How Better to Mitigate the Effects of Inflation

So the Congress appears to be ready to pass a a compromise bill designed, among other things, to combat the impact of inflation on consumers. That dealing with inflation is its primary purpose seems apparent from the title of the proposed legislation: The Inflation Reduction Act of 2022. Whether the provisions in the proposal will reduce inflation is a discussion I leave to others.

If the Congress truly wants to help people dealing with inflation, perhaps it should go through the Internal Revenue Code and provide inflation adjustments for fixed-dollar amounts that currently are not adjusted for inflation. Without trying to doing the work of Congressional staff, here are two examples where adjusting fixed-dollar amounts would help people. One is the limit above which the $25,000 active-management exception to the passive loss limitations phases out. Currently it remains at $100,000 of adjusted gross income, and amount that when it was enacted targeted the taxpayers who were not low-income or middle class. Now, many middle-class families have adjusted gross income above $100,000 and are caught by a phase-out not intended for persons in their position. The other consists of the fixed-dollar amounts used in computing the amount of social security benefits included in gross income. Those amounts were designed to exempt low-income and low-middle-class taxpayers from being taxed on social security. As I pointed out in Taxation of Social Security Benefits: Inexplicable Inconsistency and Hidden Tax Increases, “None of the amounts [in section 86] -- $25,000, $32,000, $34,000, or $44,000 – have changed. They are not indexed to increase with inflation.”

Would adjusting these fixed-dollar amounts reduce income tax revenue? Yes. Would the amount of that reduction pale in comparison to the tax breaks enacted for the wealthy? Yes. Could the amount be offset by tweaking those tax breaks? Yes. Will any of this happen? I’m not holding my breath.

Tax Can Be, And Often Is, Confusing

The headline in this morning’s Philadelphia Inquirer caught my eye: "City tax-relief programs cause confusion" Curious, I read the article.

When I went to the newspaper’s web page, I could not find the article by searching for the text of the headline. I finally found the on-line version, which appears to be the same article but for a change in the headline: “Philly officials touted tax relief efforts. But some homeowners stand to lose money.“ Perhaps because web sites don’t have the space limitations that afflict print versions, the headlines are different. Which came first? I don’t know.

The gist of the article rests on the fact that the city of Philadelphia has two programs in place to assist taxpayers in reducing their real property tax bills. Because there is an overlap, some property owners qualify for both programs. But a property owner is permitted to sign up for only one of the programs. One of the programs is a homestead reduction, and because City Council increased that amount from $45,000 to $80,000, some property owners would save more using that program rather than the other program, which reduces tax bills for property owners who have owned their homes for a long time. Fortunately, property owners are permitted to switch programs from year to year, though those who leave the longtime ownership program cannot rejoin unless they satisfy certain requirements. Unfortunately, thousands of them don’t even know that they can do so, or that they are limited to one program, or that due to the recent changes they should be recalculating how much each program saves them in property taxes.

Take a look at the article for examples of how several specifically identified taxpayers have had to cope with the changes. Until this year, the city automatically blocked property owners from enrolling in the longtime property owner program if doing so would save them less money than enrolling in the homestead exemption program. Now, the city no longer does that computation. My guess is that the city realized that selecting between the two programs is not simply a matter of arithmetic. Another factor is what the property owner thinks the property valuation changes would be in the upcoming year and in future years, which requires making an estimate that should reflect the property owner’s degree of optimism or pessimism and intentions with respect to continued ownership. Those are factors unknown to the city and its computers. Another factor is the number of people signing into the longtime ownership program, because as the number of enrollees increases, the tax reduction for all enrollees decreases based on the fixed dollar amount available to the program. That is a factor unknown to the property owner and to the city at the time the “pick one program” decision is being made.

The reporter described the situation as a “web of relief programs” and a “matrix of complex, evolving options.” The reporter pointed out that it would make more sense to stop fiddling with the programs and simply reduce the overall tax rate. Along with others, over the years I have advocated a similar approach to the federal and state income tax systems, arguing that ditching all of the special breaks, lobbyist-engineered incentives, and complex deductions and credits would permit lowering the overall rates to levels that would generate much less fuel for anti-tax groups and much less aggravation for taxpayers.

It’s the headline in the print version that made me smile. “City tax-relief programs cause confusion.” It’s quite similar to another headline, “Water is wet.” The online headline is far more descriptive, considering that every tax-relief provision in federal, state, and local income, property, sales, estate, and inheritance tax programs is confusing. And they need not be, for the simple reason that those provisions would not be needed if all of the clutter were removed and rates were reduced to amounts that did not create the need for tax-relief provisions.

