More on Legal Services Outsourcing

Beau Baez, a member of the law faculty at Liberty University, shared with me some thoughts about the outsourcing of legal research services to India. Specifically, though agreeing with my points and expressing concern about outsourcing in general, he wrote:

...lawyers in India are trained in the common law tradition and they speak English. While I don't see Big Law turning to outsourcing I can imagine many solo practitioners and small firms doing so. At aminimum I can envision a competent attorney using this kind of servicefor getting a first draft- is that really any different from what a partner does when he asks a first year associate to prepare a draft? Over time these Indian lawyers - where there is a huge glut of attorneys - will become experts in American law. I suppose that a person could be trained in India via theInternet. For four years I worked for Concord Law School, the nation's first Internet based law school. At $8,000 a year an Indian could be fully trained in U.S. law without ever leaving India (there are a numberof foreign nationals in the school right now from countries all over the world who don't have to deal with U.S. travel restrictions) and theywould have the basic skills to conduct legal research from India forAmerican law firms.

I share my reply:

You make several good points. . . . . The key consideration is "Over time these Indian lawyers -- will become experts in American law." If it's at the expense of beginner's workproduct, the issue is whether the solo practitioner or small firm can do the mentoring that the traditional first year associate gets. There's something about having the associate in a position for a face to face meeting. And if the solo is going to do that via teleconferencing, the time investment makes the outsourcing far less attractive economically. I do think, though, that the idea of training lawyers via the Internet may have an impact on what I'd call "globalized international law"....eventually, just as the existence of 50 different state laws led to the Uniform Laws movement (with varying degrees of success), so, too, a similar phenomenon could occur internationally. But I'm not so certain that it will be driven by outsourcing or outsourcing alone. I suppose the researcher in India isn't practicing law? Else there'd be all sorts of practice of law issues. Yet the first year associate must pass at least one bar exam. That provides a screening level in addition to that provided by the law school. (Nothing against Concord or any other school, but the existence of bar exams does tend to set a standard for curricular design and for weeding out students who got through on"mercy"....)

Beau then replied:

I certainly am not promoting the use of overseas outsourcing but I recognize that it may occur. In part, our state unauthorized practice of law ("UPL") rules are to blame. The UPL rules use a
physical presence standard thus a person overseas would not run afoul of them. As long as we insist on 50 distinct state bars the physical presence rules will remain because the standard is very easy to administer, and attorneys do not want to be subject to another state's disciplinary system when they provide multistate advice. A unified national bar would solve our internal problems and possibly the outsourcing possibility. However, I am not an advocate of a unified
national bar.

There are indeed some serious issues here. It is unlikely that the Indian researchers are practicing law. If the lawyer meets his or her professional responsibility requirements in the matter, he or she will be doing far more than what would be done if an associate down the hall were doing the research. Will the outsourcing tempt the lawyer to perform the same sort of review as if the work were being done in the same office? Who's at risk? Ultimately, the client. Though I dislike regulation, state disciplinary boards may find it prudent to address this question before it becomes (as have so many other practices nurtured by the Internet and its technology) a fait accompli. Perhaps bar associations can take the lead and thus steer the debate? Would it be more efficient to have a national bar rather than 50 state bars? Maybe. But addressing that issue is not an absolute prerequisite to dealing with the problems generated by the outsourcing of legal research and analysis tasks.

Would You Pay for This?

While I was away a friend and colleague forwarded an email that he had received from an outsourcing company in India, offering to do legal research and information. The company claims to produce high quality, low cost work, with excellent delivery schedules. On the side, I think they do atomic fusion, too.

Sorry about the sarcasm, but despite the company's guarantee of highest quality and accuracy available anywher, I just don't follow the logic. I'll skip over the claim of highest quality because I don't have time to pit my research skills, the research skills of people I know, and the research skills of the best lawyer-librarians with the employees of this company.

But I do want to share why I have more than just a few doubts. Doing research, in terms of gathering information, isn't very difficult. Of course, compiling legal information (not unlike what uninitiated law students think law school teachers) doesn't do much most of the time for most clients.

What matters is analysis. And it is in the analysis that a researcher finds the clues to develop the second and third layer of research. It's the reason that those teaching "legal research" in law schools end up teaching a fair bit of legal analysis.

Now, to do American law research and legal analysis, one needs to be educated in American law. Oh, a few Einsteins might teach it to themselves, but they won't be hiring themselves out to a company that is going to make the money from their efforts.

So who has that education? People who have graduated from American law schools. Now, will those graduates ship themselves off to India to work for "low cost" wages so that the owners of the company can gather profits on their efforts? NO!! They will ship themselves off to law firms that will pay them commensurate with their education and accomplishments (though perhaps not as much as the graduates would like to receive), and though their employer law firm will gather profits on their efforts, those law firms will provide guidance, mentoring, and client experience (even if not as intensely as in years past) that will refine the research and analytical skills of these newly hired attorneys.

Could it be that this company is sending its Indian employees to American law schools to learn American legal research and analysis to bring back to the company? I doubt it. The company would need to shell out at least $120,000 per employee (which makes "low cost" a bit more difficult to achieve). And once someone comes to America, as much as it is held in disdain by so many of the world's people, they tend to want to stay. Why? BECAUSE INCOME IS HIGHER, the quality of life is better, and opportunity abounds far beyond the confines of a partitioned cubicle grinding through the compilation of legal information.

I was tempted to waste a few dollars and send along an "interesting" American income tax question. But once I re-read the advertisement email, and noticed that legal research and information is one of "a number of services" that are provided, I decided to use the few dollars for something more fun than playing tax research and analysis games. After all, that happens every semester in the normal course of teaching.

All of that aside, I can't imagine a legal professional putting the fate of a client in the hands of an unknown, unseen, and unmet researcher thousands of miles away, who lacks American legal education, who lacks access to the state and local materials that are the more difficult even for domestic researchers to find, and who surely have a minimal command of the necessary language. Oh, I know that professionals in other fields are doing this, but will it make sense for the lawyer who is representing the patient, client, customer, or associate who is harmed by the use of off-shore resources to be exposed as doing the very thing of which the plaintiff is critical?

No, it would not.

