The Future of Taxes

In my post yesterday about the Congressional agenda for future tax relief, I noted that it wasn't clear to me what was meant by that term.

A regular reader who is also a former student and an adjunct professor in our Graduate Tax Program suggests that what is intended is making permanent the tax cuts enacted in 2001. Thus, the estate tax would be repealed, at least until such time as a Congress intent on its return re-enacts it.

I agree. I'm sure that this is one of the things on the agenda. But I am sure there is more. At his press conference this morning, the President emphasized that he intended to simplify the tax law: "We must reform our complicated and outdated tax code."

The President also stated, in response to a question about his overall legislative agenda:

And part of that comprehensive agenda is tax simplification.

The -- first of all, a principle would be revenue neutral. If I'm going to -- if there was a need to raise taxes, I'd say, let's have a tax bill that raises taxes, as opposed to let's simpl[if]y the tax code and sneak a tax increase on the people. It's just not my style. I don't believe we need to raise taxes. I've said that to the American people. And so the simplification would be the goal.

Now, secondly, that obviously, that it rewards risk and doesn't -- it doesn't have unnecessary penalties in it. But the main thing is that it would be viewed as fair, that it would be a fair system, that it wouldn't be complicated, that there's a -- kind of that loopholes wouldn't be there for special interests, that the code itself be viewed and deemed as a very fair way to encourage people to invest and save and achieve certain fiscal objectives in our country, as well.

One of the interesting debates will be, of course, in the course of simplification, will there be incentives in the code: charitable giving, of course, and mortgage deductions are very important. As governor of Texas, when I -- some time I think I was asked about simplification, I always noted how important it was for certain incentives to be built into the tax code, and that will be an interesting part of the debate.

So does that mean the President would not sign another special interest giveaway tax bill such as the American Jobs Creation Act? Does he really intend to oppose any more special breaks for specific individuals or entities or small groups of them? Is he ready to stand up to legislators on both sides of the aisle and oppose their special interest group tax legislation ritual? As I said yesterday, it's already messy and it will get interesting.

The President's statement also suggests that simplification, as he sees it, probably would not repeal the charitable contribution deduction or the home mortgage interest deduction. This is probably his way of saying that he understands the political reality implicit in an attempt to repeal a tax break that benefits a wide cross-section of taxpayers rather than a small group. An interesting question is "what else falls into that category?" IRAs? MSAs? Education credits? The section 135 bond interest exclusion?

It also will be interesting to see what happens to the tax breaks that are not repealed. Both the charitable contribution deduction and the home mortgage interst deduction are complicated. These are not reflected in one sentence provisions that allow a deduction. They are loaded with definitions and limitations. Many of these limitations, particularly in the charitable contribution deduction area, are attempts to shut down taxpayer abuse.

See, what makes simplification a conundrum is the "I'm special" mentality of taxpayers who seek not only the enactment of special interest tax breaks but who twist and abuse provisions that people of common sense would not characterize as intended to permit what the "I'm special" person wants to do. Thwarting the "I'm special" person requires definitions, limitations, and other provisions that add to complexity. The President's expressed desire to eliminate loopholes conflicts with his expressed desire for simplicity. Of course, a balance can be struck between the two concepts, but compromises generally leave everyone unhappy and looking for the next opportunity to strike back. It would be easier if everyone behaved "appropriately," especially when dealing with matters where "appropriately" is not something over which reasonable people can differ.

Would a different type of tax make it easier to achieve simplicity while fending off the "I'm special" folks? The types of taxes and revenue generators that hold out that promise tend to lack fairness. Inserting fairness into a tax can generate complexity, not only to prevent regressivity but also to cut down the efforts of the "I'm special" people to redefine fairness as that which ratifies their specialness.

I predict a lot of discussion, a lot of noise, studies, arguments, and much fodder for the talking heads of the 24-hour news channels. Taxes involve money, and discussions about money, especially when it involves how much one pays and how much someone else is or isn't paying, can find an audience (i.e., ratings). Will the Congress find a way to get together and fix the problem? My prediction is no, it will make it more complicated. When the day is done, there will be more credits, more anti-abuse rules, more definitions, more limitations, and more phased-in, phased-out provisions. The impact of the looming financial problem (deficits, Social Security, and Medicare topping the list) will contribute to the collapse of the system.

I could be wrong. I hope I am wrong. I'd be more than happy to post a blog that says "I WAS WRONG" after the Congress cleans up the tax law. Cleaning up the tax law, by the way, isn't a matter of making existing provisions permanent. Cleaning up the tax law means this: cutting down exclusions to the point where gross income is income, eliminating all deductions other that trade or business and income-generating activity deductions, providing for an inflation-adjusted poverty level exemption, scaling tax rates on a progressive basis that applies bracket boundaries at meaningful levels ($100,000, $250,000, $1,000,000, and $10,000,000 for example), limiting credits to genuine "paid on account" credits, eliminating all filing status categories except "taxpayer," and permitting individuals to transfer "unused exemption amounts" to other taxpayers. This approach removes the need to insert "don't tax the poor" phase-out provisions in inclusion provisions and the need to insert "let's add a tax to the rich" phase-out provisions in deduction and exclusion provisions. It means determining income net of production expenses in a manenr that truly measures income, exempting those who are poor from paying an income tax, and creating a progressivity that doesn't treat people with income of $300,000 as in the same tax bracket as those with income in the millions.

