A Slimy and Dirty Sales Tax Issue

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.

Tax Profiteers Resume Takeover Attempts

The attraction to the private sector of the revenue stream generated by certain public sector activities, such as tolls from toll roads, continues unabated, as do attempts by the private sector to hijack the public trust. Though private operation of public sector function has been an abject failure for centuries – think of the ineffectiveness of private sector fire protection in colonial Philadelphia and the collapse of the privately-owned and operated Lancaster Turnpike – the advocates of corporate expansion from the private sector into the public sector continue to press for government surrender of its commonwealth role. Emboldened by the successes of, and reaping the benefits of funding and backing from, the anti-tax and anti-regulation crowd, these privateers demonstrate that the lure of ostensibly easy cash never loses its luster when viewed by those addicted to money (or the power that money buys).

This is not my first attempt to explain to citizens and voters the dangers of letting the private sector take over, among other things, highways. If left unchecked, by the time most people realize that they’ve been taken for a ride, it will be too late to undo the deals. Unlike government, where there is at least a chance for dissatisfied citizens to exercise their right to vote to make changes, the corporate world is impervious to the unhappiness of the electorate, because its decisions are made by an oligarchy to which 99.9 percent of the nation’s population does not, and cannot, belong. Unfortunately, most people go numb when they read the fine print, and thus become no less vulnerable to being conned than they are when they are propositioned by the world’s small-time versions of Bernie Madoff and those of his ilk.

Among the various posts that examine and de-bunk the myth of private sector superiority when it comes to dealing with public assets are Selling Off Government Revenue Streams: Good Idea or Bad?, Are Citizens About to be Railroaded on Toll Highway Sales?, Turnpike Cash Grab Heats Up, Selling Government Revenue Streams: A Bad Idea That Won't Go Away, Turnpike Lease: Bad Policy and Now a Bad Deal , How Do Toll Road Lessees Make a Profit?, The Pennsylvania Legislature Gets It Right, Killing the Revenue Idea That Won't Die, Are Private Tolls More Efficient Than Public Tolls?, and More on Private Toll Roads. In those posts I explained, among other things, why the alleged economics of these deals don’t add up, why the argument that presumed but unproven private sector efficiencies more than justify the private sector profit extracted from the public good doesn't survive careful scrutiny, and why the fable of the golden goose is a lesson still worth learning. Most important, I directed attention to the failed private sector toll road experiments in places like San Diego, Orange County, and South Carolina, and warned that these demonstrations of a theory going bad when put into practice provide more than sufficient reasons to reject any more attempts to siphon public revenue into a small segment of the private sector.

Now comes another article by Joe DiStefano, Builders Extolling Private Highway Projects, in which he points out plans to put tolls on existing toll-free highways to permit private companies to take over these roads. According to DiStefano, the movers and shakers behind this plan are “using the antitax, spending-cut mood gripping voters” to “push for” this privatization. The irony is that voters would be sucked into a deal by which taxes are cut, say, $10, collectively contributing to the public sector’s inability to maintain roads, but making citizens happy, only to be met with tolls of $15. What a trade-off. Pay less in taxes so that the tax savings, and more, can be diverted into the hands of the oligarchy. The public sector does not need to include a profits component in taxes or tolls, and the argument that the private sector can make up the difference through efficiency fails because the folks at Enron, Adelphia, Goldman Sachs, AIG, Worldcom, et al have demonstrated that inefficiency, waste, and fraud are not the monopolies of government as the “free enterprise means free to do what I want without limit” philosophers would have people believe.

The irony is that the advocates of so-called “public-private transportation partnership boards,” according to DiStefano, “acknowledge this could cost more, over time, than having the government borrow the money and build the projects through tax-free bonds.” No kidding. It would cost more because it puts more money into the hands of the oligarchy than it would acquire if the public sector retained ownership, control, and guardianship of public assets. Advocates claim it is better to have “the driving public” pay tolls, rather than to have “cash-strapped governments” pay for the roads. The lack of logic in this assertion is appalling. The driving public would be paying, one way or the other, either through tolls, gasoline taxes, or even the mileage-based road fee. Not only is the driving public no less “cash-strapped” than are governments, they would, as explained in the preceding paragraph, be paying more. Why? Because they would be shifting even more wealth to the oligarchy, who are, of course, responsible for governments being cash-strapped, considering the oligarchy’s persistent campaign to reduce, and eventually eliminate taxes. With taxes eliminated, all government functions would be shifted to the oligarchy, in a quiet revolution too few have been noticing.

Advocates also admit that states could become more efficient by contracting out the design and construction planning phases of highway improvement and repair projects. But we are told that “public-private projects are expected to be more profitable for builders.” Why should citizens rally around something more profitable for builders if the alternative is to let the process be more profitable for the state, thus permitting reductions in tolls and taxes? Because, we are told, shifting profits from the state to the private sector “will help attract more private investors.” And who will those private investors be? Low-income drivers? Middle-class union members? Folks in the swelled ranks of the unemployed? Seriously, who has the money to invest in a money-making privatized road deal? In fact, when “typical” citizens invested in these deals, they ended up being the ones “holding the bag” when the projects in San Diego, Orange County, and South Carolina tanked.

In the meantime, DiStefano tells us, the legislation introduced in Harrisburg to permit this encroaching takeover of government by the oligarchy, stands to be amended so that politicians can sit on the “public-private transportation partnership boards” notwithstanding their lack of expertise in transportation planning, highway design, road construction, street maintenance, or much of anything else that is required. The private sector has always made money doing contract work for state highway departments, sometimes using contacts to get selected, so what’s at issue isn’t so much the influence of politicians on the selection process, but the reinforced indebtedness of politicians to the oligarchy that benefits from the privatization process.

And for those who think that I’m being an alarmist about the doors being opened by this takeover of highways, consider what one of the advocates has promised. “ ‘In a couple more years we’ll be looking at these [to put] courthouses and state colleges’ and other public facilities, and their funding, in private hands.” At least this advocate is being open, perhaps more open than his clients prefer. Folks, the oligarchy wants to buy state highways, courthouses, public schools, police forces, and just about everything else that government does. Corporations owned by the oligarchy will run those things, unhappy citizens will have no one to turn out of office during an election in response to being gouged while getting bad service highlighted by needing to make 911 calls to some foreign country, unions will be broken, wages for the most people will be lowered, for those fortunate enough to have jobs, and the nation, no, the world, will be at the mercy of the handful of wealthy people who have bought the world. And when those who consider these people as heroes and their positions on tax policy to be the Holy Grail of opportunity discover that they have been had, there won’t be any place to find redress, because the oligarchy will own the courts, the police, every form of travel and communication, everything. The planet will have become one big plantation. Alarmist? If you think so, wait. Wait a few years. Then decide. If, of course, you’re willing to stand aside while this public asset grab moves into high gear.