Nor does it make sense to pay someone else to do one's thinking. That's what gets politicians in trouble. And we know that lawyers don't want to come across in the same light as do politicians. Ha.

I'm Back

Though I tried to keep the blog current while I sailed across the Atlantic, toured Europe and sailed home, it wasn't the easiest thing to do. Even though it is 2004, Internet access isn't easy in the small towns of Europe (other than through expensive and slow old-style dial-up modem). And on the ocean, even with newer satellites covering most of the world, the ship charged as much as $30 per hour for access.

I kept a list of the topics on which I want to discourse. I'll start with one very soon and allocate the others across the next week or two.

Oh, while I was away the Philadelphia area was drenched, literally, with rain. On one day 12 inches fell on parts of New Jersey. Dams broke. A lot of people lost a lot. And then a tornado hit. And in Europe? It rained far more than usual, and has been raining. It has been colder. Several pictures comparing 2003 (remember the heat wave) and 2004 were striking, especially one of the beaches in southern England. Jammed in 2003, they were populated by a few brave souls bundled up in December clothing. It had warmed up a bit by mid-July. So where was the sun and fair weather? In the middle of the ocean. On a sea that was like a pond for much of the time. I suppose a few folks will cry, "Oh that is so different from last year, the world is ending, the glaciers are melting, the sky is falling" but the experts tell us that some decades ago there were summers just like this one. Weather: what goes around comes around. Literally.

Taxes, the Cosmos and Political Campaigns

The Democrats are trying to make tax simplification a highlight of their campaign promises. This is an amusing thought, but it’s also frightening because there are people who will believe it.

The Democrats, after all, were the pioneers in modern tax hypercomplexity. Beginning with Kennedy’s investment tax credit and magnified by a huge array of other credits, deductions, and exclusions, the tax law was made even more complicated through the enactment of phaseouts, scalebacks, and other hidden tax increases.

Not to be outdone, it didn’t take the Republicans long to get on the special interest complexity tax train. Absurd capital gain rate structures, a new cluster of credits, and all other sorts of finely
tailored specially-directed provisions were crammed into an already bloated code. To use an analog from an astrophysics lecture I attended yesterday, the tax universe is expanding at a constant rate and is moving toward increasing disorder. Just like the cosmos.

John Kerry’s tax proposals are inconsistent with the notion of tax simplification, so it will be interesting to see how the Democrats reconcile the party’s “tax simplification” message and Kerry’s proposals. To be fair, Kerry cannot be blamed for all of the tax complexity in the Code or even all of the complexity bestowed on us by the Democrats in Congress. He isn’t even to blame for some of the stuff enacted while he was in the Congress.

Nonetheless, why is Kerry willing to make his proposals within the confines of a Republican tax design? The tax on dividends is a fine example. The Republicans create complexity by making most dividends (a selection process that is itself complex) subject to lower tax rates essentially the same as the bizarre rate structure applicable to capital gains. As readers of my blog and listserv posts know, this is an approach wholly inconsistent with fairness, implification, and common sense. Kerry proposes to eliminate this rate twist by restricting it to taxpayers with incomes under $200,000. This creates yet another layer of complexity onto the already complex dividend taxation structure.

I’d be far more impressed if Kerry took the following position: “Look, folks, dividends are just one form of income. A person with a lot of income, no matter its source, ought to pay tax at a higher rate than someone with much less income. A person with interest income from certificates of deposit is no less entitled to a low rate than is a person with dividend income. In other words, the basic tax rate structures ought to reflect this principle, and favoritism of one sort of income over another is wrong, no matter the income level. To tax a retired person who has no pension and lives on social security and $30,000 of dividend income at a lower rate than her neighbor who has no pension income and lives on social security and $30,000 of interest income is flat out wrong and contrary to all principles of fairness.”

What stops Kerry (or his advisors) from tackling this head on? Surely it has something to do with trying to make everyone think he or she is better off under Kerry’s proposals (which in fact is not the case). In an election campaign directed pretty much at the 10% of the voters who are “swing votes” where’s the advantage in Kerry’s existing proposals? It doesn’t make much sense politically. So I’m wondering if in fact the Kerry tax advisors don’t quite know how to cut the Gordian knot of taxation.

So as far as I’m concerned, with the exception of a few individual members of Congress whose voices of common sense are drowned out in a sea of special interest tax pandering, both major parties and both major Presidential candidates don’t earn any points on the tax uestion.

So no matter who wins, the tax law will become even more disordered. Will it end as the astrophysicists predict the cosmos will “end”? Will the system collapse of its own weight, becoming a black hole that swallows all? Does anyone other than a few “tax mavens” even
understand the seriousness of the problem?

Right now, I’m going to go back to looking in 360 degrees at two shades of blue. I’ll let my brain process tax stuff later.

User Fees, UK Style

The UK government is considering a proposal to impose a road congestion fee, and this has generated all sorts of opposition. The concept is that every vehicle would be equipped with a GPS system that tracked road usage (miles, location). The car (not the driver, apparently) would be subject to a fee based on usage. I’m not certain if an adjustment is made to “reward” owners of vehicles that are fuel efficient, use alternative fuels, etc. And I’m sure the “I’m special, I don’t pay the fee” queue will form shortly.

Privacy advocates are all in a furor. Imagine, the government knowing where you are, where you drive, and when you go. Of course, there are speed cameras all over the place (including streets
where the only impact of speeding would be the impact into the vehicle stopped in front of the speeder waiting for the traffic to move).

Those who detest government involvement in citizens’ lives, or who want it to be minimized, also oppose the concept of a road fee. The “reduce tax” crowd, of course, is opposed, even though a user fee is no more a tax than is the charge for admission to the theater. Use it, pay for it.

The UK does have a problem. Even in the countryside traffic volume is up. I’ve visited the UK six times during the past eight years, and even in that short span of time I notice a difference (not
only in traffic but in manners, culture and attitude). As trucking replaced much of railroad shipping in the US, lorries are now all over UK roads, including those narrow, twisty one-laners that can require one vehicle to back up (and it’s not the lorry that backs up).

Traffic volume is up for the same reasons as in the US: more drivers, more trips, higher miles per trip. Public transportation in the outlying regions is a bit more available than in the US, but it’s
an inconvenient and expensive way to get around. Passenger rail has had its problems (just as in the US).