I know I didn't say anything about Social Security, the taxes for which fall more heavily on the lower income groups. I'll save that for another time. That, too, needs a lot of fixing. It may require a credit mechanism for the income tax. That might be about as close to merging the two as the system will permit.

So... don't throw away any of your income tax books. Even the old ones. What goes around comes around and perhaps they will be of value in the upcoming debate.

Don't Tax My Chocolate!!!

Prof. Beau Baez of Liberty University School of Law reacted to my snack food tax posting with a collection of interesting insights and anecdotes:

The state & local tax world has been dealing with definitions in this area for years, at least in states where candy is taxed but food is exempt from the sales tax. For years New York took the prize with the marshmallow distinction. Little marshmallows are used in cooking thus they are not taxed, but large marshmallows are candy (presumably used in making smores). After years of embarrassment New York finally exempted all marshmallows from the candy tax. My new New York favorite is the Oreo cookie. The regular Oreo cookie is untaxed food while the Oreo cookie with double-stuff filling is candy.

What I have always found intriguing about these distinctions is the intellectual capital that goes into the process. I can just imagine the discussions and memos at the New York tax authorities.

To: Candy Tax Policy Group.
From: Commissioner of Revenue
Re: New Oreo Cookie with Chocolate Covering.

Please investigate the tax implications of this new product from Nabisco. While it contains a large amount of non-taxable food there may be enough taxable chocolate to deem the entire product taxable. Please promulgate regulations in the New York State Register by December.

Then of course is the general lack of administrability by the grocery stores. When testers have gone into stores in the past to verify that the correct items are being taxed it has been found that stores generally overtax customers, with no effective way of getting refunds from the state. In addition, stores have not always guessed correctly and some items have gone untaxed. The state though, on a
net basis of all items sold in a store, has come out ahead. Presumably this relieves the store from poor guesses as to the taxability of wheaties with chocolate chips. Take care.

I wonder if sampling the new chocolate-covered oreo is a prerequisite for determining its classification. If so, and if the state pays, is it a taxable fringe benefit? Working condition fringe? De minimis? Oh, by the way, the eating of little marshmallows as snacks, no cooking required, is not that uncommon. Thanks to Beau for sharing these marvelous examples of culinary taxation.

Even More Tax Relief?

Well, I couldn't find a transcript of the interview. It might not even exist. On one of the many channels I surfed late last night or early this morning, the news reporter asked a Senator (I'm sure it was a Senator, a Republican, and one who was not standing for election yesterday) what the impact would be of the possible 55-45 Republican advantage in the Senate and the presumed Republican advantage in the House.

The response included, as its second or third item (and I forget the first because I had to make room for this), the comment that it meant it would be possible to enact even more tax relief.

How?

Lowering rates? Exempting everything but wages from the income tax? Lowering the tax on capital gains to zero? Adding in hundreds of new credits for every possible economically viable activity and then some?

If the theory is that reducing taxes pumps up the economy, is there a cut-off? Or is it a matter of reducing taxes to zero so that the economy grows to infinity?

Perhaps it's a matter of tax relief for some people and tax increases for others? If that is what's being contemplated, then who is in which group?

I can't say this could get messy because tax law already is messy. It could get interesting. And nasty.

Relief?

I'm hunting for a print version of a comment I heard late last night (or early this morning) about the impact on future tax legislation of the congressional elections. I don't remember who said it, and I don't remember the exact words, but I want to get that right before I blog (unlike Exit Poll results that get issued when they are totally wrong, not that my making a mistake on the identity or exact words of the commentator would be anywhere near as adverse). Once I find it, I'll be back. Clue: the word "relief" was used if my memory is working (which it might not be as I am functioning on 3.5 hours of sleep and, yes, I did keep to my 6 am gym schedule (which is the only way to wake up and function when sleep deprived)). I also have some comments to post that were shared with me on the subject of snack food taxes.

In the meantime, speaking of relief and food, I share something that a reader sent. Seems to me that there may be a lot of people reaching for some of this today, if they haven't already:

Subject: FW: Chocolate

CHOCOLATE

Can't eat Beef, Mad cow....

Can't eat chicken . bird flu

Can't eat eggs ... Salmonella

Can't eat pork ... fears that bird flu will infect piggies

Can't eat fish ... heavy metals in the waters has poisoned their meat

Can't eat fruits and veggies ... insecticides and herbicides

Hmmmmmmmmm!!!!!!!!!!!!!

I believe that leaves Chocolate!!!!!!!!

Chocolate is a Vegetable

**

Chocolate is derived from cocoa beans.

Bean = vegetable.

**

Sugar is derived from either sugar cane or sugar BEETS.

**

Both of them are plants, in the vegetable category.

Thus, chocolate is a vegetable.