Spending Cuts, Full Disclosures, Hearts, and Voices

Last month, in Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?, I noted the dilemma presented by candidates who espouse spending cuts but refuse to identify the programs that would be cut. This coy approach survives after the candidate is elected, until, hopefully, the electorate no longer connects the vague promises with the actual realities of the actions undertaken by the candidate turned legislator. The challenge to the advocates of spending cuts is to avoid losing votes by being forthcoming with their hit lists, as I explained in Cutting Taxes + Failing to Identify and Enact Spending Cuts = Default?:

So perhaps it would be helpful to learn what spending items the Republicans wish to eliminate. After all, they want to use their opposition to an increase in the debt limit as leverage to compel spending cuts. According to this report, when asked which programs could be cut, Boehner replied, “I don’t think I have one off the top of my head. But there is no part of this government that should be sacred.” Aside from the continued refusal to identify spending cuts, surely out of fear that lobbyists for those adversely affected by such cuts would descend on their Capitol Hill offices in a stampede, the Republicans are being boxed into a corner by their leader. When Secretary of Defense Robert Gates announced plans for a very small increase in the military budget for next fiscal year, plans that include shrinking the size of the Army and Marine Corps and cutting two major weapons systems, as explained in this story, Republicans objected, suggesting that the proposal puts the nation at risk. Is it possible to imagine how Republicans would respond to a proposal to decrease total defense spending when they go ballistic over smaller than expected increases? Do they truly think nothing in government is sacred? In The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I invited “the advocates of using spending cuts as the sole solution to the budget deficit crisis to identify sufficient cuts to bring the budget into balance.” I’ve had no replies from those advocates that identify specific cuts or even general spending reduction ideas. I’m not surprised.

I’ve been trying to get answers for quite some time. More than a year ago, in Some Insights into the Tax Policy Mess, I warned:

The deficit cannot be eliminated merely by cutting spending, unless Congress wants to strip the military down to pretty much nothing, eliminate Social Security and Medicare, and put an end to a variety of other programs. The nation faces huge deficits not only because tax rates on the wealthy are lower than they need to be, but also because the deficit reflects eight years of taxes that should have been collected but that were forgiven by a Congress anxious to reward the economic elite and ballooning interest payments on the debt undertaken to finance the deficits generated by trying to finance a war while cutting taxes.

A few months later, in June of last year, I challenged politicians and commentators from every spot on the spending-taxation spectrum to nominate their candidates for program reduction and elimination. In FICA, Medicare, and Payroll Taxes, I wrote:

Advocates of continued and increased spending need to identify the tax increases that will permit that to happen in the absence of a deficit, and it will take more than the return to the pre-2001 rates and the elimination of capital gains preferences that I support. Advocates of tax cutting need to identify the cuts they would make to balance the budget, and if they don’t touch defense, Medicare, Social Security – and they’re stuck with the interest payment on the debt – there’s not enough to cut.

The response was overwhelmingly quiet. No spending-cut advocate candidate had the courage to make his or her axe list public, because getting votes is much more important than getting honest. Having failed to get the specifics onto the table during the election, in November of last year, anticipating the continued stonewalling in response to requests for specific identification of programs on the chopping block, I challenged spending cut advocates, including but not limited to candidates and legislators, to step up and let Americans know what they planned to do. In The Grand Delusion: Balancing the Federal Budget Without Tax Increases, I explained the fallacious reasoning and misperceptions that cause Americans to think that by cutting waste and aid to foreign nations the federal budget can be balanced. I also explained why cutting spending would be insufficient to eliminate the budget deficit.

Finally, the spending cut advocates who have taken control of the House of Representatives have had to put their cards on the table. In GOP Bill Pairs Budget Cuts, Regulatory Rollbacks, we learn not only which programs are the targets of the spending axe wielders, but also that they intend to eliminate all sorts of rules that protect ordinary citizens from predatory wheeler-dealers, who find taxes and government regulation to be annoyances that get in the way of their objectives. I suppose they’re not unlike the folks who found the newly-arrived sheriffs in Wild West towns to be an annoyance.

So what does the House majority want to cut or eliminate? Check out the list, which is based in part on a Center on Budget and Policy Priorities report:

• A 15% reduction in Head Start funding, in addition to the expiration of funding provided by 2009 legislation, requiring the dismissal of 157,000 children from Head Start education, health, and nutrition services.
  
• A 6% reduction in funding to assist K-12 education, including termination of Mathematics and Science Partnerships and Educational Technology State Grants, reductions in assistance to special education, funding for literacy programs, Special Olympics, and a long list of initiatives designed to help American’s future generations learn what they need to know and understand in order to compete globally with the future generations of places like India, China, Korea, Germany, and Brazil, to name but a few countries whose students are performing better than are America’s children.
  
• A 24% reduction in Pell Grants, which will compel at least some of the 9.4 million college students receiving grants to drop out of college, and forcing unmeasured millions to decide not to attend college.
  
• Cuts in programs that assist high-school dropouts to become contributing members of the economy, including elimination of the Tech-Prep and Workplace and Community Transition programs.
  
• A 6% reduction in funding for community mental health services block grants and substance abuse and treatment block grants, reducing assistance for the mentally ill.
  
• Reductions in the special supplemental nutrition program for women, infants, and children, which, until now, has been able to provide women, infants, and children under age 5 with necessary food and health care that has reduced infant mortality and improved birth outcomes and diets.
  
• A 43% reduction in the Public Housing Capital Fund, thus removing almost half the funding required to make emergency and other repairs to public housing units primarily occupied by low-income senior citizens and disabled individuals.
  
• A 10% reduction in the HOME Investment Partnerships program, which assists local governments develop, acquire, and rehabilitate low-income housing.
  
• A 30% reduction in block grants to assist low-income Native Americans and Native Hawaiians living on reservations, tribal areas, and home lands.
  
• A complete termination of the Low Income Home Energy Assistance Program.
  
• A complete termination of the low-income Weatherization Assistance Program.
  
• A 56% reduction in funding for the EPA’s clean water and safe drinking water programs.
  
• A 19% reduction in funding for local law enforcement, courts, prisons, crime victim and witness initiatives, and other initiatives designed to reduce crime.
  
• A 10% reduction in funding for the Centers for Disease Control and Prevention, the agencies that deal with pandemics, food poisoning outbreaks, and other serious public health matters.
  