The government plans to use the billions raised by the fee to improve roads. And, yes, they need it. Their national “A” roads at times look like American back roads, and the “B” roads are often
paved over donkey tracks. Don’t even ask about the “unclassified” roads.

I’m a fan of user fees. Whether the GPS system is the best, or toll charging (as in the American east) should be considered, deserves debate. But if the days of free roads, like free lunches, are
going to end, then the person who eats more should pay more.

COMING ATTRACTIONS: I will be sharing my reactions to a tax-related TV spot I saw the other night. Stay tuned.

It's Not Cricket

Tax is complicated. But it's not the most complicated thing.

Friends who have studied nuclear physics claim tax is more complicated. Einstein said something to that effect, too. Puts my friends in good company.

Yesterday I watched a cricket match, and my cousin (many times removed) explained the basics and some of the more advanced rules. Baseball it isn't (though some of the terminology is the same).

Whoever invented cricket died, and then reincarnated as the inventor of income tax.

Perhaps if I begin the basic tax class with a cricket rules lesson, the students will be thrilled to ease up with a study of the Internal Revenue Code, its regulations, and all the law associated with it.

The good news: I'm not going to try explaining it here. At least not yet.

Taxing the Internet... and More: It Never Ends

Well, the Department of Revenue of New Hampshire, after proposing a 7% tax on internet (browser, chat, etc) and other communications, has backed off in deference to a legislative study on the matter.

Well, let's salute the N.H. Department of Revenue for recognizing its initial bad call. At least there was a willingness to appreciate that taxes are a matter for the legislature to initiate.

Of course, the notion that the legislature might decide to impose a tax suggests that legislators still don't quite get it. Oh, of course, they do, to the extent that they see cash cows. But a tax ought to represent either a charge for a government service or a redistribution of wealth. What service does the government providein this instance? The actual costs are incurred by the ISPs and other communication enterprises, which pay taxes, and which pass costs and taxes on to their customers. As for wealth redistribution, a 7% tax hits the poor as much as the rich (or more, in fact, as it is regressive). At a time when 21st century communication ought to be encouraged, and brought into the homes of poor and not so poor alike, the application of a 19th century revenue approach is just plain disappointing.

That's all for now.

Congress Getting into VOIP Taxation

About the time that I was posting Wednesday's item about taxation of internet phone calls, two members of Congress introduced legislation extending (or perhaps affirming) the application of the taxes on analog phone calls to VOIP phone calls. VOIP is voice over internet protocol... fancy words for "phone calls over the internet."

The proposed legislation deals with more than just taxes, and I'll leave that to others more expert to describe and critique. I don't have a link for the legislation because my Internet access is time limited at the moment, and I haven't had the opportunity to dig it up.

That's all for now....

Taxing Phone Calls Made Over the Internet

The IRS has invited comments on the applicability of the section 4251 excise tax to telephone calls made with technology more recent than what existed when Congress enacted section 4251. In its notice, the IRS describes a way of analyzing the statute that suggests it is preparing to rule that the excise tax applies to Internet phone calls.

There are three major questions:

1. Does section 4251 apply? Solid statutory analysis suggests that it does.

2. Assuming that telephone calls should be taxes, Internet telphone calls be taxed? Of course. The fact that a call is made over the Internet rather than through wires, cables, radio waves, or some other medium ought not matter if the tax is intended to tax communications made by voice transmission, as defined.

3. Should voice transmissions made by phone, as defined, be taxed? From my user-fee approach, the answer is, yes, to the extent that telephone calls, however made, impose a burden or cost that should be borne by the user. Does Internet telephony impose a burden? Yes, it consumes bandwidth.

Arguably, if question 3 is answered in the affirmative, the next question is why not, then, tax text transmissions, audio or video imbedded in text, and other forms of communication?

Does text messaging (e.g., email) impose the same level of burden? Perhaps. Perhaps not. A delay in the receipt of email can be inconvenient, but email moves as the bandwidth allows. Voice and real-time video streaming need priority access to the bandwidth, and if the technology being employed acquires that priority, it bumps other transmissions (e.g., text) down in priority. Perhaps an analog to first-class and third-class postal mail would be helpful.

Well, my views are my views, and so what? What matters are the view of others. If this issue matters, take the IRS up on its offer and comment. That, however, may not be as important as also contacting Congress. After all, IT, and NOT the IRS, enacted the statute in question and IT, not the IRS, can revoke it, and amend it. The IRS is stuck with what's there now, as are we, and can only do its best in trying to interpret a provision that Congress ought to revisit, and clarify one way or another.

The Erratic Blogger

If you're a regular reader, you've probably noticed that I usually post on Monday, Wednesday, and Friday, with an occasional fourth or fifth weekly post tossed in. Today is a Sunday, and I posted. What's up? Well, life over the next three and a half weeks will be such that my posting will be erratic. The posts may even be shorter.

Don't go away. Keep checking, and just be thankful I'm not planning any summer reruns in the style of network television. Remauledagain or Mauledyetagain is just too scary.

Happy Fourth of July at the Racinos

Racinos?

Early on the morning of Independence Day, the Pennsylvania legislature struck a blow for freedom. Or so it would like to think. The early morning thing was the result of a deadline, but it too easily appears to be an imitation of the Phillies’ 16-inning game that ended early on Saturday morning. Let’s not make this a habit. And let’s hope that the legislature’s move turns out to be the winner it claims it is, unlike the yet one more extra-inning loss that the Orioles pinned on the Phils.

What did the legislature do? It legalized slot machine gambling in Pennsylvania. The stated goal is the generation of billions of dollars of revenue that would be used to reduce property taxes and encourage economic development.

To be fair, it was a majority of the legislature that approved the legislation. Specifically, 113 of the House’s 201 members and 30 of the Senate’s 50 members voted in favor of the gambling. The tax bill passed the Senate by 50-0. I haven’t researched it, but I don’t think 50-0 votes are common in the Pennsylvania Senate.

The supporters of legalized slot machine gambling also claim that its adoption will create jobs and revive the horse-racing industry. Hmm. I thought Smarty Jones had taken care of the downturn at the tracks.