**

To go one step further, chocolate candy bars also contain milk, which is dairy. So candy bars are a health food.

**

Chocolate-covered raisins, cherries, orange slices and strawberries all count as fruit, so eat as many as you want.

**

Remember - - -

"STRESSED" spelled backward is "DESSERTS"

Taxing "Snack" or "Junk" Food

Last night having been Halloween, and almost 100 youngsters having come to my door to acquire what some of them called "the best candy in the world" (which they truly believe as they yelled it up and down the street), I decided to open November's blogging with a look at, yes, food and taxes. Oh, you can guess what is the best candy in the world (and for me, it's not what I was handing out, and no, we'll ignore the fact that I was handing out super-sized packages).

In the August 2004 edition of the Agriculture Information Bulletin No. 747-08, published by the U.S. Department of Agriculture, Fred Kuchler, Abebayehu Tegene, and J. Michael Harris, in Taxing Snack Foods: What to Expect for Diet and Tax Revenues, explore the revenue and social utility of a tax on snack or junk foods. For those interested in the limits of using government tax policy as a means of controlling behavior, or simply interested in seeing yet more proof of my quip that tax touches everything, it's a worthwhile read. It's not too long and it's full (oops) of interesting fact.

The authors don't get into the definition of "snack food" or "junk food" though they do touch upon the difference when describing some of the proposals discussed by other commentators. For example, one commentator would impose the tax on whole milk but not skim milk. No one discusses the status of chocolate. The silliness should be evident. Whole milk is a necessity for young children. Given the choice between taxing whole milk even when destined for consumption that advances rather than destroys health, or having the consumer fill out an "exempted use" certificate, junk food tax advocates would seemingly opt for the former. Chocolate, long considered to be "bad" food, now turns out to be "good" food. Someday, I know that researchers will discover the negative impact of brussel sprout consumption (after all, no cabbage should be harvested before its time).

The authors, as do some of the commentators, tend to focus in salty snack foods. Others look at the level of fat content, distinguishing between the "good" fats and the "bad" fats. The enactment of this sort of tax could make the income tax look simple. After all, tobacco is tobacco, it's bad to smoke it, and so the statutes imposing taxes on tobacco are simple in their substantive sections though complicated in their procedural and tax avoidance prevention sections.

The goal of the snack food tax is to promote a health among Americans. These particular commentators suggest that it would take a hefty tax to do that, and that a 1% tax would have no noticeable impact. That's not a surprising conclusion.

The proposals for a snack food tax raise all sorts of questions. Would there be a credit for engaging in activities that offset the bad effect of a so-called snack food? Are snack food calories burned in the gym or in doing yardwork as worthy of taxation as those that contribute to the increased gross weight of the adult population? Would there be an exception for people whose metabolisms and body chemistry make them seemingly immune to the effects of junk food, or a surtax on those who gain weight by smelling food? Isn't there something bizarre about taxing people based on genetic characteristics over which they have no control?

What's good for one person (whole milk for a 2 year old) can be bad for another person. So a tax that treats all food of a certain type as "good" or "bad" overreaches. It lacks nuance. Giving it nuance creates an unadministrable nightmare. Similarly, many of the proposals would focus not on the name or type of product but on the ingredients. One can imagine the twisting and turning in which food processors would engage to wiggle out of the tax. Statutes designed to prevent avoidance would become so complex they'd be tough to digest.

A food tax isn't the way to go. Why not?

The first question is whether tax law should be used to encourage or discourage activity. My position is no, tax law should be neutral. The idea of tax credits for those who do not murder, or tax rebates for those who inform on crime, or tax credits for those who adopt children (oops, those exist), or tax deductions for those who go to the gym is an idea that suggests too much government investigation of private lives.

It would be better for healthcare premiums to reflect lifestyle, just as life insurance premiums distinguish between smokers and non-smokers. But smoking isn't the only life-shortening activity (though I think some life insurance companies add premium surcharges for folks regularly engaged in hazardous hobbies and activities). Even assuming people were truthful about their lifestyle (diet, exercise, etc.), and even assuming it was possible to scale health insurance premiums to reflect lifestyle, the likelihood is that the higher premiums would be faced by those least able to pay. The commentators in the cited article devote some of their pages to that socio-economic indicator.

If tax advocates convince the citizenry that a tax is the only way to regulate behavior (which speaks volumes about the deficiencies of modern and post-modern eduction to instill discipline in students), then perhaps there is a better approach than taxing consumers. Rather than taxing the "user" the government could regulate the "dealer." Corporate America, which has collectivized farmland and institutionalized food production, invests much money in urging consumers to purchase foods which are not healthful. The use of Saturday morning cartoon slots for the airing of food commercials directed at youngsters is no secret. Could an environmental pollution tax be imposed on companies that generate "bad" food? What's worse, a bit of smoke from a coal burning power plant or 1 billion servings of who knows what? I don't know which is worse. Neither, however, is good.