• A 10% reduction in funding for the Food and Drug Administration, the agency charged with protecting the quality of the nation’s food and drug supply, which already is suffering from insufficient funding to deal with the significant increases in food-borne illnesses.
  
• A 9% reduction in funding for the Food Safety Inspection Service, which is the agency charged with inspecting farms, food factories, and other components of the nation’s food supply.
  
• A 4% reduction in funding for the National Institutes of Health.

But it wasn’t enough to slash spending in ways that will increase costs in the future and that will increase class sizes in K-12 education, cause mortality rates among low-income individuals to increase, and leave the next generation less prepared to compete in a global economy. The House majority also took the opportunity to block the EPA from curbing greenhouse gas emissions, to negate EPA rules designed to prevent the growth of algae in Florida’s lakes and streams caused by excessive use of fertilizer and other pollutants, to stop the EPA from implementing a plan to clean up the Chesapeake Bay – putting fishermen, crabbers, and others who make their living in the Bay at risk of going out of business so that farmers and others who in making their living dump all sorts of waste and poisons into the Chesapeake Bay watershed – and to terminate plans to remove hydroelectric dams from the Klamath River. The House majority also acted to let mining companies that slice off the tops of mountains continue to do so even if it increases water pollution.

The Economic Policy Institute claims that, if enacted, the legislation would cause a loss of 800,000 jobs. Not surprisingly, leaders of the House majority attacked the Institute’s methodology, and in a response, the Institute not only defended its analysis, but noted that close to one million jobs would be lost.

Most observers doubt that the House-passed legislation will be enacted, because it is likely to face sufficient opposition in the Senate to fail to get to the President’s desk. And if did get to the President, there is almost unanimous consensus that the bill would be vetoed. So, perhaps, knowing this, the House majority is having its moment in the sun, grandstanding for the benefit of its backers who want at least a show of support for the “let me do whatever I want” philosophy. That will permit them, during the next campaign, to argue, “I tried, but the evil people who want clean water, safe food, nutrition for starving children, health care for at-risk infants, education for students who the hope of tomorrow, and all other sorts of ‘bleeding heart’ nonsense outnumbered us and stopped us, so join with us to take over the Senate and the White House so that we can cut spending to the point where Americans will need either to pay more state and local taxes or watch the quality of life for all but the wealthy go down the tubes.” Oh, wait, their campaign managers will take out that last part, and replace it with “so join with us to take over the Senate and the White House so that we can make America a wonderful place the same way the tax cuts we advocated made the economy roar.” Oops. That won’t work, either, will it? So perhaps, “join with us to take over the Senate and White House so that we can do all sorts of wonderful things,” leaving out the “which will have effects we won’t share with you, just as we didn’t tell you what programs we would be cutting until after we extracted your vote back in 2010.” I wonder what the 2010 election results would have been had, during the fall, candidates announced they were in favor of a polluted Chesapeake Bay, more crowded K-12 classrooms, termination of low-income energy and weatherization assistance, reductions in Head Start, Pell Grants, food for starving children, and funding for the agencies charged with protecting an already endangered food supply system. I wonder what would have happened had the candidates been forthcoming. Perhaps the outcome would have been different. Or perhaps we would have learned that a majority of Americans prefer polluted waters, starving children, more homeless low-income people, tainted food, worsening education, and increased illiteracy and innumeracy. Perhaps there are fewer and fewer “bleeding hearts” because there are fewer and fewer people with hearts. I doubt it. I think Americans with hearts need to find their voices. And soon.

Truly, Tax Ignorance Is Frightening

Last week, Paul Caron’s TaxProf Blog published Maule: The Tax Consequences of Congressional Sleepovers, in which I explained that additional factual analysis was required before any conclusions could be reached concerning the tax consequences of members of Congress sleeping in their offices. It is not uncommon for people to seek conclusions before all the requisite facts are known. Recently, for example, a tax practitioner posed a question to a tax listserve, and in my response I identified facts that needed to be resolved before an analysis could be undertaken that would lead to a conclusion. I encounter this problem frequently, when I get calls and emails from lawyers who want “the answer” but who are dismayed when I ask questions that in the aggregate constitute an inquiry as to “what, really, is going on here?” Otherwise, discussion is restricted to a discussion of the, for example, 81 possible analyses arising from the application of law to three possible factual determinations with respect to four key questions. I use the term “restricted” not because the discussion is constrained – to the contrary, it is 81 times as long as it would be had the necessary facts been determined – but because the discussion, though useful intellectually, does nothing for the client who needs an answer, and who is likely to balk at paying for 81 times as much discussion as is necessary.

That is why it is even more offensive to listen to people jump to conclusions, that is, proclaim outcomes without knowing the facts. In many instances they don’t even realize that there are facts they need to know, because they haven’t bothered to do the analysis. That’s probably because they don’t realize that there is analysis that needs to be done.

A brilliant example of the “speak without knowing what you need to know” nonsense has emerged in connection with the debate over members of Congress catching shut-eye in their offices. On Thursday, Paul Caron’s TaxProf Blog published a link to a “conversation” between MSNBC commentator Lawrence O’Donnell and Representative Jason Chaffetz of Utah. In MSNBC Calls Congressmen Who Sleep in Their Offices “Tax Criminals”, the lack of tax law knowledge was alarming, not merely because lack of tax law knowledge often is per se dangerous, but because the two people involved are in positions that demand they not speak unless they understand what they are describing. A commentator who, for whatever reason, lacked any sense of sections 119, 132, or 162 of the Internal Revenue Code, made accusations against a member of Congress who is entrusted with the responsibility of being a lawmaker. Chaffetz, who before agreeing to the interview, ought to have brushed up on the applicable law, or at least consulted with a tax professional, made absolutely no attempt to raise the issue of excludable fringe benefits or the principle that criminal tax fraud charges won't stick when there is doubt about the applicable outcome (the latter being something to which O’Donnell, too, should have paid attention). O’Donnell made a big deal of Chaffetz’ failure to request tax advice from the IRS, though he didn’t bother to ask whether Chaffetz had sought advice from some other professional source. I suppose I could ask O’Donnell whether he had obtained any information about the applicable tax law, for example, by having an MSNBC intern do some research, perhaps even taking a look at Maule: The Tax Consequences of Congressional Sleepovers. At least O’Donnell vowed to ask the IRS for an opinion. It will be interesting to learn if he followed through, if he obtained any sort of answer, and what the IRS says.