See, the parlors at the race tracks that will have slot machines are called “racinos.” That’s a new word for me. The crossword puzzle designers are probably thrilled that they can use an R or a C in figuring out the intersecting word!

So what will these racinos really do? Estimates are that property taxes will be reduced by several hundred dollars a year. That sounds nice, except that most folks’ property taxes are in the thousands and tens of thousands of dollars a year. Early on, proponents were touting the legalization of gambling as a way to cut property taxes in half. And, property tax relief cannot be funneled to a locality unless that local government agrees not to raise taxes by more than an annual wage-and-employment index unless they obtain approval of their voters.

The legislature rejected an amendment to the legislation that would have prohibited legislators from owning interests in gambling enterprises. Instead, they are restricted to 1 percent interests. Considering how tightly New Jersey regulates gaming, it’s a wonder that Pennsylvania isn’t learning from its next-door neighbor. Perhaps they weren’t on speaking terms, since it’s likely that Pennsylvania racinos will siphon some business away from Atlantic City.

So where will the gambling revenues go if not for the substantial property tax relief that was promised? About $1 billion heads for economic development. Another portion will be used to improve education for young children. $750 million will be used to decrease the Philadelphia wage tax, starting in 2007, if certain slot revenue levels are attained. Another $636 million will be used to pay for the expansion of the Convention Center in Philadelphia, the one that is losing business every day because the union rules compel would-be exhibitors to go elsewhere. Expanding the Convention Center under these circumstances is like enlarging stores that sell 8-track tapes. But, hey, there’s money so let’s spend it.

Where will these racinos be? After all, if they create jobs, it will be in the areas near the new gambling parlors. Two will be in downtown Philadelphia. Next to City Hall, perhaps? I can’t wait for the zoning questions that will pop up when the neon signs are proposed.

Three other slot parlors are permitted, one designated for Pittsburgh, and two that aren’t designated. The Philadelphia Inquirer story suggests that the other two may end up near the Poconos or Allentown. The racinos will be at seven horse-racing tracks. And two small gambling halls are destined for Western Pennsylvania.

The big question, though, is whether slot gambling in Pennsylvania will raise the projected revenue. After all, almost everyone who starts a business expects to do well, but there are no guarantees in life other than, yep, death and taxes.

Is there room in the market for more slot machines, considering that casinos are nearby not only in New Jersey but Connecticut and several other northeastern states? Every time I see a new state lottery enacted or a new game added to an existing lottery I think that the gambling market is saturated. Ha ha, I learned on my cross-country driving adventure last summer that gambling is everywhere, and there don’t seem to be enough opportunities. It seemed that there was a slot machine at every rest stop, restaurant, and store once I got west of the Mississippi. Then I arrived in Las Vegas. In the middle of summer the slot machines were running full bore, with people trying to operate two or three at a time. I don’t want to digress, but it’s the fastest growing city in the country. Hmmmm. Then again, there’s far more going on in Las Vegas than gambling. Oh, and there are casinos on the cruise ships, and don’t get stampeded when the ship crosses into international waters and the tables open!

The Pennsylvania legislation permits 61,000 slot machines. Spread over 14 locations, but with 2 having only 500 each, that’s an average of 5,000 machines per racino or parlor. FIVE THOUSAND. But that’s small compared to the Vegas floors. It’s going to be educational, watching what some consider an “evil” taking root in Pennsylvania. What’s left to legalize? Ah, I should shut my mouth.

There is, though, one aspect of slots that is an improvement on the lottery. The lottery has a very few huge winners, and a handful of moderate winners. Slot machines seem to give better odds for smaller jackpots. Personally, I’d rather have a 20% chance at winning $1,000 than a .00002% chance of winning $10,000,000 (even though the arithmetic tells me that both have the same statistical probability value). But what do I know? I rarely gamble. I’m better at guessing the number of jelly beans in a jar (which I did as a child and I won, though I never figured out how to build a career on that skill other than being a crowd counter, which didn’t interest me).

The irony is that the slot revenue is a temporary fix on spiraling school taxes. Unless slot revenue grows at the rate that local school district expenditures grow, all that has happened is a postponement of the reality: we are paying a lot for public education, and as a graduate school and post-graduate educator, I’m not convinced we’re getting our money’s worth. All we need now are the teacher unions asking for bigger salary hikes since, “after all, there’s all that gambling revenue available.” I predict that property owners won’t see much in the way of property tax decreases. I’ll try to remember to share some thoughts about the underlying problems that cause the big property tax hikes seen in recent years.

The history of the attempt to legalize gambling beyond the state lottery (which came into existence in 1972) would make for an interesting cable channel documentary. People have proposed video poker in bars (people are less inhibited when drinking, so the revenue on those things would be huge, right?), floating casinos, keno, dog racing, blackjack and roulette tables, and legalized sports gambling (talk about the big bucks.... people bet on whether there will be a left-handed pinch hitter in the sixth inning.... but.... people bet on everything. Life, they say, is one big gamble, so why not profit from it?)

But nothing happened. Sometimes it was a governor who considered gambling to pose too many moral questions. After all, there still are many Pennsylvania residents who think the lottery siphons money from those least able to afford such discretionary spending. Another governor wanted a statewide referendum, but for some reason that didn’t get approved. Weird. It is a democracy, isn’t it? And last summer, a gambling proposal was defeated. So this is big news in Pennsylvania.

The politics behind the passage of this legislation will consume half of the documentary time. Take a look at the Philadelphia Inquirer story for the details. I just had lunch and don’t want to spoil my dinner appetite. It’s a typical special interests bill, with deals for airports and gaming lands, and a candid reference by the bill’s chief sponsor (of whom I am a total non-fan) to the making of sausage. Suffice it to say that gambling companies have contributed close to $6 million to political campaigns in the state since 2000. Gambling and elections? Why not? Maybe a coin toss in Florida, simplified gambling that it is, would be better than what was being used four years ago.

EUREKA: I have it. Let’s hook slot machines and video poker to electronic voting. How appropriate, no?

Happy Independence Day. After all, there are a lot of places where gambling (with money) is illegal, though ironically life in most of those places is a much bigger gamble. We are blessed, folks, even if we do goof more than we’d like.

