taxable and non-taxable items often is a fine line so thin and delicate that it requires an electron microscope to detect the boundaries. Two recent rulings, from two different states, provide an interesting glimpse into a world that many tax practitioners and most taxpayers have not entered. It’s worth the visit.

In New York, §1105(a) of the Tax Law subjects all retail sales of tangible personal property to the sales tax. An exemption is provided by §1115(a)(3) for “[d]rugs and medications intended for use, internally or externally, in the cure, mitigation, treatment or prevention of illnesses in human beings … and products consumed by humans for the preservation of health but not including cosmetics or toilet articles notwithstanding the presence of medicinal ingredients therein….” The New York Sales and Use Tax Regulations, specifically 20 N.Y.C.R.R. §528.4(b)(1) defines drugs and medicines as “articles, whether or not a prescription is required for purchase, which are recognized as drugs or medicines in the United States Pharmacopeia, Homeopathic Pharmacopeia of the United States, or National Formulary, and intended for use in the diagnosis, cure, mitigation, treatment or prevention of disease in humans.” They also provide that “[t]he base or vehicle used (oil, ointment, talc, etc.) and the medium used for delivery (disposable wipe, syringe, saturated pad, etc.) of a drug or medicine will not affect its exempt status.” In examples of drugs and medicines exempt from taxation, the regulations list “antiseptics.” The regulations, in 20 N.Y.C.R.R. §528.4(d) define “cosmetics” as “[a]rticles intended to be rubbed, poured, sprinkled or sprayed on, introduced into, or otherwise applied to the human body for cleansing, beautifying, promoting attractiveness, or altering the appearance, and articles intended for use as a component of any such articles are subject to tax.” Finally, they define “toilet articles” as “[a]ny article advertised or held out for grooming purposes and those articles which are customarily used for grooming purposes, regardless of the name by which they may be known,” and give soap, toothpaste, and hair spray as examples of are taxable toilet articles.

In Virginia, as in New York, retail sales of tangible personal property are subject to the sales tax. Similarly, §58.1-609.10(14)(a)(i) of the Virginia Code provides an exemption for “[a]ny nonprescription drugs and proprietary medicines purchased for the cure, mitigation, treatment, or prevention of disease in human beings.” Section 58.1-609.10(14)(b) provides that “The terms ‘nonprescription drugs’ and ‘proprietary medicines’ shall be defined pursuant to regulations promulgated by the Department of Taxation.” and also provides that “The exemption authorized in this subdivision shall not apply to cosmetics.” Virginia Tax Bulletin (VTB) 98-4 (5/15/98) defines nonprescription drugs “as any substances or mixtures of substances containing medicines or drugs for which no prescription is required and which are generally sold for internal or topical use in the cure, mitigation, treatment, or prevention of disease in human beings.” Tax Bulletin 98-4 also provides that cosmetics, toilet articles, devices, food products and supplements, or vitamins and mineral concentrates sold as dietary supplements, other than those sold pursuant to a written prescription by a licensed physician, are not within the exemption. The bulletin defines cosmetics as “articles applied to the body for cleansing, beautifying, promoting attractiveness or altering the appearance (includes makeup, body lotions, cold creams, and hair restoration products),” and toilet articles as “products advertised or held out for sale for grooming purposes (includes soaps, toothpastes, hair sprays, shaving products, colognes, deodorants, and mouthwashes).”

The revenue departments in both states were asked to consider the status of antibacterial soap, antibacterial hand gel, antibacterial hand spray, antibacterial hand lotion, antibacterial hand wipes, hand gel sanitizers, conditioning hand sanitizers, hand sanitizers, and antibacterial hand foams. The antibacterial soap considered by the New York Department of Taxation and Finance was described as follows:

Each of the products’ drug facts label lists an active ingredient of either alcohol, between 68% -72%, or triclosan 0.3%; identifies its purpose as “Antiseptic;” and describes its use as “to decrease bacteria” on hands or skin. The product labels variously indicate that the products leave hands “feeling clean and virtually germ-free;” “clean, soft and virtually germ-free;” “clean, lightly scented and virtually germ-free;” “deeply cleansed and feeling smooth and soft;” “clean and conditioned;” “gently cleansed and conditioned;” “lightly scented, feeling moisturized and looking younger, while effectively fighting germs;” “lightly scented, deeply cleansed and feeling smooth and soft, while effectively fighting germs;” and “lightly scented, gently cleansed and conditioned, while effectively fighting germs.” Many of the products also tout their skin nourishing and softening effects.

The petitioner in New York was either the same entity or one working in concert with the petitioner in Virginia, because the Virginia Department of Revenue explained:

Each of the product's drug facts label lists an active ingredient of either alcohol, between 68%-72%, or triclosan 0.3%. The label identifies the product's purpose as "antiseptic;" and describes its use as "to decrease bacteria" on hands or skin. The product labels from the different categories indicate that the products leave hands "feeling clean and virtually germ-free; "clean, soft and virtually germ-free; "clean, lightly scented and virtually germ-free." Many of the products also advertise their skin nourishing and softening effects.