One of the reasons so many bad decisions have been made with respect to this nation’s tax law, economy, national security, and other concerns is that far too many people choose to issue proclamations without taking the necessary steps to be informed about the information that needs to be known in order to issue a proclamation that is sensible and correct rather than nonsense. It’s one thing when two people in a bar toss about silly assertions with respect to the local professional sports team. If they’re both full of nonsense, so what? But when a national cable news commentator, viewed here and abroad, and a member of Congress toss about silly assertions and demonstrate ignorance, it’s not only an embarrassment, it’s also dangerous. Why? It adds to the national culture of ignorance that has become frighteningly pervasive. Somehow, in the effort to score faux debating points and rile up “the base,” commentators and politicians neglect their obligation to speak from an informed perspective. Their fiduciary duty to the citizens of this nation demands nothing less.

And in the meantime, too many politicians are trying to cut funding for education, goaded by a significant segment of national commentators. One wonders who benefits from these efforts? Could it be that widespread ignorance is useful to a select few? Truly, ignorance, including tax ignorance, is frightening.

On Deficits, Taxes, and Government Spending: Looking Back at the 1940s

Last week, in So Where Have the Tax Reductions Gone?, I focused on the fact that federal tax receipts, as a percentage of gross domestic product, had fallen to a 60-year low of 14.8 percent. As recently as 2008, the share had been 17.5 percent.

Now comes news that the Administration’s proposed budget would generate a deficit of $1.65 trillion, roughly 10.9 percent of GDP. That would be the highest since 1945, when it reached 21.5 percent of GDP. In 1945, the nation was at war, a war that was declared and a war that was financed, to the fullest extent possible, by taxation representing increases over pre-war levels.

Slightly different numbers emerge from other analysts. For example, the US Government spending web site puts the 1945 deficit as 24.07 percent of GDP, following 1944’s 22.35 percent and 1943’s 28.05 percent. During those same years, according to another chart on that site, government spending as a percentage of GDP during 1943 through 1945 amounted to 46.68, 50.02, and 52.99 percent of GDP. Rough computation tells us that tax receipts accounted for the difference. Thus, in those three war years, taxes represented 18.63 percent, 27.67 percent, and 28.92 percent of GDP.

Comparing those war year numbers with the current situation, using the Administration’s budget as the benchmark, taxes represent 14.8 percent of GDP, spending represents 25.7 percent of GDP, and the resulting deficit constitutes 10.9 percent of GDP. Do these numbers suggest that government spending is out of control, as certain segments of the electorate and of the business world contend? Hardly. Considering that the nation remains at war, in fact a war fought on at least as many fronts as was the war being waged in the 1940s, it makes sense to compare how responsible politicians managed the economy sixty years ago with how irresponsible politicians manage it today. During the last year of the war, government spending had reached 53 percent of the economy and taxation had reached 28.92 percent of it. Now, spending as a proportion of GDP has been cut by 51.5 percent (53 to 25.7), and taxes by 49 percent (28.92 to 14.8). In other words, both taxes and spending have been cut by roughly the same amount, and yet the anti-tax movement wants even more tax cuts.

What gets little attention in the mainstream media, on most blogs, and from most commentators, especially those supporting further reductions in taxation, is the impact on the deficit of not only the refusal of Congress to raise taxes in time of war, as happened in the 1940s and again in the 1960s, but also its foolish move to reduce taxes during a time of war. Not only did the series of resulting and continuing annual deficits contribute to the total accumulated deficit, the interest payments on those deficits have literally and figuratively compounded the problem. Five years ago, in A Memorial Day Essay on War and Taxation, a commentary which not only I have quoted on several occasions but which has been mentioned occasionally by other commentators far from the mainstream media, I explained why the failure of politicians to demonstrate leadership and ask for sacrifice from all citizens, and not just the dedicated members of the Armed Forces, was unwise and destined to create systemic economic and national security problems for the country:

I wasn't around during the last full-fledged, unlimited global conflict. Yet I've listened to as many tales as were shared with me by those alive at the time as I could find, and I've read and watched a lot. So I've heard and read about rationing, double shifts, postponed plans, substituted products, and sacrifice. Every tax practitioner, and every citizen, should understand that during World War Two income tax rates skyrocketed, wage withholding was introduced, and the entire revenue-expenditure structure was altered. War hung as a cloud over every life, and over every dollar. Is that good? I think so. Why? Because war is so serious and so terminal a course of action that it should not be permitted to recede to the background.

Yet the current global war has not been managed in the same manner. Politicians have chosen to fight without increasing revenue, imposing rationing, or deferring projects and activities. In their defense, they argue that none of these things are necessary, that a nation can have its guns without giving up its butter. I disagree, and I happen to think that politicians are reluctant to do what needs to be done because they are more concerned about maintaining their position in office than in making the tough decisions that war requires. So our national leaders have chosen to put the cost of the current war on our children and grandchildren. Those who decry the huge deficits, triggered in part by war and in part by the almost insane concept of decreasing tax revenues (mostly for the wealthy) during wartime, pretty much focus on the economic impact. They ask if, or suggest that, our grandchildren will be facing income tax rates of 80 percent in order to reduce an unmanageable deficit. I think it will be worse. I think our children and their children and grandchildren will become subservient to our nation's creditors. The sovereignty of the United States of America is far from guaranteed, and is at risk. Were these considerations discussed when those in power decided that war can be done on the cheap?

War cannot be done on the cheap. War is not free. War ought not be purchased on a credit card. War is a national commitment. Hiding the true cost of war in order to influence a nation's willingness to engage in war is wrong. Ultimately, the price to be paid will be dangerously high.

Though sometimes when I re-read things that I have written, especially things written years or decades ago, I recognize where I could have used different words that would have made the piece better. Every once in a great while, I realize that I have changed my mind, or would have presented a different analysis. But every time I re-read what I wrote in A Memorial Day Essay on War and Taxation, I wonder what happened that day. Something inspired me. Something made me deeply concerned and almost angry. Perhaps it was the fact that while Americans were dying, and continue to die, most of the nation was rolling along, almost oblivious to the realities of the world. Something, culturally, is very wrong, and it’s not the efforts of a nation to help those who are in need, which is what some people want to eviscerate as the national price for waging war while lowering rather than raising taxes. Something, morally, also is very wrong. Leadership requires something more than gathering votes by telling people the nation asks less of them. Our parents and grandparents responded unselfishly. Can we not honor them by doing likewise?