Philadelphia Tax News

An update on a story to which I've given quite a bit of attention on this blog:

Mayor Street of Philadelphia agreed to the budget and the provision reducing the Philadelphia wage tax.

The planned decreases in the business privilege tax did not make it. So.... we'll check in on the statistics a year or so from now and see what impact this had.

No news of note on the Keystone Opportunity Zone tax break for Comcast and some other taxpayers with offices in that dreadful area in need of the sort of rehabilitation encouraged by Keystone Opportunity Zone tax breaks (center city Philadelphia).

More of How Much is Enough, Part Two

My description and analysis of the "janitor for a day" plan brought some informative and thought-provoking comments. Here are three of them.

1. Prof. H. Beau Baez of Liberty University School of Law wrote:

"Having recently retired from state government and having served on my agency's retirement committee I am fairly well versed on this issue. First,
the states do believe that it would violate the Constitution to impose the employer portion of the tax on the State (the inter-governmental tax immunity doctrine). Second, the States do not opt-out of Social Security but rather they opt-in by contract with the federal government.

"I found the discussion of the Texas teacher's one-sided. Clearly they are abusing the system but the federal government has been abusing state &
local employees for years because of WEP (Windfall Elimination Penalty). If a person works for a state agency that is not subject to Social Security
then that person's record becomes tainted forever. WEP acts as a penalty for state employees that also have earnings subject to Social Security. This penalty reduces Social Security benefits.

"Here is an example: I spend 20 years with a state agency and receive a state pension. I then spend 20 years teaching for a non-state owned law
school. When I retire my Social Security benefits are calculated for the 20 years I contributed into the system. However, my benefits are then reduced (i.e., penalized) because I worked for a state government. I know of no rationale for the claw-back provision except as a mechanism to pressure state governments to opt-in to the Social Security system.

"So, what the Texas teachers took from the federal government, the federal government took back from many other state government employees that did not make state government their lifelong careers. I do not see articles in the press discussing the injustice of reducing a person's Social Security benefits merely because he worked for state government. As best as I can tell, even one year's service (maybe less) with a state government is enough to trigger WEP.

"States have been trying to eliminate WEP for years, but the loss to the treasury would be significant. Thus we have a Congress that believes in
heads I win (no WEP relief) and tails you lose (Texas teacher loophole closed)."

2. Another commentator pointed out that the legislation to stop state and local governments from opting out of Social Security was a political compromise. That legislation was the same legislation that brought Federal employees within the social security system. The recollection of this commentator was that although some concern was expressed about the ability of the federal government to impose the employer portion of the FICA tax on the states it wasn't a major factor in the determination.

3. Yet another commentator pointed out that employees participating in private retirement plans pay FICA taxes and pay into the private plan (directly or through employer contributions that are made in lieu of higher salary), making it reasonable that they would collect under both when they retire. In contrast, the state and local employees using the "janitor for a day" plan pay into the state retirement plan but do not pay FICA taxes. Persons who, like Prof. Baez, have been employed by a state or local government and then become employed in the private sector, are for some reason treated differently. Or, as this commentator put it: "The issue might be framed as why former state Social Security exempt employees accrue Social Security benefits at a lower rate than workers generally."

* * * * * * * * *

These comments reinforce the need for the social security system to be fixed. There are all sorts of ideas floating about as to what needs to be fixed and how it should be done. Wednesday's posting about the "janitor for a day" plan focused on a very narrow, technical question, namely, whether a surviving spouse should be treated as having been a participant in the social security system, and the now-eliminated law that said in effect "yes, if they work as little as one day" was a classic example of something not thought through or perhaps the result of political compromise.

As for the larger question of how state and local employees are and should be treated, there are several points to consider.

1. So long as state and local employees have a pension plan and are exempt from social security, there is some sense in treating the state retirement plan as a substitute for social security. Thus, when a state or local employee leaves government service and enters the private sector, becoming subject to social security, the social security participation ought to be treated as a continuation of the state retirement plan, and the benefits ought to reflect the accumulated years of service. Then a mechanism is needed to figure out which plan pays how much of the benefit, but that is secondary to making certain that the retiree is in the same position as he or she would have been in had the retiree been subject to social security for the entire time or to the state retirement plan for the entire time.

2. The complexity arises when the state retirement plan is considered to be an analog to the private retirement plan, which, for all intents and purposes, it very much resembles. Certainly employees in the private sector can move from job to job and "tack" the benefits from each of the private plans in which they participate. It gets arithmentically complicated, but it gets done. And the private sector employee, when retired, collects from those plans AND from social security, which is computed without regard to the private retirement plan benefits. If the state retirement plan is treated as another private retirement plan, then the employee ought not to suffer a reduction in social security benefits on account of the state retirement plan.

3. The answer, of course, is to require ALL employees to participate in the social security system (railroad employees have their own, analogous system but for purposes of this discussion we'll sweep that into the phrase "social security system"). If the reason for allowing state and local employees to stay out of the social security system is some sense that the federal government cannot tax state and local governments, then stop using the word "tax" to describe payments into the social security system, and call them what they are: insurance premiums or retirement plan contributions, depending on one's view of what social security is and should be.

4. The fact that, at least in Texas, some employees were in the social security system and some were not suggests that something more was at work and it surely wasn't Texas objecting to the "taxation" of its employees. Perhaps the unions representing the teachers had something to do with it?

5. I take the position that social security was originally intended to be insurance, and in any event, ought to be insurance. Just as society, through government, medial, churches, and many other (but not all) groups send the message that it is better to be employed than to be on welfare, so too the message ought to be "it is better to have a retirement plan, even if it is your own IRA, than to be on retirement welfare." If, in fact, social security is a retirement plan, albeit mandatory, as some say it is, then it should be operated and funded as one, such that the benefits ought to match the contributions and plan earnings and the Ponzi-scheme arrangement currently in use ought to be jettisoned. It is "political compromise," the bane of all efficiencies, that generates this "both entitlement retirement plan (yet unfunded) and retirement welfare" arrangement that is much like an animal trying to be a dog and a cat at the same time.