The commentators who wrote the cited article do conclude that hundreds of millions of dollars in tax revenue could be raised by a food tax as low as 1 percent. We've been warned. Throwing that information out in front of legislators is like throwing raw meat in front of a carnivore. Legislators who find taxes to be delectable will be salivating over the prospect of taxing "junk" food, and more likely than not some exception would be inserted for "product x manufactured in processing plants located within 2 miles of rivers that are at least 15 feet deep and that do not freeze in the winter." And to cut the trade deficit, perhaps taxes on imported "junk" food would be even higher.

All of this leaves a bad taste in my mouth.

Intaxification

Huh?

There's a game/challenge where a person changes a word by adding, subtracting, or changing one letter, and then creating a definition.

Paul Caron, on his TaxProfBlog noted that someone had created intaxification and then issued a challenge. Could we do the same using tax words?

Of course I had to jump in. You can see my list on a dedicated page on Paul's blog. Reaction has been of two sorts: kudos and silence. Hopefull it's not that they say "Maule tix us off."

Being "Special" Never Ends?

The buzz over the recent legislation permitting certain, but not all, plaintiffs to deduct their attorney fees in computing adjusted gross income (thus sparing them the inequities caused by treating the deduction as an itemized deduction and as an add-back in computing the alternative minimum tax) continues unabated. The spin is enormous, so I suppose it's fitting that in this last week of the campaign we take a closer look at how people can make things appear other than as they are. What surprises me is that neither candidate has said much, if anything, about this issue. That's probably because neither one could get much mileage out of it, and would risk putting voters into such a deep sleep that they wouldn't wake up until November 4.

In an ABA Journal eReport, David Hudson describes the provision as one that will "end double taxation of attorney fees on plaintiff discrimination awards." Unfortunately, double taxation was not and is not the problem. Understandably, many people think of the problem as double taxation, but that's because they are using or thinking of the concept in a way that isn't truly double taxation.

The plaintiff sues for damages and recovers. If no exclusion applies, the damages are included in the plaintiff's gross income. The plaintiff pays his or her attorney. Because the payment is for the collection of income, it is deductible. The issue is whether it is or should be deductible as an itemized deduction or as a deduction allowed in computing adjusted gross income. The Congress has opted for the latter, in the case of certain plaintiffs, but only after October 22, 2004.

The plaintiff is taxed on the damages. The plaintiff deductions the amount paid to the attorney (though the plaintiff may end up with little or no tax benefit from the deduction). The attorney includes the fee in gross income and is taxed. Is this double taxation? Only in a very very broad interpretation of the phrase, one so broad that it would include almost all transactions (due to what economists call the multiplier effect) and thus one that proves way to much.

Consider for example, a person who mows lawns. The person charges the customer $500 for the season. The person has gross income. The person pays an employee $300 to do the mowing. The person has a deduction. The employee has $300 of gross income. This is not double taxation. Does it become double taxation if the person owning the business cannot make use of the deduction because they have other deductions in excess of gross income? No.

Even if there is no deduction for the payor, there is no double taxation as that term is conventionally used. For example, suppose the employee who earns the $300 pays a physician $50 for a quick physical. The employee does not deduct the $50 because it is a personal expense. The physician has gross income of $50. This is not double taxation (nor triple taxation when the physician in turn spends $20 on gasoline for her personal use vehicle).

Double taxation refers to the same economic entity being taxed twice. For example, if A and B form a C corporation to conduct business, and the corporation makes $100, the corporation is taxed, and then when it distributes the earnings net of tax, A and B are taxed on the same income. Even though the corporation is a separate entity, economically it is A and B who are earning the income. Triple taxation can occur if A or B contributes appreciated property to the corporation, but that discussion takes us too far afield.

According to the ABA Journal eReport, many in the employment law bar viewed the situation as one of double taxation because the attorneys also pay taxes on the fees. I wonder how many of the employment lawyers took tax and learned what double taxation is. A question asked by one such attorney, "Why should the employment discrimination plaintiff have to pay a tax on attorney fees when the lawyer receives the money and pays taxes on the very same fees?" should bring the reply, "First, the plaintiff has a deduction, which may or may not be useful, and second, if there is taxation of both the plaintiff and the attorney, there is also taxation of the lawn mowing employee, the physician, and the gasoline seller."

The point is that to describe the plight of the plaintiffs as one of "double taxation" is a reach for sympathy that goes too far. Add in the discriminatory nature of the legislative relief, and it is too much of the "my problem is the same as yours but because I'm special I get treated better" approach too often seen in postmodern culture.

The ABA Journal eReport also informs us that the legislation was advocated by the employment law bar, the ABA, and the U.S. Chamber of Commerce. I knew about NELA's involvement, but the ABA's support for the legislation was news, as was the participation of the U.S. Chamber of Commerce. NELA representatives assert that the legislation will encourage settlements, and that pitch brought the U.S. Chamber of Commerce into the fold. As for the ABA, I am informed that although the ABA joined, the Tax Section did not support the proposal because it violated the principle that the change should reduce, not increase, complexity, and that by creating additional classes of specially treated plaintiffs, it failed that test. It's good to see that the TAX attorneys had it right, even if other members of the bar (who perhaps regret not taking or paying attention during tax class) don't get it.