A Small Step in Correcting a Warped Tax-Benefit Imbalance

Five years ago, in So Who Should Pay Taxes for Police Protection?, I discussed a proposal by the governor of Pennsylvania that Pennsylvania towns relying on state police for all of the policing in the town pay a $25-per-person tax for those services. That proposal went nowhere. That outcome occurred despite the fact that even legislators opposed to tax increases supported the idea, in part because these towns had reduced local taxes, or avoided increasing them, by eliminating police departments and relying on state police services funded by taxpayers not living in those towns. To finance the increased costs incurred by the state police, Pennsylvania took money from the road and highway safety fund. That also adversely affected taxpayers not living in the towns that shifted to others the costs of benefits their residents receive.

Now for some good news. According to this report, the budget legislation signed last night by the governor will “reestablish the Motor License Fund’s purpose as the main account caring for the state’s roads and bridges.” Funds previously diverted to financing state police protection for towns that eliminated their police departments will now be used to fix transportation infrastructure. In turn, the general fund will be tapped to continue funding that state police protection for those towns.

Of course, though this is good news because more roads and bridges will get the repairs they need, it is bad news because residents of the towns without police departments will continue to get the benefits of police protection by shifting the cost to taxpayers throughout the state. That is wrong. And it is a growing problem. Half of Pennsylvania’s towns have eliminated their police departments, and the number is growing. The proposal made five years ago failed even though the per-resident tax of $25 pales in comparison to the $300 to $400 per-person cost of providing police protection.

Most of these towns are filled with voters who oppose public welfare programs and thus subscribe to the argument that “everyone should pay for what they use,” which is a quote from officials in several of the towns that eliminated police departments because they wanted the benefits but wanted others to pay the cost. Of course, this sort of hypocrisy isn’t limited to the cost of police protection. It’s no secret that some of the counties in this country with the highest rates of dependence on government assistance are also vote in force for politicians who claim to oppose government assistance. Until hypocrisy is removed from the political arena, progress, rather than regress, will continue to elude the nation.

Tax Law, Like All Law, Is Everywhere

When I saw the story in this morning’s Philadelphia Inquirer, I thought to myself, “If Reader Morris sees this story, and I don’t know if he did, I can guess at the question he would ask if he decided to forward it to me. He would ask, ‘Does she have gross income?’ Or perhaps he would ask a broader question, ‘What are the tax consequences?’”

The story is a tale of catastrophe, sadness, frustration, and finally joy. Six years ago, a tree fell on Linda Smalley’s fence and deck. The tree was growing on an adjacent lot. She tried to contact the owner of the empty lot next door but failed. Beset by injuries from an auto accident, she looked for help by contacting the officials and departments of the city of Philadelphia and the Commonwealth of Pennsylvania. She struck out.

Several weeks ago the Philadelphia Inquirer published a story about her plight. In addition to the flood of emails from readers who were no less frustrated with the inability of public officials to deal with the situation, offers to pay for removal of the tree were received. Some offered to contribute though unable to cover the entire cost. A few offered to take out the tree through their own labor. Eventually, one unidentified woman footed the bill for removal of the tree and repair of the deck. Her response and offer arrived very quickly after the first story was published. Smalley was elated. In addition, a local company is paying for removal of a tree in Smalley’s yard that threatens to fall on its own at a time of its own choosing.

So what are the tax consequences to Smalley? The answer depends on a fact that is not known, that is, whether she took a casualty loss deduction for the damage. If she did, then the tax benefit rule would kick in to the extent the deduction generated a reduction in her tax liability for the year in question. My guess is that she did not take the deduction, but I could be wrong. If she did not take the deduction, the next question is whether she has income. Yes, she has income because the removal of the tree and the repairs have increased the value of her property and thus has increased her economic wealth. But that doesn’t mean she has gross income, because gifts are excluded from gross income and there is no question that the money provided by the unidentified woman arises from detached and disinterested generosity.

So what are the tax consequences to the unidentified woman? Does she get a deduction? No, because Smalley is not a charity and there are no other deductions that are even plausibly relevant.

And what about the company paying to take down the tree in Smalley’s yard? Technically, the company is paying its landscaper to do the work. It’s unclear if the landscaper is an employee or an independent third party. If an employee, then the company would simply continue to deduct the employee’s salary. If an independent contractor, arguably the expenditure qualifies as advertising for the company because it already is getting positive publicity for its actions.

The study of law, including tax law, changes how law students and lawyers look at the world. After sitting through my first-year Torts class, I began to notice potential and actual tort litigation every which way I turned. Conversations with other students and over the years with other attorneys assured me that I am far from alone in this reaction. And, of course, after sitting through my first tax course, and probably even sooner considering that I learned a good chunk of tax law before I entered law school, I do see tax issues in many of the activities and transactions I observe or encounter in my reading. Reader Morris, like many others, surely has the same reaction. And it’s not just that tax law is everywhere. Law is everywhere, even when it’s not noticed.