Not only do I think (and feel) that this topic will generate material for this blog in the months and years to come, I also predict that it will become a crisis by the end of the decade. The result, some combination of higher "taxes" and reduced benefits, is going to pose challenges that "political compromises" will not solve. The longer reform is postponed, the more expensive it will be. That's assuming, of course, that reform at that late stage will rescue the system.

How Much is Enough? Part Two

I don’t know how I missed this one. Perhaps because it involves social security benefit computations rather than the social security tax itself my attention wasn’t caught when the issue first made the news. This is the sort of news, though, that was buried in the back pages and which most people probably thought had nothing to do with them. I first noticed it today in a Philadelphia Inquirer article (yes, in the back pages), and a little research filled in the story, particularly this informative article in the Washington Post a few months ago.

This is a complicated story. It raises some difficult questions. So bear with me as I try to explain this correctly and yet without getting too technical.

As a general proposition, a person who does not pay social security taxes is not eligible for social security benefits, other than as a child or spouse (under certain circumstances) of a person who does participate. There are two groups of people who do not pay social security taxes: those who aren’t employed or self-employed, and those who are employed in positions that are exempted from the social security system. One group that is exempted are state and local employees who are participants in state pension plans. Question number one: why does this exemption exist? Why should someone participating in a state pension plan escape social security taxes (and give up the benefits) while someone participating in a private pension plan is subject to social security taxes (and eligible for benefits)?

If that were all, it would be relatively simple even if the underlying policy question baffles us. But, of course, it gets complicated. If a person not participating in the social security system because they are covered by a state or local government pension is married to a person who does participate, and the social security participant dies, the surviving spouse, whose benefits would otherwise reflect their status as the surviving spouse of a social security participant, takes a cut in surviving spouse social security benefits because the surviving spouse participates in the state or local government pension plan. If, however, both spouses are social security plan participants, when one dies, the other receives the higher of the benefits to which each was entitled. Question number two: why are spouses treated as a unit rather than as individuals? Why, again, does marital status have an impact on the computation of social security benefits (as it does for some married couples under the income tax) considering that payment of social security taxes is not affected by marital status?

Thus, it is better for both spouses to be social security participants. One might think that the public employee, such as the school teacher, can’t be a social security participant because they haven’t paid social security taxes. Wrong. The social security law treated a person as a social security participant if they retire from a job not exempt from social security, even if they work for a day. Of course, one day’s coverage won’t get the person social security benefits on their own (because 40 calendar quarters are required), but it gets them status as a social security participant spouse. The difference can be as much as $2,000 a month of social security benefits to a person who has not paid into the social security system. Question number three: why did the social security law treat a person as a participant if they worked for as little as one day in a covered job?

Not surprisingly, some public employees, mostly school teachers, decided that they would get themselves hired for a day and retire from a covered job. Where can such a job be found? The school district. Yes, the school district, whose janitorial, cafeteria and similar employees are within the social security system. Question number four: why are school district janitorial and similar employees within the social security system while school district teacher employees not? Question number five: why would the school district hire a retiring teacher as a janitor for a day, that is, what is the benefit to the school district? Hint: the teachers PAID THE SCHOOL DISTRICT A FEE for the right to be hired for a day.

In 2002, the General Accounting Office brought this abuse to light. The practice of signing on as “janitor for a day” seems to be prevalent in Texas. The GAO reported that in 2002, there were 3,521 Texas public employees, mostly school teachers, who switched to a covered job, most on the last day of their career. That’s 25% of all public education retirees in Texas. Although the use of the loophole received most attention in Texas, there are at least 2,300 other state and local pension plans. The GAO suggests that employees under those plans may be using the loophole. The cost to the social security system was estimated at $450 million. It has been estimated that if everyone is permitted to do what these public employees are doing that the Social Security deficit would triple.

The fun begins. When the GAO report broke, several Republican members of Congress introduced legislation to close the loophole that treats a person as a social security participant if they work in a covered job for just one day. The legislation requires 60 months of covered employment to so qualify. The legislation also contained numerous provisions designed to curtail all sorts of Social Security Program fraud and abuse.

The legislation was brought to the House floor under suspension rules, which require a 2/3 majority for passage. The bill was killed, because only 249 members voted yes. That’s not enough even though the yeas outnumbered the 180 nays, of which 166 were provided by Democrats. Though I usually cast blame on both sides of the aisle, this story is one that is steeped in partisanship.

Shortly before the vote, Lloyd Doggett, a Democrat member of Congress from Texas, called some Texas teachers. They contacted the two largest teachers unions (the National Education Association and the American Federation of Teachers). The unions swamped Congress with letters claiming that the proposed legislation would “cost their members dearly.” Those voting no claim that the teachers are fighting “discrimination.” Under this logic, if the teachers had not held jobs, they would qualify for their deceased spouse's entire Social Security benefit. The unions, of course, neglect to mention that had the teachers not worked they wouldn’t be getting the public pension. Doggett points out that what the teachers were doing was “perfectly legal” and he’s right. Question number six: Is it enough that something is “perfectly legal” to go ahead and do it? Or should other constraints, moral and ethical, bear on the decision? Question number seven: Should the analysis reflect the “relative injustice” of the situation, and if so, is there an injustice when someone who pays into a pension system and not social security is restricted to the pension when they retire?

The unions and those supporting them claim that the legislation would cause the teachers to be treated “not as fairly” as most American workers covered by social security. Huh? Question number eight: How is it unfair to be covered by a pension plan that is far more generous than social security? Would a person trying to get by on social security consider herself to have an unfair advantage over a pension-getting retired school teacher?

The unions also argue that the teachers were using a legal loophole, and that “wealthier Americans” use tax loopholes “all the time.” Let’s ignore the hyperbole. “All the time” is a bit extreme and is overloaded rhetoric. Question number nine: is the “everyone else is doing it” defense acceptable? Even if it is, is the “everyone else is doing something else that’s sort of like what I’m doing” just as acceptable?