The attorney for the taxpayer in one of the cases pending before the Supreme Court suggests that the Court will dimiss the case because the issue does not have ongoing successful plaintiffs, thanks to the legislation. I don't agree. It has significance for all the plaintiffs who don't fall within the effective date of the legislation. It has significance for all the plaintiffs who weren't permitted to hitch a ride on this "us only" legislation. This attorney then argues that the passage of the legislation confirms the taxpayer's argument, that taxpayers not be taxed on the portion of the damages paid to the attorneys as attorney fees.

Again, I disagree. First, if that's what Congress intended, it would have included ALL plaintiffs in the legislation. It didn't. So there's an argument that Congress, by excluding the plaintiffs who don't get legislative relief, intended to DENY them the deduction and thus create support for the IRS position. Second, the legislation does not address the question of whether the attorney should be treated as having an interest in the fees before they take the form of damages, thus causing the attorney to be the "owner" of the income to the preclusion of the taxpayer. Third, the legislation does not address the question of whether it is appropriate to treat the attorney and the plaintiff as partners, such that each is taxed on a portion of the damages. Fourth, if the Supreme Court dismisses the cases, it leaves the Courts of Appeals in a three-way split on the issue as it applies to all the plaintiffs not beneficiaries of the legislative relief. Fifth, if the Supreme Court remands the cases, the legislation does nothing to assist the Courts of Appeals in resolving the case, for the legislation as much supports the IRS as it does the taxpayer, and probably is a stronger argument for the IRS than the taxpayer. It's amazing what happens when Congress messes up. Of course, we're used to it by now because it happens so often.

The ABA Journal eReport concludes with some complaints by the lobbyists for the provision that was enacted. The ABA tried to persuade Congress to exclude emotional distress damages from gross income, and the other sought income averaging for back-pay awards. Both provisions add complexity. Income averaging was repealed when tax rates were reduced to a differential far less than what existed when income averaging was part of the tax law. The folks who express disappointment and displeasure that these goodies didn't make it definitely get an A for perseverance. They promise they'll be back, trying again. Notice that it's not the tax lawyers pressing for these changes.

Note that with careful planning, the damages can be structured so that income averaging is accomplished in effect. Another topic from the tax courses that so many lawyers and law students don't like. Well, as was said by an ancient philosopher, "Know your enemy." There are ways of dealing with these issues other than getting "special relief for MY client" into the tax code.

Nonetheless, it is disappointing that segments of the ABA joined in seeking legislation that was selective in the reach of its relief. Surely it makes it a wee bit more difficult to defend accusations that lawyers cater to their special interests rather than lobbying for the common good. Not that lawyers are the only ones doing this, but they surely are putting the client focus and the dollar above the common good. Admittedly, I wonder if there's much agreement anymore on what constitutes the common good, especially in a country that is as polarized as is the United States.

Are We Making It?

Stuff, that is.

A question that businesses need to ask when their owners sit down with their tax return preparers to provide information needed to fill out federal income tax returns.

The recently enacted American Jobs Creation Act provides a deduction equal to 9% of "qualified production activities income" (or, if lesser, 9% of taxable income determined before taking into account this new deduction). So, in the tax game, one must figure out the meaning of the term "qualified production activities income." In the legislation, Congress gives us a definition, which I will paraphrase in somewhat comprehensible English rather than quoting from the statute. Take "domestic production gross receipts" and subtract the sum of the cost of goods sold to generate those receipts, other deductions, expenses, and losses directly allocable to those receipts, plus a ratable portion of all other deductions, expenses, and losses.

So, now in the tax game, we must figure out the meaning of "domestic production gross receipts." Those are defined as gross receipts derived from any lease, rental, license, sale, exchange, or other disposition of what I will call qualified products, plus gross receipts derived from construction performed in the United States, plus gross receipts dervied from engineering or architectural services performed in the United States for construction projects in the United States. Qualified products consist of "qualifying production property which was manufactured, grown, or extracted by the taxpayer in whole or in significant part within the United States, any qualified film produced by the taxpayer, and electricity, natural gas, or potable water produced by the taxpayer in the United States."

One can see that what they're getting at is simply a matter of rewarding, with a tax deduction, United States production and certain related services. The popular press calls this the deduction for domestic manufacturing. That term is a bit misleading.

The legislation excludes "the sale of food and beverages prepared by the taxpayer at a retail establishment" and also excludes "transmission" of electricity, natural gas, or potable water. Why? Well, transmission isn't production. But cooking and preparing food is, but for some reason Congress decided that taxpayers engaged in retail food production aren't as deserving of tax relief as are the taxpayers whose factories are processing the food. More on that in a moment.

The legislation defines "qualifying production property" as tangible personal property, computer software, and certain sound recordings. Unlike the other property, which must be produced in the United States, a qualified film is film for which at least 50% of the compensation relating to its production is for services performed in the United States by actors, production personnel, directors, and producers. So producing part of a product in Canada disqualifies the taxpayer for this deduction, unless the product is a film. Film, for some reason, is special. Why?