The Unintended Consequences of Tax Policy As a Social Tool

Long-time readers of this blog, like my students who paid attention and my friends and colleagues who listened, know that I object to the use of the tax law to promote specific social objectives. For example, why should the IRS be the agency responsible for regulating residential energy-saving improvements, adoption of special needs children, or purchases of fuel-efficient automobiles? Ought not the Department of Energy, the Department of Health and Human Services, and the Department of Transportation be dealing with these matters, if at all? I pointed out the ineffectiveness of this approach in "Professor Maule Goes to Washington" and in Not To Its Credit, among other posts. Now another interesting lesson in the futility of using tax as an economic policy scalpel comes from France.

Pierre Cahuc, of the National Institute of Statistics and Economic Studies National School for Statistical and Economic Administration, the University of Paris Pantheon-Sorbonne, the Centre for Economic Policy Research, among other institutions, and Stephane Carcillo, of the International Monetary Fund, have published a paper in which they examine the effect of a French tax law that exempted overtime wages from income tax and social security contributions. In The Detaxation of Overtime Hours: Lessons from The French Experiment, they explain how a law designed to increase the number of hours worked not only failed to attain its objective but provided “highly qualified wage-earners, who have opportunities to manipulate the overtime hours they declare,” a blueprint for reducing the taxes they paid on their non-overtime wages.

Two major lines of questioning present themselves. One deals with the policy. The other focuses on why tax law is not the best tool for advancing the policy.

Presumably, France wanted to increase the number of hours worked because it wanted to improve its economy by increasing worker productivity. Coupled with this goal were concerns that the supply of workers capable of doing the work that needed to be done were in short supply. French law prevents employers from simply telling qualified workers that they must work additional hours, even if compensated. It is unclear whether French law prohibits employers from training people to do the work that needs to be done, whether directly or indirectly through foundation of, or support for, educational institutions providing the training. Perhaps a deeper problem is the unwillingness of people to learn these skills, though arguably people with no jobs or bleak employment prospects because their current skills are no longer desired would jump at the opportunity to re-tool and find employment.

The analysis is complicated by the advantages to employers of getting more hours out of employees rather than hiring additional employees. A good example of this phenomenon can be found in large American law firms, which prefer to hire, say, 10 new associates each earning $160,000 than 20 new associates each earning $80,000. The 10 new associates, in order to make their salaries manageable by the firm, are pressed to bill upwards of 2,400 hours, which translates into 52 weeks of 65 or more hours in the office, whereas 20 associates earning $80,000 would not need to bill anywhere near those numbers of hours, and thus might have a chance of investing some time in life outside of law. There are two factors that push law firms in the direction of hiring fewer associates and seeking more output from each employee. One is fringe benefits, which as a percentage of salary, decrease as salary increases. In other words, the cost of fringe benefits for two $80,000 associates exceeds the cost of fringe benefits for one $160,000 associate. The employer portion of the FICA tax is one example of this phenomenon. The other factor is that it is easier, in many respects, to train 10 new associates rather than 20, because training 20 associates chews up disproportionately more resources than training 10 associates. Though hiring 20 new associates would be a better approach socially, and perhaps even morally, it is economically the less desirable approach, at least in the short run. In the long run, the economic costs of the psychological side effects of demanding upwards of 2,400 billable hours from associates makes hiring 20 rather than 10 new associates the better choice, but business organizations much prefer decisions based on short-term, rather than long-term analysis, and might even lack the ability to engage in the latter.

Thus, it is not difficult to understand that employers in France, persuading or working in concert with the French government, decided to find a way to induce employees to work more hours. They chose to use the tax law to do so. It backfired. That is not surprising. In every instance where the Congress has used the tax law to encourage behavior, all sorts of people have crawled out from under the wood pile to claim that they were engaging in that behavior and thus entitled to the tax break, even though they were not engaging in that behavior. One need think only of the abuses with respect to the credit for new home purchases, the earned income tax credit, the plug-in electric and alternative motor vehicle credits, and the biodiesel fuel credit, to name but a few, to understand the inherent weakness of trying to use tax law to do what should be done through other means.

Why Teaching Isn’t Just a Matter of What One Knows or Understands

My Friday morning email from Law.com brought a story whose headline was alarming. Half an hour later, Paul Caron’s email conveying the morning’s TaxProf Blog posts carried the headline for his post on the topic. The first headline? “Law Professor, a Former Tax Attorney, Convicted for Failing to File Tax Returns.” The second headline? “Tenured Law Prof (Former Tax Lawyer) Convicted of Failing to File Tax Returns.”

Wow.

Professor Robin Kimberly Magee, a member of the faculty at Hamline University School of Law, was convicted by a jury in Minnesota of failing to file state tax returns. She had told investigators when initially questioned, and asserted again at trial, that “she didn’t understand tax law.” According to her on-line biography at the school’s site, “While in private practice, [she] concentrated in the area of criminal, entertainment, and tax law.”

At first, Magee was charged with failing to file returns and pay taxes, which are felony charges, but those were dropped, and she was convicted of the gross misdemeanor counts of failing to file state tax returns. According to the Minnesota Department of Revenue, Magee failed to file returns from 1991 through 2003, so the Department filed returns on her behalf. Magee continued to not file state returns for 2004 through 2007, and for unexplained reasons the state did not file returns on her behalf for those years. Those were the years for which she was convicted of not filing returns. Although state taxes had been withheld from her salary during those years, it is unclear whether she owed additional taxes or was entitled to, and received, refunds.

In her defense, Magee’s attorney claimed that Magee “relied on the state to complete her tax filings.” However, that is not an appropriate approach to dealing with one’s obligation to file tax returns, nor does it necessarily leave the taxpayer in a position of having fully satisfied his or her income tax liability. A taxpayer can, under certain circumstances, request the IRS or a state revenue department to complete a return, for example, computing the tax liability, but to do so, the taxpayer must file a return that contains sufficient information for the government to do so.

Surprisingly, after the conviction, Magee told reporters that “she felt vindicated.” That reaction is difficult to comprehend. How is it possible to interpret the conviction as approval of what she did? According to the story, her supporters, who were not identified, claim that she was “unfairly prosecuted because she has publicly criticized local prosecutors in the past.” Proving unfairness would require some sort of showing that the state does not prosecute other taxpayers who fail to file returns, though the wrinkle in the argument is the unexplained decision by the state to stop filling out returns on Magee’s behalf. Perhaps it was vindictive. Perhaps it was a matter of deciding that after 13 years of communications to the taxpayer informing her of her duty to file, her failure to do so, and the state’s corrective actions, someone decided that enough was enough.

The Dean of Hamline’s law school said the school was “disappointed” and would review the situation to see what steps would be taken. He noted, “Her actions are contrary to the values of our law school where we expect faculty to lead by example in teaching respect for the rule of law.” Indeed. Suffice it to say Magee is not the only member of a law faculty to act contrary to the school’s value and to act inconsistently with the rule of law. I have empathy for the other members of the faculty of Hamline’s law school. It’s not fun discovering what colleagues have done that ought not to have been done.