Teachers are a key component of the Democratic Party’s core base. Teachers and their unions are substantial financial supporters of the Democratic Party. Question number ten: should the political allegiance and financial support of a group of people demand that politicians support their position even if it flies in the face of what is right for the nation? Question number eleven: did it occur to the teachers, the unions, and the politicians supporting them that if the “janitor for a day” ploy continues it will cost someone else, either in the form of reduced benefits or higher social security taxes? Question number twelve: did it occur to these politicians that if benefits for others are not reduced and social security taxes are not increased that this “janitor for a day” ploy would increase the federal budget deficit? Question number thirteen: did any of the politicians see anything inconsistent in their thinking?

So, the Republicans re-introduced the bill, and let it take the slower track that does not require a 2/3 majority for passage. It was enacted, and signed into law as the Social Security Protection Act. If you want to read it (good luck), you can find it here. The effective date is July 1, 2004. That caused a flurry in retirements among Texas public school teachers. From September of 2003 through May of 2004 the Texas Teacher Retirement System processed 35% more retirement applications. One school district alone temporarily hired 3,500 workers. Question number fifteen: why was the effective date set at July 1 rather than, as usually is the case, the date that the provision is first read out of the Congressional committee reporting the bill? Question number sixteen: why are the voters living in these school districts tolerating this abuse of the system?

One teacher was hired to move furniture. Question number seventeen: what happens if that teacher throws out her back or otherwise is injured while engaged in employment for which she has not been trained?

This story, unfortunately, is so typical of how things are done today. It begins with a badly drafted legislation containing an indefensible provision, it is tainted with the “married people are special (sometimes)” discrepancy, it encourages greed, it generates reform attempts that are blocked by unions and politicians who cannot put the public good above individual and group gain, and it is reformed with a prospective effective date that triggers a flurry of superficial employment. It pits those who think “just because it’s not illegal doesn’t mean you ought to do it” against those who think “life is fine as long as you simply stay within legal boundaries.” It gives sustenance to those who think government needs to regulate every little bit of life because people, left to their own devices, lack the judgment to take a wider view of things. It also gives “I told you so” energy to those who predicted that every attempt to make life easier for those truly in need will generate abuse by those who aren’t in need but want to appear as though they are.

None of this would have happened had Social Security been left as an insurance program designed to assist those whose pensions and other income were insufficient to support them after retirement. Social Security was enacted, after all, as the Federal INSURANCE Contributions Act. Yep, the I in FICA means INSURANCE, not entitlement.

So not only are there millionaires pulling down huge pensions and raking in investment returns (taxed at very low rates) grabbing Social Security because they paid into the system, there were people who wanted in on Social Security benefits even though they hadn’t paid into the system and already were covered by a very generous pension plan. OK, every once in a while a wealthy person declines social security, and there were some teachers who didn’t succumb to the “janitor for a day” ploy. And perhaps a reporter will feature them so that people can see that there are good decisions being made and role models worth noting.

But, for the most part, the story inspired me to re-use the blog headline I used the other day. It was either that or “Twenty Questions” but I ran out at seventeen.

How Much is Enough?

The headline in yesterday's Philadelphia Inquirer may be a bit overdone but still carries a big oomph to most of those who saw it: Executive pay rose 33 percent in 2003.

For people dealing with increases in gasoline prices, other energy costs, and even the price of food, and trying to make things balance when getting raises of 1.5 or 2.5 percent, it must be at best, bewildering, and at worst, infuriating, to see that the "executives" are getting 33 percent pay raises. For folks not getting raises, or without jobs, it surely is both bewildering and infuriating.

Headlines, though, can be a bit two sweeping. The linked story reports five results from the Inquirer's 11th annual review of executive pay, which was limited to CEOs of 200 plus local companies:

1. Topping the list were Ralph Roberts, CEO of Comcast, who earned $35.9 million in 2003, and Charles M. Cawley, recently retired CEO of MBNA Corp. who earned $34.8 million in 2003.

2. For these two men, their 2003 pay were DECREASES. Both had higher salaries in 2002.

3. The average increase for all the CEOs in the survey was 33 percent more.

4. The MEDIAN earnings of these CEOs in 2003 was $700,000.

5. Of the 950 executives on the list, only 45 are women.

From this information, one can infer that some executives received increases far exceeding 33%, because the two most highly compensated executives had earnings decreases. Statistics, though, are misleading, because one can also infer that many of the CEOs went home with salaries much lower than $700,000. And if someone's salary went from $100,000 to $300,000 (extremely modest by the standards of those at the top of the list), that's a 200% increase. That sounds like a lot, but is a 200% increase on a $100,000 salary as good as a "mere" 5% increase on a $10,000,000 salary? NO. Not at all.

In another story run by the same paper, the headline, "Just how special are CEOs?" doesn't really give a clue as to the information that the Department of Labor shared:

1. There are roughly 9,500 CEOs in the Philadelphia area.

2. There are fewer than 9,500 bank tellers in the area. There are fewer than 9,500 bartenders in the area. Same for telemarketers, plumbers, and dishwashers. [So it's true, everyone wants to be the boss. Big surprise.]

3. There are fewer than 9,500 employees at the area's major employers, including Comcast, Vanguard, Merck and Cigna.

4. There are three times as many CEOs as there are dental hygienists.

5. The median per-hour pay of local CEOs is $63 ($132,000 a year).

6. The typical dentist in the area earns more than $132,000 a year.

7. There are far more small businesses run by board-hired CEOs.

8. The Labor Department definition of CEO probably includes people that most of us would not think of as CEOs, and includes owners of small family businesses.

9. There are about 400,000 CEOs nationwide.

10. About 5% of the 400,000 CEOs run government agencies, roughly 8,000 run educational institutions, and roughly 8,000 run engineering and architectural firms. Fewer than 40,000 run companies, enterprises, and financial institutions.

11. Company CEOs average $170,000 a year, bank chiefs $140,000, and local government agency CEOs $81,000.

It's always worthwhile checking out the facts. Despite the tendency of many critics (including myself at times) to lump business executives into one big pile, the situation in the business world isn't that much different than it is in other professions.

For example, it's common to hear complaints about "grown men making tens of millions a year to play a boys' game" whenever a high profile professional athlete signs a mega-bucks contract, but littel attention is paid to the guys scraping by on the rookie minimum or the journeyman's $120,000. And, female professional athletes, if the few in the big bucks media spotlight are ignored, earn very modest sums.