The other day Senators Grassley and Baucus announced that the legislation was not intended to provide a deduction for companies, like Starbucks, that brew coffee. According to this bipartisan explanation, the legislation "does not treat coffee brewing as manufacturing" because of the exclusion of food and beverage preparation gross receipts from the definition of "domestic production gross receipts." They point out that roasting coffee beans DOES qualify for the deduction.

I don't drink coffee. I dislike its taste so much that I won't even eat coffee flavored chocolate. Understand that for me to shrink from something chocolate means something very bad has happened to it. Weirdly, I like the smell of coffee. Perhaps it's the similarity to politics: like the soundbite? Wait til you find out the true flavor of the politician.....

Anyhow, not only do I not drink coffee, I don't pay much attention to the ins and outs of its production and brewing. According to this report, the distinction between roasting and brewing will benefit Starbucks and other coffee vendors, and was the result of lobbying by a former chief counsel of the Senate Finance Committee. The statement by Grassley and Baucus was in response to quotes in the linked report that claim bean roasting and brewing are the same, and qualify as manufacturing, because they both transform a product. That's true, just as cooking raw meat transforms it into an edible steak or whatever, but Congress decided NOT to extend the deduction incentive to food preparation jobs. How is it that bean roasting isn't precluded by the exception? Simple. It's not done at the retail establishment. Thus, amounts paid by a fast food chain for preparation of frozen potato slices at the factory will qualify, but amounts paid to the store employee to fry the slices will not. No pun intended, but there's some really fine lines being sliced here.

Now the fun begins. There is an incentive for a company that manufactures and sells processed foods and beverages to increase the charge made by its factory to its stores, so as to increase the amount of factory gross receipts and thus increase the deduction. There exists in the tax law a provision that permits the IRS to adjust these charges, but it's unclear if that provision applies if the factory and retail outfits are all part of one legal entity. No matter, the point is, there's more complexity on account of this provision. The complexity is what I (and others) call "compliance complexity," that is, an increase in the amount of record keeping and computations needed to figure out the amounts that enter into computation of the deduction.

Some taxpayers will be familiar with the issue of identifying "what is manufacturing," to borrow the technically incorrect term as used in the popular press. That's because some states have exceptions in their tax law for manufacturing activities. Some states provide tax credits for manufacturing activities. So there are taxpayers, tax advisors and state tax officials who have grappled with the question. The problem is that the definition of manufacturing varies from state to state, and thus despite the existence of an "experience base" on which taxpayers and their advisors can draw, there is a further complexity because of the multitude of taxing jurisdictions each with a different definition to apply.

I wonder if taxpayers will be so busy keeping track of what they're making that they'll run out of time to do the making. Perhaps the hidden agenda is to create more jobs for accountants and tax practitioners, as they're the ones who will need to deal with this mess. Yet there is a shortage of accountants and tax practitioners, and surely a shortage of trained and experienced accountants and tax practitioners, for the schools don't issue unto the world hordes of graduates ready to step in and do what needs to be done. They need training, but most employers don't want to, and cannot afford, to do the training. Is there some way to treat the education of a student as manufacturing, considering that education is a process that transforms the brain (just as roasting transforms a coffee bean)?

Interestingly, despite the shortage of nurses and the value to the economy and the American lifestyle of most service providers, Congress saw fit not to allow a deduction for gross receipts from providing services. Perhaps Congress is on the cutting edge of the swing back of the pendulum, as a service economy is encouraged to become once again a manufacturing economy. What will we make? Robots, of course. Robots to perform services. And robots to create other robots. Then all that will be left are those who cannot be replaced by robots.

Who's that?

Easy. Tax bloggers. Ha ha.

Is It Any Wonder?

Readers know that neither major party presidential candidate impresses me when it comes to taxes and tax policy. Though it is almost too easy to guess at why the incumbent doesn't get it, it had been troubling that a challenger eager to discredit the incumbent's policies wasn't reaching back and throwing his best stuff. A recent report on the Senator's facile agility with numbers suggests that tax law isn't easily grasped by anyone running for office. With an exception, perhaps, for Senator Byron L. Dorgan. He was Tax Commissioner of North Dakota from 1969 through 1980. I know nothing about his baseball score reporting abilities.

Too Much Sarcasm, If Any?

My recent post concerning John Kerry's to the recent tax legislation contained a statement that could be interpreted in ways not intended. So here's an attempt to clarify.

I stated, "The spokesman [for Kerry] (or perhaps the person for whom he speaks) levels promises of obliteration against "unwarranted international tax breaks" but refrains from promising similar treatment to unwarranted domestic tax breaks, which far outnumber the handful, if any, of international tax breaks in the bill." The "if any" modifier struck one reader as amazing. He explained that there are some "really, really bad" international provisions in the legislation, and I'm not about to disagree. Another reader joined in by describing the "if any" as puzzling, and he shared the conclusion that most of the international provision are terrible policy, and have a revenue cost far more than what has been asserted.