Ironically, Magee, who has not taught a course since 2009, is assigned to, and has taught, criminal procedure, criminal law, property, police practices, and a seminar on race and law. It could have been worse. She doesn’t teach tax law. Over at Tax Update Blog, Joe Kristan, in Sometimes Those Who Can’t Do, Really Do Teach, opines that the conviction “gives anybody borrowing money to pay the $28,000+ Hamline Law School tuition reason to ponder what they’re getting for their money.” If Magee had been teaching tax courses, I’d share that concern. Fortunately, Hamline students who take tax courses are taught by other faculty. I don’t expect the intellectual property experts or the torts experts or the land use experts to have the ability to teach or practice federal securities regulations, though every now and then someone combines, for example, intellectual property with securities regulations to carve out a valuable academic and practice niche. My question is whether the clients for whom Magee practiced tax law are concerned about her assertion that “she didn’t understand tax law.” Isn’t is late in the day for her to make that claim?

The difficulty is that Magee wasn’t tripped up by some complicated tax provision such as the many that cause taxpayers to file inaccurate returns. Even in those situations, lawyers – and even law faculty who aren’t members of the bar – should know enough to get help so that they avoid negligence penalties. The difficulty is that most citizens know, and all citizens and lawyers should know, that they have an obligation to file income taxes with the state in which they reside. That part of tax law isn’t confusing, and it should be remembered that although tax law is complicated, not every part of it resembles rocket science. Some aspects of tax law are fairly easy to learn and to understand. Magee didn’t struggle with tax technicalities. She practiced tax law, but nonetheless simply didn’t bother to file her state income tax returns, for at least 17 years. Ironically, Magee also practiced criminal law, was teaching courses in criminal law and criminal procedure, and ought to have been aware that failure to file a tax return is within the realm of crimes.

Perhaps the answer lies in Professor Magee’s personal statement in her on-line biography. She writes, “I believe, as the founders of this country espoused, that the greatest threat to law and order, peace and liberty is tyranny, not crime. I, therefore, believe that the highest calling of the lawyer is the call to fight against tryanny [sic] and government-sponsored or tolerated oppression. Thus, I struggle in my classes to instill in my students the knowledge of the law and the critical and analytical skills to hold the government (and everyone else) accountable to the rule of law and the rights of all people." Could her failure to file have been some sort of protest against government? I don’t know. Could her failure to file have been based on some belief that the requirement to file tax returns is tyranny? I don't know. Could her failure to file have reflected her belief that she was not subject to the law? I don't know. Perhaps Professor Magee will enlighten us by explaining why she hadn’t been filing state income tax returns. And I’m sure I’m not the only person who is curious and wants to know if she filed state income tax returns for 2008 and 2009, and if she has filed federal income tax returns.

So Where Have the Tax Reductions Gone?

A TaxProf blog post sent me to an interesting AP article, the headline of which must surely take the wind out of the sails of the “our taxes are too high so let’s cut or eliminate them” crowd: “High Taxes? Actually, They’re at a 60-Year Low.” Wow.

The AP article, relying on a Congressional Budget Office report and scenarios worked out by H&R Block’s Tax Institute, points out that federal tax receipts have fallen to 14.8 percent of the gross domestic product, the lowest since 1951. That compares to the 17.5 percent share of GDP paid in federal taxes in 2008. So much for the rumors and allegations that the current Administration has caused taxes to increase. Interestingly, even though corporations are awash in profits and cash, the CBO reports that corporate tax revenues have fallen by a third. It’s no wonder that the budget deficit is growing and federal debt is skyrocketing.

So if the federal government is taking a significantly smaller portion of GDP, where’s the tax reduction going? Granted, a small portion is heading the way of states that have increased their taxes, though those increases don’t make much of a dent in the amount of tax payment reductions for the private sector. The savings aren’t being used to create jobs, a conclusion that correlates with the huge build-up of cash in corporations and other business enterprises. It’s not being used to buy more things, as consumer spending statistics show reductions in, and at best, steady retail sales.

Could it be that the money representing federal taxation’s decreased share of GDP has been and is heading offshore? Is it being stashed somewhere, as insurance against the looming catastrophic consequences of bloated federal debt? And as for who is doing this, surely it is not the poor who are putting money aside. And it’s unlikely that the middle class, whose real earnings have been dropping during the past decade, can afford to set cash aside in offshore tax havens. That leaves, of course, the folks who we were told would use their tax cuts to create jobs and turn the economy into a robust machine. That hasn’t happened. So what are they doing with their tax cuts? And why?

When Tax Cuts Cause Privatization, Taxpayers Pay More, Not Less

Several weeks ago, in The Price of Insufficient Tax Revenue, I described how the City of Camden, New Jersey, was compelled to make substantial reductions in its police, fire fighting, and other departments because of insufficient tax revenue. Now comes news that not only reveals the scope of Camden’s budget cuts, but also suggests that something a bit more complicated is involved.

According to the Philadelphia Inquirer story, Camden had no choice but to dismiss both of its animal-control officers. That move has left the city without the personnel required to deal with stray animals, including those with rabies, those posing a threat to adults, children, and infants, those already having bitten people, those that are fighting, those lying dead in the street, and those contributing to a build-up of filth. When one resident had to deal with cats roaming private property and “howling through the nights,” one resident stated, simply, “I would have called somebody, but with all the layoffs, I didn’t know who to call.” Eventually a nonprofit organization showed up on its own initiative and tried to deal with the problem. Multiple 911 calls with respect to several dangerous dogs finally brought a police officer, along with a private animal-control contractor whose initial reaction to the non-profit’s volunteer had been, “I’m not the person to call.”

It turns out that Camden privatized animal control as “a necessary cost-cutting measure.” It has hired a private contractor, whose winning bid of $190,970 is $20,000 more that what the city had been paying annually for salaries and benefits to the two animal-control officers to whom it had given pink slips. Hello? How is that a cost-cutting move? To me, it’s another example of how privatizing what are and should be public government functions end up costing taxpayers more in order to provide the profit margin demanded by the private sector but unnecessary when government handles a public matter. This phenomenon has arisen in connection with such functions as trash and snow removal, recycling, and leaf disposal, as I discussed in Another Tax v. Private Cost Increase Choice, as well as highway maintenance, as I discussed in Are Private Tolls More Efficient Than Public Tolls? and More on Private Toll Roads. As I wrote in Another Tax v. Private Cost Increase Choice:

Shifting public services into the private sector simply puts more money, in the form of profits that don’t exist and don’t need to exist in the public sector, into the pockets of those who are eager to turn public services into their own money-generating machine. That money comes from taxpayers, duped into thinking that “holding the line on taxes” is a good thing. Only when they compare the impact on their own budgets – too often done after the fact than beforehand – do some or many of them realize that they are getting the same or decreased services but paying out much more.