Lawyers are perceived as hauling in huge salaries, but for every "Wall Street partner" taking in $500,000 a year or every big-time plaintiffs' injury counsel getting fees in the tens of millions, there are lawyers scraping by on $25,000 or $30,000 doing public defense or other pro bono work, or trying to establish a general practice in a small town.

Any good statistician will agree that a few very high salaries will boost the average to an amount not seen by most of the people in the category being measured. That's why the surveys use median, that is, the point at which half are above and half are below. A median of $700,000 means that half of the CEOs earn less than that amount. Although $500,000 or $600,000 may seem like a fortune to someone without a job or earning $60,000, it, too, pales when compared with a salary of $5,000,000, $15,000,000 or $30,000,000.

That's why the tax reform focus and the social reform focus needs to be on dollars and not occupations. And that's why the practice of the Congress of using $100,000 or $150,000 or $80,000 as a cut-off, above which tax deductions or other benefits are denied or phased out, is so unrealistic. The highest income tax rate applies to taxable incomes over (roughly) $319,000. Even though taxable income isn't the same as gross income (such as salary), putting a person with taxable income of $325,000 in the same marginal tax bracket as someone taking in $30,000,000 skews the progressivity of the federal income tax.

There are three issues here. One is how high the highest rate ought to be. The second is defining the point at which it applies. The third is the proportion by which the rate climbs from zero to the point at which the highest rate kicks in, including the question of how many different rates should exist. Much has been written about these issues, because they've been around to be discussed since long before the income tax was first enacted.

The stories about CEO pay, and the eye-grabbing, eye-popping effect of learning that there are salaries of $30,000,000 or more compel me to share a few thoughts about the question of defining the point at which the highest rate should apply. There is a point at which additional income no longer has value to purchase food, clothing, housing, and vacations. A person can only eat so much, even if they're intent on "supersizing" at the five-star version of McDonalds. I understand that some people "need" 6,000 pairs of shoes, or 10,000 pieces of jewelry, or a home with garage space for 30 vehicles, but there is a limit. It may vary, but no one has TIME to consume $100,000,000 in a year.

The facts bear that out. Most individuals with mega-salaries invest a substantial portion of their incomes. That permits them to acquire control over other companies, charitable foundations, and political offices. Although some grass-roots candidates seem to demonstrate that a huge flood of individuals each contributing $10 or $20 can generate enough money to offset the big-time contributions (funneled through multiple "independent" organizations), the gist of the matter is that control of business, government, and charity (read: control of society) is in the hands of those with huge amounts of "excess" money.

So the question comes down to this: Should the control be in the hands of the few who have huge amounts of money or in the hands of government, through imposition of higher taxes? That is a way of characterizing the debate between those who advocate tax cuts and those who advocate tax increases. The wrinkle, imposing very low taxes on capital gains earned on the investments themselves, simply intensifies the contrast.

Both sides ultimately argue in futility. What good is it to have government taking in more money if the decisions as to its use are made by the same people who make the decisions if they had held the money in their own hands? Is the question really a matter of WHICH GROUP of moneyed interests will get to make the decisions? Is there any place for the "typical" American citizen who has neither the time nor the resources to engage in power brokering?

The argument that salaries should be limited by the government misses the point. Government control of salaries would be yet another step away from a free-market system. But doesn't that last sentence require support of minimal taxation? No. It is one thing for the government to control the market (which it has done many times, through war-time rationing, war-time and peace-time price controls, setting of the federal funds rate, etc.) and it is another for government to charge for its services in providing security, opportunity, and fairness in the operation of the free market. A stock or other financial exchange isn't free if its electronic data is being hacked, its buildings bombed, and its personnel kidnapped, and what other way than government-provided defense to protect that freedom?

It may be useful to inquire how or why those with mega salaries obtain them? Is it hard work? Cleverness? God-given (or nature-provided) talent? Fraud? Luck? Fortune of birth? Some combination? Ought it matter? It does, to the extent that there are penalties other than taxes on the fraudulent acquisition of income. Is there a difference between $30,000,000 a year earned by someone who designs the perfect anti-spam software and sells a lot of it and the $30,000,000 a year earned by someone who can hit, throw, or catch a ball in ways that few others can and whose skills are in high demand? Is the first $30,000,000 a reflection that the software is priced too high? Is the second $30,000,000 a reflection that the cost of advertising (built into product prices) is too high and thus generates too much spendable revenue for team owners? Add into the comparisons $30,000,000 earned by someone who is hired as CEO by a company with huge revenues with low profits who turns those revenues into higher profits by reducing the company's workforce. Does this represent the cost of the skills demanded by the shareholders of that company (who, by the way, are most of us through our retirement and mutual funds)? Or does this represent the failure of the company to reduce the prices of its products and services?

Somehow, even though some holding radical views disagree, it isn't difficult to see that the person on whose desk the decision ultimately rests incurs risks, and attendant stress, that permits a reasonable conclusion setting compensation at some multiple (say, 2 or 3) of someone employed to provide services without taking similar risks. But how does one justify salaries that are 300 times or 400 times the average salary of all employees, and 500 to 1,000 times the salaries of the lowest paying employees? How does one justify extremely high salaries in industries that continue to generate barely acceptable quality of product or service, that shift the burden of testing, repair, and risk to the consumer, and that move jobs overseas for reasons of money acquisition rather than quality improvement? Yet would any of us really begrudge a $30,000,000 salary to the person who invents the fool-proof anti-spam software (or the perfect cancer drug, or the perfect diet)?

Everyone has a different perspective on the issue. Should we vote on it? At a ballot box? At the store? By changing channels? By turning off all the electricity-driven things in the house? By cutting driving in half?

Or perhaps does the eternal quest for the get-rich-quick-with-little-effort answer continue to inspire the spammers and the flim-flammers? Could it be that the effort to stand alone at the top condemns the interaction on the corporate mountainside to be counterproductive, because individual goal trumps (ha, ha) the collective good?

There are some major warning signs lurking in the information published in the two Philadelphia Inquirer articles (and in a variety of other sources). Without a careful study before the crises erupts, the reactions may be instinctive, limbic, and dangerous. Now is the time to ponder the larger question of which megadollar salaries (executive or otherwise) are a mere symptom.