My original comment was part of a larger question for John Kerry: why criticize bad international tax provisions while keeping quiet about the bad domestic provisions? One of the readers noted that Kerry hasn't paid much attention to domestic corporate tax reform, whereas he has shown much interest in changing international tax rules. The provisions to which Kerry hasn't addressed himself (e.g., lower rates on dividends and capital gains) don't seem to be getting any attention at all.

Here's my attempt at clarification, which might just go to show that my sarcastic style can at times be too effective at the literal level: The "if any" is a backhanded challenge to the person making the allegation [about the tax bill having bad international tax provisions in it]. Simply stating that there are unwarranted provisions is stating a conclusion. I made the same assertion with respect to domestic provisions and I gave examples. Did I list all of them? No. I would expect that there would be something in the way of an explanation. I appreciate readers stepping in to do someone else's job. So my "if any" can be seen as sarcastic.
So be it. (Note I didn't say, "Oh, there are none." and that wasn't what I was trying to imply.) Perhaps it is silly to be socratic with politicians and their spokespersons?

The Value of a Job

The National Association of Colleges and Employers has released the results of the salary survey it conducted in teh summer of 2003. Here's a sampling:

Chemical engineering - $51,853
Electrical engineering - $49,946
Computer science - $47,419
Accounting - $40,546
Information sciences - $39,718
Marketing - $34,628
History - $32,108
English - $30,157
Psychology - $27,454

I'll let readers draw their own conclusions.

The Never-Ending Quest?

A reader sent me this (which I post somewhat belatedly):

Your latest blog reminded me of a Jefferson quote: "I think it an object of great importance... to simplify our system of finance and bring it within the comprehension of every member of Congress." --Thomas Jefferson to Albert Gallatin, 1802. ME 10:306

Wouldn't it have been better had Jefferson seen to it that his idea was memorialized in the Constitution? Wouldn't it be fun seeking to toss out tax litigation on the grounds that a member of Congress couldn't understand it? It would take only one. That's not difficult. Cross-examination would be a delight.

Jefferson said nothing about the President being required to understand a tax act. Too bad. Franklin Roosevelt seemingly did his own tax returns. Nothing is so honorable as subjecting one's self to the same obligations as one tries to subject one's fellow citizens.

More on Tax (Act) Names

In a recent post about the need for tax authorities to approve children's names in Sweden, I mentioned some of the names that had been give by tax "authorities" (or at least tax drafters) to tax acts. I've since been reminded of some bits of trivia that are worth mentioning in connection with the names of tax acts:

The Technical Amendments Act of 1958 contained substantive tax law changes, including the enactment of Subchapter. I should add that it is not unusual for an amendment buried in a "technical corrections" portion of a tax act to contain changes that are far more than technical.

The Tax Reform Act of 1969 was the first major tax act to be called something other than the "Revenue Act of 19xx." And now, in recognition of the person who reminded me of this, take a moment to read Mark Cochran's epic poem on that act (25 St. Mary's Law J. 355 (1993)). Proof that tax people can be artistic. I refrain from diverting into a "tax poetry" discussion. At least not now. Perhaps later.

And if tidbits of trivia about tax act names are going to get full attention, I must repeat the complaint I first made 25 years ago: There have been several tax acts with "simplification" in the title.... and ha ha simplify they did not.

And my favorite: The name of at least one tax act has included the phrase "tax reduction", but the legislation in fact raised taxes.

Blue Screen of Death on the Road?

According to a report written by By Declan McCullagh for CNET News.com, Microsoft is putting serious effort into making its "Windows Automotive" the software used in tomorrow's automobiles. It would control almost everything, including mapping out directions, finding the closest fuel station, making phone calls that the driver wishes to make, and overseeing radio and other entertainment systems.

Microsoft is making this move principally for economic reasons. It has not grown during the past few years, its stock price hasn't changed much, and the market for personal computers is filling quickly.

Though Windows Automotive is based on Windows CE and not Windows 9x, NT, and XP, I cannot help but wonder whether another success by Microsoft in its marketing focus will bring yet another mess in its product performance. Could Windows Automotive be the operating system that finally brings literal meaning to "blue screen of death?"

Declan reports that the Windows Automotive system will not be connected to the brake system. Whew! That's a relief.

More Discussion of the Limited Attorney Fee Deduction

Ronald B. Schwartz, an attorney with the firm of Hedberg, Tobin, Flaherty & Whalen, P.C. in Chicago, shared his thoughts about my criticism of Congress' failure to provide to all plaintiffs the same special attorney fee deduction that it provided to plaintiffs in civil rights lawsuits. (See Save a Few, Let the Rest Drown.) He has graciously consented to let me post our dialogue.

Ron begins:

Dear Prof. Maule,

I believe your analysis of sec. 703 of the Job Creation Act of 2004 is missing some key points. First, "unlawful discrimination," as used in sec. 703 is defined very broadly. See http://www.workplacelawyer.com/CRTRA_HR4520Provision.pdf Sec. 703 certainly applies to legal claims other than employment law claims. It is defined so broadly that I am not ready to concede that defamation claims are not covered. I consider the right to be free of defamatory comments a civil right. See page 346, lines 14-18.