By the time residents of Camden and New Jersey generally decipher the impact of the tax-cut philosophies that at first glance seem so attractive, and realize that in the long run, their financial positions have worsened, it will be too late. Why? Because the remedy will not simply be restoration of the taxes that ought not to have been cut, but imposition of even higher taxes to make up not only the lost revenue but the public resources siphoned into the hands of the select few who benefit from privatization.

Worse, comments from Camden officials suggest that response times will increase, coverage will decrease, efforts to eliminate dog fighting will diminish, and assistance provided to police searching dog collars and doghouses for drugs will disappear. One official pointed out that a study conducted a few years ago revealed “privatization was more expensive.” It still is.

The Problem with Income Tax Vehicle Credits

Late last week I received a press release from the Treasury Inspector General for Tax Administration (TIGTA), summarizing a report which disclosed that roughly $33 million in erroneous tax credits for plug-in electric vehicles and alternative-fueled vehicles had been claimed by “at least 12,920 taxpayers through July 24, 2010.” Considering that taxpayers had claimed $163.9 million in credits between January 1, 2010 and July 24, 2010, for these types of vehicles, that means 20 percent of the credits that were claimed were erroneous. That is a high error rate. Too high.

Some of the credits were claimed by taxpayers who were in prison for all of 2009. That impediment to purchasing qualifying vehicles somehow did not get in the way of these prisoners from claiming credits to which they were entitled. Labeling these credits as “erroneous” is way too kind. Presumably, some of the credits indeed were claimed erroneously, because the complexity of the credit provisions makes it easy for a taxpayer to misidentify a vehicle as eligible for the credit, or to make arithmetic or other errors when computing the credit. One error noticed by TIGTA was the claiming of both the plug-in electric vehicle credit and the alternative-fueled vehicle credit for the same vehicle, when in fact a vehicle cannot qualify for more than one credit. It’s not surprising, in light of the complexity of the various multiple vehicle credits, for taxpayers to be confused and make this sort of error.

TIGTA concluded that the IRS was not spotting erroneous credits with sufficient frequency. It concluded that the IRS had “inadequate . . . processes to ensure information reported by individuals claiming the credits met qualifying requirements for vehicle year, placed in-service date, and make and model.” TIGTA also concluded that “the IRS cannot track and account for plug-in electric and alternative motor vehicle credits claimed by individuals on paper-filed tax returns because it has not established processes to capture this information from those returns.” TIGTA made recommendations for fixing these problems, and the IRS agreed. By taking steps to implement these recommendations, the IRS managed to stop another $3.1 million in erroneous claims from generating revenue losses.

The cause of these difficulties rests, of course, with the Congress. During the past two decades, Congress has heaped credit upon credit onto the tax system, putting administration of environmental, energy, health, labor, child care, and all sorts of other matters into the hands of the IRS rather than the federal agencies charged with oversight of these areas. At the same time, the Congress has failed to provide the IRS with sufficient funding to administer these credits. It’s not surprise, then, that the IRS hasn’t developed a full and efficient set of procedures to manage each of the many dozens of credits that it must supervise.

Results such as the ones TIGTA discovered with respect to the two vehicle credits pale in comparison to what awaits us when full implementation of the tax aspects of health care reform is undertaken by the IRS, as I explained in IRS Ought Not Be the Health Care Enforcement Administrator. My reservations about putting almost every aspect of government activity on the shoulders of the IRS pre-dates health care reform, as was noted in the nightmarishly-titled ”Professor Maule Goes to Washington” and in Not To Its Credit. In the latter post, I wrote:

I wonder how many taxpayers benefit from these credits, and whether making tax credits available for the activities that permit the credit to be claimed is the most effective and efficient way of encouraging people to engage in those activities. It's not that I object to the goals. I object to the Internal Revenue Service being turned into a institution that is focused more on the technical requirements of energy production activities than on administering revenue laws. I wonder why financial incentives to produce and conserve energy aren't administered by the Department of Energy. Well, I know the answer. The Congress, though every now and then publicly trashing the IRS and characterizing it as harmful, then turns to the same agency to administer its favorite incentives programs. Which should speak more loudly to America? What Congress says when it grandstands or what it does when it overburdens the tax law and the IRS because it apparently doesn't trust other agencies to administer laws relating to agriculture, energy, employment, or health?

Yet I wonder, if the desire by Congress to encourage the purchase of electric cars and alternative-fueled vehicles had been implemented through a direct rebate program administered by the Department of Energy, whether a similar 20 percent error rate would have been avoided. I don’t know. Is it easier for prisoners to file tax returns falsely claiming these vehicle credits than it would be for them to file rebate claims with the Department of Energy? Would vehicle purchasers be less likely to get confused by the rules if reimbursements were not imbedded in the tax system?

Ironically, these credits exist because Congress wants to encourage Americans to purchase vehicles that operate without, or with less, dependence on non-renewable resources, such as foreign oil. Without the incentives, far fewer Americans would purchase hybrid and electric cars, principally because they are more expensive than gasoline-fueled vehicles. The private sector, without the injection of government programs, fails to achieve this goal. The reason is that the government, at the same time, also skews the economics of the private transportation sector by failing to increase highway fees and fuel taxes to reflect the true economic cost of operating vehicles. The implementation of a mileage-based road fee, which I last discussed in Mileage-Based Road Fees Gain More Traction and Looking More Closely at Mileage-Based Road Fees, might in and of itself trigger a much more significant shift to electric and alternative-fueled vehicles. That outcome would permit abolishing the income tax vehicle credits and make rebate systems administered by the Department of Energy unnecessary.

How to Kill a Bad Tax System That Will Not Die?