In both instances, the petitioner argued that alcohol and triclosan are treated by the FDA as over-the-counter drugs, and has proposed to include them in products that help mitigate the risk of disease and infection. In Virginia, the petitioner also pointed out that Public Documents (P.D.) 99-32 (3/18/99) and 05-135 (8/10/05) provide that the Department of Revenue “considers” FDA guidelines when classifying products, and that Tax Bulletin 98-4 specifically treats rubbing alcohol and antiseptics, which are contained in the antibacterial products under consideration, as exempt from the sales tax. The petitioner claimed that the products are marketed for their antibacterial products, and that customers purchase the products to avoid illness.

In its ruling, the New York Department of Taxation and Finance decided that if the antiseptic ingredient were removed from the products, they would be classified as cosmetics or toilet articles, because in that condition they would be “expressly designed to cleanse, beautify or promote the attractiveness of a purchaser, or for grooming purposes.” The Department concluded that adding the antiseptic ingredients did not transform the products into drugs or medicines, because the regulations state that cosmetics and toiletries are not exempt “notwithstanding the presence of medicinal ingredients therein.” The Department cited previous rulings in which it concluded that lotions are taxable but antiseptic gel is not if its sole purpose is treatment of minor burns, scratches, cuts, insect bites, and other minor skin conditions.

In its ruling, the Virginia Department of Revenue explained that “only those nonprescription drugs and proprietary medicines purchased for the cure, mitigation, treatment or prevention of disease in human beings qualify for the nonprescription drugs exemption. Cosmetics and toiletry items, except those that contain medicinal ingredients and that are principally used for medical purposes, are taxable. A product that is a cosmetic is not a medicine even though it may have medicinal properties.” The Department decided that if the antiseptic ingredient were removed from the products, they would be classified as cosmetics or toilet articles, because in that condition they would be “expressly designed to cleanse, beautify, or promote attractiveness of the purchaser, or they are used for grooming purposes.” Clearly, the staff at the Virginia Department of Revenue had read the ruling issued three months earlier by the New York Department of Taxation and Finance.

The Virginia Department of Revenue elaborated on its position by giving an example from its Nonprescription Drug Exemption Question and Answer Summary. That document distinguishes between a cosmetic containing an acne treatment and an acne treatment product intended solely for use in treating or preventing acne. It also cited a previous ruling in which it concluded that toothpaste containing a nonprescription drug is not exempt because toothpaste is generally sold for grooming purposes and that the nonprescription drug added to help prevent gingivitis was a secondary function to the intended use of the product. The key point, according to the Department, is that the “primary purpose of a product” is controlling.

The conclusions, and the reasoning, in these rulings are questionable. Do not most people purchase toothpaste in order to prevent cavities, and not simply to whiten their teeth? Would not a person without gingivitis or the risk of that disease purchase a toothpaste that does not contain the medicine? Very few people purchased antibacterial soaps and gels until outbreaks of assorted influenzas generated advice from government agencies to use those products for the purpose of fighting the spread of disease. Even Fairfax County in Virginia, in this publication was among those jurisdictions that recommended the use of antibacterial soaps and gels in order to prevent the spread of disease. Under these circumstances, is not the primary purpose of these products the prevention of disease? A consumer interested only in cosmetic purposes would purchase the cheaper, non-medicinal product. If asked, “What is the reason you switched to antibacterial soap?”, would not the answer be, “Because I wanted to reduce my chances of picking up a disease” or something similar? The fact that sales of these products soared after government agencies and public health officials – and probably individual physicians – recommended their use in face of threatened influenza outbreaks disproves the assertion that people have been purchasing them primarily for cosmetic or grooming purposes.

These rulings, however, illustrate a more serious problem than simply disagreement over the question of why people purchase antibacterial products. That question arises because there is a sales tax that has exemptions requiring retailers, shoppers, and revenue departments to distinguish between medicines and cosmetics. The existence of products that are both compel revenue departments to issue regulations or other guidance, and many chose to rely on a “primary purpose” test. The difficulty with a primary purpose test is that it ultimately requires exploration of the mental state of consumers, a task that not only is daunting and impossible to administer efficiently, but also alarming when one things of technology on the horizon that will permit reading people’s thoughts. Understandably, a test that looked simply to the presence of medicinal ingredients would invite manufacturers of all sorts of products to inject antiseptic or other pharmaceutical substances into the product. As horrible as it sounds, might not the solution be a repeal of all sales tax exemptions, which would permit a reduction in the overall rate and the streamlining of revenue department sales tax divisions? A quick scan of exempt and non-exempt items for each state’s sales tax reveals not only inconsistencies between states – something that adds to the cost of retailing in multiple states – but also hundreds of these “fine line” definitional conundrums that distract taxpayers, their advisors, retailers, and revenue department employees from other, more productive, activities.

Finally, for those who think tax is “nothing but numbers” or “all about numbers,” even those who think – often wrongly – that they are mathematically challenged and cannot “do tax” should be surprised and delighted that there are tax experts focused not on computations but on whether antibacterial soap is a medicine or a cosmetic, whether Clearasil is a medicine or a cosmetic, whether gingivitis-fighting toothpaste is a medicine or a cosmetic, whether, oh, never mind, there’s no point in trying to list all of them. That would take the “fun” out of it for those yet to discover the secrets of sales taxes.