Second, after the August 1996 amendments to the Internal Revenue Code, personal injury recoveries continue to be non-taxable, which means that attorney's fees are not taxable to the client in personal injury cases. Consequently, Sec. 703 has nothing to do with personal injury trial lawyers.

Third, Rep. Pryce (Rep.) has sponsored the Civil Rights Tax Relief Act on behalf of NELA for four or five years. In addition to eliminating double taxation of attorney's fees, that bill would have once again made emotional anguish in non-physical injury cases non-taxable. In addition, that bill would have allowed income averaging because recoveries typically include back pay for two or more years.

Fourth, Sen Grassley (Rep.) recognized early on the inequities of double taxation. Also, Sen. Grassley is a champion of the False Claim Act. Double taxation of attorney's fees had a huge impact on relator recoveries in qui tam cases. Sen. Grassley was on the Conference Committee for the Jobs Creation Act. The House version of the bill did not have CRTR. Grassley insisted that CRTR be part of the final bill. The only part of the Senate version which did not survive the Conference Comm. was that the Senate version was retroactive to 1/1/2003. The final bill has no retroactivity for sec. 703.

Many lawyers from NELA and Taxpayers Against Fraud worked tirelessly to end double taxation of attorney's fees. Their efforts, including those of Sen. Grassley and Rep. Pryce, should be celebrated.

My reply:

Dear Ron,

I think that underlying your argument is the premise that everyone benefits from this legislation, so let's be happy. I do not agree with the premise.

First, the definition of civil rights case is spelled out in a very long, statute-specific provision that leaves no room to bring a common law tort within its ambit. Defamation has never been considered a "civil right" for purposes of the statutes, cases, marches, movements, and civil rights legislation that has been enacted. In fact, if defamation is covered, there's not much in the way of compensatory damages not covered. If that is the intent of Congress, apply the provision to ALL taxable damages, not just a select list.

Second, punitive damages in personal injury cases are taxable. Thus, the problem exists with respect to the attorney fees related to them. Of course, the sympathies are not as strong, because cutting back on net punitive damages isn't as brutal as cutting back on net compensatory damages. Punitive damages have a windfall quality whereas compensatory damages may be needed to reimburse expenses necessitated by the tort.

The bottom line question remains, "What's so special about civil rights litigants and workplace plaintiffs that isn't so special about other plaintiffs? In other words, why not provide relief to everyone?" The answer so far seems to be, "Those with good lobbyists get better protection of the laws than those without lobbyists (who may end up with no protection)." I know squeaky wheels get grease, but good civic prevention dictates that all wheels be greased before they get squeaky, for then it's sometimes too late.

I'd like to quote your comments, in full, if you agree, along with my thoughts. Attribution anonymous or identified, as you wish. If you don't wish to be quoted, I will paraphrase your arguments, because I think your view adds to the database on which the debate proceeds.

Thanks for writing,

Ron's reply to my reply:

>>>Dear Prof. Maule,

When you write "what's so special" about employment and civil rights recoveries, I can't tell whether you favor no income tax on any personal recoveries or to only exempt actual damages for P.I. Regarding punitive damages, of course you are correct that they are taxable in P.I. cases, as well as in all other civil cases. However, in allocating damages in a settlement, lawyers for plaintiffs will do their best to minimize the allocation of punitives to reduce income taxes for their clients.

To answer your question: First, employment is pervasive in our society. Second, the August 1996 tax code amendments set the stage for employment laws and civil rights laws not being enforced because of the tax consequences. Prof. Richard Epstein at the U of C law school may have seen that consequence as a good thing.
(Forbidden Grounds: The Case Against Employment Discrimination Laws). I disagree.

You have my permission to quote my comments in full on your blog, for attribution to me.

I clarified my previous reply:

Dear Ron,

I wasn't addressing the question of whether (or which) damages should be taxed. In the long run, taxing damages that presently are untaxed would probably cause an increase in damage awards, as juries would take the taxation into account.

I was addressing the question of how attorney fees should be treated, which is what the legislation addresses. (The other proposals, dealing with inclusion of damages in gross income, did not "survive" into the legislation).

My position is that attorney fees paid by the plaintiff, whether fixed fee or contingent, should be deductible in computing adjusted gross income. This solves the problems caused by the 2% floor on miscellaneous itemized deductions, the 3% phaseout of itemized deductions, and the alternative minimum tax effect.

The legislation solves these problems for certain awards but not all awards. Even if you persuade the IRS that attorney fees in defamation cases are within the legislation (though I doubt you do but if you do succeed would be a better result than if you fail), it doesn't change the fact that Congress could have and should have simply made attorney fees in ALL damages cases deductible in computing adjusted gross income if the damages are included in gross income.

Many of us continue to wait, in hope that someone involved in the drafting and decision making with respect to this provision will explain why Congress and its staff did not step forward and provide relief to those taxpayers who don't happen to have lobbyists working for them on Capitol Hill. After all, a democracy in which only the folks with money can get things done is not so much a democracy but an oligarchy of the monied. Public officials should do what is right, and not simply that which is brought to their attention by lobbyists.