The travails of the Philadelphia property tax system and the Board of Revision of Taxes that has administered that system are well known. The ever-lengthening story of recent attempts, during the past four years, to reform the administration of the tax has been the subject of a similarly increasing list of MauledAgain posts, starting in An Unconstitutional Tax Assessment System, and continuing in Property Tax Assessments: Really That Difficult?, Real Property Tax Assessment System: Broken and Begging for Repair, Philadelphia Real Property Taxes: Pay Up or Lose It, How to Fix a Broken Tax System: Speed It Up? , Revising the Board of Revision of Taxes, How Can Asking Questions Improve Tax and Spending Policies?, This Just Taxes My Brain, Tax Bureaucrats Lose Work, Keep Pay, Testing Tax Bureaucrats Just Part of the Solution, A Citizen Vote on Taxes, Freezing Real Property Tax Reassessments: A Nice Idea, The Tax Price of a Flawed Tax System, Can Bad Tax Administration Doom the Tax?, Taxes and Priorities, R.I.P., BRT, A Tax Agency Rises from the Dead, and Tax Law as Subterfuge: Best Use Valuation v. Current Market Valuation.

Disaffection with the Philadelphia property tax and the BRT is widespread. The City Council, as discussed in A Citizen Vote on Taxes, put the matter to a vote by the city’s taxpayers. Not unexpectedly, as related in R.I.P., BRT, the voters chose to replace the BRT with a bifurcated arrangement, in which setting property values was separated from the appeals process. And it was only a matter of time before those with vested interests in the way the BRT was doing business sued, and as reported in A Tax Agency Rises from the Dead, they were successful in persuading the courts to put the brakes on reform. Though the property assessment function now resides in its own agency, the BRT continues and has jurisdiction over appeals.

But two can play the same game, and as reported in this recent story, a coalition of property owners and property tax reform advocates has sued the city, asking that the property tax system be declared illegal. If they succeed, the city would be compelled to enact a new system, presumably one reflecting what the voters approved. The plaintiffs also want the 2010 property tax increase to be rolled back, and they want refunds issued to those who have already paid property taxes computed at the new rate. They want a judge to “protect taxpayers from unmanageable increases in their property-tax bills” and to suspend sheriff’s sales arising from tax liens. The plaintiffs claim that the city is dragging its feet, worried that taxpayers will rebel – particularly in voting booths – when properly computed assessments are issued. Ironically, the mayor and his administration have consistently sought property tax reform and took the lead in the attempt to dismantle the BRT. The city’s defense is that it takes time to reassess the roughly 577,000 properties in the city, and that it won’t happen “overnight.” The city claims it will take two years. The plaintiffs are impatient, and claim that two years is too long. The plaintiffs also are sincere, as many of them will face higher property tax bills on their own properties if they succeed with their lawsuit. It’s a rare case of putting public interest above personal status.

Some city leaders think that assessments generated by a flawed revision implemented by the BRT as the reform movement was getting underway ought to be implemented immediately, despite the inaccuracies in the information underlying those assessments. They view the plaintiffs’ case as having merit. They are concerned that city inaction will bring about judicial intervention, forcing the city to do what it could do now. A Carnegie Mellon University professor thinks that most elected officials prefer to be told by a court to implement changes that generate increased property tax bills for some or many taxpayers, because it lets them offer the easy excuse that they were required by a judge to adopt a system that caused property taxes to increase for those taxpayers. There is concern that the process of reassessing properties will end up being administered by a judge, something that has been characterized as a “thankless job.”

History has a strange way of repeating itself. In 1981, a court ordered the city to establish an equitable property tax system within six years. Taxpayers are still waiting. One wonders why those who were ordered to do so but did not do so are not sitting in jail somewhere for their dereliction of duty.

When is No Tax Increase a Tax Increase?

The parade of severe winter weather parading through parts of the country, including the Mid-Atlantic area, have had a devastating effect on the snow removal budgets of states and localities. For example, as of last week, according to this report, New Jersey has spent all of the money allocated for snow removal for the 2010-2011 winter season, and as of last week, the calendar page had yet to turn to February. Running out of budgeted snow removal funds will happen when the actual frequency and intensity of winter storms exceed pretty much everyone’s expectations, and that surely has been the case this winter. The snag is that most states and localities, having used most or all of their reserve funds to cover revenue shortfalls in the last two years, are faced with the difficult choice of suspending snow removal or cutting back on other services, such as trash removal, police protection, fire protection, or pretty much any other expense the cutting back of which will bring no fewer howls of protest than will the suspension of snow removal. I wonder if increased expenditures on snow removal constitutes the sort of “government expansion” that the anti-tax crowd despises so much.

So how do anti-tax-increase advocates propose to get out of this conundrum? By dismissing tax increases as some sort of unholy evil deed, they are left with choices such as suspending snow removal or cutting back on police protection, or worse. But wait! The governor of New Jersey, whose defiant resistance to tax increases has generated proposals that jeopardize the safety of motorists and pedestrians, as described in Cut Taxes? Cut Spending? Cut Safety?, and whose other cutbacks include one that has imperiled the city of Camden, as described in The Price of Insufficient Tax Revenue, has come up with an alternative. According to this Philadelphia Inquirer story, he has requested the federal government to provide $53 million to New Jersey as reimbursement for snow removal costs.

If the request by Governor Christie is approved, where does the federal government get the money? One choice is to take it from an existing program. Does a worker get fired? Does a school get closed because funding is reduced? Does an airport reduce its operating hours because it has fewer air traffic controllers? Does the Department of Defense recall several drones, a few tanks, or a destroyer from wherever they are deployed? Or, wait, does the federal government increase taxes to pay for the increased spending on “snow removal reimbursements” to New Jersey and other states? How would that fly with Governor Christie’s anti-tax-increase, pro-tax-cut colleagues in Washington, some of whom have murmured about the possibility of his seeking the Republican presidential nomination in 2012 (a prospect which, incidentally, Christie has been denying)? Is the secret to claiming success as a tax cutter the ability to foist expenses off on another governmental entity, while blaming that entity for tax increases? Oh, wait, indeed, hasn’t this happened under federal legislation that cut federal taxes while shifting spending burdens onto states by using those wonderful “spending mandates”? Do the politicians and their staff who devise these schemes attend the same courses that were attended by Bernie Madoff, the executives of Enron, and the funds transfers specialists in Nigeria?

And keep in mind, as you slip and slide on roads plowed once but not twice as in former years, or treated with less or no salt, that these deprivations were made necessary by the refusal of certain politicians to undo the unwise state and federal tax cuts enacted for the benefit of the wealthy. Perhaps as you are slipping and sliding, or sitting in one of those eternal weather-induced traffic snarls, you can ponder the impact on business productivity, job creation, national defense, and K-12 education of underfunding snow removal expenditures. Perhaps you can join in delight with those who think that cutting back overtime pay for snow plow operators and spending less money on road brine is a good way of “starving the beast.” The government, of course, is us, and so perhaps the silver lining in this winter of transplanted Arctic climate, is that people will understand that starving the government beast is nothing more than self-starvation.